Capital gains relating to slump sale & Recent Developments CA Chandresh Bhimani
Contents Modes of Mergers and Acquisitions Slump sale - Concept - Pre-section 50B position - Section 50B - Overview Undertaking Cost of acquisition of Undertaking Slump Sale v/s Itemised Sale Slump Sale : Some issues Implications in the hands of the purchaser Recent developments 2
Modes of Mergers & Acquisitions M&A Merger / Demerger Acquisitions Others Asset Purchase Stock Purchase Buy-back Capital Reduction Slump Sale Itemized Sale
What is Slump sale 4
Concept of Slump Sale Slump sale means sale of an undertaking for a lumpsum consideration without assigning values to the individual assets and liabilities it comprises of The term undertaking includes part of the undertaking but whatever undertaking is transferred, it must constitute as a business unit to be carried on without any interruption The consideration for such transfer may be discharged by transferee company in any mode Consideration is received by transferor company and not its shareholders Can be achieved through shareholder resolution and a business transfer agreement (timeframe : 1 2 months) 5
Pre-Section 50B - Position Transfer of undertaking as a going concern for slump consideration not liable to capital gains - No taxation with reference to individual asset in absence of earmarked sale consideration - No taxation for transfer of business as cost of undertaking and cost of improvement not ascertainable - Charge fails in absence of support computation mechanism SC in PNB Finance Ltd (307 ITR 75) in the context of slump sale held as under: In this case, s. 45 applies. There is no dispute on that point. The first test is that the charging section and the computation provisions are inextricably linked. The charging section and the computation provisions together constituted an integrated code. Therefore, where the computation provisions cannot apply, it is evident that such a case was not intended to fall within the charging section, which, in the present case, is s. 45. 6
Section 50B: Overview Section 50B introduced w.e.f. AY 2000-01 for computation of capital gains in case of slump sale of undertaking. Slump sale defined u/s.2(42c) Undertaking defined u/s.2(19aa) Net worth of undertaking constitutes cost of acquisition Long term v. Short term determined w.r.t age of the undertaking Indexation benefit not available Report from an accountant which certifies computation of net worth to be furnished in prescribed form 7
Slump sale - Computation Mechanism SLUMP PRICE CAPITAL GAINS MINUS NETWORTH OF THE TRANSFERRED UNDERTAKING Tax WDV of depreciable assets plus Net Worth of theundertaking Book Value of other assets minus Book Value of all liabilities Revaluation to be ignored while computing the Net Worth 8
Slump sale Sec 2(42C) Section 2(42C) defines slump sale 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. Conditions to be satisfied cumulatively in order to qualify an arrangement as slump sale - There should be transfer of one or more undertakings - Transfer should be as a result of sale - Sale should be for a lump sum consideration - No values should be assigned to individual assets or liabilities in such sales Specific exception provided - Determination of value of an asset or liability solely for the purpose of payment of stamp duty, registration fees or other similar taxes or fees not regarded as assignment of values to individual assets or liabilities 9
Slump price Sale for a lump sum consideration without assignment of values to individual assets and liabilities Factors supporting lump sum consideration - Business valuation on DCF or yield method - Valuation as a multiple of capacity, customer base etc - Negotiated value for the undertaking Issues : Whether following impact the slump sale - Absence of assignment of individual values in document of sale v/s. in transaction of sale - Reference in any collateral documents or evidences such as Board resolution, pre-sale correspondences exchanged; asset valuation report,etc [Refer, Artex Manufacturing [227 ITR 260(SC)] 10
Slump price Impact of separate valuation of Land and Building or intangible for payment of stamp duty / registration charges / sales tax Adjustment contemplated for working capital [Premium Automobiles (264 ITR 229(Bom)] 11
Undertaking 12
Meaning and scope of Undertaking Sec 2(19AA) Undertaking is defined in Explanation 1 to Sec 2(19AA) as under: For the purposes of this clause, undertaking shall include 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. Yallamma Cotton Woollen and Silk Mills Co Ltd vs Official Liquidator 40 Com Cas 466 while examining the expression undertaking in the context of floating charge Mysore HC observed as: undertaking is not anything which may be described as a tangible piece of property like land, machinery or the equipment; it is in actual effect an activity of man which in commercial or business parlance means an activity engaged in with a view to earn profit. 13
Undertaking Extracts from P. Alikunju, M.A. Nazeer Cashew Industries v. CIT 166 ITR 804 (Ker) Undertaking" in common parlance means an "enterprise", "venture", "engagement". It can as well mean "the act of one who undertakes or engages in a project or business" (Webster)... In R. C. Cooper v. UOI, (1970) 40 Com Cas 325 (SC), it was observed that undertaking relates to the entire business although there may be separate ingredients or items of work or assets in the undertaking. The undertaking will therefore be the entire integrated organisation consisting of all property, movable or immovable, and the totality of undertaking is one concept which is not divisible into components or ingredients. 14
Cost of Acquisition 15
Cost of acquisition - Net Worth Net worth of an undertaking constitutes cost of acquisition Net worth defined to mean aggregate value of total assets of undertaking (excluding revaluation) as reduced by book value of liabilities Aggregate value of total assets - In case of depreciable assets : WDV of block of assets - Capital assets claimed deduction u/s 35AD : NIL - Other assets : Book value Illustrative ambiguities - Cost / book value of scientific research assets claimed u/s.35 - Cost / book value of scientific research assets for which weighted deduction claimed u/s.35(2ab) - Cost / book value of Telecom license amortised under section 35ABB 16
Itemised sale vs. Slump sale Itemized sale Huge block of asset of other items and / or expansion plan for recoupment where consideration likely to get adjusted in block of assets without giving rise to immediate taxable income. (However, this may impact future depreciation) Presence of high cost non depreciable assets where benefit of indexation or FMV substitution as on 1.4.81 is available. Transfer of obsolete / non-moving stockin-trade / consumable likely to result in business loss. Slump sale From the perspective of sales tax and stamp duty. If rigor of section 50C is to be avoided. If balance sheet has certain nondepreciable assets which have lost value and are not likely to fetch any price. Cases where section 50C or TP provisions etc permitting notional taxation is not a concern Sales tax, stamp duty, etc is not a concern If appreciation is attributable to inventory or depreciable assets. If age of undertaking is more than 3 years whereas the age of valuable assets within it is less than 3 years. 17
Slump sale : Issues 18
Issue 1: Transfer of an undertaking having negative net worth Facts A Co B Co A Co sells its business undertaking having negative networth ( excess of acquired liabilities over and above the value of assets) to B Co Transfer of undertaking Issue What will be the cost of acquisition for the purpose of computation of capital gains Current Position Recent Mumbai Special Bench ITAT decision in case of Summit Securities negative net worth to be added to sale consideration Contrary decisions rendered earlier Zuari Industries Ltd. [9 SOT 563 Mumbai ITAT]a 19
Issue 1 : Transfer of an undertaking having negative net worth Scenario A Sale consideration 100 Less: cost o f acquisition (networth) Aggregate value of total assets 300 (500) Less: Value of liabilities (200) NIL Capital Gains (restricted to) 100 (negative net worth ignored) Scenario B Sale consideration 100 Less: cost o f acquisition (networth) Aggregate value of 300 total assets (200) Less: Value of (500) liabilities Capital Gains [100 (-200)] 300 Which of the scenario represents correct computation of capital gains? 20
Issue 2 : Transfer of business undertaking excluding certain assets / liabilities Test to apply : Whether buyer is put in position to continue the running business without the impugned asset? Citation Premier Automobiles vs ITO (264 ITR 229)(Bom) DCIT vs Mahalasa Gases & Chemicals (84 TTJ 992)(Bang) Rohan Software (P) Ltd vs ITO (115 ITD 302)(Mum) Max India Ltd [112 TTJ 726] I.C. I India Ltd [23 SOT 58] Exclusion o f asset Transfer of manufacturing undertaking -sundry debtors not transferred Transfer of manufacturing and distribution undertaking - excess land, vehicle and debtors not transferred Sale of software business including intellectual properties, etc; exclusion of building and motor car does not defeat slump sale Transfer of manufacturing division -Technicalknow-how transferred in subsequent period; until that use thereof given on royalty payment Transfer of fertilizer unit - Bank balance, chequeon hands, unpaid insurance claims not transferred 21
Issue 3: Slump exchange B1 B2 Consideration by way of shares ABC XYZ Transfer of B2 Facts ABC transfers B2 on a going concern basis to XYZ XYZ discharges consideration to ABC by way of shares Issue Whether the transfer of undertaking for shares taxable? Current Position Bharat Bijlee Ltd. (Delhi ITAT) - Transfer in consideration for shares would qualify as exchange and not sale, hence provisions of slump sale not applicable Since cost of acquisition not ascertainable, computation mechanism fails 22
Issue 4 : Other issues Does section 50C apply to slump sale covered by section 50B? Is section 50B a charging provision or machinery provisions? - Impact on exemption under sections 47(xiii) /(xiv) or 47(iv)/(v) etc. which exempts capital gains chargeable under section 45 - Whether exemption can be claimed under section 54EC / 54F 23
Slump sale : Purchaser s consideration 24
Slump sale: Purchaser s Consideration Purchaser entitled to allocate value of consideration to individual asset on fair basis including intangible assets acquired, depreciable assets, stock in trade, etc. [Shreyans Industries Ltd 277 ITR 443 (P&H) ] Business information, contracts, employees, and knowhow acquired in a slump sale - eligible for depreciation? - AREVA T & D INDIA LTD. VS. DCIT [2012] 20 taxmann.com 29 (Delhi) To safeguard against seller s tax arrears / liability [S.281 / S.170] 25
Budget 2012 26
GAAR Provisions... Taxation of an Impermissible Avoidance Arrangement based on GAAR Broadly in line with DTC Bill Applicable with effect from April 1, 2012 Very open-ended provision with widest discretion to tax authorities Review by GAAR Approving Panel of 3 Commissioners Treaty override where GAAR invoked Threshold and guidelines to be prescribed by CBDT GAAR order directly appealable before Appellate Tribunal 27
...GAAR Provisions... Arrangement to be Impermissible avoidance arrangement if fails to pass Primary Test Any one of Secondary Tests Main purpose or one of the main purpose is to obtain tax benefit Creates rights/obligation unlike parties at Arm s Length Or Results in direct/indirect misuse/abuse of tax provisions Or Lacks/deems to lack commercial substance in whole/part Or Entered into/carried out not for bonafide purpose 28
...GAAR Provisions... Tax consequence if GAAR invoked - Illustrative list of consequences: Disregard/combine/recharacterise steps or parts Treat as if impermissible avoidance arrangement not entered into Disregard any accommodating party or treat any accommodating party and other party to be same Reallocate income/expense/deduction/relief/rebate etc Determine residence of a person/location of asset/location of transaction at place other than stated place of residence/location of asset/location of transaction Considering or looking through arrangement by disregarding corporate structure 29
Other key amendments... Corporate Restructuring Fair market value of asset transferred deemed to be consideration where not specifically determined / ascertainable 30
Direct tax code bill, 2010 31
Slump sale under DTC Provisions in respect of slump sale arrangements similar to the current provisions of the Act. Definition of slump sale similar to definition under the Act Includes division of a business Net worth in relation to an undertaking transferred under a slump sale to mean value determined in such manner as may be prescribed. No specific definition of undertaking Clause 315 of the DTC Bill 2010 provides that any direction for aggregation of two or more items shall be construed also to include a direction for aggregation of negative and positive amounts in all their combinations. 32
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