Written in : March 1999

One remarkable feature of this budget was that it has proposed many welcome changes in tax laws. Many of these are forward looking and indicate a modern approach of government to business. Last week we saw some changes in appellate process as examples of welcome changes. Let us now see the other changes.

Many companies offer sweat equity and stock options to employees as a part of their remuneration and to retain them in the long run.

How tax laws treat them has been uncertain. The Budget now ensures that these come under the tax net and explains how. Because it makes the law clear and much litigation gets avoided, I'd say it is a welcome move.

Stock options are offered to employees as an incentive. In stock options, employees get the chance to take stock (shares, etc) in companies at a value lower than market value. The employee benefits. Often such options are offered by parent or holding companies and not necessarily the employer.

The law now proposes that whenever an employee exercises his option to acquire stock under the stock option plan, he should be taxed on the perquisite which he receives. The perquisite is the difference between the market value of shares and the amount he pays to acquire them.

When the employee sells the stock later on, the market value on the date he acquired it (and not the cost he paid) will be considered to be his cost for computing capital gains.

Company law now allows sweat equity to be issued. Sweat equity is shares issued in consideration of value offered to the company in terms of services, know how, intellectual property rights etc.

That is, if you provide the company services in return of which it gives you shares, then such shares are called sweat equity.

In all such cases, the Budget now proposes, there shall be considered to be a perquisite coming about in the hands of the employee or director. And, there would be tax levied on such perquisites. The value of the perquisite would be the difference between the market value of stock and the amount paid, if any, to acquire them.

The treatment for capital gains is proposed to be the same as for ESOPs.

Business has become far more dynamic now than ever before. Businesses go through changes much more now than ever before. Mergers and amalgamations, spin-offs, de-mergers are common.

Tax laws have to remain in step with business reality if business is to thrive.

Says the finance ministry: 'The business and economic environment of the country has thrown up the need for rationalisation of laws relating to business re-organisation for restructuring of production systems and better utilisation of resources which have become necessary with a view to enable the Indian industry to rearrange itself to become globally competitive.'

Last year, the tax laws were amended to allow for smoother change over of proprietory concerns and partnership firms to companies. That was a very welcome move.

This Budget goes a step further. It now changes the antiquated law of treatment of amalgamations and offers a new set of law for demergers and spin offs, and for slump sales of undertakings.

A demerger is a process where a part of an undertaking is spun off to another company. It helps businesses reorganise themselves by selling off units which they don't wish to retain. There has been no tax law dealing with such situations so far.This Budget introduces regulations to deal with demergers.

Primarily, the law says that demergers shall be tax neutral. If your company goes through a demerger, it would dispose of an undertaking to someone else. Law now says that there would be no additional tax liability on such a transfer if some conditions are fulfilled.

Not merely that, tax benefits and concessions that are available to any undertaking should be available to the undertaking in the new hands as well. That is something.

The conditions imposed are that the business of an undertaking should be transferred as a going concern, that is, as a business and not as a sale of assets individually. Fair enough.

Even the accumulated losses and unabsorbed depreciation of the transferred undertaking should be allowed to be carried forward in the hands of the company taking it over if they are directly relatable to the undertaking. If they are not directly relatable, then the losses and depreciation should be apportioned between the demerged company and the new company in proportion of the assets coming to the share of each of them from the original company.

The government has reserved rights to prescribe guidelines or conditions to ensure that demergers are made for genuine business purposes.

Undoubtedly, there are many shortcomings and creases in the proposed law and one hopes these will be ironed out shortly. It is a good beginning, by any means.

The tax law relating to amalgamations anything but encouraged them. The requirement of getting approval from the prescribed authority was impossible to meet with in many cases. Explains the ministry: 'In amalgamation, the existing conditions under section 72A for the carry forward and set off of accumulated losses and unabsorbed depreciation are too stringent to really offer any meaningful incentive for the revival of business.'

The law is now proposed to be changed drastically. Under this law, benefits under tax laws relating to carry forward of losses, depreciation etc will be continued to be allowed in the hands of the amalgamated company if seventy five percent in value of the assets are retained by the amalgamated company for a period of at least five years and further that the amalgamated company carries on the business of the amalgamating company for at least five years from the date of amalgamation.

The Government has again reserved itself rights to prescribe conditions necessary to ensure the revival of business or to prevent the misuse of the concession.

The changes, it seems, will make amalgamations more attractive and help revive sick units.

Slump sales are where entire units are sold off lump sum, without assignment of values to individual assets or liabilities.

How would slump sales be taxed has been a matter of debate for decades now. There is an opinion that these may not be taxable at all.

According to the proposed changes, in cases of slump sales there would result capital gains in the hands of the transferring company. To calculate the capital gains you would deduct the 'net worth' of the company from its sale price. You would ignore the cost of individual assets but would consider only the net worth of the company calculated in a defined way.

Whether the capital gains would be long term or short term would depend on whether you have been owning the business for over three years or not. Remember, it is the holding of the business which is important, not that of individual assets.

Company law now allows for buy back of shares by companies. The shares bought back have to be extinguished and physically destroyed and the company is precluded from making any further issue of securities within a period of 24 months from such buy-back.

How such buy backs would be treated tax-wise has been unclear. The law is now proposed to be changed to say that when shares are bought back, there would be no dividend considered to be given by the company.

It is also made clear that shares bought back would result in capital gains in the hands of the shareholders and the difference between the amount received and the cost would be the capital gains.