Deciphering The Effect Of New Valuation Rules On Slump Sale

Prior to the amendment made by the Finance Act of 2021, the entire amount of consideration was construed as the actual consideration received or accumulated on account of the transfer of the division or enterprise, as the case may be, in the case of a slump sale.

At the time of enactment, the Finance Act of 2021 made an amendment to the above provision, and the amended section 50B(2)(ii) now states that the Fair Market Value (FMV) of capital assets as of the date of transfer shall be deemed to be the "full value of the consideration" received or accruing as a result of the transfer of such capital asset. The amendment further stated that the fair market value of capital assets must be calculated "in the prescribed way." It's worth noting that the change takes effect retrospectively, starting on April 1, 2020, for the tax year 2020-21.

Effect of Compliance:

To comply with the new criteria for calculating fair market value of capital assets in slump sales, businesses would have to reassess their tax liabilities and maybe restructure mergers & acquisitions.

According to the new guidelines, transactions in which business entities are transferred at book value rather than market value within or outside of a group are likely to result in a larger tax burden depending on the fair market value of the assets. It will have an impact on group restructuring transactions in which business undertakings were previously transferred for a book value regardless of the fair market value of underlying assets, particularly immovable properties, since such transactions may now be subject to higher tax liabilities.

Since the rules take effect on April 1, 2020, they will apply to both ongoing and completed transactions in financial year 2021. According to Mr. Amit Maheshwari, Partner at AKM global, "in some circumstances where the transaction has already been carried out, the entities will need to reassess if the consideration is in conformity with these regulations."

Even if the actual consideration received is lower, the slum sale amendment rules notified recently by the Central Board of Direct Taxes provide for using the higher of the fair value of the business transferred or the fair value of the consideration received as the deemed consideration for computing capital gains on slump sale or exchange.

Except in specific cases where it could be the listed price such as shares, securities, fair market value as per valuation report for jewellery or artistic work, the fair value of assets transferred is defined to mean book value.

The fair value of consideration received is defined as fair market value as per valuation report except that in case of immovable property received for which this stamp duty value has to be taken.

According to some experts, the computation process under the newly issued guidelines could lead to litigation since a slump sale uses the total worth of the items being transferred as the consideration instead of looking at individual assets.

This could open a pandora's box when assessing whether the transaction is a slump sale or an item-by-item sale, such as when purchasing assets through business transfer agreements.

The rule essentially provides that all assets of the business undertaking other than 5 specific categories of assets that are immovable property, jewellery, shares, securities and artistic work will be valued essentially based on book value. On the other hand, fair market value of these 5 categories will be determined as per the existing valuation rules, assuming these assets are being transferred individually.

In terms of the anticipated slump sale/exchange arrangements, the foregoing amendment to section 50B(2) is expected to have a far-reaching impact. The aforementioned deeming fiction was established largely as an anti-abuse mechanism to fill in the gaps in the previous rules. If the FMV of the capital assets is greater than the actual consideration received or accrued as a result of the slump sale, the seller will face additional taxation.

In the future, taxpayers should carefully consider the implications of FMV computations using the authorised methodology before engaging in any slump sale transaction. In order to make a business choice about attaining higher tax efficiency, a comparative pros and cons study of completing the transaction as a 'slump sale' vs a 'itemised sale' would be required.