India: Can A Slump Sale Carve-Out Certain Assets And Liabilities?

This article addresses whether transactions excluding certain identified assets and, or, liabilities will qualify as a slump sale under the Income Tax Act, 1961.

The Income Tax Act, 1961 (Income Tax Act) defines slump sale¹ as a transfer of an 'undertaking' for a lumpsum consideration where no value is assigned to the assets and, or, liabilities being sold. A sale of assets and liabilities is not necessarily a slump sale unless it amounts to the sale of an undertaking as a going concern for a lumpsum consideration².

Commercially, sellers prefer slump sales over itemised sales in view of the tax efficiencies of a slump sale.³

Going Concern and Undertaking

Meaning of 'Undertaking'

The Income Tax Act defines 'undertaking' for the purpose of inter alia a slump sale as "...any part of an undertaking, or a unit or 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..."⁴.

Indian courts have held that the principal tests of an undertaking⁵ is whether the undertaking being sold: (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 operations⁶.

While the Revenue authorities in Commissioner of Income-Tax v. Narkeshari Prakashan Limited⁷ contended that a publishing house selling 1 of its 2 branches cannot be treated as a sale of an undertaking for the purpose of a slump sale, the Bombay High Court held that the sale was of the entire business, as a whole, as the branches were independent and could function without each other⁸.

Meaning of 'Going Concern'

The Income Tax Act does not define 'going concern'. The Institute of Chartered Accountants of India in its Implementation Guide to Standard on Auditing⁹ explains that an enterprise is a 'going concern' when it is continuing in operation for the foreseeable future.

Indian courts have held that a transfer of an undertaking on a going concern basis means that the undertaking concerned is capable of being independently operated by the purchaser¹⁰. The Delhi High Court in Indo Rama Textile Ltd.¹¹ held that "...To ensure that it is a going concern, the Court while sanctioning a Scheme can certainly examine whether essential and integral assets like plant, machinery and manpower without which it would not be able to run as an independent unit have been transferred..."¹²

Exclusion of Employees in Business Transfers

For a business transfer to constitute a 'slump sale' it must be a transfer on a going concern basis and, accordingly, the business must be capable of being run independently by the purchaser for the foreseeable future.

Consequently, where all, or a sizeable number of, employees are excluded from the business transfer, Indian courts have held that the transfer is not on a going concern basis¹³ and, consequently, not a slump sale¹⁴.

Exclusion of Assets and, or, Liabilities in Business Transfers

While parties may negotiate for exclusion of certain assets and liabilities from the purview of a business transfer, there remains uncertainty on whether a sale of an undertaking which excludes certain identified assets and, or, liabilities can nonetheless qualify as a slump sale under the Income Tax Act.

Exclusion of all Liabilities in Business Transfers

It is a fairly established position that where all liabilities of a business are excluded from the transfer, the transfer will not qualify as a slump sale. In Kampli Co-operative Sugar Factory Ltd. V. Joint CIT¹⁵ where only the assets of the undertaking were sold, the Income Tax Appellate Tribunal negated that the sale did not qualify as a slump sale¹⁶.

Exclusion of Identified Assets and, or, Liabilities in Business Transfers

Where identified assets or liabilities are excluded in business transfers for lumpsum consideration, the business transfer will not qualify as a slump sale if such exclusion results in: (i) the business being transferred not constituting an 'undertaking'; and, or, (ii) the transfer not being on a 'going concern' basis.

Exclusion of Liabilities in Business Transfers

The Supreme Court in Commissioner of Income Tax Central Calcutta v. Mugneeram Bangur¹⁷held the sale of business by way of a going concern along with its goodwill and all stock-in-trade to be a slump sale notwithstanding the exclusion of seller's liabilities in respect of limited matters being: "...income-tax, super-tax or any other tax or duty on income or revenue in respect of the profits of the business..."¹⁸.

Similarly, the Delhi High Court in Triune Projects Private Limited v. Deputy Commissioner of Income Tax¹⁹ held that the exclusion of certain defunct assets and bad debts will not affect the slump sale nature of a business transfer. For completeness, we quote²⁰ "...To expect a purchaser to buy and pay value for defunct or superfluous assets flies in the face of commercial sense...".

Exclusion of Assets in Business Transfers

In Rohan Software Pvt. Ltd. v. Income Tax Officer²¹, the seller sold a software business to the purchaser. The sale included inter alia know how, technology, licenses as well as employees, but excluded certain identified assets such as the premises as well as the car used for the business. The Income Tax Appellate Tribunal held that the sale will constitute a slump sale as the assets excluded were not integral to the business transferred.²²

In summary

Sellers seeking the beneficial tax treatment available on slump sales must ensure that the transaction framework for the business transfer addresses that: (i) the business transferred constitutes an 'undertaking' i.e. an independently functioning business unit; (ii) the business once transferred must be capable of being run independently by the purchaser; and, finally, (iii) the consideration must be lumpsum (the whole or part, of which is not attributable to any identifiable asset and, or, liability of the concerned undertaking)²³.

The determination as to whether exclusion of certain identified assets or liabilities results in deviations from the principles above will necessarily be subject to inter alia the nature of the business being transferred, and the nature of assets and liabilities proposed to be excluded. This determination is a matter of detail, and we recommend that this is closed between the parties as early as possible to mitigate protracted negotiations.

Footnotes

1. Per Section 2(42C) of the Income Tax Act,1961 slump sale means "...the transfer of one or more undertaking, by any means, for a lump sum consideration without values being assigned to the individual assets and liabilities in such sales.

Explanation 1.—For the purposes of this clause, "undertaking" shall have the meaning assigned to it in Explanation 1 to clause (19AA).

Explanation 2.—For the removal of doubts, it is hereby declared 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.

Explanation 3.—For the purposes of this clause, "transfer" shall have the meaning assigned to it in clause (47);...".

2. Commissioner of Income Tax Central Calcutta v. Mugneeram Bangur AIR 1966 SC 50, see paragraph 6.

3. For a slump sale, the sellers will be subject to long term capital gains tax per Section 50B of the Income Tax Act whereas in the event of an itemised sale, the tax liability of the sellers will be on the capital gains on every individual asset and liability transferred (which could be long term or short term). Additionally, there are GST benefits to the seller in a slump sale.

4. Explanation-1 of Section 2(19AA) of the Income Tax Act.

5. In Halsbury's Laws of England, 3rd Edn., Vol. 6, Art. 75 at p. 43, undertaking is explained as "...Although various ingredients go to make up an undertaking, the term describes not the ingredients but the completed work from which the earnings arise...".

6. Rustom Cavasjee Cooper v. Union of India, [1970] 40 Comp Cases 325 (SC).

7. (1970) 1 SCC 248.

8. In Asst. Commissioner of Income Tax v. Devi Sea Foods Limited (2020) 183 ITD 341 a sale involving a sale by the assessee of 3 windmills to another entity ostensibly through a slump sale, was held to be a slump sale. The Tribunal taking note of the fact that the sale included both the assets and liabilities noted that a "...separate undertaking is one which can be separated from the business unit and both the business units should be run separately, independent of each and they should not be dependent on each other...", see paragraph 6.1.

9. (SA) 570 – available at (https://resource.cdn.icai.org/56366aasb44686sa570.pdf) and last accessed at 1200 hours on 4 January 2023. See paragraph 1.3.

10. See inter alia Indo Rama Textile Ltd (2012) 110 CLA 1 (see paragraph 40), Rajashri Foods Pvt. Ltd. KAR ADRG 06 / 2018 (paragraph 9) and In Re: SCV Sky Vision AAR No. 04/AP/GST/2021 (see paragraph (B))

11. (2012) 110 CLA 1- This judgement was not in context of a slump sale, but a modification application for a scheme of demerger.

12. Indo Rama Textile Ltd (2012) 110 CLA 1, see paragraph 41.

13. In In Re: SCV Sky Vision AAR No. 04/AP/GST/2021, the seller and the purchaser were engaged in the same business of broadcasting and cable operations. The business transferred excluded inter alia employees of the seller. The Authority for Advance Rulings (GST) Andhra Pradesh held that such exclusion results in the transfer not being on a going concern basis. The ruling in this case follows the principles as to the meaning of 'going concern' as set out in Rajashri Foods Pvt Ltd KAR ADRG 06 / 2018 (see paragraph 9). In In Re; Airport Authority of India GUJ/GAAR/R/46/2021 the Authority for Advance Rulings (GST) Gujarat held that "...transfer as going concern may involve transfer of employees as requisite to carry on the business without interruption...".

14. The Income Tax Appellate Tribunal in Weikfield Products Co. vs. Dy CIT (2001) 71 TTJ (Pune) 518 held a sale of a business division that excluded inter alia the employees to not be a slump sale.

15. (2001) 70TTJ (Bang) 874.

16. The Tribunal noted that "...only the assets excluding investment and deposits was sold and the liabilities remained with the assessee...", see paragraph 5.

17. AIR 1966 SC 50.

18. Commissioner of Income Tax Central Calcutta v. Mugneeram Bangur AIR 1966 SC 50, see paragraph 3

19. (2017) 291 CTR (Del) 268.

20. Triune Projects Private Limited v. Deputy Commissioner of Income Tax (2017) 291 CTR (Del) 268, see paragraph 10. These principles were also observed by the Kerala High Court in Zacharia v. State of Kerala 1977 (039) STC 0221 where the seller retained inter alia sundry debts and sundry credits, etc. which had accrued prior to the sale of the business. The court held that the mere fact of such retention would not by itself show that the seller had not transferred the business as a whole. See also Commissioner of Income Tax v. Max India Ltd. (2009) 319 ITR (P&H).

21. [2008] 115 ITD 302 (Mum).

22. Rohan Software Pvt. Ltd. v.Income Tax Officer [2008] 115 ITD 302 (Mum), see paragraph 24.

23. Vatsala Shenoy v. Joint Commissioner of Income Tax (2017) 5 SCC 104, see paragraph 30.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.