This article is written by Anupam Bhaduri pursuing a Diploma in Mergers and Acquisitions, Institutional Finance and Investment Laws (PE and VC Transactions) from LawSikho.

Introduction

The taxation regime of a country plays an important role in deciding the M&A landscape of that country. This was most notably observed when Japan became a global leader in a short span of two years. Among other factors, the amendments introduced to the taxation schemes played a monumental role in shaping up Japan as the world leader. 

The Finance Bill, 2021 passed by both houses of the Parliament has made some serious changes in the tax regime surrounding the Indian M&A landscape. This article exhaustively deals with the changes that are proposed to come into effect hereon. 

Developments proposed by the Finance Bill, 2021

The Finance Bill, 2021, as proposed by the Lok Sabha introduces direct and indirect taxes and regulatory changes in the budget. 

Key changes

• Goodwill shall no longer be considered as a depreciable asset and companies cannot make further claims for tax depreciation even against goodwill that have been purchased. The Bill states that any amount that has been paid in lieu of the goodwill can be reflected as the cost of acquisition. However, any depreciation that has been obtained in the past years shall be deducted from the cost of acquisition.
• To date, slump sale was considered non-taxable based on judicial precedents. However, they have now been incorporated under taxable schemes as well.
• The Board of Advance Rulings shall replace the Authority of Advance Rulings. The Authority of Advance Rulings was set up to ascertain the income tax liability of non-residents avoiding expenses incurred due to long-drawn litigation. 
• Faceless appeals shall also be allowed to ICAT.
• Earlier, the reopening of tax assessments had a limit of 4-6 years. The new Finance Bill reduces this to 3 years. 
• The double taxation avoidance agreements specify provisions in relation to benefit of lower taxes. This has now been extended to foreign institutional investors subject to the condition that other requirements laid down are met. 
• Special purpose vehicles made dividend payments to are exempted from tax withholding. The dividend payments however have to be made to real estate investment trusts and infrastructure investment trusts. 

Regulatory updates

• Any foreign investment made in India whether directly or indirectly by countries that share a border with India will require to have government approval for the same.
• FDI limit in the insurance sector has been increased from 49 to 74% (subject to meeting certain conditions).

Corporate tax rates

With reference to domestic trades made in India, the taxation rates are stipulated at 30% with an incurable surcharge of a maximum of 12%. A further cess of 4% can be levied bringing the effective tax rate to 34.94%. However, the domestic companies with a turnover of less than INR 4 billion are provided with a concessionary tax rate of 29.12%. However, there are scenarios when the tax computed on the book of profits is deemed lower than the normal tax computations. In such cases, the rate of taxation is determined as the minimum alternative tax, and 21.55% is charged on the book of profits. This Finance Bill aims to reduce the minimum alternative tax rate to 17.47%. 

The tax rates for domestic companies are also being brought down to 25.17%. This concessional rate is optional and can be availed from FY 19-20 only if the company is willing to let go of exemptions due to holidays and other tax benefits granted. Also, new manufacturing companies will have a concessional rate of 17.16 percent and shall be exempted from MAT. 

Detailed analysis of changes made

Goodwill

In order to ascertain the impact of the depreciation due to acquiring goodwill being removed, it is important we understand how goodwill is valued. Primarily, goodwill comes into existence when the total consideration paid for an acquisition is higher than the fair value of the assets acquired. Goodwill arises mostly in cases of slump sales. Up until now, the tax laws in India allowed a depreciation against intangible assets like patents, copyrights, business rights, and licenses to name a few. The past judicial precedents thus held that companies would be allowed to claim a depreciation allowance on the goodwill for the overvaluation of assets. 

The Finance Bill, 2021 introduced the following amendments in the Income Tax Act:

• Section 2(11) which defines a block of assets shall henceforth exclude goodwill of any business or profession from the definition.
• Section 32(1) has been amended to exclude the depreciation that was allowed on goodwill. Explanation 3 of the aforementioned Section 32(1) will no longer treat goodwill as an intangible asset. 
• Section 50 shall witness the introduction of a new proviso where the CBDT shall lay out a procedure to compute the written down value of the block of assets and any short-term capital gain arising from the same if goodwill was claimed as a ground for depreciation previously. 
• The Finance Bill further clarifies, through the amendments in Section 43(6)(c)that the WDV shall be reduced by the determined cost of the goodwill. This shall be achieved through:

1. Depreciation allowed on the goodwill before the assessment year 1988-89. 
2. The depreciation value attached to the goodwill after the assessment year 1988-89 as if it were the only asset in the block of assets.

However, it is important to note that in such situations, depreciation claimed against the goodwill and the subsequent reduction determined itself cannot surpass the written down value of the asset block.

Slump Sale taxation amendments

To date, various courts opined that a sale consisting of a lump sum exchange of consideration without the individual valuation of assets is the sole criterion for the deal to be ascertained as a slump sale. The Finance Bill, 2021 proposes to amend Section 2(42)(c) to include all forms of transfer stipulated under the provisions of Section 2(47) to be included under the ambit of slump sale.

The amendment of Section 50B(2) now adds a mechanism to compute the fair market value of the capital assets on the date of transfer. This FMV shall be considered as the full value of the consideration that is to be taxed.

The language of the amendment and the repercussion of the same is a lot like the GAAR provisions that were introduced earlier in 2017. With this amendment in place, capital gains calculated for the seller under Section 50(B) shall be done on the determined FMV on the date of transfer, irrespective of the actual consideration received. 

From the buyer’s perspective, the capital gains shall be taxed on the amount paid. If consideration paid is less than the FMV, it shall be treated as a capital reserve and this shall not be taxable under either Section 56(2)(x) or Section 50(B). However, if the buyer has paid more than the fair market value as consideration, the excess amount shall be deemed to be goodwill. No depreciation can be availed on the goodwill as per the new amendment and the goodwill, in this case, shall be written under the bracket of capital assets. The capital gains from this would only arise at the instance of subsequent transfer. 

Recomputation of last year’s book of profits 

The Finance Bill, 2021 has introduced a new subsection (2D) to the already existing Section 115JB. This comes as a means to provide some relief to the taxpayers who have been affected by the Advance Pricing Agreement. The new amendment brings into force the procedure where the Assessing Officer shall be recomputing the book of profits of past years if an increase in income of the assessee is noticed due to APA. However, certain restrictions have been imposed. They are:

• No recomputing shall be made available if the assessee has already used up their MAT credit.
• The assessment for recomputing shall be made through an application and such request shall be entertained only if the past years are beginning on or before the 2020-2021 assessment year. Furthermore, no claim for interests on the refund on account of a reduction in the amount of tax payable shall be entertained.

Stamp duty exemptions to restructuring 

The biggest boost to M&A deals comes in the form of addressing restructuring of public sector companies as tax neutral. The amendment also stipulates that restructuring shall now be considered as a demerger under the provisions of Section 2(19AA) of the Indian Stamps Act, 1899. 

No stamp duty shall be levied under the provisions of this Act subject to the fulfillment of the following conditions. 

• A transfer of business and or right in immovable property is made.
• The transfer here must be made by a Government company or its subsidiaries, to another government company, whether owned by Central or State.
• The restructuring of the companies allowed shall be any scheme of arrangement along with demergers, disinvestment, or strategic sale. 
• Further, stamp duties shall be exempted in case of the Government company going through a winding-up, striking off, closing, liquidation, or shut down.

Conclusion

The Finance Bill, 2021 brings in a plethora of changes in income tax computations and determining stamp duty. In the truest sense of the term, the amendments made will garner mixed reactions. Speaking of the government companies alone, the individual companies will derive massive benefits from the changes made in the Indian Stamp Act. However, for the private sector, there will be discontentment over the removal of tax depreciation being removed goodwill and the effect being retrospective. Further, the ire over the taxation regimen to be implemented over slump sales will further make the Indian demographic conscious of M&A deals. While the Indian economy is trying to recover from the bane of COVID-19 by implementing a linear taxation scheme, smaller to medium size companies shall find some respite through the concessional taxation rates and the APA redressal. Also, it must also be noted that an effort to boost FDI in the insurance sector could further open gates for new opportunities. Encouraging FDI is the need of the hour and the Finance Bill delivers on that front. 

References

1. https://www.indiabudget.gov.in/doc/Finance_Bill.pdf.
2. https://economictimes.indiatimes.com/news/economy/policy/tax-benefit-on-mergers-and-acquisitions-withdrawn/articleshow/80629225.cms?from=mdr.
3. https://dhruvaadvisors.com/files/M&AinIndia_TaxPerspective.pdf.
4. https://www.taxmann.com/post/blog/5742/taxmanns-analysis-of-changes-made-in-the-finance-bill-2021-as-passed-by-the-lok-sabha/#exemption-to-be-available-to-non-resident-investors-and-category-III-aif-sSection-10-23FF.
5. https://home.kpmg/xx/en/home/insights/2021/03/india-taxation-of-cross-border-mergers-and-acquisitions.html.

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