In this blog post, Neha Susan Rajan, a student pursuing her BA LLB (Hons.) at School of Law, Christ University and a Diploma in Entrepreneurship Administration and Business Laws by NUJS, discusses the taxation methodology of slump sale.
“Different colours of the rainbow may appear as separate entities but in reality, the rainbow is a single phenomenon; this is a case of slump sale only.”
The right to levy tax is constitutionally protected right of the State under Ar.265. The tax regime is well structured and decentralised. This right can be exercised by Central Government, State Government and Local authorities at the grass root level. Taxes are divided into direct tax and indirect taxes. Direct taxes are those taxes where the burden of paying tax is directly borne by tax payer. These include Income Tax and Wealth tax. Indirect taxes include customs, Goods and services tax, etc.
Artificial person like Company is subjected to the taxation. Indian Corporations are taxed on their worldwide income while foreign companies are taxed on income that arises from operations in India. Taxes charged on a corporation include Minimum Alternative Tax (MAT), Fringe Benefit Tax (FBT), Securities Transaction Tax (STT), Dividend Distribution Tax (DDT) and Wealth Tax. Even sale of an undertaking or an investment can be taxed. This is known as Capital Gain Tax. This can be house, ranch, cattle house and family business. It is a voluntary tax since it is only payable when asset is sold. This article attempts to understand the taxation issues that arise through a sale of undertaking.
What Is Slump Sale
Slump sale means sale of undertaking for a lump sum without assigning any particular value to assets and liabilities. In order to make it a slump sale, it should maintain following conditions (S.2(42 C)).
- There must be a sale. This means there should be transfer of assets and it should be for a consideration in cash or kind.
- ‘Undertaking’ shall include any part of an undertaking or a unit or division of an undertaking or a business activity taken as a whole, but does not include individual assets or liabilities or any combination thereof not constituting a business activity. (S.180). This should be approved by shareholders by special majority. Furthermore, the articles of association and memorandum of association of the transferor company must contain provisions to support it.
- Lump sum consideration means it should not be done in instalments but in one time.
- Individual values must not be assigned to assets and liabilities; net worth of the assets is taken into consideration.
Assignment of the values can be done in exceptional cases. They include:
- Payment of stamp fees
- Registration fees
- Any other taxes
The slump sale transaction mainly confers three advantages- first, it enables improvement of operation of weaker business; secondly, elimination of negative synergy and facilitate strategic investment; thirdly, to seek tax and regulatory benefits.
Meaning of undertaking
“Undertaking” in common parlance means an “enterprise”, “venture”, and “engagement“. It can as well mean “the act of one who undertakes or engages in a project or business”. The word “business”means “some real, substantial and systematic or organised course of activity or conduct with a set purpose”. Hence the words “industrial undertaking” in the Income Tax Act, 1961 means “any venture or enterprise which a person undertakes to do and which has relation to some industry or has some industrial consequences”. In 2015, Kolkata Tax Appellate Tribunal held that transfer of specific assets of an undertaking does not constitute to be a Slump Sale merely on the ground being a transfer of going concern. It is quintessential to determine whether the business is being transferred along with all necessary assets and liabilities that constitute an integral part of the undertaking.
The word undertaking is distinct from its components. “Plant, machinery and dead stockare are individual items of an Undertaking. Business Undertaking not only includes tangible items but also comprise intangible items like, goodwill, manpower, tenancy rights and value of banking licence”.
Lump sum consideration
The slump sum price must not be paid in instalments but it should be one-time payment.The lump-sum consideration received by the seller in a slump sale transaction is a capital receipt under S.50B of the Income Tax Act,1961 not business receipt under S.25. Hence, the amount received cannot be treated as compensation for the discontinuation of business.
Sale means transfer of assets
In CIT v Bharat Bijlee, there was no monetary consideration for transfer of undertaking but transferee issued preferential shares and bonds to the transferor. The Bombay High Court held that it was a case of exchange not sale. Hence, it can be only called a transaction under S.2 (42C) when the transaction shows the true nature of the sale.
Slump Sale And Income Tax Act
Under the Income tax Act, 1961, the slump sale is defined under S.2 (42 C). This is elaborately discussed under the Capital Gains Tax i.e, S. 50 B. Prior to the introduction of this provision, the judiciary was of the view that that “transfer of an undertaking for a slump consideration did not trigger capital gains tax as the cost of acquisition of an undertaking is not capable of being quantified”. Consequently, the Income Tax Act was amended in 2000 to enable levy of tax on transaction involving slump sale. This became effective from April 1 2000. This intends to recognise demerger, slump sale under the concept of capital gains and rationalise the existing provisions of the merger.
S.50B determines the computational mechanism of capital gains. Gains arising on slump sale are chargeable as long term capital gains if the undertaking is owned and held by the assessee for more than 36 months preceding the date of transfer. Else, gain is chargeable as short term capital gains. Every assessee should furnish the return of income, a report of an accountant indicating the computation of the net worth of the undertaking or division and certify that the net worth of the undertaking or division has been correctly arrived at in accordance with the provisions of this section.
Computation of the Net Worth
The Sick Industrial Companies (Special Provision) Act, 1985 defines “net worth” as “the sum of total paid up capital and free reserve”. The SEBI (Disclosure and Investor Protection) [DIP] Guidelines, defines “net worth” means “aggregate of value of the paid up equity capital and free reserves (excluding reserves created out of revaluation) reduced by the aggregate value of accumulated losses and deferred expenditure not written off (including miscellaneous expenses not written of) as per the audited balance sheet”.
Explanation 1 to S.50 B defines “Net worth” as the aggregate value of total assets of the undertaking or division minus the value of liabilities of such undertaking or division as appearing in its books of accounts. The “aggregate value of the assets” include in the case of depreciable assets, the written down value of the block of assets determined in accordance with S. 43 (6)(c)(i); in the case of capital assets where the deduction allowable for expenditure under section 35AD, it is NIL and in the case of other assets, the book value of such assets.
Itemized Sale vs. Slump Sale
The itemized sale is different from slump sale. In itemized sale, the income from the sale of individual assets is taxed separately. Consequently, income from the sale of assets in the form of “stock in trade” will be taxed as business income, and the sale of capital assets is taxable as capital gains.
In CIT v. Mugneeram Bangur& Co, the firm had sold the business as a going concern along with its goodwill and all stock in trade, etc., to a company for a lump sum price. The Supreme Court held that the sale was of a whole concern and no part of the price paid was attributable to the cost of land and hence, taxable.
Slump Sale and Indirect Tax Concerns
As far as the indirect taxes like sales tax, value added taxes are concerned, when the undertaking is sold as going concern, it does not become to these taxes such that it does not qualify to be a sale of movable goods. In the case of ‘The Deputy Commissioner of Sales Tax (Law) v. DatPathe’ , the Court have held that the transfer of one unit/ business as a going concern having separately identifiable assets, liabilities, income and expenditure would be considered as transfer of business as a ‘going concern’ and accordingly not attract any VAT or sales tax. VAT is chargeable only when the transferor close downs the business by the effect of sale of undertaking. This is left to the discretion of the State to tax VAT.
Impact of Negative Net Worth on Slump Sale
In SRM Energy Ltd v. DCIT (2015), the Mumbai Tribunal held that the negative value of the net worth must be taken into the consideration for the purpose of the computation of the capital gains. It can be a negative value but not zero.
Slump Sale and Stamp Duty
Under the Indian Stamp Act, the stamp duty is imposed on the transfer of the immovable property. This Act does not talk about anything specific to slump sale. Explanation 2 to S.2 (42 C) of the Income tax Act does not bar to assign individual valuation of assets for the purpose of determining the value of stamp duty.
The buildings and lands are considered to be immovable property while the debate lies on the question whether the installations and machinery include within the ambit of immovable property. In the case of ‘Duncans Industries Ltd. v. State of U.P. and Ors’, the Court held that unless the machinery could be removed from seller’s plant to new location, it cannot be considered as sale of goods. Hence, the value of the machinery is needed to be determined in the sale deed for immovable property.
In order to constitute a slump sale as per the statutory provision the transaction should reveal the true nature of the sale indicating a consideration for the same and tax is chargeable as long-term or short-term capital gain, as the case maybe, under section 50B of the Income Tax Act by computing the net worth of the undertaking. It is clear that a slump sale of even a part of an undertaking is taxable under income tax whereas the state cannot enforce indirect taxation such as VAT unless the transferor close downs the business by the effect of sale of undertaking. Since slump sale is a lucrative way for a business entity to transfer an undertaking, it is advisable for the parties to negotiate and commercially agree the cost burden of each party owing the complications involved in the different levels of determination in taxation.