Treatment as per Income Tax & Ind AS on slump sale between common control entities

Treatment as per Income Tax Act and Indian Accounting Standard in case of Slump sale / Sale of Division/ sale of undertaking between entities under common control for acquirer

Common Control: Common control business combination means a business combination involving entities or businesses in which all the combining entities or businesses are ultimately controlled by the same party or parties both before and after the business combination, and that control is not transitory.

Analysis: Division controlled by same entity pre and post Sale

Accounting Treatment under Ind AS 103, Business combinations:

As per Para 9-12 of Appendix C of Ind AS mentioned below –

9 The pooling of interest method is considered to involve the following:

(i) The assets and liabilities of the combining entities are reflected at their carrying amounts.

(ii) No adjustments are made to reflect fair values, or recognise any new assets or liabilities. The only adjustments that are made are to harmonise accounting policies.

(iii) The financial information in the financial statements in respect of prior periods should be restated as if the business combination had occurred from the beginning of the preceding period in the financial statements, irrespective of the actual date of the combination. However, if business combination had occurred after that date, the prior period information shall be restated only from that date.

10 The consideration for the business combination may consist of securities, cash or other assets. Securities shall be recorded at nominal value. In determining the value of the consideration, assets other than cash shall be considered at their fair values.

11 The balance of the retained earnings appearing in the financial statements of the transferor is aggregated with the corresponding balance appearing in the financial statements of the transferee. Alternatively, it is transferred to General Reserve, if any.

12 The identity of the reserves shall be preserved and shall appear in the financial statements of the transferee in the same form in which they appeared in the financial statements of the transferor. Thus, for example, the General Reserve of the transferor entity becomes the General Reserve of the transferee, the Capital Reserve of the transferor becomes the Capital Reserve of the transferee and the Revaluation Reserve of the transferor becomes the Revaluation Reserve of the transferee. As a result of preserving the identity, reserves which are available for distribution as dividend before the business combination would also be available for distribution as dividend after the business combination. The difference, if any, between the amount recorded as share capital issued plus any additional consideration in the form of cash or other assets and the amount of share capital of the transferor shall be transferred to capital reserve and should be presented separately from other capital reserves with disclosure of its nature and purpose in the notes.

Analysis: There are 3 major points in this:

1. Since transaction between common control entities, Pooling of Interest method will apply which means that all assets and liabilities need to recognize in the books of Acquirer at book value in the books of acquire,

2. Consideration paid, if any can be calculated on the basis of fair value as well (i.e. discretion not mandatory)

3. Difference between Purchase Consideration and Net Assets in the books of acquirer (either positive or negative) need to adjust against other equity i.e. Capital Reserve and no goodwill will create in this case.

Crux: Carrying amounts of acquire become additions of acquirer after sale of division/ sale of undertaking /slump sale and difference if any between Purchase Consideration and carrying amount adjust against Capital reserve.

Eg. Assume there are 5 companies involved in this model:
Company A: Ultimate holding (outside India)
Company B: Subsidiary of Company A (Govern X Business Globally: established outside India)
Company C: Subsidiary of Company A (Govern Y Business Globally: established outside India)
Company D: Subsidiary of Company B (Carrying X & Y Business in India: established in India)
Company E: Subsidiary of Company C (Carrying y Business in India: established in India)

Major decisions apart from ordinary business govern by their holding companies (outside india subject to permission of ultimate holding)

Company D transferred Y Business under slump sale to Company E in Cash (in other words sale of undertaking)

Balance sheet of D (in Books)

Suppose Purchase Consideration is 100, In this net assets recognized in the books of E related to acquisition of Division and balance 25 transferred to capital reserve.

Treatment under Income Tax Act for acquirer:

Explanation 3 to Sec 43(1): Where, before the date of acquisition by the assessee, the assets were at any time used by any other person for the purposes of his business or profession and the Assessing Officer is satisfied that the main purpose of the transfer of such assets, directly or indirectly to the assessee, was the reduction of a liability to income-tax (by claiming depreciation with reference to an enhanced cost), the actual cost to the assessee shall be such an amount as the Assessing Officer may, with the previous approval of the Joint Commissioner, determine having regard to all the circumstances of the case.(Referred Case: In the ITAT Bangalore Bench ‘A’, Sanyo BPL(P.) Ltd. v/s CIT, Circle-12(3), Bengaluru)

Explanation 6 to Sec 43(1): When any capital asset is transferred by a holding company to its subsidiary company or by a subsidiary company to its holding company, then, if the conditions of clause (iv) or, as the case may be, of clause (v) of section 47 are satisfied, the actual cost of the transferred capital asset to the transferee-company shall be taken to be the same as it would have been if the transferor-company had continued to hold the capital asset for the purposes of its business.

Explanation 7 to Sec 43(1): Where, in a scheme of amalgamation, any capital asset is transferred by the amalgamating company to the amalgamated company and the amalgamated company is an Indian company, the actual cost of the transferred capital asset to the amalgamated company shall be taken to be the same as it would have been if the amalgamating company had continued to hold the capital asset for the purposes of its own business.

Deduction of Bad Debts allowed: CIT v/s T Veerabhadra Rao, K Koteswara Rao and Co.,155 ITR 152 (SC)

Continuation of tax Benefits related to transferred undertaking: Eg. 80HH, 80IA

No Creation of Intangible asset in this transaction: In the ITAT Bangalore Bench ‘A’, Sanyo BPL (P.) Ltd. v/s CIT, Circle-12(3), Bengaluru

Analysis: Except in case of transfer between common control entities, buyer is free to adopt his purchase cost as the ‘original cost’ for the purpose of claiming depreciation under Income tax act. Even in the case of slump price paid by the buyer, he can on the basis of technical evaluation, ascribe values segregating the slump price into price for different assets for the purpose of claiming depreciation.

But as far as transfer between common control entities is concerned, it has been specifically provided under section 43 that both the “actual cost” and “written down value” will be same as in the hands of acquire company.

Crux: In Income Tax Return of Acquirer, Actual Cost is equal to WDV in books of Acquire and same treatment with liability which means that there is neither upward nor downward in the net assets of acquire company while preparing income tax return of acquirer.

Eg. Balance sheet of D (as per Income Tax)

Suppose Purchase Consideration is 100, in this Actual cost in Income tax return of E is equal to WDV in Income Tax Return of D i.e. 75 and liabilities at 25.