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Taxability Of Slump Exchanges: Hit or Miss?

Published on Fri, May 30,2014 | 23:05, Updated at Mon, Jun 09 at 17:25Source : 

By: Ravi Mehta, Tax Partner - EY

Today, Merger & Acquisition is a vital part of a Corporate’s economic activity and one of the popularly used mode of asset acquisition in India is ‘slump sale’. A Slump Sale in layman’s words refers to sale of an identified business (technically referred to as an ‘Undertaking’) for a lump sum consideration without assigning specific values to the assets and liabilities comprised in that business.  

The taxability of such slump sale has been a subject matter of intense litigations. Originally, these litigations emanated because of the absence of a computation mechanism in the tax law for determining capital gains in case of transactions involving transfer of the entire Undertaking.  Numerous Courts, including the Apex Court, in these litigations had taken the position that in the absence of a computation mechanism for calculating capital gains, the charging provisions cannot be applied.

The Legislature therefore tried to put this controversy to rest by inserting specific provisions under income tax law vide Finance Act, 1999. Through these provisions, the legislature specifically defined the concept of “Slump Sale” as well as laid down the manner of computing capital gains arising on transfer of business in form of Slump Sale.

However hard the legislators strive to develop improved legislation (considering past experiences, judicial precedents and laws of other countries), loopholes do exist in these provisions which allows the Tax Payers to reap the benefits.  

One such matter which has emanated in the recent past is the interpretation of the scope of the term ‘Slump Sale’, as defined in the tax law. The controversy has been - whether the scope of the taxability for a ‘Slump Sale’ transaction has to be restricted only to those involving cash consideration (purportedly interpreted to mean ‘sale’), or whether this should also cover transactions where consideration is non-cash – viz., transaction of ‘slump exchange’ (e.g. consideration is either issue of shares, bonds, securities or any other consideration in kind).

Taxability of capital gains arising on slump exchange has been a vexed issue, with different courts taking divergent positions. The recent Bombay High Court (HC) decision in the case of Bharat Bijlee is a classic example of this. Herein the taxpayer transferred an undertaking to the transferee company under a court sanctioned Scheme of Arrangement in exchange for preference shares of the transferee company.  

The taxpayer took a view that the current income tax provisions lay down the mechanism for computing capital gain arising on “slump sale” and is silent on “slump exchange”. The taxpayer in fact went a step ahead and claimed that since the price for transfer is a lump sum consideration without any value assigned to individual items, the sale consideration as well as the cost of acquisition of the various assets comprised in the transfer could not be ascertained.  In absence of specific consideration or cost of acquisition, it was not possible to compute capital gains and hence the transaction was not subject to tax.

The Income tax Appellate Tribunal (ITAT) ascribed with the Taxpayer’s view and ruled in their favour.  On further appeal by the Revenue at the Bombay HC, the HC also agreed with the ruling of the ITAT and held that slump exchange is not covered under the provisions of slump sale as provided under the laws.  In this context, it would be interesting to note that the Bombay HC while opining on applicability of provisions of slump sale, has stopped at that and not given an opinion on the chargeability of the transaction under generic capital gain provisions.

Contrary view was taken by the Delhi HC, a couple of years back in the case of Srei Infrastructure Finance Limited. Even that case involved a transaction of transfer of business under a Scheme of Arrangement under the Companies Act, 1956. The taxpayer in that case had sold its financing business and shareholdings in another subsidiary to its subsidiary. The Delhi HC had ruled that on transfer of business in exchange of another asset, there is indeed a monetary consideration which is discharged in the form of shares.  Thus provisions of slump sale would cover such instances of slump exchange.  The Bombay HC distinguished the Delhi HC ruling on the grounds that in case of Srei, the consideration for transfer was both in the form of cash and shares.  Since an element of monetary consideration was involved, it could not be said that there is no sale. Interestingly, it is not clear from the text of Srei’s decision whether the consideration for transfer involved money consideration making the transaction as ‘sale’.

While on this topic it would also be noteworthy to note that, the Finance Act 2012 inserted a specific provision which provides that where the consideration received on transfer of a capital asset is not ascertainable or cannot be determined, the fair market value of such capital asset would be considered as the full value of consideration. Interestingly, even the draft Direct Tax Code seems to cover a slump exchange within the fold of ‘Slump Sale’.

While the conclusions of Bharat Bijlee’s case seems to have been drawn based on the wordings of the current provisions of income tax law on slump sale, it would be interesting to see revenue/legislator’s reaction to this ruling  since the same would be unfavourable from the exchequer’s perspective. Possibly an appeal by the Revenue before the Supreme Court, or a prospective/ retrospective amendment in the statute is not a distant possibility in today’s age.   

(Shruti Lohia, Senior Tax Professional, EY Contributed To This Article)


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