Taxing gaps in slump sales

With the world economy poised to gain momentum, corporates all over the globe are discussing their plans for mergers and acquisitions. One concept that is being considered is that of a ‘slump sale’ as it has an edge over other modes of business restructurning on account of the tax efficiencies that come with it.

Indian taxation provides definitions for ‘slump sale’ and special provision for the computation of capital gains in case of slump sales. Section 2(42C) of the Income Tax Act, 1961, defines a slump sale as the transfer or sale of one or more undertakings for a lump sum consideration without values being assigned to individual assets and liabilities.

The term ‘undertaking’ has been defined under sub-clause (19AA) of section 2 of the act to include any part of an undertaking, or a unit or division of an undertaking or a business activity taken as a whole. It does not include individual assets or liabilities or any combination thereof that does not constitute a business activity. The judiciary in India seems to agree that a blend of assets and liabilities shall not constitute an undertaking, unless it can be an independent business concern.

The Finance Act, 1999, under section 50B, introduced concessional tax treatment in computation of capital gains in case of a slump sale. It provides that any profits or gains arising to the transferor, from a slump sale shall be chargeable to income tax as capital gains and shall be deemed to be the income of the previous year in which the slump sale took place. In this regard, the net worth of the undertaking shall be the cost of acquisition and the cost of improvement of the ‘undertaking’.

Prior to the insertion of section 50B of the act, there were several judicial pronouncements that held that the transactions of slump sale are not taxable on account of absence of computation mechanism under the act.

The first and main source of disagreement is whether section 50B of the act is a self contained code providing the charging as well as computation mechanism or if section 45 is the mother code for slump sale (like in the case of every other capital gains) and section 50B provides for its computation. If the transaction were to fall within the ambit of section 45, as this is an undertaking, capital gains would not be levied on the transfer of capital assets between a holding and its subsidiary and vice versa.

Recently, in Punjab Finance Ltd v CIT the Supreme Court while delivering a judgment on the pre-section 50B scenario held that the charging section and the computation provisions together constituted an integrated code. Where the computation provisions cannot apply, it is evident that such a case was not intended to fall within the charging section.

However, while deciding on this aspect, the court did not take account of earlier judgments, which had held that the provisions of section 50B of the act are substantive in nature.

Bombay High Court in Premier Automobiles v CIT, held that the liability of tax on transfer of capital asset of an undertaking, shall be governed by the charging provisions of section 45 of the act. However, the court did not take note of the judgment of the Ahmedabad Bench of Tribunal in the case of Industrial Machinery Association v CIT, which had held that that the provisions of section 50B of the act is a substantive provision, which specifically brings to charge all capital gains arising from a “slump sale”.

In addition, even the computation mechanism prescribed in the act to compute the capital gains in a slump sale are not free from all doubts. A bare reading of its provisions would not clarify how capital gains are to be computed in the case of transfer of an undertaking that has negative net worth. In this context, the Delhi Bench of the Tribunal in Paperbase Co Ltd v ACIT, following the decision in Zuari Industries Ltd v ACIT, held that in case of a slump sale, where the liabilities are more then the value of the assets, the net worth or the cost of the acquisition, has to be taken as nil and the entire consideration is liable to capital gains tax.

Another source of dispute is how the transferee accounts for itemised assets of the undertaking, as there are no specific provisions in the law to determine ‘actual cost’ or ‘written down value’ of the asset. Thus, the tax authorities can contest the value assigned to each asset in by the transferee.

In this regard, Gujarat High Court in CIT v Spunpipe & Construction Co. Ltd held that in the case of acquisition of an undertaking as a going concern, the consideration could be bifurcated between various assets in a fair and reasonable manner permitted by law. Similar inference can also be drawn from “Accounting Standard 10 on Accounting for Fixed Assets”.

In any business reorganisation that entails a slump sale, all concerns about taxability should be put on the table so that they are addressed during negotiations and in the business transfer agreement. It is also necessary that the law pertaining to ‘slump sales’ should be evolved beyond uncertainties so as to provide for mergers and acquisitions.

Aseem Chawla is a partner, Amit Singhania is a senior consultant and Jasmeet Singh is an associate at Amarchand & Mangaldas & Suresh A Shroff Co.