India: Central Board Of Direct Taxes (CBDT) Notifies Rules For Computing FMV For A ‘Slump Sale'

Amongst the various modes of restructuring through which a business can be transferred, 'Slump Sale' has been one of the most popular methods, especially when the restructuring was within the group.Slump sale provides the requisite flexibility as it enables the transfer of a business on a going concern basis by simply executing a business transfer agreement between the parties. It has been finding favor even from a tax perspective too, as there have been no minimum valuation rules to determine the value of consideration for such transactions. Thus, the price for transfer could be determined by the parties mutually (except where transfer pricing provisions apply, the scope of which has been drastically reduced in the context of domestic transactions).
 
Having said that, taxation of a Slump sale has been a matter of litigation whereby the tax authorities have been attempting the replacement of sale consideration by deeming the fair valuation as consideration and also business transfers involving non-monetary modes of discharge of consideration (commonly termed as 'Slump exchange'). However, the overall judicial position has been in favor of the taxpayers on both these issues.
 
Changes by Budget 2021
However, such transactions will now have to be evaluated in greater detail for their tax implications in view of the amendments brought by the Finance Act, 2021, which overturns this position:

• Definition of 'Slump Sale' widened to mean a transfer of one or more undertaking by any means, thus covering all kinds of transfers including exchange, relinquishment, etc.
• Fair Market Value (FMV) of capital assets to be computed in a prescribed manner and shall be replaced as 'sale consideration.'  

 
Current notification prescribing valuation methodology
The mechanism for determination of the FMV has now been notified in Rule 11UAE vide Notification No.68/2021¹ dated 24 May 2021.   As per the Rule, the FMV of capital assets for the purpose of slump sale the FMV of the capital assets shall be higher of:

• FMV1 - FMV of the capital assets transferred by way of Slump sale on the date of Slump sale; or
• FMV2  - FMV of the consideration received or accruing as a result of a transfer by way of Slump sale

Determination of FMV1
Formula for determination of FMV1 = A + B + C + D - L,  where,
A = book value of all the assets (other than jewellery, artistic work, shares, securities and immovable property) as appearing in the books of accounts of the undertaking or the division transferred by way of slump sale as reduced by the following amount, which relates to such undertaking or the division -  

1. any amount of income tax paid, if any, less the amount of income tax refund claimed, if any; and
2. any amount shown as asset, including the unamortised amount of deferred expenditure, which does not represent the value of any asset;

B  = Open market value of jewellery and artistic work on the basis of the valuation report of a registered valuer
C  = FMV of shares and securities as determined as per rule 11UA (1) on the date of slump sale;
D  = stamp duty value of the immovable property;
L  = book value of liabilities as appearing in the books of accounts of the undertaking or the division transferred by way of slump sale, but not including the following amounts which relate to such undertaking or division, namely: —

1. the paid-up capital in respect of equity shares;
2. the amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared before the date of transfer at a general body meeting of the company;
3. reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation;
4. any amount representing provision for taxation, other than the amount of income tax paid, if any, less the amount of income tax claimed as refund, if any, to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto;
5. any amount representing provisions made for meeting liabilities, other than ascertained liabilities;
6. any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares.

Determination of FMV2
Formula for determination of FMV2 = E + F + G + H, where,
E = value of the monetary consideration received or accruing as a result of the transfer;
F  = FMV of non-monetary consideration received or accruing as a result of the transfer represented by property referred to in rule 11UA(1) determined as per rule 11UA(1) for the property;
G = Open market value of the non-monetary consideration received or accruing as a result of the transfer represented by property, other than immovable property basis of the valuation report of a  registered valuer
H  = stamp duty value of the immovable property in case the non-monetary consideration received or accruing as a result of the transfer is represented by the immovable property  

Our Comments

To put it simply, the formula for the determination of FMV1 is based on the Net Asset Valuation (NAV) method. In a case where the undertaking transferred includes purely operational assets related to the business without any assets/investments in immovable property, shares, securities, jewelry and artistic work, the NAV shall as per the values recorded in the financials (requiring no major adjustments).

However, in a case where the assets of the undertaking include any of the above-referred assets, or where the consideration is paid in kind, the book value of such assets needs to be replaced by their respective fair valuations as per the method prescribed for such assets in the Rules. This requirement can result in inflation of the value of sale consideration substantially where the underlying valuations of such assets are high. This may call for mandatory discharge of tax liability despite no consideration being paid/agreed for the same. Considering these aspects, the amendment looks harsh for cases involving group restructuring for the ease of business without any actual divestment or monetization of assets.  Similarly, cases of distressed sale/those involving genuine disputes on valuations are likely to be affected.

While the amendment was introduced in March 2021 in the Finance Bill, the above amendment is effective from 1 April 2020. Thus, any Slump sale transactions undertaken during the intervening period would also fall within its ambit. Accordingly, one may need to evaluate the impact of the said amendment on the intervening period transactions and revisit their tax positions.

In a case where the above results in any additional tax liability, it raises a question arises whether such additional tax will be subjected to interest for a shortfall in payment of advance tax. It is expected that the CBDT should relax the provisions for such interest as taxpayers' performance was impossible in the absence of a mechanism in this regard.

Footnote

1. https://www.incometaxindia.gov.in/communications/notification/notification_68_2021.pdf