This article is written by Yash Mukadam,  pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from Lawsikho.com.

Introduction

Restructuring of businesses is often conducted to help a business expand in size or in the territory and to assist a business in diversifying risk. A restructuring can range from acquiring an asset to acquiring entire undertakings to even entering into partnerships with other businesses. These three happen to be among the most common modes of restructuring. 

This article compares the three modes of restructuring by studying them from different angles. No single model is better than the other. In fact, each one has its own advantages and disadvantages. A business needs to thoroughly understand the objective of its restructuring and then choose which one fits its requirement the best. 

Understanding asset purchase, business transfer and joint ventures

Asset Purchase: As the name suggests, an Asset Purchase or an Asset Sale (from the other perspective) involves the itemized sale of assets of an undertaking or a piecemeal sale of the assets of an undertaking. An Asset Purchase hasn’t itself been defined under any of the statutes however the word asset can be understood to mean any resource owned by an undertaking, regardless of whether it has the possession or not. Assets can not only be tangible like land, machinery, etc. but even intangible like intellectual property. 

Business Transfer: A Business Transfer (also referred to as Slump Sale) is one of the methods of undertaking a business restricting in order for the business to prosper and become better. It involves the sale of an undertaking as a going concern. A Slump Sale is defined under 2(42C) of the Income-tax Act 1961 as “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 in such sales.”

Joint Venture: Joint Venture itself is not defined as a term in any of the statutes but it is mentioned under the definition of ‘Associate Companies’ under the Companies Act, 2013 which has been defined as – “in relation to another company, means a company in which that other company has a significant influence, but which is not a subsidiary company of the company having such influence and includes a joint venture company.”

A Joint Venture can be inferred to mean a separate legal entity in which two or more have come together by pooling in resources, for a purpose, without losing their own identities as separate companies. While many joint ventures tend to be companies registered under the Companies Act 2013, It is also worth noting that joint ventures can also be formed under the Indian Partnership Act, 1932, and the Limited Liability Partnership Act, 2008. However, a joint venture can also be formed without incorporating a completely new entity, this is known in common parlance as a ‘Strategic Alliance’. A joint venture can be formed on a long-term basis for perpetual running or can be formed on a short term basis for realizing a particular project, it can involve setting up an entirely new business or an already existing one being joined by a new party. Thus, there is no fixed structure of a joint venture. 

When are they preferred? 

Asset Purchase: A major advantage in an Asset purchase would be the flexibility to handpick the assets and liabilities one wants to acquire. The buyer may even choose not to take any liabilities but take just the assets. Given that the assets to be bought can be cherry picked, it’s a lot cheaper compared to a business transfer and also a lot less risky. It can also be helpful when a buyer wants to test waters before acquiring an entire business. 

Business Transfer: A business transfer is preferred when a purchaser wants to acquire an entire business undertaking to either expand his existing business or to diversify into a new business altogether. The consideration paid for a business transfer is generally a lump sum amount. Buyers can benefit largely by acquiring businesses that they think have a much higher value than what they are paying for it.

A business transfer offers several tax advantages such as non-applicability of GST and the ability to get tax incentives and benefits of the old business transferred to the buyer. None of these advantages are available in an asset purchase. Recently L&T sold its electrical and automation business to Schneider Electric, a global player in energy management and automation, for ₹14,000 crore in an all-cash deal. All of the business’s assets such low and medium voltage switchgear, electrical systems, industrial and building automation solutions, energy management systems, metering solutions, manufacturing plants as well as its 5000 odd employees got transferred to the transferee. 

Joint Venture: A joint venture is preferred when businesses are looking to benefit from each other’s expertise and resources. It provides a faster and cheaper alternative to starting something from scratch while also minimising the risks associated with a new venture by allowing the partners to share those risks. A joint venture is also often the most efficient and fastest mode of getting access to newer markets. This can be especially important for foreign entities to enter into countries that allow restricted foreign investment in certain sectors.

The only option for them would be to join hands with a local business. It can also help businesses to test waters before entering into a full merger. A joint venture can allow for an easy exit, unlike after a merger where things are much more complicated, making the exit that much harder. One of the latest developments in the JV front, Keppel Land, through its wholly-owned subsidiary, has entered into a joint venture with leading Indian developer, Emerald Haven Realty to jointly develop a freehold condominium project. According to Keppel Land’s president, they chose to enter into this arrangement so that the project could benefit from Emerald’s extensive network and deep understanding of the local property market, as well as Keppel Land’s international experience and strong execution capabilities.

Tax applicability

Asset Purchase: Gains arising on sale of capital assets are taxedis taxed as a long-term capital gain or a short-term capital gain, depending on how long the asset had been held by the assessee. In case of non-depreciable assets, the capital gain is computed as the amount by which the sale consideration of the asset exceeds its cost of acquisition. On the other hand, section 50 of the Income Tax Act, 1961 is applicable in case of depreciable assets forming part of a block of assets. In such cases, capital gains arising from transfer of assets are treated as short term capital gains regardless of the period of holding. GST is applicable on asset transfers as such transfers are to be treated as supply of goods under entry 4 of Schedule II of the Central Goods and Services Tax Act, 2017.

Business Transfer: Section 50B of the Income Tax At, 1961 lays down a special provision for computation of tax in case of a slump sale. Any gains arising from slump sale are chargeable to income tax at the rate applicable to long term capital gains if the undertaking had been held by the assessee for more than 36 months or at the rate applicable to short term capital gains if the undertaking had been held for less than 36 months. Capital gains arising on slump sale are calculated as the difference between sale consideration and the net worth of the undertaking. The method of calculating the net worth has also been laid out in the section. GST is not applicable on a business transfer.

Joint Venture: It has been previously established that a joint venture can take many forms such as a company, a partnership, a limited liability partnership or even an unincorporated entity. The applicability of tax will depend on the type of form a joint venture takes. If it is a company, then a corporate tax rate adopted in that year’s Finance Act will be applicable and will depend on the turnover/gross receipt bracket the company falls under as well as its residency status. Partnerships and Limited Liability Partnerships, as entities, are treated similar to companies. Taxation of unincorporated joint ventures can get tricky, if not structured properly, as the term ‘Association of Persons’ is not defined anywhere in the Income Tax Act, 1961 but has been interpreted in case laws. 

Instrument involved and stamp duty applicable

Asset Purchase: The instrument used for an asset purchase is referred to as an asset transfer agreement. It is imperative that the agreement lists out the details of the assets and liabilities being transferred, the terms and conditions of the transfer and the consideration payable for each asset and liability. Stamp duty payable on it is state specific and will also depend on how the agreement is modelled viz. either as an agreement to sell or as a conveyance deed. It is advisable that the agreement be structured as an agreement to sell as a deed of conveyance has much higher stamp duty implications.

Business Transfer: The instrument used for an asset purchase is referred to as a business transfer agreement. Such an agreement lists out assets, liabilities, contracts, employees etc. being transferred as well as terms and conditions of the transfer. However, a business transfer can also be given effect by way of a scheme of arrangement under Sec 230-232 of the Companies Act, 2013 which is an NCLT driven process. Again, stamp duty payable on it is state specific and will also depend on how the agreement is modelled viz. either as an agreement to sell or as a conveyance deed. It is advisable that the agreement be structured as an agreement to sell as a deed of conveyance has much higher stamp duty implications.

Joint Venture: The instruments and documents involved also depends on the structure chosen for establishing a joint venture. After a partner is identified, a ‘memorandum of understanding’ or a letter of intent is signed for expressing their intention to enter into definitive agreements. If the joint venture is to be a company then the definitive agreements will generally be a Joint venture (shareholder’s) agreement, memorandum of association and articles of association.

A joint venture in this case will have to be registered with a registrar under the Companies Act, 2013. A limited liability partnership will have a Limited Liability Partnership Agreement, as defined by section 2(o) of the Limited Liability Partnership Act, 2008. Such a partnership will have to be registered under the act governing it. Other unincorporated structures will involve entering into partnership or collaboration agreements, depending on the intention. Other agreements with regard to matters such as trade mark licenses and technology transfers will also have to be entered into, regardless of the structure chosen. Stamp duty applicable will depend on the instrument entered into, which in turn depends on the structure chosen and will be subject to state specific laws. 

Concluding remarks

Both tax applicable and stamp duty payable can have major cost implications and hence these considerations also need to be taken into account when choosing a mode of transaction. All of them have their own advantages and disadvantages and choosing one ultimately depends on the objectives of the parties involved in a transaction.

References

• “The Income-Tax Act, 1961.” Income Tax Department, www.incometaxindia.gov.in/pages/indiacode/income-tax-act.aspx.
• “The Companies Act, 2013.” India Code, www.indiacode.nic.in/bitstream/123456789/2114/1/201318.pdf.
• “The Limited Liability Partnership Act, 2008.” India Code, www.indiacode.nic.in/bitstream/123456789/2023/1/A2008-06.pdf.
• https://www.livemint.com/companies/news/l-t-sells-its-electrical-and-automation-business-to-schneider-electric-for-rs-14-000-crore-11598877278444.html
• https://www.constructionweekonline.in/projects-tenders/14865-keppel-land-collaborates-with-tvs-emerald-to-develop-premium-residential-project-in-chennai

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