Taxing Times Ahead for Slump Sale Transactions

Slump sale transactions are a preferred method of transferring a business as a going concern. They are often used for internal restructuring purposes and for sale of a whole or part of a business undertaking to a third party. Several global transactions also comprise of a slump sale element to execute the transfer of the Indian business to the buyer’s affiliate in India. In a slump sale, a business undertaking is transferred by one party to another as a going concern for a lumpsum consideration, without attributing specific values to assets and liabilities. They could be executed at book value or fair value or any negotiated price. It is very common for slump sale transactions that involve internal restructuring to be undertaken at book value. Also, in global sale transactions, where India is only one part of the global business, it is common for the India business to be transferred by way of a slump sale at minimal consideration/ book value of the assets. It used to be a preferred method of transfer as it was easy to execute and not complex from a taxation perspective either. However, a recent retrospective amendment to the Income Tax Act, 1961 (“IT Act”), by way of the Finance Act, 2021, may change things for such transactions.

Firstly, the definition of slump sale has been modified to make it wider. Earlier, only transfer of a business undertaking through a ‘sale’ was considered as slump sale. The definition has now been amended to state that transfer of an undertaking through any means would be considered as slump sale. This amendment nullifies the ratio of the Bombay High Court in the case of CIT v. Bharat Bijlee Ltd., (2014) 365 ITR 258, wherein it was held that transfer of a business undertaking against issuance of bonds or preference shares was not a sale, but an exchange; and, therefore, slump exchange transactions could not be regarded as slump sale as defined under Section 2(42C) of the IT Act and accordingly, cannot be taxed under Section 50B of the IT Act. The modified definition brings slump exchanges also within the purview of the definition of a slump sale under the IT Act.

Secondly, under Indian tax laws, a slump sale transaction is subject to short/ long term capital gains tax, depending on the period for which the undertaking is held by the Seller. It is not subject to any indirect taxes such as GST. Prior to the recent amendment, capital gains tax was calculated as the difference between the sale consideration and the ‘net worth’ of the undertaking. The sale consideration as indicated above was the lumpsum consideration for which the business was transferred. The ‘net worth’ of the undertaking was calculated based on the book value of assets forming part of the undertaking. If the lumpsum sale consideration was equal to or lower than the net worth of the undertaking, then there was no capital gains tax payable.

Under the new Section 50B of the IT Act, which came into effect on April 1, 2021, retrospectively from April 01, 2020, a deemed concept has been introduced for determining the sale consideration. Irrespective of what is agreed contractually, for income tax purposes, the sale consideration is deemed to be the fair market value (“FMV”) of capital assets as on the date of transfer, calculated in the prescribed manner. The Central Board of Direct Taxes (“CBDT”) has notified the rules for determining the deemed sale consideration through the introduction of Rule 11UAE of the Income tax Rules, 1962 (“Rule”). The Rule provides for two methods to compute the FMV of the capital asset transferred by way of slump sale. While one method takes into account the actual sale consideration paid, the other method determines the sale consideration by assigning values to specific assets. The higher of the two values is deemed to be the sale consideration received by the seller from the transfer of its undertaking.  Contrary to the spirit of slump sale transactions where individual values are not assigned to specific assets that form the business undertaking, the Rule prescribes fair valuation of individual assets that are subsequently aggregated. For example, fair value of immoveable properties is based on stamp duty values. Fair value of shares is based on adjusted book value of the company and fair value of other securities (preference shares and debentures) are based on the valuation report obtained from a merchant banker. The FMV so derived will be deemed to be sale consideration. This may lead to incongruous situations as the value of the business undertaking as a whole, as a going concern is not reckoned. The ‘net worth’ of the business undertaking, as mentioned earlier, will be computed based on the book value of the assets forming part of the undertaking, which will be considered as the cost of acquisition of the undertaking. The difference between the FMV and the ‘net worth’ will be subject to capital gains tax. This is likely to lead to higher capital gains tax incidence in the hands of the Seller.

Prior to the amendment, unless the Seller entity was a listed company, valuation reports were not necessary for slump sale transactions that were a part of internal restructuring or global transactions. However, due to the recent modifications to the Income Tax Act, all slump sale transactions will now require a fair valuation report for determining deemed sale consideration, which needs to be computed as per the prescribed methodology.

The recent modifications will increase the transaction cost of slump sale transactions – especially for undertakings that are heavy on immoveable assets or securities. For internal restructuring, such as spin offs or subsidiarisation, it is likely that parties may now prefer a demerger rather than a slump sale, if the tax incidence is high. For global transactions, which have an India piece, it is possible for the India leg of the transaction to be executed as a slump sale at book value, so long as capital gains tax is paid on fair value.