[Kaishena Chauhan is a student at Jindal Global Law School]
Introduction
Business transfers can happen in two ways- slump sale and asset sale. Slump sale is when the entire undertaking of a business is transferred as a whole, while asset sale involves itemised sale of assets within an undertaking. Transferring items in a business transfer determines the type of sale. From a buyer’s perspective, asset sale appears beneficial as cherry-picking of only the required and profitable assets without the liabilities becomes an easy option. Whereas seller’s perspective prefers slump sale to maximise the transfer and claim tax benefits. Since asset sale is sort of a variant of slump sale, the lines between the two ways of business transfer get blurred when some kind of cherry picking is also permitted in slump sale. This blog shows that the jurisprudence on ‘undertaking’ under slump sale has shifted from its contemporary meaning of “lock, stock and barrel” by liquidating the definition of slump sale to allow pick and choose.
Undertaking in a Slump Sale
Definition of ‘Slump sale’ is under Section 2 (42C) of the Income Tax Act 1961 (Act) as “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 transfer”. Further, Explanation 1 to Section 2 (19AA) of the Act defines ‘undertaking’ to “include any part of an 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”. The essence of this transfer remains to be “as whole” without just the transfer of “individual assets and liabilities”. The issue that arises is what items should be transferred to constitute a slump sale or whether omission of some items should be allowed.
Going Concern conundrum in an Undertaking Transfer
In some business transfers, “superficial assets” can be excluded from the transfer since paying money for not-so profitable assets would go against the commercial sense. Ratio of Smifs Securities emphasis on “any part of an undertaking” rather than “business activity taken as whole” to approve the slump sale with some exclusion or cherry picking. Here, exclusion of defunct assets may be a valid reasoning to allow cherry picking since these assets can no longer serve the purpose of any business activity. There are other arguments as well which allows for exclusions and thus loosen the definition of undertaking. It includes, first, the varied interpretations of ‘going concern’, which makes a slump sale transfer difficult to identify. There is no universal basis from which the term ‘going concern’ can be evaluated. In CIT vs. ICI (India) Ltd., assets such as bank balance and insurance claims were not transferred since ‘smooth transfer’ of the going concern was possible with them. In Mahalasa Gases, assets like sundry creditors, account balance, car, etc. were not considered being a part of “basic structure” of a business. It is to be noted that assets like bank balance and sundry creditors are not superficial assets and are the current assets forming the ‘basic structure’ of any business, used in all day-to-day activities. Thus, exclusion of such assets with no concrete justification appears to set a per in curium precedent and reflects this transfer as an asset sale in the veil of a slump sale. This reasoning ranks the convenience of a buyer in excluding the liabilities over the essence of slump sale.
Secondly, transfer of undertaking qualifies as slump even if some assets are retained by the seller. Again, what items can be retained is unascertained through the laws and remains abstract on facts. In ACIT, Visakhapatnam and another, where the ‘windmills operation’ was called one business unit of the seller, then selling of three windmills independently as slump sales is paradoxical understanding of “does not include individual assets...any combination”. This subjective sale questions as to what kind of an independent sale can constitutes a ‘going concern’ or a slump sale or does it become an item-wise asset sale. In ACIT, Kochi, the sale of land and building of a hotel was approved as a slump sale despite the advanced discussion on the importance of transferring of other assets and liabilities, which were admitted to be huge. Here, the combination of two independent asset and not the undertaking itself was found to be a going concern to constitute a slump sale. The ambiguity persists on the ‘shall or mandatory’ elements for constitution of a slump sale. These cases show that the primary mandate for transferring a ‘going concern’ is the transfer of the most important assets of the business and the subsidiary assets and liabilities of the business then becomes a secondary or a ‘may’ condition. Spentex Industries defines ‘going concern’ as “business activity capable of being run independently in a foreseeable future”. However Ooty Gate Hotel, an essential asset of the business was not transferred, and the ‘going concern’ was left to be determined from the intention of parties to sale. If ‘going concern’ can simply be ascertained from the ‘intention to sale’, then sales not meeting the criteria of slump sale can be easily disguised to pass the mandate. This shows that the threshold of ‘going concern’ is not legally concluded and remains subjective.
Moreover, arbitrariness occurs when buyer gets the leverage to argue that business can continues as a ‘going concern’ “without purchasing all of the assets and liabilities of the undertaking”. This argument poses a conundrum with the general comprehension of undertaking. Halsbury's Laws states that “although various ingredients go to make up an undertaking, the term describes not the ingredients, but the completed work from which the earning arise”. The intention to introduce the notion of slump sale was for “those undertakings whose assets & liabilities has lost its value in the market. In these cases, assignment is not done for each asset or liability but as a whole”. In Mugneeram Bangur too, undertaking was defined as entire business together with “depreciable assets and liabilities” without item-wise earmarking. These strict meanings of undertaking conflicts with the reasoning of Rohan, where “all” is not found to be a pre-condition for a slump sale. Here, giving a leverage to one party determine ‘going concern’ provides a great scope for favourable cherry-picking and hence, confirms more to the aim of an asset sale. Therefore, the legislature should explicitly prescribe what ‘whole’ essentially means. And if it means ‘going concern’, then further provide clarity on the basic composition of ‘going concern’, that can be used universally to some extent to maintain uniformity in slump sale cases.
Conclusion
Concludingly, the current state of affairs raise concerns about the convergence of slump sales towards the characteristics of an asset sale, wherein buyers can selectively choose to acquire profitable assets without assuming associated liabilities. The recent trend showcases an inclination towards accommodating exclusions and selective transfers. Moreover, the subjective determination of a ‘going concern’ adds another layer of complexity for undertaking, allowing for varied interpretations and potentially enabling transactions that do not align with the original intent of a slump sale. To address this trend, there is a compelling need for precise definitions and explanations within the legislative framework to ensure the integrity of the tax provisions, prevent potential misuse or manipulation in business transfers and keep the two ways of business transfers separate in their own sense. Lastly, cherry picking should be made an exception, only to be allowed in situations where basic structure of a going concern undertaking can be adversely affected.