Let’s begin with an example.

In April 2019, Tata Sponge Iron Ltd., a subsidiary of the giant, Tata Steel, acquired Usha Martin’s Steel Business. The UML group made this sale because they wanted to ensure substantial debt reduction. Tata Steel, later, announced that they had acquired the steel business of the UML group through a slump sale on a going concern term. 

Like the one explained here, various businesses are acquired and sold through a slump sale. In this form of purchase, one does not need to assign any particular value to any asset or business liabilities. And, this has made it an effective strategy for companies to handle these kinds of transfers. But, one also needs to address some tax implications that come along with these sales. 

So, without wasting any more time, let’s delve deeper into the topic and understand the functioning of a slump sale.

What is a Slump Sale?

In simple words, the transfer of a business undertaking or some portion of the company to a different entity for a lumpsum amount is known as slump sale. It is done on a growing concern basis. 

When a slump sale takes place on a growing concern basis, movable and immovable assets, liabilities, contracts, intellectual properties, debtors, employees, etc., all get transferred to the purchaser entity. Also, as per the rules, the purchaser entity must remain in business in the near future compulsorily.

Understanding Slump Sale from an Income-Tax Perspective 

Slump sale has been recognized under Section 2 (42C) of the Income Tax Act, 1961. As per the provisions, slump sale has been defined as transferring one or more undertakings in one go, without any specific value assigned to the liabilities or the assets. 

Further explanation goes into stating that even if the value of specific assets is determined, it will only be for the sole purpose of calculating the payments such as registration fee, stamp duty, etc. These assigned values will play no role in making the sale.

Note: The term “undertaking” can mean any portion of a business, any specific unit or division, or entire business activity. Under no circumstances will it include any personal assets or liabilities or any combination of that sort, which does not connect with the business.

Tax Implications Associated with a Slump Sale

Now that you know what a slump sale is let’s understand the tax regulations associated with a slump sale.

Section 50B of the Income Tax Laws, 1961 specifies the tax mechanisms that will be subject to any capital gains arising out of a slump sale. Go through the below-mentioned points to see how capital gains are taxed as per the laws.

  • Capital gains that arise out of a slump sale are generally considered to be long-term capital gains. Having said that, if the purchaser holds the undertaking for a period of more than 36 months (or 3 years), a tax rate of 20% will be applicable.
  • In many cases, the undertaking is not owned and held for a period of 3 years. Capital gains arising from those transfers will be termed short-term capital gains. In these scenarios, a tax rate of 30% will apply.
  • The tax implications arise in the year the transfer of the undertaking is done. The capital gain accrued from a slump sale is computed as the difference between the net worth of the undertaking and the price set by the purchaser.

Calculating Net Worth to Determine the Taxability

Calculating the net worth forms an important step in determining the capital gains. Therefore, let’s gain more clarity into the term by learning the steps followed in calculating the net worth of the undertaking.

  • While determining the net worth of the undertaking, you cannot consider any changes in the price of the assets or the liabilities arising out of revaluation of the same.
  • When it comes to assigning value to the depreciable assets per the laws, the Written down Value will prevail.
  • For the assets or liabilities where 100% dedication is allowed as per 35AD, such value of the assets will not be considered.
  • For the other assets (the ones not discussed above), the value set in the book of accounts will be final.

If the net worth comes to negative, after considering the above factors, the cost of acquisition will be taken as zero for the computation of capital gains.

Role of Companies act, 2013 in the Event of a Slump Sale

Suppose the slump sale involves more than 20% of the undertakings of the net value of the seller company. In that case, the company’s shareholders need to pass a special resolution stating that they agree to the transfer. 

This has been provided by Section 180 of the Companies Act, 2013. The Business Transfer agreement will come into force from the day the special resolution has been passed.

Changes Made to Slump Sale Provisions

The Finance Bill, 2021 has made certain amendments in the slump sale rules, slated to be effective from the 1st of April, 2021.

Previously, the calculation of the capital gains arising from a slump sale was determined by the difference between the net value of the undertakings and the price in consideration.

As per the amendment, the Fair Market Value of the assets and the liabilities on the specific date of transfer will be the value of consideration. Moreover, if the capital gain is goodwill, the value will be treated as zero, provided it has not been acquired from a previous owner.

These proposed changes can highly impact the acquisition and merger transactions occurring from this financial year, as per some financial advisors. 

Key Takeaway

As evident, you need to consider various aspects such as capital gains, net worth, the portion of undertakings, proposed changes to sum up a slump sale scenario. While following these may sound a little complicated, at first, having a good idea on this will help you understand the detailed aspects the next time you come across the term slump sale in a transfer or a merger.

And, for more information, you can always contact FinGurus!