Plugging loopholes within Section 50B governing Slump Sale Transactions : Amendments by Finance Act, 2021
This presentation would aim to simply explain what a slump-sale is and proceed to explain the concept of a slump sale in a tax perspective due to several issues faced pertaining to the tax-computation mechanism of a slump sale and the confusion surrounding certain methods of slump transfers and whether they can qualify as a slump sale and the recent amendments by Finance Act, 2021.
What is a slump sale?
a. Basic understanding of slump sale
A slump sale, also referred to as a business transfer, is the transfer of a business undertaking as a whole, on a ‘going concern’ basis, wherein the acquirer wants to acquire the whole setup of a business undertaking along with all assets and liabilities of the target company but, without acquiring the target company which houses the business.
b. Legal understanding of slump sale
1. Slump sale is purely a tax concept governed by Section 50B and Section 2(42C) of the Income Tax Act, 1961.
2. Section 2(42C) of the Act defines slump-sale as follows: “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”. The prerequisites to a business transfer being in the nature of slump sale will be – a) transfer of a business undertaking, b) by way of sale, c) for a lump sum consideration and c) without values being assigned to the individual assets and liabilities.
c. Commercial understanding of of slump sale
1. The acquirer wants to quickly diversify into a new business or wants to expand its existing business at a new location (an asset sale could be preferred but, target companies do not prefer asset sale owing to its tax disadvantage wherein capital gains are required to be paid individually on each asset);
2. The seller wants to segregate their core company operations from its non-core operations;
3. A company wants to separate one of its businesses to enable private equity investment into that particular division of business; or
4. In case of non-corporate entities, such as partnership firms, sole proprietors, Hindu undivided families, trusts, an association of persons and co-operative society slump sales would be one of the few options available for transfer of the business undertaking since they are not eligible for court-approved demergers.
d. Definition of business
In legal parlance, a business is called an ‘undertaking’ of a company. The term ‘undertaking’ has been defined in the Income Tax Act, 1961 for the purpose of determining and computing the capital gains arising out of a business transfer and under the Companies Act, 2013 for outlining the decision-making process of a company pertaining to the business transfer which acts as the corporate authorization allowing the transfer of business.
e. Section 2(19AA): Income Tax Act, 1961
The term “undertaking” includes (a) any part of an undertaking, or (b) a unit or division of an undertaking or (c) a business activity taken as a whole, but does not include individual assets or liabilities or any combination thereof not constituting a business activity.
Need for special provisions for a slump-sale under the Income Tax Act, 1961
1. Section 50B was inserted to provide the computation mechanism of capital gains in case of a slump sale. Section 50B deems the ‘Net Worth’ of the business undertaking as to the ‘Cost of Acquisition’ for the purposes of capital gains computation in a slump sale. Net-worth, for this purpose, would be the – ‘Difference between the ‘Book Value of Assets’and ‘Book Value of Liabilities’. In the case of depreciable assets, the written down value of such assets would be taken as the book value.
2. However, certain questions still remained unanswered post the introduction of Section 50B with respect to the valuation of intangible assets like the business goodwill, whether a slump sale can be structured as a slump exchange or any other transfer mechanisms mentioned in Section 2(47) of the Income Tax Act. All these issues will be addressed in the later sections of this presentation.
Capital gains calculation under Section 50B
As mentioned above, a special computation mechanism was put in place for calculating the capital gains arising out of a slump sale. The key factors of computing capital gains arising out of slump sale are:
1. The capital gains are taxed in the year an undertaking is transferred and the capital gains tax levied is upon the difference between the sales consideration and the cost of acquisition wherein the cost of acquisition is deemed the “net worth” of the undertaking for the purpose of Section 50B.
2. If an undertaking is held for more than 36 months, it would be a long-term capital asset and capital gains tax rate of 20% (excluding surcharge/ cess) would apply and if capital assets are held for less than 36 months, it would deem to be short-term capital gains tax capped at a rate of 15–30 % (excluding surcharge/cess), depending on the nature of shares and securities.
Parameters to make your business transfer a slump sale?
There are three parameters which if satisfied would bring your business deal under the ambit of Section 2(42C) of the Income Tax Act, 1961.
Transfer of an undertaking
1. As discussed above, an undertaking is primarily a business of a company which even if separated from the company can continue with its function and operations immediately after the business transfer and falls under the definition of an ‘undertaking’ under Section 2(19AA) of the Income Tax Act, 1961.
2. What additionally needs to be kept in mind is that all assets and liabilities of the undertaking are transferred ‘as is’ on a going concern basis to the acquirer. In other words, the acquirer is not at the liberty to cherry-pick the assets of an undertaking that they find desirable and leave the remaining assets or liabilities out of the business acquisition process.
3. Although, certain clarifications have been made by various income tax tribunals concerning the requirements of transferring all assets and liabilities of an undertaking in a slump sale:
Simply put, it isn’t necessary to transfer all assets and liabilities for a business transfer to qualify as a slump sale. However, the assets and liabilities that are being transferred should be able to form an undertaking or part of an undertaking or a unit or division of an undertaking or a business activity taken as a whole by themselves and the business operations of that undertaking should be able to instantly resume after the business transfer is consummated.
Lump sum consideration
1. The consideration for slump sale has to be a ‘lump-sum’ figure without attaching individual values to the assets and liabilities which are forming part of the business undertaking. In other words, the business needs to be valued as a whole in its entirety and not in parts.
2. However, it is clarified that the values of an asset or liability can be individually ascertained but this should be done only for the purpose of payment of registration fees, stamp duty or other similar taxes or fees and this shall not be regarded as an assignment of values to individual assets or liabilities for the purpose of determining the lump sum consideration price of the business undertaking.
Transfer by way of sale
[Slump exchange=slump sale]
1. The “sale” parameter has been the most contentious and litigated parameter of a slump sale. Although, it now stands amended by the Finance Act, 2021 and is replaced with the words “transfer by any means”, which will be discussed under the next section of this presentation. But, keeping into consideration the decades of litigation and interpretations of courts and tribunals which revolved around this one word – ‘sale’, it is only fair to discuss it under this presentation.
2. The decades of litigation and interpretation surrounding slump-sale is owing to a lot of businesses structuring their business transfer as an exchange wherein the consideration paid in lieu of the business transfer is not monetary consideration but payment by the buyer in the form of non-monetary considerations (issue of shares/debentures etc.) (“slump exchange”). This mechanism was adopted by many companies to escape the ambit of Section 50B and thereby, avoid the payment of capital gains tax. This was backed up with the contention that an ‘exchange’ cannot be deemed a ‘sale’ as they are different modes of transfer in law and are addressed separately under Section 2(47) of the Income Tax Act.
3. Thus, a lot of ambiguity surrounded slump-sale, as a matter of law, specific to the issue of whether the consideration amount in a business transfer can be paid in kind and yet, fall under the definition of a slump-sale under Section2(42C) of the Income Tax Act.
High Courts and Tribunals approach
Areva T&D India Ltd. v. CIT (Madras High Court )
CIT v. Bharat Bijlee Limited (Bombay High Court)
Hence, to sum it all judgements and interpretation, the general view was that, even if not in whole, the presence of at least some monetary consideration is mandatory for business transfer to constitute as a sale. In the absence of any monetary consideration at all, a slump transfer cannot be deemed to be a slump sale for the purpose of Section 50B.
Plugging loopholes within Section 50B: Recent amendments by Finance Act, 2021
As discussed above, slump-sale has been a highly litigated matter across numerous states in India. However, the recent amendments made to the Income Tax Act and Income Tax Rules by the Finance Act, 2021 gazetted on March 28, 2021, has put to rest decades of arguments between businesses and income tax assessing officers as to whether a slump exchange should fall within the ambit of Section 50B or not.
Modifications introduced to slump sale
The new definition of slump sale states as follows: “transfer of one or more undertakings by any means for a lump-sum consideration without values being assigned to the individual assets and liabilities”. This new definition now allows the transfer of a business undertaking not only ‘by way of sale’ but also ‘by way of an exchange’ or any other transfer structure defined in Section 2(47) of the Act to be included within its scope.
While computing the ‘net worth’ of an undertaking which is then deemed ‘cost of acquisition’ under Section 50B, the insertion of Explanation 2(aa) of Section 50B clarifies that the value of any goodwill of business or profession (other than goodwill acquired by purchase from a previous owner) would need to be taken as NIL.
Prior to Finance Act 2021, the full value of consideration was the lump sum value agreed which was considered while computing capital gains for slump sales.
Post Finance Act 2021, a new clause in Subsection 2 of Section 50B has been inserted, where “Fair market value of the capital assets as on the date of transfer, calculated in the prescribed manner, shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of such capital asset.”
The CBDT notified Rule 11UAE under the Income Tax Rules 1962, vide its Notification dated 24th May, 2021, for the computation of fair market value of capital assets in case of a slump sale.
For the purpose of section 50B (2)(ii), The fair market value of the capital assets shall be the higher of
> FMV1 determined under Rule 11UAE (2) or
> FMV2 determined under Rule 11UAE (3)
FMV 1 shall be the fair market value of the capital assets transferred by way of slump sale
FMV2 shall be the fair market value of the consideration received or accruing as a result of transfer by way of slump sale
FMV Computation for Sales Consideration in Slump Sale
|FMV1 = A + B + C + D – L|
|Meaning : The fair market value of the capital assets transferred by way of slump sale|
|A||Book value of Assets (other than jewellery, artistic work, shares, securities and immovable property) as appearing in the books of accounts of the undertaking minus the following amount which relate to such undertaking:
i) any amount of income-tax paid, if any, less the amount of income-tax refund claimed if any; and
ii) any amount is shown as asset including the unamortised amount of deferred expenditure which does not represent the value of any asset.
|B||The price which the jewellery and artistic work would fetch if sold in the open market on the basis of the valuation report obtained from a registered valuer.|
|C||The fair market value of shares and securities is determined in the manner provided in sub-rule (1) of Rule 11UA.|
|D||The value adopted or assessed or assessable by any authority of the Government for the purpose of payment of stamp duty in respect of the immovable property|
|L||The book value of liabilities as appearing in the books of accounts of the undertaking or the division transferred by way of slump sale, but not including the following:
i) Paid-up equity share capital;
ii) The amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared before the date of transfer at a general body meeting of the company;
iii) Reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation;
iv) Any amount representing provision for taxation, other than amount of income-tax paid, if any, less the amount of income-tax claimed as refund, if any, to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto;
v) Any amount representing provisions made for meeting liabilities, other than ascertained liabilities;
vi) Any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares.
|FMV2 = E + F + G + H|
|Meaning : Fair market value of the consideration received or accruing as a result of transfer by way of slump sale|
|E||The value of the monetary consideration received or accruing as a result of the transfer.|
|F||The fair market value of non-monetary consideration received or accruing as a result of the transfer for property referred in Rule 11UA(1) determined as per the manner provided in Rule 11UA(1).|
|G||the price which the non-monetary consideration received or accruing as a result of the transfer represented by property, other than immovable property, which is not referred to in sub-rule (1) of rule 11UA would fetch if sold in the open market on the basis of the valuation report obtained from a registered valuer, in respect of property;|
|H||The value adopted or assessed or assessable by any authority of the Government for the purpose of payment of stamp duty in respect of the immovable property in case the non-monetary consideration received or accruing as a result of the transfer is represented by the immovable property|
Tabular Representation of Computation of FMV 1
|Value of Assets side||Rs. xxx|
|Less: The following assets|
|Shares and Securities||(-)xxx|
|Income Tax Paid – Income Tax Refund Claimed||(-)xxx|
|Book Value of Assets||Value of ‘A’ in the formula||Rs. xxx|
|Market Price of Jewellery, Artistic Work based on valuation report||Value of ‘B’ in the formula||Rs. xxx|
|Value of Shares and Securities as per Rule 11UA(1)||Value of ‘C’ in the formula||Rs. xxx|
|Value of Immovable Property considered to calculate Stamp Duty||Value of ‘D’ in the formula||Rs. xxx|
|Value of all Assets [A1]||A + B + C + D||Rs. xxx|
|Value of Liabilities side||Rs. xxx|
|Less: The following|
|Paid-up equity share capital||(-)xxx|
|Reserves and Surplus||(-)xxx|
|Provision for Tax||(-)xxx|
|Provision for unascertained liabilities||(-)xxx|
|Contingent Liabilities||Already Not covered|
|Value of Net Liabilities [A2]||Rs. (-)xxx|
|FMV 1 [A1 – A2]||As per Rule 11UAE(2)||Rs. xxx|
Tabular Representation of Computation of FMV 2
|E. value of the monetary consideration||Rs. xxx|
|F. If a property is covered under Rule 11UA(1):
b) Archaeological collections, drawings, paintings, sculptures or any work of art.
c) Shares and Securities
|Value determined as per
|G. Any other movable property not covered under Rule 11UA(1)||At Market value Based on valuation report||Rs. xxx|
|H. Immovable Property||Value considered to calculate
|FMV2||E + F +G + H||Rs. xxx|
Section 50B of the Income Tax Act, 1961 is the governing provision for slump sale. Section 50B failed in certain ways owing to its inability to clarify whether slump exchange can be a slump sale and if yes, what will be the computation mechanism for non-monetary considerations. The majority of the courts and tax tribunals were of the opinion that in the absence of any monetary consideration, a slump transfer cannot be deemed to be a slump sale for the purpose of Section 50B.
The loopholes in Section 50B were finally plugged the recent amendments made to the Income Tax Act and Income Tax Rules by the Finance Act, 2021 gazetted on March 28, 2021 which clarified that a business transfer can be through any means of transfer as provided in Section 2(47) of the Income Tax Act and just through the sale.
It also made provisions to enable the taxation of slump exchange by introducing the computation mechanism under Rule 11UAE which now captures not only monetary considerations but non-monetary considerations as well. The Rule 11UAE under the Income Tax Rules, 1962 prescribe the valuation method of slump exchange as per the Net Asset Value (NAV) method and the seller will have to pay tax on the fair market value as computed as per Rule 11UAE even if the actual consideration received is less than the fair market value of capital assets.