Budget 2021: Significant impact on past and future M&A transactions

Five ways in which FM Nirmala Sitharaman's announcements will change the tax dynamics of merger & acquisitions and corporate restructuring in the country

Amid the current economic scenario, Union Budget 2021 was keenly awaited. There were speculations on what steps the Government would take towards economic recovery and whether they would affect people in the form of increased tax rates or introduction of cess. The budget focused on six key areas for growth – health and well-being, financial capital and infrastructure, inclusive growth, human capital, innovation and R&D, and minimum government and maximum governance. On the corporate tax front, no increase in tax rates brings relief for corporates. 

Depreciation on goodwill – impact on past transactions

From a transactions/restructuring perspective, some important proposals have been announced in the budget. The key one is depreciation on goodwill. Goodwill may arise in the case of purchase or reorganisation of business and depreciation on the same is an important consideration for the recipient. The controversy on whether goodwill is an asset entitled to depreciation was put to rest by the Supreme Court way back in 2012. As per the proposal, no depreciation would be allowed on goodwill, whether acquired or otherwise. This would have an impact on valuations. While the cost of acquisition of goodwill would be available at the time of disposal of assets, the sale of goodwill pertaining to business is not common. Further, the proposal would also impact past transactions where goodwill has not been fully tax depreciated. For such cases, depreciation on goodwill may not be available from FY 2020–21 onwards.

Slump exchange – taxable 

Another important tax proposal is the change in the definition of slump sale. In the case of a business carve-out, slump sale is a commonly followed mode for transfer of business on a going-concern basis. There have been cases where business transfer is carried out for a non-cash consideration, thereby treating it as slump exchange. A view has been adopted in such cases that the same is not covered under slump sale and hence, not taxable. There are courts which have approved such views as well since 2014. The budget proposes to amend the definition of slump sale to include all forms of transfer within its ambit, thereby expanding its scope.

Capital withdrawals – taxable in certain cases

Another update on the restructuring front is the tax treatment on distribution of money or assets by a firm, LLP, and certain other entities, to any partner on dissolution or reconstitution. Any such distributions in excess of a partner’s capital account will be subject to tax in the hands of the partnership firm/LLP as capital gains. Also, any capital balance accrued on revaluation of assets or creation of self-generated goodwill will not be available as deduction for this purpose.  

PSU restructuring

In order to facilitate the Government’s plan of disinvestment of public sector companies (PSCs), changes have been proposed in the definition of ‘demerger’ to cover reconstruction or splitting up of a PSC into separate companies. Further, the provisions related to carrying forward of losses have been amended to enable carrying forward of losses by a PSC in the case of amalgamation involving a PSC in certain specified situations.

Timing for reopening tax assessments: impact on period of tax Indemnities 

In case of transactions, the time period of tax indemnity is a matter of debate between the transacting parties. The buyer generally likes to seek protection for the statute of limitation and sometimes build protection through escrow mechanism, etc. The Indian tax laws currently provide a time of six years for reassessment proceedings and the budget proposes to reduce the same to three years, except in certain specified cases where the period goes up to ten years. 

Conclusion

The amendments to the definition of demerger and the condition for carrying forward of tax losses for PSUs should provide flexibility and help the Government’s large disinvestments plans become more lucrative. With deal activity poised to grow and preference of strategic buyers to acquire businesses, the proposed amendment of depreciation on goodwill may have an impact on valuation. Further, the proposal may also impact future depreciation claims on goodwill which arose in past transactions. It would be interesting to see if the Government brings in certain relaxations on this front.

The authors are experts in the area of M&A Tax at PwC India. Saurabh Kothari, Rohit Choraria also contributed to this article. Views expressed are personal.