No one would like to go back in time to a period that had economic challenges. The positive actions of the Government of India amidst the pandemic, such as the launch of three AtmaNirbhar Bharat packages, COVID-19 vaccination drives, amongst others, have rejuvenated the Indian economy. This has given many new hope for a better tomorrow in the digital economy, which is now the new normal.

The first paperless budget, Budget 2021, addressed many changes in the direct tax and regulatory regime, such as

  • exempting senior citizens from filing income-tax returns,
  • reducing the timeline for reopening of assessment to three years from six years,
  • introducing faceless assessment before tax tribunals,
  • increasing the threshold for the applicability of tax audit for taxpayers who carry out 95% of their transactions digitally,
  • rationalisation of single Securities Market Code,
  • increasing the foreign direct investment limits for the insurance sector, and many more.

In addition, Budget 2021 has proposed significant changes in the tax laws governing taxpayers undertaking restructuring and deals, as follows:

1. Depreciation on goodwill – No more a reality

Mergers and acquisitions between the parties bring many synergies to the table. One such tax synergy is the availability of tax depreciation on goodwill arising pursuant to merger and acquisition.

The Income-tax Act, 1961 (Act) defines intangible assets to include know-how, patents, copyrights, trademarks, licences, franchises or any other business of commercial rights of similar nature. As the definition of intangibles does not specifically mention the goodwill of a business or profession, the claim of depreciation on goodwill has been a matter of debate. The Supreme Court’s ruling in the case of Smifs Securities Limited,[1] held that the goodwill of a business is an asset eligible for depreciation under section 32 of the Act.

The Finance Bill, 2021, proposes to exclude ‘Goodwill of a business or profession’ from the definition of ‘block of assets’ and from the list of assets eligible for depreciation. The Finance Bill also proposes that in a case where the goodwill of a business/ profession forms a part of the block of assets for prior assessment years, and the taxpayer has claimed depreciation, the written down value and short-term capital gain will be determined in the manner prescribed. It is proposed that the cost of acquisition for goodwill shall be the purchase price in the case of acquisition, and in cases referred to in section 49 (1) (i) to (iv) of the Act, it shall be the cost to the previous owner (reduced by the depreciation already claimed by the taxpayer in prior assessment years), and in any other case, it shall be nil.

Given the above, it shall be of utmost importance for taxpayers undertaking restructuring/ acquisitions to re-evaluate the effective tax cost for the company, because of the proposed amendment relating to depreciation on goodwill, which the Supreme Court has favourably allowed in the past.

2. Caught out – slump exchange now a taxable transfer

Slump sale is a popular and quick mode of structuring/ deal activity, whereby, a business undertaking is transferred as a going concern for a lump sum monetary consideration without assigning values to individual assets and liabilities. In contrast, a slump exchange means the transfer of business in exchange of assets other than by cash.

While the income-tax provisions in India provide for a specific mechanism to levy capital gain tax on slump sale transactions, the taxability of ‘slump exchange’ has been a vexed issue and the High Court[2] has held the slump exchange to be non-taxable. The Finance Bill, 2021, has now proposed to expand the scope of the term ‘slump sale’ to mean the transfer of one or more undertakings, ‘by any means’. Hence, this increases the scope for the levy of tax on slump sale over slump exchanges also.

3. Reconstitution/ dissolution of partnership firm/ association of person (AOP) now taxable

The Finance Bill, 2021, now proposes to amend the existing sub-section and insert a new sub-section under section 45 of Act, where a partner/ member of the firm/ AOP receives any capital asset or money or other asset at the time of dissolution or reconstitution, which exceeds the balance in their capital account firm/ AOP at the time of dissolution or reconstitution shall be taxable. The fair market value of such capital asset/ other asset/ money transferred on the date of receipt by the partner less the balance in their capital account shall be chargeable to income-tax, as the income of such firm/ AOP under the head ‘capital gains’. Any increase in the partner’s capital account pursuant to the revaluation of assets, self-generated goodwill shall be ignored. The proposed amendment has cleared the uncertainty in situations of asset revaluation, where the payment to the partner/ member was in excess of their capital contribution/ balances.

The proposed amendment shall impact many small businesses, operating as partnership firms and looking to partner with various parties who bring in expertise and recognise the expertise/ business value of the firm with the existing partners.

4. Other key amendments

i. A significant amendment in Budget 2020 was dividend taxability and the withholding tax implications thereon. While the Finance Act, 2020, made various amendments to the Finance Bill proposals, the issue of withholding of tax by the special purpose vehicle (SPV) on the distribution of dividend to a business trust remained unaddressed. The Finance Bill, 2021, has now addressed this and proposed to exempt the SPVs from tax deduction at source on the dividend paid/ payable by them to business trusts (Real Estate Investment Trusts and Infrastructure Investment Trust). The proposed amendment is a welcome move towards the cash trap on dividend repatriation for business trusts that are tax pass-through.

ii. Understanding the impossibility of the taxpayer estimating the dividend income during the year for advance tax estimations, it has been proposed to ease the advance tax compliance and related consequences for delay in the remittance of advance tax, easing the advance tax liability on the dividend to accrue only after it is declared.

iii. Withholding tax on payment of dividends to Foreign Institutional Investors/ Foreign Portfolio Investors to be allowed based on the rate prescribed or the treaty rate, whichever is lower, subject to the furnishing of a valid tax residency certificate.

Considering the pandemic, the fiscal deficit and the Indian economy’s need for growth, Budget 2021 has made promising economic and budgetary allocations. Overall, Budget 2021 is a good budget, aiming to revive the economy, augmenting the ease of doing business, and eliminating tax harassment. With the Government’s continued focus on promoting the digital economy, Budget 2021 will help achieve the target of making India a US$5tn economy.

Authors: Amit Jain, Partner, Deals Tax PwC & Ashish Nahar, Director Deals Tax PwC.

Note:-

[1] [(2012)348 ITR 302 (SC)]

[2]  Areva T&D India Ltd [TS-458-HC-2020(MAD]

Amit Jain & Ashish Nahar

Closing note: The views expressed are personal and the article includes inputs from Komal Jain, Manager, Deals, PwC India and Raghav Agarwal, Associate, Deals, PwC India.

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