CONCEPT OF SLUMP SALE & TAXATION ISSUES IN INDIA

Parth Semwal Trainee June-July 2011 INDEX Introduction Undertaking in a slump sale

Computation of capital gains & Net worth Case Law Study on direct tax liability on slump sale issues 4.1 Issues relted to direct tax attraction in slump sale (i)Whether slump price is attributable to the stock in trade?

(ii)Whether transfer of business or undertaking by way of slump sale constitutes transfer of capital asset and whether there was any cost of acquisition of such business or undertaking or division. (iii) Whether sale of the assets of an assessee effected for the purpose of closing down the business would be covered by that proviso and would be assessable as profit? Overall analysis of slump sale taxation

Introduction: The term slump sale is used when an undertaking or a business is sold without attributing separate values to each of the assets which are sold. In other terms, if there is a sale of an undertaking or a business for a lump sum price it is considered to be a slump sale. In the contemporary world the most fashionable form of such deals falls under the less-than-glamorous term of slump sale its defined under the section 2(42C) of Income

Tax Act, 1961- it says slump sale means the transfer of one or more business undertakings as a result of the sale for a lumpsum consideration without assigning values to individual assets and liabilities in sale. The law expressly provides that undertaking shall have the meaning assigned to it in explanation 1 to clause (19AA) specifically clarify that for the purposes of this clause, 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. Under Sec.293(1) (a) Companies Act, 1956 (CA) defines that sell, lease or otherwise dispose of the whole, or substantially the whole, of the undertaking of the company, or

where the company owns more than one undertaking, of the whole, or substantially the whole, of any such undertaking. The seller company can undertake a slump sale after obtaining its share holder approval under Sec. 293(1) (a) of CA. Approval requires simple majority of votes even for the entire undertaking of the company. A slump sale of an undertaking can be affected with the shareholders approval. It should be ensured that the Memorandum and Articles of Association of the transferor company contain enabling provisions to affect such a sale.Vinati points out the main elements of a slump sale are therefore (a) sale of an undertaking; (b) lump sum consideration; and (c) no separate values

are assigned to individual assets and liabilities. One of the major criteria under the definition is that the assessee should own the undertaking and should transfer the undertaking by way of sale. Singhania & Singhania in there book says that Undertaking for the purpose of the definition if the assets/ liabilities of the specific part of the undertaking cannot by themselves constitute a business activity. Likewise, transfer of assets which exclude a few significant assets without which the business cannot be carried on effectively, may not be considered as a transfer of business. Moreover, they clarified that transfer by any other mode (like compulsory acquisition) is not covered by the definition of slump sale under section 2(42C).

Undertaking in a slump sale As discussed above Income Tax Act (ITA) defines undertaking to 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. (Explanation 1 to section 2(19AA) of the ITA). Until now, interpretation of this term has been at the center of substantial debate In contemporary days debate over definition of slump sale as given in Sec. 2(42C) and also to definition of the word undertaking the major issue is whether a particular business activity of an undertaking can be transferred on slump sale basis.

To elaborate further on the above issue let us examine with the help of recent case which came before income tax appellate tribunal (ITAT) in Rohan Software Pvt. Ltd. v. Income Tax Officer Background of the Case; M/s Rohan Software Pvt. Ltd (The Taxpayer) an Indian company which was engaged in the business of software development and related activities. The taxpayer transferred assets and property in its business including intellectual property, codes, formulae and designs; the business along with all the rights to IPRs (intangible assets) developed was taken over by M/s ICICI Infotech Services Ltd. (IISL) in 1999 for a lump sum consideration. However, the taxpayer did not transfer any buildings, vehicles or other assets and liabilities pertaining to income tax matters. The

taxpayer treated the transaction as a transfer of an undertaking by way of a slump sale and characterized the gains from the sale as long-term capital gains because the undertaking was owned and held for more than 36 months. The tax authorities took the position that the transfer of intellectual property, codes, formulae and designs, did not, in and of itself, constitute the transfer of an undertaking as a going concern because the taxpayer had not transferred certain assets of the undertaking. Also, it was alleged that the transfer had been effectuated only for a period of three years. Accordingly, the tax authorities treated the gains arising from the transfer as business income. In this tribunal clarified the definition undertaking shall have the meaning assigned to the undertaking.

Explanation 1 to Sec. 2(19AA) was introduced with effect from 01.04.2000 by the Finance Act, 1999. Undertaking includes, as per the definition, 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. Moreover, tribunal further elaborated that in the instant case of the assessee, though in the purchaser's books of account the individual assets have been priced independently, assessee had not assigned separate values and consequently sold the items for independent price. It is not the revenue's case also those individual assets had the price

fixed separately and charged. Undertaking is explained in explanation 1 to section 2(19AA). According to this Explanation, as we noted already above, includes any part of an undertaking or a unit or division of an undertaking or a business activity as a whole. Therefore in light of abovementioned facts tribunal decided that Sec.50B of the ITA, long term capital gain on the slump sale was worked out and deduction under Sec. 54EA was valid to be claimed. The expression transfer as defined in Section 2(47) of the Act, includes several forms of transfer; and sale is only one such form of transfer. Under Section 50-B any profits on gains arising from the slump sale affected in the previous year shall be chargeable to income tax as capital gains.

In case of calculate method of accounting from transfer of undertaking by slump transitions Supreme Court of India in PNB Finance Ltd v. Commissioner of Income Tax-I, New Delhi, had led down three important tests to find out whether it attracts rise to taxable capital gains under Sec. 45 of Act. Whereas the second test which needs to be applied is the test of allocation/attribution. This test is spelt out in the judgment of this Court in CIT v. Mugneeram Bangur & Co. this test applies to a slump transaction. S.C clarifies that the object behind this test is to find out whether the slump price was capable of being attributable to individual assets, which is also known as item-wise earmarking.15 In

addition to the above laid test SC also lead down third test which distinguishes conceptual difference between an undertaking and its components. Plant, machinery and dead stock are individual items of an Undertaking. Business Undertaking can consists of not only tangible items but also intangible items like, goodwill, man power, tenancy rights and value of banking licence. However, the cost of such items (intangibles) is not determinable. In the case of CIT v. B.C. Srinivasa Settyreported16 in this Court held that sec. 45 charges surplus which arises on the transfer of a capital asset in terms of appreciation of capital value of that asset. In the said judgment, SC also held that the asset must be one which falls within the contemplation of Sec. 45. Computation of capital gains & Net worth:

Under Sec. 50B of the Income-tax Act, 1961, introduced by Finance Act 1999 with effect from Assessment Year (AY) 2000-01, governs taxability of capital gains pursuant to transfer of an undertaking17 in a slump sale. It provide that any profits or gains arising from the slump sale effected in the previous year shall be chargeable to income-tax as capital gains arising from the transfer of long-term capital assets and shall be deemed to be the income of the previous year in which the transfer took place: Bare provision provided that any profits or gains arising from the transfer under the slump sale of any capital asset being one or more undertakings owned and held by an assessee for not more than thirty-six months immediately preceding the date of its transfer shall be deemed to be the capital

gains arising from the transfer of short-term capital assets. sub sec 2 to sec. 50 B says that capital assets being an undertaking or division transferred by way of such sale, the net worth18 of the undertaking or the division, as the case may be, shall be deemed to be the cost of acquisition and the cost of improvement for the purposes of 48 and 49 no regard shall be given to the provisions contained in the second proviso to sec. 48. Moreover under sub section 3 to sec. 50 B provides that every assessee, in the case of slump sale, shall furnish in the prescribed form along with the return of income, a report of an accountant as defined in the explanation below sub-section (2) of sec.28819 indicating

the computation of the net worth of the undertaking or division, as the case may be, and certifying that the net worth of the undertaking or division, as the case may be, has been correctly arrived at in accordance with the provisions of this section. Clause (g-a) of Sub-Section (1) of Sec.3 of the Sick Industrial Companies (Special Provision) Act, 1985 defines net worth means the Sum of total paid up capital and free reserve20. Under the recent amendments to the SEBI (Disclosure and Investor Protection) [DIP] Guidelines, 2000: in clause 1.2.1, the existing sub-clause (xixa) shall be substituted by the following: (xixa) 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.21 Under ITA explanation 1of Sec.50 B defines net worth which shall be the aggregate value of total assets of the undertaking or division as reduced by the value of liabilities of such undertaking or division as appearing in its books of account: provided that any change in the value of assets on account of revaluation of assets shall be ignored for the purposes of computing the net worth. In addition explanation 2.-For computing the net worth, the aggregate value of total assets shall be, - (a) in the case of depreciable assets, the written

down value of the block of assets determined in accordance with the provisions contained in sub-item (C) of item (i) of sub-clause (c) of clause (6) of sec 43; and (b) in the case of other assets, the book value of such assets. Case Law Study on tax liability on slump sale issues This chapter focuses on major tricky issues related tax attraction in slump sale Firstly, Whether the slump price is attributable to the stock in trade? CIT v. Mugneeram Bangur & Co.22 the Supreme Court was concerned with a problem arising on the sale of going concern. The firm had sold the business as a going concern with its goodwill and all stock in trade, etc., to a company for a lump sum price. Sikri.J., held that the sale was of a whole concern and no part of the price paid was attributable to

the cost of land and no part of the price was taxable. Sikri.J., quoted Lord Phillimore observation If a business be one of purely buying and selling, like the present, a profit made by the sale of the whole of the stock, if it stood by itself, might well be assessable to income tax; but their view of the facts (if it be open to them to consider the facts) is the same as that of Stout C.J. - that is, that this was a slump transaction.23 Ulitmely court held that the sale was the sale of the whole concern and no part of the slump price is attributable to the cost of land. Secondly, whether transfer of business or an undertaking by way of slump sale constituted transfer of capital asset and whether there was any cost of acquisition of such business or undertaking or division.

In response to these issues Zuari Industries Ltd.v. ACIT24, the assessee was engaged in the business of manufacture and sale of chemicals, fertilisers and allied products as well as cement and furniture. It sold its cement division located in Andhra Pradesh to Zuari in which 50 per cent stake was held by the assessee against lump-sum consideration. This scheme was effective from April 1, 2000. In the return filed for the assessment year 200102, it stated that the net worth of the cement division, as per computation done under Section 50-B of the Act. The claim of the assessee was rejected by the assessing officer (AO). He computed the capital gains at Rs 226.443 crore. This was upheld by the

Commissioner After insertion of Section 50B in the Act, profits on transfer of such asset is chargeable to tax under the head "Capital Gains" and cost of acquisition for the purpose of Section 48 would be the net worth as computed under the provisions of Section 50B. In view of this legal position, the Learned Counsel for the Assessee, perhaps, has not seriously challenged this aspect of the matter though raised before the lower authorities. Accordingly, we hold and proceed on the footing that profit arising on the transfer of cement division by way of slump sale is chargeable to tax under the head Capital Gain.25

In paragraph 9 of tribunal decision it was said that the value of assets as per books of accounts is much more than the value of liabilities. No prudent person would have acquired the unit unless the value of assets or benefits attached to the division is more than the liability. The division was purchased since value of assets was more than the liabilities. It is because of written down value of assets Under sec 43(6)(c) of the Act, that value of depreciable assets had to be computed at substantially low figure which resulted in the value of assets lesser than liabilities but on that account net worth cannot be reduced below the Nil account since such process would be contrary to the scheme of the section itself.

Therefore, in view of the above discussion, it is held that net worth of the cement division would be taken as Nil which shall be deemed to be the cost of acquisition for the purpose of computing capital gain under Sec. 48 of the Act.26 Thirdly, Whether sale of the assets of an assessee effected for the purpose of closing down the business would be covered by that proviso and would be assessable as profit? Commissioner of Income-tax, Kerala v. B. Kalikutty and Anr27 the facts are that the assessee was running the business of plying buses. He plied the buses for some time in the previous year and sold them in that year. The question was whether the amount realised by

him in excess of their WDV up to their original cost was taxable under the second proviso to Section 10(2) (vii). The SC held that even on the assumption that the sale of business was a closing down sale or realistation sale the amount was nonetheless taxable since the sale was made after the amendment of the second proviso to Section 10(2)(vii) by Act No. 67 of 1949. In that case their Lordships held that in CIT v. Ajax Products Ltd.28 the SC clarified the position about the effect of the amendment made in 1949 in the proviso and they have also explained the impact of the amendment made in the second proviso on the three conditions laid down by the Hon'ble SC in CIT v. Express Newspapers Ltd.29. Then

their Lordships of the Supreme Court observed as follows: The words 'whether during the continuance of the business or after the cessation thereof were not present in the unamended proviso. In the two decisions cited earlier, in the absence of such words, this Court held that to attract the said proviso the machinery shall have been sold before the business was closed down. This clause omits that condition for the eligibility of the tax. Following the above decision the later decision of the SC in K.B. Kalikutty's case (supra) held that the amending words in the proviso eliminated the third condition which had been laid down for its applicability in the previous decision, vis., that the machinery shall have

been sold when the business was being carried on and not for the purpose of closing it down or winding it up.

Conclusion/Overall analysis of slump sale taxation It is an eye-catching selection for a business entity desire for selling an undertaking, knowing the involvedness drawn in grit of the costs and taxes on any such arrangement designed for the transfer of business, it is wise for parties to settle and commercially concur on the cost burden of each party at the very outset. If we look to the S. 50B overrides the Sec. which provide the mode of computation of capital gains on sale of an asset, S. 50C, providing for

substitution of sale consideration of land/building by its value as per valuation of stamp valuation authority, is not applicable where land/building is part of the undertaking. On the hand disadvantages is there is no indexation benefit is available.