Slump sale transaction – Tax issues

In the global environment, most high profile corporate acquires control over another company by
acquiring shares. In many situations, a company acquire business undertaking of the target company
by entering into a contractual agreement. One of the methods of contractual transfer / disposal of
business undertaking is ‘slump sale’ transaction as prescribed in the Income-tax Act, 1961 (‘the Act’).
Under the slump sale transaction, one or more undertakings are transferred / sold for a lump sum
consideration on going concern basis, without assigning values to the individual assets and liabilities
of that undertaking.

Unlike transfer of capital asset by the amalgamating company to an Indian amalgamated company
under the scheme of amalgamation is exempt from capital gains tax under the Act, the slump sale
transaction give rise to liability for capital gains tax in the hands of the transferor company.

Capital gains in the hands of the transferor

A manner of computing capital gains tax in the hands of transferor under the slump sale transaction
has been specifically prescribed under the provision of the Act. The capital gains is equal to difference
between the sale consideration received and ‘net worth’ of the undertaking which is the aggregate
value of the total assets of the undertaking as reduced by the value of liabilities as appearing in the
books of accounts. For the purpose of computing net worth of the undertaking, the value of
depreciable assets is considered as the written down value (WDV) as prescribed in the Act, while the
value of non-depreciable assets to be taken as per the books.

Depreciation in the hands of transferor and transferee

The tricky issue arises while calculating WDV of the depreciable assets. The Act provides that the
WDV of the block of assets is required to be reduced by the depreciation actually allowed in respect of
that block of assets.

The Act has prescribed specific mechanism of taxing succession of business event which also covers
slump sale transaction (section 170 of the Act).

In a scenario, when a succession of business occurred during the financial year, the depreciation is to
be apportioned between the predecessor and the successor in the ratio of the number of days for
which the assets were used by each of them (fifth proviso to section 32 of the Act)

In line with the above mentioned provisions, when the slump sale transaction is entered during the
year, the depreciation on the depreciable asset is to be apportioned between the transferor and the
transferee in the ratio of number of days for which the assets were used by each of them.
However, interpreting above mentioned provisions may be difficult; a practical difficulty also arises to
mention proportion depreciation in the prescribed income tax return form of transferor and transferee,
as depreciation automatically calculates at applicable full rate or at half rate on depreciable assets.

Goodwill in the hands of transferee

In a scenario when a transferee paid consideration more than the amount of assets acquired, the
excess would be considered as goodwill and such goodwill will not be allowed as deduction for
computing the total income of the transferee.

Carry forward and set off of losses in the hands of transferee

The transferee cannot avail benefits of carry forward and set off of losses of the undertaking, if any.

Expenses incurred in relation to slump sale transaction

It is advisable for parties involved in the slump sale, to negotiate and commercially agree on the
burden of expenses (like franking charges, professional fees etc) in relation to transfer of business. In
case, the transferor has incurred expenses, such expenses would not be considered as expenses
incurred for the purpose of business and accordingly, would not be allowed while computing business
income. However, such expenses would be reduced while computing capital gains in the hands of
transferor considering that expenses have been incurred in connection with the sale of undertaking. In
case, the transferee has incurred expenses in relation to transfer of business, such expenses would
be considered as cost of acquiring business.

Stamp duty implication

Another tricky issue on applicability of rate of stamp duty on the business transfer agreement entered
for transfer of business undertaking. As all assets and liabilities are transferred in the slump sale
transaction and no values are assigned to the individual assets. Many people apply a different rate of
stamp duty on the business transferred agreement.

Value Added Tax implications

There is a controversy on applicability of value added tax (‘VAT’) on the slump sale transaction. As
VAT is leviable on sale of goods, many people take a view that no VAT would be levible on transfer of
business / undertaking under slump sale on the rationale that business is not goods.

Retention of some of the assets / liabilities by transferor in slump sale transaction

Another issue arises on the characterisation of transaction as slump sale when a transferor retains
some of the assets and liabilities with itself after transfer of business. Tax authorities may challenge
such transaction as not a slump sale transaction and the same may be treated as itemised sale of
assets and liabilities. Based on various judicial precedents, a view can be taken that the main
conditions / requirements for slump sale is that the undertaking to be transferred as a going concern
and the transferee is in a position to carry on the business uninterruptly.

Drafting of the Agreement

In light of the above, parties should keep in mind while entering into arrangement for slump sale
tranasaction and accordingly, Business Transfer Agreement is to be appropriately drafted.

While many corporate opt for slump sale for transfer of business undertaking, considering the
complexities involved in slump sale, cooperates should evaluate an option of transfer of business
assets through itemised sale or through demerger or through sale of shares of the company.