Sale of a business is taxable as a capital gain in the year of sale/transfer, be it transfer by way of shares or on slump-sale basis. There might be contingent consideration payable in business transfer agreements.
The stand of the Revenue has always been to tax the contingent consideration if any, payable as capital gains in the year of transfer, while that stand of the transferor has always been that it should be taxed only in the year of actual receipt. Deferring the taxation to the year of receipt stems from the fact that it is only upon meeting the conditions precedent (usually performance oriented), that the contingent consideration accrues or becomes receivable by the transferor, thus the reasoning it is taxable only in the year of receipt.
Section 45, the taxing provision, deems the computed capital gains as the taxable income in the year of transfer. Wherever the law has granted the power to tax something on deferred basis in the year of receipt, the law has always carved out a specific provision as in the case of compulsory acquisition, wherein the additional compensation if any received is taxed in the year of actual receipt irrespective of no transfer existing in the year of receipt. There is no such specific carve-out thus for contingent consideration in the law.
Taxable scenarios
One has to recap that (the law on) capital gains is first not an income as generically understood. Nonetheless, to tax certain capital profits, the law has carved out each and every taxable scenario under capital gains.
Section 50D deems fair value of the capital asset as on the date of transfer to be the deemed consideration in the event the consideration is unascertainable/indeterminable. Going by this, the contingent consideration cannot be taken up for taxation in the year of transfer. There might also be cases where the contingent consideration might only remain on paper with no amounts accruing to the transferor eventually.
Maintaining an escrow for taking care of contingent consideration/ obligation has also gone through judicial scan with either way verdicts. What remains factual, however, is: income, if it does not accrue to an assessee, cannot be taxed howsoever the law is read due to real income principles. On a separate point under Ind-AS, business combinations are measured at fair value basis, where even the contingent consideration is taken into account for examining if at all there exists any goodwill or bargain purchase in the hands of the acquirer/transferee. This fair value accounting of acquirer/transferee neither has anything to do with the accounting of acquiree/transferor nor on the taxability or otherwise of the contingent consideration in the books of the acquiree/transferor; bereft for considering prudential accounting principles where definitely the concept of accrual concept comes to the fore.
Thus, there appears no dichotomy existing on principles on accounting versus tax. It is time there’s clarity on the taxing issue of contingent consideration.
The writer is a chartered accountant