Capital Gain Computation- Advance Money Received, Slump Sale & FMV Computation

COMPUTATION OF CAPITAL GAIN IN CERTAIN CASES

1. Section 51 – Advance Money Received

2. Section 50D- Fair Market Value deemed to be full value of consideration in certain cases

3. Section 50B – Special provision for computation of capital gains in case of Slump Sale

Section 51 – Advance Money Received

Many times we observed in property transaction that buyer enter into the transaction paid advance money against the consideration and then after some time if something went wrong he cancelled the transaction. In such cases, generally seller of that property forfeit the advance money received by buyer. So if such situation occur how tax will be levied on such advance money forfeited by seller? Hence today I am covering this topic to enlighten you all regarding taxability of advance money forfeited by seller.

Clause (ix) is inserted in section 56(2) by Finance (No. 2) Act, 2014 to provide for taxability of any sum received as an advance or otherwise in the course of negotiations for transfer of capital asset. Since it is a capital receipt it was earlier allowed as a deduction from the cost of acquisition under section 51. The same is now taxed as a revenue receipt in the year of receipt under the head “Income from other sources”.

Tax impact on buyer:

• Forfeiture of earnest money by the vendor if due to default on the part of vendee, will not amount to relinquishment of a right in that asset. Therefore the amount forfeited will not be allowed as a capital loss under the head capital gains.
• However, if the seller fails to honor the deal and pays the buyer double the compensation, this will be treated as capital gain because it amounts to relinquishment of a right by the buyer.
• Does advance money for the purchase of a commercial property be treated as business expenditure incurred by the buyer?

No, the amount cannot be claimed as revenue expenditure. If the payment is made for the purpose of acquiring a capital asset, the amount lost upon forfeiture will not be considered as revenue loss though the amount may not have the same consequence or character in the hands of the recipient or beneficiary.

Section 50D- Fair Market Value deemed to be full value of consideration in certain cases

Prior to section 50D, capital gains are calculated on transfer of a capital asset, as sale consideration minus cost of acquisition. In some recent rulings, it has been held that where the consideration in respect of transfer of an asset is not determinable or ascertainable, then, as the machinery provision fails, the gains arising from the transfer of such assets is not taxable and also that fair market value cannot be taken as deemed full value of consideration unless there is a specific provision in this respect. This particularly happens when shares in Indian companies are transferred ‘without consideration’ by companies as part of restructuring exercise. Obviously, these transfers are not “gifts” but consideration for them is general improvement in business/ synergies etc. which is not “ascertainable” or “quantifiable”

In order to overcome this situation provisions of Section 50D has been introduced by Finance Act, 2012 which is applicable w.e.f. 1-4-2013.

The extract of Section 50D is as under:

Fair market value deemed to be full value of consideration in certain cases.

50D – “Where the consideration received or accruing as a result of the transfer of a capital asset by an assessee is not ascertainable or cannot be determined, then, for the purpose of computing income chargeable to tax as capital gains, the fair market value of the said asset on the date of transfer shall be deemed to be the full value of the consideration received or accruing as a result of such transfer”.

Section 50B – Special provision for computation of capital gains in case of Slump Sale

1. What is meant by slump sale?

Slump Sale means the transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to the individual assets and liabilities is such sales.

2. Whether sale of undertaking be taxable as ‘Business Income’ or ‘Capital Gain’?

The Supreme Court in PNB Finance Ltd. V. CIT (175 Taxman 242) after considering Sections 41(2), and 45, held that gain from slump transactions is neither taxable as business income u/s. 41 (2) nor as Capital gains u/s. 45 of the Act.

To attract section 41 (2), the subject matter should be depreciable assets and the consideration received should be capable of allocation between various assets. In case of a slump sale, there is an undertaking which gets transferred (including depreciable and non-depreciable assets) and it is not possible to allocate slump price to depreciable assets and therefore, the same cannot be taxed u/s. 41 (2).

To attract Capital Gain, held that the charging section and the computation sections are integrated code and if one fails other fails. If the computation sections fail then even the Charging section fails.

Conclusion

In case of slump sale, there are bundle of assets (including intangible assets like goodwill) that are transferred and in absence of any specific provision like Section 50B, it is not possible to determine the cost of the said assets and thus, the computation mechanism fails and so does the charging section. Therefore, it was held that the gains from the transfer of a bundle of asset on a slump basis are not chargeable to capital gains also. Thus, the slump sale was held to be not chargeable to tax prior to insertion of Section 50B

3. Is the benefit of indexation is available in case of slump sale?

As per Sec 50B, no indexation benefit is available on cost of acquisition, i.e. net worth.

4. Whether transfer of assets without transfer of liabilities regarded as Slump Sale?

Slump sale provisions do not apply where assets of an undertaking are transferred without transfer of liabilities. This is clear from the following

Definition of ‘undertaking’: ‘include any part of an undertaking or a unit or division of an undertaking or a business activity taken as a whole’

As per Explanation 1 to S. 50B: Net worth is the difference between ‘aggregate value of total assets of the undertaking or division’ and ‘value of liabilities of such undertaking or division’.

Therefore, transferring the asset without transferring the liabilities shall not be regarded as Slump Sale.

Some Practical Issues

Issue 1 – If the transfer of the property in goods is not pursuant to a contract but pursuant to a Court Order?

The transfer of the property in goods pursuant to an order of a court cannot be regarded as ‘Sale’. This is quite clear from definition of “Sale” that only contractual transfer is regarded as ‘Sale’ and thus, the statutory transfers or transfer effected by orders of the court or operation of law cannot be regarded as Sale.

Issue 2 – if undertaking is transferred for a consideration other than ‘money consideration’, say for allotment of shares in transferee com­pany ?

The transfer of the property in goods for other than ‘money consideration’ would be regarded as ‘Exchange’ and not ‘Sale’ and therefore wouldn’t be covered in the ambit of Slump sale and consequently would not be taxable under the IT Act. Such transaction could be regarded as ‘Slump Exchange’. [Supreme Court case in CIT vs. R. R. Ramkrishna Pilai]

(Source – Book on Practical Aspects of Tax Audit, TDS, HUF & Capital Gains  written by CA Agarwal Sanjay ‘Voice of CA’ & Team)

Republished with Amendments