Slump Sales: A Comprehensive Guide to Structuring Deals for Success

Slump Sale – Section 50B of Income Tax Act, 1961

The terms, ‘business transfer’ and ‘slump sale’ are used interchangeably in the Indian context and both refer to transfer and sale of an entire business undertaking of the seller on a going concern basis for a lump-sum consideration. In India, ‘Slump sale’ is purely a tax concept and the Income-tax Act, 1961 (“ITA”) defines a slump sale under Section 2 (42C) as :

“Slump sale” means 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.

The term “undertaking” has the same meaning as in Explanation 1 to Section 2(19AA) defining ‘demerger’. As per Explanation 1 to Section 2(19AA):

“Undertaking” includes any part of an undertaking, a unit or division of an undertaking, or a business activity taken as a whole. However, it does not include individual assets or liabilities or any combination thereof that does not constitute a business activity.

Analysis of the above definition :

1. Undertaking can be a Body Corporate, Firm, Proprietorship, Etc.

2. Undertaking can comprise one or more than one businesses of the Seller.

3. Entire Business should be transferred under the slump sale by assigning value to the entire business undertaking rather than assigning value to individual asset and liability.

Examples:

Case 1 – XYZ Firm plans to sell its entire business to a company interested in purchasing the entire business for Rs. 1 Cr as consideration. Since Rs. 1 Cr is a lump-sum consideration received for the entire business.

It would be treated as a Slump Sale.

Case 2 – XYZ Firm plans to sell its entire business to a company interested in purchasing the entire business for Rs. 1 Cr. In the agreement, the consideration is categorically assigned against each asset and liability as follows:

Movable Property – 40L

Sundry Debtors – 30L

Immovable Property – 1 Cr

Loan & Liabilities  – (70L)

In this case, since the firm has categorically assigned the consideration to each asset and liability, it won’t be treated as a Slump Sale. Instead, it will be considered an Asset/Liability Sale, and tax will be calculated on an individual asset and liability basis, considering the period of holding of each individual asset/liability.

To ensure that consideration is not assigned to individual assets and liabilities, the following paragraph can be specified in the Slump Sale Agreement:

“Consideration payable to the Seller by the Buyer for the purchase consideration of the Business Shall be Rs. [.] (Amount in Figures) (“Purchase Price”)”.  

4. All assets and liabilities related to the business must be transferred to the Buyer; there can be no exceptions.

However, assets or liabilities unrelated to the business being taken over by the Buyer can be retained by the Seller and need not be transferred to the Buyer. (One should consult their legal consultant as the Income Tax Officer may, at their discretion, term a particular asset or liability as related to the business. If it is not transferred to the Buyer, it won’t be treated as a Slump Sale.)

5. Business should be transferred as Going concern all the licenses/permits required to run the business should also be transferred to the Buyer.

A) Taxability of the Slump Sale:

Indirect Taxes:

The Slump Sale transaction is not subject to any Indirect tax as services by way of transfer of a going concern, as a whole or an independent part thereof is exempted as per serial no. 2 of Notification No. 12/2017- Central Tax (Rate) dated 28th June, 2017.

Income Tax : 

1. Capital Gain on Slump Sale –

Profits from a slump sale are treated as capital gains from the transfer of long-term capital assets, deemed to be income of the year in which the transfer occurs. For purposes of computing capital gains from a slump sale, the net worth of the undertaking is deemed to be the cost of acquisition.

CBDT vide Notification No.68/2021 dated 24/05/2021 notified Rule 11UAE of the Income Tax Rules, 1962 to compute the Fair Market Value (FMV) of Capital Assets for the purposes of section 50B of the Income-tax Act, 1961 for the purpose of computing the capital gains in case of an exchange of assets in a slump sale.

Rule 11UAE provides that FMV of the undertaking, transferred by way of slump sale, for purpose of capital gains computation, shall be higher of:

a. FMV1 – FMV of the capital assets transferred by way of slump sale determined as per formula prescribed; or

b. FMV2 – FMV of the consideration received or accruing as a result of transfer by way of slump sale determined as per formula prescribed.

Computation of FMV1 – FMV of capital assets transferred by way of slump sale is as follows :

**Book value – Book value according to income tax records. 

Computation of FMV2 – FMV of consideration received or accruing as a result of transfer of undertaking under slump sale is as follows :

 ∴ FVOC = FMV 1 or FMV 2 Whichever is Higher 

Computation of Networth = Asset (-) Liabilities

 Key points to be considered while calculating Net worth –

a. Revaluation of Assets shall be ignored.

b. Value of self generated goodwill should be considered as NIL

Computation of Capital Gains under Slump Sale :

 Long-Term vs. Short-Term Capital Gain: 

2. Withholding of Taxes 

a.) Buyer is not obligated to withhold any taxes at source (TDS) because the sale doesn’t involve specific asset transactions. They simply pay the agreed-upon sale consideration to the seller.

b.) Seller is also not obligated to collect TCS (Tax collected at source) as TCS applies to the sale of specific goods exceeding a certain threshold, as per Section 206C(1H) of the Income Tax Act & slump sale involves transferring an entire business undertaking as a whole, not individual goods.

B.) Factors to be considered before/after entering into Slump Sale Arrangement – 

1. Business Transfer (Slump Sale) Contract factoring the below clauses : 

a. Employee Transfer – When considering a slump sale agreement, ensuring a smooth transition for your employees is critical.

• • • Respect for Choice: Employees have the right to decide if they want to transfer to the new owner. This clause ensures they are not forced into a new situation.
    • Reduced Anxiety: Clear communication through meetings with buyer representatives helps address employee concerns and fosters a sense of security.
    • Job Security: Formal employment offer letters guarantee clarity on terms and future employment, minimizing disruption and uncertainty.

b. Non – Compete Clause – A non-compete/non-solicitation clause protects both parties. It safeguards the buyer’s investment by limiting seller competition and preserving customer/employee relationships. This ensures a fair transaction for both.

c. Representations and Warranties – A Representation and Warranties (R&W) clause in a slump sale agreement is vital for both the buyer and seller. It acts as a safety net by clearly outlining expectations and potential consequences for any misrepresentations.

Buyer : Ensured disclosure (financials, legal) and recourse for hidden problems.

Seller : By clearly outlining the business’s condition through warranties, Seller minimize the risk of unexpected lawsuits or claims from the buyer after the sale.

d. Indemnity – This indemnity clause shields the buyer in a slump sale. It protects them from pre-sale liabilities, seller misrepresentations, and a wide range of potential issues (taxes, debts, legal claims). The seller must compensate the buyer for any losses within 30 days.  This clause is independent of other legal rights and remains in effect even after the agreement ends.  Overall, it minimizes risk and ensures financial recourse for the buyer. 

2. Novation Deed : A novation deed is a legal document that formally releases the seller from obligations under existing contracts and replaces them with the buyer. In simpler terms, it allows the buyer to “step into the shoes” of the seller regarding specific contracts. A valid novation deed requires written consent from the seller, buyer, and the other party to the contract.

3. Valuation Certificate : CA Certificate certifying Net worth calculation as per section 50B and Full Value of Consideration (FVOC) as per Rule 11UAE of the Income Tax Act is crucial.

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If the FVOC exceeds the net worth of the company calculated as per section 50B, it is advisable to obtain a valuation report from a Merchant banker to justify the FVOC.

4. Furnishing of Form 3CEA : Form 3CEA is a report prepared by a Chartered Accountant (CA) that calculates capital gains arising from a slump sale. As per Section 50B of the Income Tax Act, 1961, this form needs to be submitted electronically along with the income tax return if a business undergoes a slump sale.

5. Stamp Duty Payment : A slump sale agreement acts as a legal document recording the transfer of ownership of an entire business unit. Proper stamp duty payment ensures the agreement is recognized by the courts, making it legally enforceable. Without it, the agreement might be deemed invalid, potentially jeopardizing the entire transaction.

C.) Goodwill on Purchase of Business : If the Full value of consideration paid by the buyer is more than Net worth of the Selling company usually the differential amount is treated as “Goodwill” in the books of the Buyer however it is noteworthy to note that the depreciation on the above “Goodwill” recognised by the Buyer is not allowed as deduction under the Income tax act, 1961.