The Income Tax Appellate Tribunal declares slump sale surplus as a capital gain
One of the most fashionable trends of business in the present day world is a transfer through slump sale. This kind of deals falls under the expression of “slump sale”. People are often confused with the issue relating to the concept “slump sale” and its taxability in India.
Slump sale is one of the commonly used ways to acquire a business. However in such transactions, taxation is one of the key issues of consideration for both the purchaser as well as the vendor.
In India, “slump sale” was included in the Income Tax Act, 1961 by the Finance Act, 1999, with the incorporation of section 2(42C).
The term ‘slump sale’ can be defined as a transfer of an undertaking as a result of the sale for a consideration without assignment of values to the personal assets and liabilities. With the introduction of slump sale deals, many judgments and precedents have emerged in India.
The expression “slump sale” is used when a business or an undertaking is transferred without attributing individual values to each asset that is sold.
In other words, if there is a transfer of an undertaking or a business for a lump sum consideration, it is a slump sale.
A recent judgment dated May 25, 2012 of the Income Tax Appellate Tribunal, New Delhi in the case of Assistant Commissioner of Income Tax, New Delhi v. Smt. Sangeeta Wij, on slump sales is significant on the issue as it has been held that the consideration received by the vendor in a slump sale transaction amounts to a capital receipt. The amount cannot be considered as a compensation for incomplete obligations.
This judgment provides the practical implications of slump sale transaction.
Brief facts of the case:
The vendor being the assessee, the proprietor of S.D. Engineering Consultants, had the business of providing consultancy services. The vendor formed a company “ICT-SD Engineering Consultants Private Limited” with the purchaser. He also transferred all the assets and liabilities of the business as a going concern to the buyer vide Memorandum of Understanding dated 31.10.2007 followed by an agreement dated 4.12.2007. The total consideration was Rs.12, 000,000/- According to the Agreement, the sale was for a lump-sum consideration without value being assigned to personal assets. The capital gain of the vendor was Rs.11, 526, 275/-.
To lower down capital gains tax, the vendor invested in real estate. The good will was valued at Rs.4, 800,000/- in the purchaser’s balance sheet. The vendor was chosen as the full-time Director of the Company for a minimum tenure of five years. It was agreed if he was relieved before the end of five years, he would be sufficiently compensated and he shall not carry out any activity, directly or indirectly in any other business related to the Company.
The amount of INR 12,000,000/- was added in the total income of the assessee by the department on the basis of the Agreement. The amount was paid for discontinuation of his business.
The Assessing Officer relied on the fact that the assessee was the full-time director of the Company and was prohibited from getting engaged in any activity that was related to the Company.
The net worth of the company was Rs.473, 725/- as on 31.10.2007 gave rise to a goodwill which was over-valued and was not substantiated by the financial statement of the company.
For the said reason, the Assessing Officer contended the compensation of Rs.12, 000,000/- was not a capital receipt and was liable for capital gains, but a business receipt in the form of a compensation for not getting engaged in any activity relating to the business of the Company and was liable to tax under section 28(v a) (a) of the Income Tax Act.
Arguments of the vendor/assessee:
The assessee relied upon the Agreement and stated that it was a slump sale as per provisions of section 50 B of the Income Tax Act. The assessee filed the documents required under the section 50 B which was a report of the Chartered Accountant calculating the net worth, long term capital gain, and the exemption as per section 54 F of the Income Tax Act.
The assessee further contended that the consideration of Rs.12, 000,000/- was on account of transfer of business as a moving concern or in other words, it was a slump sale as defined in the Income Tax Act, 1961 and there was no competition in the business carried on himself and the purchaser who was engaged in the business of providing consultancy services in airports, highways, etc. The assessee’s business was connected with building projects like metro stations, rail stations, etc. as well as industrial projects.
The assessee contended that the present case comes within the purview of Proviso (i) to Section 28 (va) of the Act, which provides that any sum received for a transfer of the right to carry on any business is taxable only under the head “capital gains”.
Upon perusing the contents of the Agreement and upon hearing the arguments of the parties, the ITAT held that the recitals in the Agreement were specific. It was observed that the Assessing Officer tried to re-write the agreement which is allowed in law. The intention of the parties can easily be revealed from the contents of the Agreement. The amount of Rs.12, 000,000/- was the consideration and not related to the business of the Company though the vendor was at liberty to do any business after leaving the same.
The documents relating to the sale of business and property was filed before the Assessing Officer and on scrutiny, the Assessing Officer held that the vendor had received the amount as a compensation for not carrying on any business similar to that of the company which, should be chargeable as profits and gains of business, as per section 28 (va) of the Act. As such according to the view of the Assessing Officer, the compensation was not a capital receipt which is liable for capital gains, but it was a business receipt for discontinuance of the business of the vendor.
As a result the Assessing Officer treated the amount as business income and added it to the total income of the assessee. The vendor preferred an appeal before the Assistant Commissioner of Income Tax who allowed the same and held that the Assessing Officer was not justified in altering the treatment of income from capital gains as per Section 50B which dealt with the special provision for computation of capital gains for slump sale of the Income Tax Act to business profits as per Section 28 (va). Thereafter, the Revenue filed an appeal against the order of the Commissioner of Income Tax before the ITAT.
The ITAT held that the amount of Rs.11,526,275/- arrived at by the Assessing Officer as the value of good-will amounted to long term capital gains within the meaning of section 50B of the Act.
Accordingly, the ITAT upheld the order of the CIT and declared that the amount was received by the assessee for transferring the right to continue the business as consideration and it was not a compensation for which the CIT was right in deleting the addition made by the Assessing Officer in calculating the total income of the assessee.
Significance of the judgment:
The latest ruling of the ITAT has re-affirmed that Revenue does not have the right to lift the veil of a document only to suit their purpose. Moreover, unless the facts suggest consideration for sale of business is a capital receipt chargeable to tax as capital gains and cannot be considered as compensation under Section 28(va) of the Act. Therefore, to avoid unwanted tax issues, purchasers and vendors should be careful to deal with business transfer contracts.