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The Undeniable Truth Of BTAs

Published on Sat, Feb 21,2015 | 09:15, Updated at Mon, Feb 23 at 14:15Source : Moneycontrol.com 

The Undeniable Truth Of BTAs

By: Pallavi Puri- Partner, & Pranav Gadi- Associate, J. Sagar Associates

Consolidation of business, acquisition of new business verticals or even disposing off those businesses which are not profit generating are some of the common forms by which ownership of businesses can be transferred. In common parlance, transactions of such nature are termed as business transfers or slump sales.

This method of disposal or acquisition, though tried and tested, and one of the most favoured forms of acquiring a running business, does in reality pose various challenges in terms of practical implementation. A business transfer (or a slump sale), means a transfer of a business operation/ business unit (i.e., an entire identifiable business undertaking) from the current owner i.e., the seller to another i.e., the purchaser, as a going concern, on an ‘as is where is basis’, lock, stock and barrel. Tax laws impose a lesser levy of tax on transactions structured as slump sales when compared to a sale of identified assets of a business (or assets sale/ itemised sale, as commonly known). A mere shift of owners of the business/ undertaking results out of such a sale purchase transaction, which is primarily governed by a set of transaction documents (which if without any consideration, and when approved by the high court might also be construed as a merger). These documents highlight and provide for the entire contours of this shift from the seller to the buyer.

In order to effectuate a smooth transfer, the transaction documents – typically the business transfer agreement (or BTA, as commonly known), covers, amongst others, the manner and mode of transfer of the existing contracts, licenses (where transferable), insurances, litigations (depending on the nature of the suit), leasehold and freehold properties and the personnel forming part of the undertaking in question. In addition, protections are built around operations of the business during the interim period between signing and closing of the transaction. Some BTAs also provide for price adjustment mechanisms thereby building in flexibility to the parties to adjust the purchase consideration post-closing by undertaking an audit of the books or diligence of the assets of the business. This is especially the case in industries which have a lot of raw materials and inventory on shelf which needs to be finally accounted for. The net working capital of the undertaking, amongst others, is one of the most important factors taken in account to arrive at this price adjustment.

Whilst, BTAs contain a long list of conditions precedent that have to be complied with for the consummation of the transfer on the D day (i.e., the closing), from a practical perspective a majority of these can actually be initiated or fulfilled only post-closing. This is particularly in cases where government approvals are required to be procured for operations of the business which is being transferred.

Many business undertakings in the manufacturing space have industrial units set up on land which is generally owned by the State owned Government industrial organisations, and are taken on perpetual lease basis. As per the governmental corporations bye laws, before any undertaking is transferred to the purchaser, the current lessee (i.e., the seller) needs to obtain the consent of the lessor (i.e., the industrial corporation) and also pay a transfer levy as of the date of transfer. This process is very cumbersome and time consuming. It entails a lot of ancillary documentation for initiating the process of transfer. Another disadvantage of such permission is the transfer levy which is applicable. Such levy is generally a double digit percentage of the current market rate of the premium multiplied by the area taken on lease, and no authority gives the transfer consent unless such transfer levy has been paid. Bearing this cost opens another commercial debate between the seller and the purchaser although many bye laws indicate that this cost is to be incurred by the transferee (i.e., the purchaser).

Another aspect revolving around approvals and consents which raises practical difficulties is the timing of obtaining them. Manufacturing units can only be operational once they have obtained the requisite statutory approvals, licenses, consents, etc. Where licenses can be transferred, BTAs generally cast an onus on the seller for applying for such transfers as a condition to consummate the closing, such that on the closing the purchaser can commence operations smoothly. However, what is important to note here is that while an application for transfer of these licenses is an obligation on the seller, the actual license can only be issued after the business has been transferred in the name of the buyer. Similarly, where the buyer needs to obtain fresh licenses, incorporating conditions precedent obligating the seller to provide all assistance in procurement of the licenses is in a sense futile as most of the licenses required for the smooth operations of the business being purchased, can only be applied for after the buyer becomes the owner of the business.

Thus, technically a transition of the entire business on one day, the closing, seems rather difficult to achieve, due to the various practical difficulties that arise around procuring the operational consents.

Another interesting legal debate that arises in BTAs is whether the approval from the income tax assessing officer under Section 281 of the Income Tax Act, 1961 is required or not. Divergent views emerge on this aspect – while the sell side insists that adequate representations and warranties backed by indemnities in relation to the pendency or absence of tax proceedings or capacity will suffice, it is in effect merely a contractual remedy. As per the legislation, a transfer of assets that happens without seeking this approval will be void, unless a no objection certificate/ approval is obtained from the assessing officer. The intent of this legislation is that no company should sell off its assets without obtaining a no-objection from the tax authorities, irrespective of whether there are any demands/ claims pending from the tax authority. Thus, a no objection saves a business transfer from being declared void from the tax department, and compromising on this certificate is not in the best interest of the buyer and may reflect adversely on the quality of diligence while representing a buyer. However, this approval or no objection is not easy to obtain. The authorities may raise certain questions or in cases where there are huge demands from the authority, they may ask for guarantees to back up the claim. Thus, this also results in delays for the transfer to take place.

Considering these nuances, a question that arises is – are these business transfers really as smooth as they seem ‘prima facie’?

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