Understanding Slump Sales: A Comprehensive Guide

Introduction and Meaning

• A slump sale refers to the transfer of an entire business undertaking, or part thereof, from one entity to another as a going concern. In a slump sale, all assets and liabilities of the business or part of the business are transferred together as a package, typically for a lump sum consideration. This includes tangible assets like property, equipment, and inventory, as well as intangible assets like goodwill and intellectual property rights.
• The term “slump” denotes a sale of the entire undertaking or part of the undertaking, essentially in a single transaction, without itemizing individual assets and liabilities. This approach simplifies the transfer process and minimizes legal and administrative complexities compared to traditional asset-by-asset transfers.
• Slump sales are commonly used in mergers and acquisitions, restructuring, and divestitures, as they offer certain advantages such as simplicity of transfer and potential tax benefits. However, it’s important for both the seller and the buyer to conduct thorough due diligence to ensure transparency and fairness in the transaction.

A. Framework of slump sale as per Income Tax Act, 1961

• Section 2(42C) of the Income Tax, 1961 (the ‘Act’) defines the term ‘slump sale’ as the transfer of one or more undertaking(s) for lump sum consideration. Furthermore, a slump sale does not involve values being assigned to individual assets and liabilities of the undertaking so transferred.

B. Constituents of a valid slump sale

• A sale in order to constitute a slump sale must satisfy the following tests:

i. Business is sold off as a whole undertaking and as a going concern

ii. Sale for a lump sum consideration

iii. Materials available on record do not indicate the item-wise value of the assets and liabilities transferred

a. Complexities around what would constitute transfer of whole undertaking

• Explanation 1 to section 2(19AA) of the Act defines the term ‘undertaking’ which includes any part of an undertaking, or a unit or a 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.
• Essentially, the Act emphasized that an undertaking as a whole should be transferred on a going concern basis by way of a slump sale and not individual assets and liabilities of the said undertaking. Thus, the transferred undertaking should represent an identifiable stand-alone business activity and should contain all the assets and liabilities including employees, contracts and licenses, debt or borrowing that are required for conducting such business. The transferred undertaking should have the inherent ability and potential to run the business immediately after the business transfer and also, generate revenues independently.
• A slump sale transaction does not allow an entity the ability to cherry-pick assets in an undertaking and leave out specific assets or liabilities in the business acquisition process.
• A crucial element in comprehending what qualifies as an undertaking for a slump sale has led to legal disputes at the judicial level. Indian courts, in their rulings, have established that the primary criteria for identifying an undertaking for sale include:

(i) includes the entirety of the business irrespective of separate ingredients; and

(ii) is independent of, and not reliant on, another for its functioning or operations.

• Though, all the assets and liabilities forming part of the business proposed to be sold needs to be transferred to the buyer in a slump sale, however, below judicial precedents indicate that exclusion of certain assets and liabilities could be permitted:

i. In the case of CIT vs. Max India Ltd. . [2009] 319 ITR 68 (P&H), Punjab and Haryana High Court held that it is not necessary that all assets of a business should be transferred in a transaction for it to qualify as a slump sale. However, it is essential that the assets being transferred hold the capability to become an undertaking in itself, and can function without any interruption.

ii. In the case of Rohan Software Private Limited v. Income Tax Officer [2008] 115 ITD 302 (Mum), the transaction involved the transfer of a software business by the seller to the purchaser. This transfer encompassed key assets such as know-how, technology, licenses, and employees, while expressly excluding specific assets like the premises and business vehicle. The Income Tax Appellate Tribunal (‘ITAT’) held that this transaction constituted a slump sale, as the excluded assets were deemed non-essential to the transferred business entity.

• In view of the judicial precedents and considering the intent of the law, in order to satisfy the criteria for a slump sale, the transferor should consider transferring the essential assets and liabilities of undertaking that are required for conducting business. This ensures that the transferred undertaking has the ability to run the business independently and generate revenues without relying on external support.

b. Sale is on a going concern basis

• Another important aspect of Slump sale is to ensure that the sale is on a going concern basis. While the term ‘sale’ is not defined under the IT Act, inference can be drawn from section 4 of the Sales of Goods Act, 1930 (“SOGA”) which defines a sale is a contractual arrangement where the seller transfers ownership of goods to a buyer in exchange for a monetary price. Therefore, under SOGA, the payment of monetary consideration is a fundamental requirement for a transaction to qualify as a sale.
• Since a part of an undertaking comprising of a business activity is sought to be transferred by way of a slump sale, the same is done on a ‘as is, where is’ basis. In other words, in slump sale, it is crucial that undertaking is transferred as a ‘going concern’. There should be no disruption in the operation of the transferred undertaking. Hence, it is important for the buyer to ensure that the buyer has all the requisite infrastructure, licenses and preparedness to start running the business simultaneously with the slump sale completion.
• The Institute of Chartered Accountants of India (‘ICAI’) in its implementation guide to standard on auditing has defined Going concern in AS – 1 as follows:

“The enterprise is normally viewed as a Going Concern, that is, as continuing in operation for the foreseeable future. It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of the operations.”

• The concept of going concern is an underlying assumption in the preparation of financial statements, hence it is assumed that the entity has neither the intention, nor the need, to liquidate or curtail materially the scale of its operations. If management conclude that the entity has no alternative but to liquidate or curtail materially the scale of its operations, the going concern basis cannot be used and the financial statements must be prepared on a different basis.
• The below judicial precedents also highlights that a transfer of an undertaking on a going concern basis means that the undertaking concerned is capable of being independently operated by the transferee.

i. In the matter of M/s. Manipal Health Systems Pvt Ltd vs Assistant Commissioner of Income Tax (ITA Nos. 1076, 1208 and 1209/Bang/2017), the ITAT held that wherever any left-out asset is insignificant to the Assessee’s business and the entire business has been sold as a going concern, it would be a slump sale but wherever any significant asset without which business of the Assessee could not be continued, sale of entire business leaving that asset would not be a slump sale.

ii. In the matter of Indo Rama Textile Ltd.( CO.PET. 4/2003) the Delhi High Court held that “it should constitute a business activity capable of independent operation for a foreseeable future. To ascertain its status as a going concern, the Court, while approving a Scheme, possesses the authority to scrutinize whether essential and integral assets, such as plant, machinery, and manpower, without which it would be incapable of functioning as an independent unit, have been effectively transferred.”

• In light of the aforementioned judicial precedents and the underlying legislative intent, it is imperative to understand that the transferred undertaking should possess the inherent capacity to be operated independently by the transferee/buyer over the foreseeable future when transferred under slump sale basis.

c. Consideration for slump sale

• The consideration for the slump sale has to be lump-sum in nature without attributing individual values to the assets and liabilities forming part of the transferred undertaking. In other words, the business needs to be valued as a whole in its entirety and not in parts.
• However, it is clarified that the determination of the value of an asset or liability for the sole purpose of payment of stamp duty, registration fees or other similar taxes or fees shall not be regarded as assignment of values to individual assets or liabilities for the purpose of determining the lumpsum consideration price of the undertaking.

Tax Implications on slump sale

A. Direct tax 

a. Section 50B of the Act 

• Section 50B of the Act is a special provision for computation of capital gains tax in case of slump sale and prescribes that slump sale shall be eligible to capital gains tax.
• Section 50B(1) of the Act provides that capital gains arising from transfer of any capital asset forming a part of the undertaking which is held for more than 36 months preceding the date of sale, shall be computed as Long Term Capital Gain (LTCG).
• In case, the undertaking is held for less than 36 months, then the profits and gains arising out of transfer of such an undertaking shall be Short Term Capital Gain (STCG).
• STCG chargeable as per normal rate of taxation, while LTCG is chargeable at 20%.
• Taxability shall arise in the year of transfer of undertaking by way of sale.

b. Methodology of computation of capital gain

• The gain or loss resulting from slump sale shall be a Capital Gain/(loss) under the Act as follows:

• Full value of considerations (‘FVC’) shall be deemed to be Fair Market Value (‘FMV’). The methodology for determining the FMV of capital assets is outlined in rule 11UAE(2) and Rule 11UAE(3) of the Income Tax Rules, 1962 (‘Rule’), which has been explained in point (d).

c. Methodology of computation of Net worth of undertaking

• Computation of Net worth of undertaking under the Act as follows:

 * Ignore revaluation effect

• If Net worth comes to be negative then cost of acquisition shall be taken as zero.
• In case of assets on which 100% deduction has been taken under section 35AD of the Act (specified business) and self-generated goodwill, the value of assets shall be taken as nil.
• In this regard, a report of a chartered accountant in Form 3CEA certifying that the net worth has been correctly arrived at in accordance with Section 50B of the Act is required to be submitted by the seller along with its tax returns. It is important to note here that neither Section 50B of the Act, nor Form 3CEA lays down the date as on which the net worth is to be determined. However, there have been certain rulings where the courts have held that the net worth determination should be undertaken as on the date of transfer.

d. Valuation of capital asset

• The methodology for determining FMV has been prescribed by the Central Board of Direct Taxes (CBDT). In this regard, Rule 11UAE in the Rules states that for the purpose of section 50B(2)(ii) of the Act, the FMV of capital assets shall be higher of the following:

i. The FMV1 shall be the fair market value of the capital assets transferred by way of slump sale, which is in accordance with the formula determined under Rule 11UAE(2) of Rules; or

ii. The FMV2 shall be the fair market value of the consideration received or accruing as a result of transfer by way of slump sale, which is in accordance with the formula determined in Rule 11UAE(3) of Rules.

B. Indirect Tax

a) Slump sale of business – Implications under GST

• The sale of a business as a whole, on a going concern basis, entails the transfer of all assets and liabilities of the business comprising moveable and immovable property, stock-in-trade, receivables, payables, intangibles etc. for a lump-sum consideration. The transfer of a business on a going-concern basis, as a whole or an independent part thereof, has been exempted from GST.

In essence, the framework surrounding slump sales, as discussed by the Income Tax Act 1961 and pertinent judicial precedents, underscores the importance of a comprehensive and seamless transfer of business entities. From tax implications to the nuances of GST and unutilized credits, slump sale demands careful consideration and adherence to legal and regulatory guidelines. In conclusion, recognizing and fulfilling the criteria for a valid slump sale is paramount for both buyers and sellers, ensuring a smooth transition and maximizing the benefits of this favored method of business transfer.

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The contributors to the Article are Sumit Mahajan, AccuWiz Consulting LLP along with inputs from Sonakshi Sood.

Disclaimer: The content/information is only for general information of the user and shall not be construed as legal advice. The facts stated are based on information available in public domain. Views expressed above are personal.