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Business / Undertaking Hive off – Slump Sale Vs Demerger

By May 15, 2021 No Comments
  1. Slump Sale:

Section 2 (42C) of the Income Tax Act, 1961 (“IT Act”) defines slump sale as the transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to the individual assets and liabilities in such sale. Therefore, slump sale would mean the transfer of all assets and liabilities of an undertaking. Explanation 1 of Section 2 (19AA) of the IT 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”. Therefore, undertaking does not mean a combination of individual assets which would not constitute a business activity in itself. Further, another essential element of a slump sale is that the assets and liabilities of the undertaking should be transferred to ensure continuity of business, therefore, for a transaction to be characterized as a ‘slump sale’, it is essential that the undertaking should be transferred on a going concern basis. The consideration for the slump sale must be a lump-sum figure without attributing individual values to the assets and liabilities forming part of the transferred undertaking. To give effect to the slump sale, a business transfer agreement is required to be entered into between the transferor and the transferee.

The ITA states that gains arising from a slump sale shall be subject to capital gains tax in the hands of the transferor in the year of the transfer. In case the transferor held the undertaking for a period of 36 (thirty-six) months or more, the gains would be taxable as Long-Term Capital Gain (“LTCG) otherwise as Short-Term Capital gain (“STCG”).

Other Considerations:

  • There should be no GST (as defined hereafter) on the sale of the business as a Slump Sale. This is because what is being sold is the undertaking or the business on a Slump Sale basis, and ‘business’ per se does not qualify under the definition of ‘good’.
  • It is also pertinent to note that the gains arising from a slump sale shall be subject to capital gains tax in the hands of the Company. In the event the Company held the undertaking for a period of 36 months or more, it would be taxable as a long-term capital gain tax and otherwise as short-term capital gain tax.
  • Stamp duty: The Stamp duty shall be payable on the business transfer agreement and the assets which are getting transferred in terms of the respective state-specific stamp duty act/schedule.

2.         Demerger:

Section 2 (19AA) of the IT Act defines demerger as the transfer of one or more of the undertaking of the demerged company to any resulting company under a scheme of arrangement prepared under the Companies Act, 2013. The resulting company shall be a separate special purpose vehicle created by the Company for this purpose.

Such demerger should, inter alia, take place in a manner that:

  • the property and the liabilities of the undertaking or undertakings being transferred by the demerged company are transferred at values appearing in its books of account immediately before the demerger;
  • the resulting company issues, in consideration of the demerger, its shares to the shareholders of the demerged company on a proportionate basis;
  • the shareholders holding not less than three-fourths in value of the shares in the demerged company become shareholders of the resulting company or companies by the demerger;
  • the transfer of the undertaking is on a going concern basis.

The “demerged company” means the company whose undertaking is transferred, under a demerger, to a resulting company. The “resulting company” means one or more companies (including a wholly- owned subsidiary thereof) to which the undertaking of the demerged company is transferred in a demerger and, the resulting company in consideration of such transfer of undertaking, issues share to the shareholders of the demerged company.

Further Section 47 of the IT Act lays down that the following transfers relating to demerger do not attract capital gains tax liability:

  • Transfer of assets in a scheme of demerger from the demerged company to the resulting company, if the resulting company is an Indian company.
  • Transfer or issue of shares by the resulting company to shareholders of the demerged company in consideration of demerger of the undertaking.
  • If all the above criteria are satisfied, the demerger will be considered tax neutral and exempt.

Other Considerations:

  •  Since a business is transferred on a ‘going concern basis under an amalgamation, the Goods and Service Tax (“GST”) should not be applicable. Further, Section 18(3) of the Central Goods and Service Tax Act, 2017 in relation to the availability of input tax credit provides that where there is a change in the constitution of a registered person on account of an amalgamation, the registered person shall be allowed to transfer the unutilized input tax credit in his electronic credit ledger to such amalgamated company, subject to certain conditions being met.
  • The provisions of the CA, 2013 require that every scheme of arrangement under Sections 230 to 232 shall indicate an ‘appointed date’ from which it shall be effective and the scheme shall be deemed to be effective from such date and not at a date subsequent to the appointed date. The ministry of corporate affairs (“MCA”) has clarified that the appointed date may be a specific calendar date or may be tied to the occurrence of an event that is relevant to the scheme.
  • Stamp Duty shall be payable on the NCLT order in terms of the state-specific stamp act/ schedule. In case of involvement of immovable properties as part of the scheme of demerger, registration fee and the mutation cost may also be applicable.

3.  Tabular analysis of the aforesaid options: Can be accessed on www.samistilegal.in / publications.

A brief process for Slump Sale is provided herein below:

  • The Company shall decide on the division to be hived-off based on the comparative analysis of stamp duty, registration cost, transfer fee, and mutation cost for immovable property getting transferred. The Company shall also consider strategic reasons for the division going out keeping in perspective the importance of track record, employee-related issues, etc. The Company may also be required to incorporate a new company.
  • A comprehensive business transfer agreement needs to be executed covering the assets and liabilities getting transferred as part of the hive off.
  • The Company would need corporate authorization like board and shareholders approval, as applicable, in terms of the Companies Act, 2013.
  • As detailed above, the process may take around 30 days for completion.

A brief process for demerger is provided herein below:

  • The Company shall decide on the division to be hived-off based on the comparative analysis of stamp duty, registration cost, transfer fee, and mutation cost for immovable property getting transferred. The Company shall also consider strategic reasons for the division going out keeping in perspective the importance of track record, employee-related issues, etc. The Company may also be required to incorporate a new company.
  • An application along with the scheme shall be submitted to the jurisdictional National Company Law Tribunal (“NCLT”).
  • The scheme should be approved by the requisite majority of the shareholders and/or the creditors of both companies.
  •  The Company will also be required to get the valuations of the hived-off division from a registered valuer.
  • As detailed above, the process may take around 9-12 months for completion.

Author: Prashant Jain, Co-Founder & Partner

Disclaimer: The content of this article is intended to provide a general guide to the subject matter and that the same shall not be treated as legal advice. For any queries, the author can be reached at prashant@samistilegal.in.

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