SLUMP SALE – AMENDMENTS BY FINANCE ACT, 2021

The essence of this amendment seems to be to align this method of transfer of capital assets with other methods (such as transfer of shares, gifts, assets), wherein a minimum value has been prescribed and such prescribed minimum value did not apply to transfer of capital assets forming part of an undertaking transferred on a slump sale basis. For example, an immovable property could be transferred as an indivisible part of an undertaking under slump sale at any value, without having any reference to the value adopted or assessed by the stamp valuation authority, which if otherwise transferred on a stand-alone basis would need to be transferred at any value higher than the value adopted or assessed by the stamp valuation authority. In addition, the Finance Act, 2021 also expands the scope of section 50B from merely ‘sale’ of an undertaking to any form of transfer of an undertaking, whether or not a ‘sale’ per se, essentially to include ‘slump exchanges’ within its ambit.

Section 50B was inserted by the Finance Act, 1999 with effect from 1st April, 2000 and since then this amendment by the Finance Act, 2021 is the first major amendment to this code of taxing profits and gains arising from slump sales. This article evaluates the following amendments in the ensuing paragraphs:

i. Amendment in section 2(42C) of the Act;
ii. Substitution of sub-section 2 of section 50B of the Act;
iii. Insertion of clause (aa) in Explanation 2 to section 50B of the Act; and
iv. The date of enforcement of these amendments and whether these amendments will have retrospective effect.

LIKELY IMPACT OF THE AMENDMENT ON M&As / DEALS

The amended section 50B is, however, likely to impact internal group restructurings wherein intra-group transfers were resorted to at book values which would often be less than the prescribed fair values. Such internal transfers of ‘undertakings’ or divisions from one company to another are often resorted to to get to the deal-ready structure (e.g., one company has two divisions and a deal is sought with respect to only one division – the other division will need to be moved out) and such transactions could have remained tax neutral if made within the group, similar to the way amalgamations / de-mergers remain tax neutral. Such restructurings could at times also be driven by regulatory changes or external factors and imposing tax consequences on such internal restructurings will discourage such transfers and the companies will need to resort to time-consuming structures like amalgamations / de-mergers which require a long-drawn process under sections 230 to 232 of the Companies Act, 2013, including approval by the National Company Law Tribunal.

Moreover, in case of transactions where the sale consideration against transfer of the undertaking is discharged in the form of shares / securities (‘slump exchange’), the seller would no more be able to walk away without paying its dues to the taxman.

ANALYSIS OF THE AMENDMENTS BY THE FINANCE ACT, 2021
(a) Amendment in section 2(42C) of the Act
Section 2(42C) defines the term ‘slump sale’ and read as follows before amendment by the Finance Act, 2021: ‘slump sale’ means the transfer of one or more undertaking as a result of the sale, for a lump sum consideration without values being assigned to the individual assets and liabilities in such sale.

The text underlined above is being substituted by the Finance Act, 2021 with ‘undertaking by any means’. Therefore, the amended definition of slump sale reads as follows: ‘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 sale.

Thus, the amendment replaces the words ‘as a result of sale’ with ‘by any means’, thereby expanding the scope of the term ‘slump sale’ from merely ‘sale’ to ‘any transfer’. This amendment seeks to neutralise the judicial precedents like CIT vs. Bharat Bijlee Ltd. (365 ITR 258) (Bom) wherein the assessee transferred its division to another company in terms of the scheme of arrangement u/s 391 of the Companies Act, 1956 and that consideration was not determined in terms of money but discharged through allotment or issue of bonds / preference shares; it was to be regarded as ‘exchange’ and not ‘sale’ as envisaged under the then section 2(42C), and therefore could not be taxed as a ‘slump sale’. In other words, judicial precedents established the principle that a ‘sale’ must necessarily involve a monetary consideration in the absence of which a transaction, though satisfying all other conditions, will not qualify as a ‘slump sale’ and would merely be an ‘exchange’. Therefore, with the expanded scope of the term ‘slump sale’ to mean transfer ‘by any means’, transactions of varied nature will get covered including but not limited to slump exchanges.

Effective date of the amendment
The Finance Act, 2021 provides that the amendment shall be effective from 1st April, 2021 and shall accordingly apply to the assessment year 2021-22 and subsequent years.

With its applicability for A.Y. 2021-22 one could argue that the amended provisions are applicable to transactions executed on or after 1st April, 2020 and to this effect the amendment is retrospective in nature.

Could this amendment be considered merely clarificatory and therefore retrospective?
The Explanatory Memorandum to the Finance Act, 2021 while explaining the rationale of this amendment, begins the last paragraph with ‘In order to make the intention clear, it is proposed to amend the scope of the definition of the term slump sale by amending the provision of clause (42C) of section 2 of the Act so that all types of transfer as defined in clause (47) of section 2 of the Act are included within its scope.’ The language is suggestive that the amendment is merely clarificatory in nature which is also abundantly clear from the language used in the Explanatory Memorandum with respect to this amendment, claiming that the pre-amended definition also included transactions like slump exchanges. A paragraph from the Explanatory Memorandum to the Finance Act, 2021 is reproduced hereunder:

‘For example, a transaction of – sale may be disguised as – exchange by the parties to the transaction, but such transactions may already be covered under the definition of slump sale as it exists today on the basis that it is transfer by way of sale and not by way of exchange. This principle was enunciated by the Supreme Court in CIT vs. R.R. Ramakrishna Pillai [(1967) 66 ITR 725 SC]. Thus, if a transfer of an asset is in lieu of another asset (non-monetary), it can be said to be monetised in a situation where the consideration for the asset transferred is ascertained first and is then discharged by way of non-monetary assets.’

In the absence of a retrospective operation having been expressly given, the courts may be called upon to construe the provisions and answer the question whether the Legislature had sufficiently expressed that intention of giving the statute retrospective effect. On the basis of Zile Singh vs. State of Haryana [2004] (8 SCC 1), four factors are suggested as relevant:
(i) general scope and purview of the statute; (ii) the remedy sought to be applied; (iii) the former state of the law; and (iv) what it was that the Legislature contemplated. The possibility cannot be ruled out that Indian Revenue Authorities (IRA) could contest this amendment to be clarificatory in nature to have always included ‘slump exchanges’. However, since the change doesn’t specifically call itself clarificatory nor does it give itself a retrospective operation, a reasonable view can be that the said change is prospective.

Essential characteristics of slump sale
With the modified definition, the Table below compares the essential characteristics of a transfer to qualify as a slump sale under the pre-amendment definition vis-à-vis the post-amendment definition u/s 2(42C) of the Act:

As one can see, all the essential characteristics of a transfer of an undertaking to qualify as a ‘slump sale’ continue, the only change being a transfer through sale vs. by any means.

By any means could have a very wide connotation when read with the newly-inserted Explanation 3 which provides that for the purposes of this clause [being section 2(42C)], ‘transfer’ shall have the meaning assigned to it in section 2(47).Therefore, this will include transactions or transfers wherein an undertaking is transferred for a lump sum consideration like an amalgamation which does not satisfy the conditions prescribed u/s 2(1B) of the Act or a de-merger which does not satisfy the conditions prescribed u/s 2(19AA) of the Act. A ‘gift’ of an undertaking will also be included within the meaning of ‘transfer’, but in the absence of the ‘lump sum consideration’, may not qualify to be a ‘slump sale’ even under the amended definition.

(b) Substitution of sub-section 2 of section 50B of the Act
The Finance Act, 2021 also substituted sub-section 2 of section 50B and the substituted text reads as follows:

[(2) In relation to capital assets being an undertaking or division transferred by way of such slump sale –

(i) The ‘net worth’ of the undertaking or the division, as the case may be, shall be deemed to be the cost of acquisition and the cost of improvement for the purposes of sections 48 and 49 and no regards shall be given to the provisions contained in the second proviso to section 48;

(ii) The fair market value of the capital assets as on the date of transfer, calculated in the prescribed manner, shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of such capital asset.]

Essentially, the clause (ii) above has been newly inserted through substitution of the sub-section 2 as the clause (i) above existed in the form of previous sub-section 2 itself.

Section 50B provides for a complete code in itself for computation of profits and gains arising from transfer of ‘capital asset’ being an undertaking in case of slump sale. The erstwhile sub-section 2 provided that the ‘net worth’ of the undertaking would be considered as the cost of acquisition and there was no provision deeming the value of sale consideration or overriding the consideration agreed between the transferor and transferee. The newly-inserted sub-section 2 continues to provide that the ‘net worth’ of the undertaking shall be considered as the cost of acquisition and includes a deeming provision to impute the consideration, being the prescribed fair market value.

Rule 11UAE has been inserted in the Income-tax Rules, 1962 vide a notification dated 24th May, 2021 providing a detailed methodology for arriving at the deemed consideration of the ‘undertaking’ as well as a methodology for arriving at the value of non-monetary consideration received, if any (slump exchange transaction or amalgamation / de-mergers which may qualify as slump sale if they do not meet their respective prescribed conditions). The prescribed valuation rules provide for valuation of specific assets in line with already existing valuation methodologies under Rule 11UA and in this specific context, the Rule provides for value to be the value determined in accordance with the Rule or agreement value, whichever is higher.

Sub-rule (2) of the newly-inserted Rule 11UAE provides for determining the fair market value of the ‘capital assets’ transferred by way of slump sale and that could imply that the prescribed rules will not apply to value any asset other than ‘capital assets’ and such other assets will need to be taken at book values, for example, a parcel of land held as stock-in-trade and not as capital asset. Notably, even the newly-inserted sub-section (2) in clause (ii) refers to ‘fair market value of capital assets as on the date of transfer’ which supports the interpretation that Rule 11UAE would apply only to value ‘capital assets’ forming part of the undertaking being transferred through slump sale. However, one would need to be careful while applying this interpretation, as the specific clauses of Rule 11UAE do not distinguish between the assets as ‘capital assets’ or otherwise.

(c) Insertion of clause (aa) in Explanation 2 to section 50B of the Act
Explanation 2 to section 50B of the Act provides the mechanism to arrive at the value of total assets for computing the net worth. The said Explanation provides guidance on determination of values of respective assets forming part of the undertaking, in order to arrive at the ‘net worth’ being cost of acquisition for the purposes of section 50B of the Act. The Finance Act, 2021 inserted clause (aa) in Explanation 2 to section 50B which reads as follows:

(aa) in the case of capital asset being goodwill of a business or profession which has not been acquired by the assessee by purchase from a previous owner, nil.

Consequent to the insertion of the above-mentioned clause (aa), if ‘goodwill’ is one of the assets on the books of the undertaking, its value shall be considered to be ‘Nil’ for computation of net worth if it is not acquired by way of purchase which will result in its book value not being considered for computing the cost of acquisition. The amendment seems to be one of the consequential amendments made by the Finance Act, 2021 with respect to ‘goodwill’.

In a situation where the goodwill is appearing on the books by virtue of a past amalgamation or a de-merger, its value shall be taken as nil for computing the net worth of the undertaking. Whereas, if the goodwill was purchased prior to 1st April, 2020 and depreciation has been allowed thereof, it would be considered as a depreciable asset and its written down value shall be considered while computing the ‘net worth’. Similarly, if the goodwill is acquired on or after 1st April, 2020, it will not be considered as a depreciable asset pursuant to other amendments made by the Finance Act, 2021 and its book value shall be considered while computing the net worth of the undertaking.

CONCLUSION

From a commercial perspective, the amendments do not impact genuine transactions. Even in genuine transactions where there are valuation gaps, the current law does not put the buyer in any adverse position and the tax risks seem to be restricted to the seller, primarily because section 56(2)(x) does not tax ‘undertaking’ as a property in the hands of the buyer.

One will still need to deal with challenges in application of the prescribed valuation methodology, especially valuation required to be as on the date of the slump sale, and the availability of the financials and data points to apply the rule.