Slump sale is defined under Section 2(42C) of the Income-tax Act, 1961 (“the Act”) to mean the transfer of one or more undertakings[1], by any means, for a lump sum consideration without values being assigned to the individual assets and liabilities in such transfer. Accordingly, ‘slump sale’ implies transfer of an entire business undertaking (assets and liabilities) as opposed to sale of shares.
The undertaking proposed to be transferred should contain all the essential elements viz., the assets, liabilities, employees, etc. which are critical for running the business, as a going concern.
The term ‘succession’ implies a change in ownership of a business from one person (“the predecessor”) to another (“the successor”). Section 170 of the Act deals with the provisions relating to income tax liability in the event of succession of business pursuant to any business restructuring – transfer of business, amalgamation, demerger, etc.
In June 2020, the Mumbai Bench of Income Tax Appellate Tribunal in the case of M/s. Archroma India Pvt. Ltd. v. ITO[2] ruled that transfer of business by way of slump sale falls within the ambit of Section 170 of the Act and constitutes succession of business by the transferee.
Section 170 of the Act states that where a predecessor carrying on any business is succeeded by the successor, who subsequently continues to carry on that business:
- the predecessor (being the transferor) is assessed for the income of financial years up to the date of succession; and
- the successor (being the transferee) is assessed on the income of the financial years after the date of succession.
Pursuant to sub-section (3) of Section 170 of the Act, in the event the predecessor cannot be found or where the predecessor has been assessed but the tax cannot be recovered from him, the successor is made liable for the income tax in respect of the following:
- the sum payable (income tax, etc. including capital gains tax due on the transfer by way of slump sale resulting in the succession) for the financial year in which succession has taken place; and
- the sum payable by the predecessor for the financial year immediately preceding the year in which the succession took place.
Nevertheless, the Act entitles the successor to recover the sum(s) paid in (i) and / or (ii) above from the predecessor.
Further, it is to be noted that the transferee of the business is considered as a successor of only the undertaking being acquired under slump sale, and the entity level tax liabilities do not get transferred.
Further, the Finance Act, 2022, introduced a sub-section (2A) to Section 170 in the case of a ‘business reorganization’. As a consequence, the assessments (including re-assessments) / proceedings (whether pending or completed) on the predecessor entity made during the course of pendency of the scheme / restructuring application before the relevant court, are deemed to have been made on the successor. Accordingly, this would have a bearing on slump sale transactions undertaken by way of filing a scheme / composite scheme (as part of the overall group restructuring) as against the transactions undertaken by way of executing a business transfer agreement.
It is worthwhile highlighting that the provisions of Section 170 of the Act come into effect only if there is a transfer of ownership of a business. A mere agreement to transfer would not bring the said provisions into operation and there has to be an actual transfer of ownership of a business[3]. Also, succession results only if the ownership of a business as a whole is transferred to another person. Where the business is split up and there are different parts of the business, there is no succession.
DEPRECIATION PROVISIONS
The successor (being the transferee) is entitled to claim depreciation on the assets acquired based on the purchase price paid (i.e., on an actual cost basis). For this purpose, a purchase price allocation (“PPA”) report is obtained from an independent valuer for allocating the purchase price towards the tangible and intangible assets.
Section 32 of the Act deals with the depreciation provisions, and its sixth proviso provides the way depreciation shall be allowed to predecessor and successor in case of succession of a business.
It states that in the year of succession, the depreciation shall be calculated as if no such succession has taken place, and the total amount of depreciation shall be apportioned between the predecessor and successor in the ratio of number of days the asset was used by them. It is to be noted that the sixth proviso to Section 32 of the Act is applicable only in the year of succession and not in subsequent years. This principle has been upheld by the High Court of Karnataka in the case of Padmini Products (P.) Ltd.
[4]
For the subsequent year(s) after the succession, the written down value (WDV) of the assets of the successor is required to be determined by reducing the amount of depreciation claimed in the year of succession from the actual cost (in accordance with the PPA).
IMPLICATIONS UNDER SECTION 281 OF THE ACT
Section 281 of the Act requires a transferor to obtain the permission of the tax officer before creating a charge on certain ‘assets’ in favor of another person or transfer of certain assets, in the event there are any ongoing tax proceedings or pending claims / demands against such transferor.
The term ‘assets’ has been defined under the Act exhaustively to mean land, building, machinery, plant, shares, securities and fixed deposits in banks, to the extent to which any of the assets does not form part of the stock-in-trade of the business of the assessee. It is to be noted that a ‘business undertaking’ is not specifically covered under the definition of assets and accordingly, it may be possible to take a view that provisions of Section 281 of the Act should not become applicable in case of transfer of business undertaking by way of slump sale.
In addition, it is imperative to note that Section 281 of the Act has no bearing on the succession provisions contained under Section 170 of the Act. In other words, even if the transferor complies with Section 281 of the Act and secures the permission of the tax officer before the transfer of its business undertaking by way of slump sale, the transferee would still be considered as a ‘successor’ and thus, can be made liable for income tax dues of the predecessor in accordance with the provisions of Section 170 of the Act.
CONCLUSION
Transfer of an undertaking by way of slump sale is a well-known form of business transfer owing to its simplicity and ease of implementation. The provisions of the Act relating to succession ensure the seamless transition of tax liabilities and obligations from the predecessor to the successor and aims to maintain the integrity of the tax system by ensuring that taxes are paid correctly and timely, even in cases of changes in ownership or legal status of the taxpayer. Accordingly, the transferee must conduct proper diligence prior to acquisition of a business undertaking to determine the outstanding tax demands of the transferor and build in appropriate indemnity provisions in the transaction documents to safeguard itself from any potential tax exposure if succession provisions become applicable.
[1] The term ‘undertaking’ has been defined under Section 2(19AA) of the Act to include any part of 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.
[2] M/s. Archroma India Pvt. Ltd. v. ITO (ITA Nos. 306/Mum/2019 and 6919/Mum/2018 and C.O. No. 07/Mum/2020).
[3] Bhagwandas Harikishandas v. CIT, (1938) 6 ITR 176 (Nag).
[4] Padmini Products (P.) Ltd. v. DCIT, Circle 12(2), Bengaluru, (2020) 121 taxmann.com 237 (Karnataka)
This insight has been authored by Sumit Bansal (Partner), Shivani Chhabra (Tax) and Taranjeet Singh (Tax). They can be reached at sbansal@snrlaw.in, shivanichhabra@snrlaw.in and taranjeetsingh@snrlaw.in respectively, for any questions. This insight is intended only as a general discussion of issues and is not intended for any solicitation of work. It should not be regarded as legal advice and no legal or business decision should be based on its content.