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Reserve Bank of India recently made an amendment to the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 dated May 20, 2016 by way of insertion of new Regulation 10A (“Regulation”). The new Regulation provides that when a transfer of shares/security between a resident buyer and a non-resident seller takes place, twenty five per cent of the total consideration can be paid by the buyer on a deferred basis within eighteen months from the date of the transfer agreement. This window of time provided to make the total payment comes as a welcome change as it enables the buyer to get some additional time to make the payment. In other words, this window of eighteen months shall prove to provide some relief and financial ease to the buyer with respect to closing the transaction.
Earlier, when an investor wanted to transfer his shares, the total consideration for such transfer was to be paid upfront at the time of taking delivery and an escrow mechanism was permitted (with several restrictions) under the automatic route for a maximum period of only six months. This led to a number of complications especially when Options Contract(s) were in place, as the person making the purchase had to arrange for a huge sum of money in a short period of time. Adding to the woes of the parties was the fact that the RBI had disallowed the fixation of a price prior to exercising such an Option. Consequently, it often led to sudden realization of one’s financial obligations and the mounting of an unanticipated burden when the price of the security was determined at the time of exercising the Option.
A concern which may arise is the loss one party may incur because of the fluctuating currency exchange rates, however, this has been addressed by the Regulation itself as it provides for an escrow arrangement for the allowed twenty five per cent between the buyer and the seller, if both parties mutually agree.
Alternatively, an indemnity may be furnished by the seller for twenty five per cent of the consideration for a period of eighteen months if buyer pays the entire consideration to ease up the financial burden on him. This would act as a deterrent to litigious claims as payments will be guaranteed even in situations where the buyer may default on his dues.
The amendment plays out favorably for the buyer in two ways; it gives him a comfortable timeline to meet his payment obligations while using it to protect himself from any breach of warranties on part of the seller by securing the indemnity rights. Secondly, it gives him a financial edge by saving him the expense of payment of interest for a period of eighteen months on such deferred payments.
However, there are some ambiguities in the Regulation with regard to determining who the constructive owner of the shares would be during the eighteen month period of deferment till the closing of the transaction. This may become a point of contention when benefits are to be conferred on members like payment of dividend, issue of bonus shares and so on. There is also no time period prescribed for the payment of indemnification in case of a default by a buyer with regard to payments to be made to the seller if it’s not decided by the parties contractually.
On the whole, this will be widely hailed as a move on part of the Government to make the transfer/issue of shares and securities smooth and easy. It is also indicative of the government’s increasing liberal outlook on making entry and exit from the Indian markets more conducive to investors by bringing it in line with the globally accepted risk allocation mechanisms. Coupled with other initiatives like Make in India and the thrust on bringing in Foreign Direct Investment, this amendment will surely bring more goodwill and trust in the Indian institutional setup.
1. Stamp Duty on Immovable Property in a Slump Sale
Although individual values cannot be assigned to the various assets for purposes of the transaction in a slump sale, appropriate values have to be considered for purposes of stamp duties. Under the Indian Stamp Act, 1899, stamp duty is payable in relation to transfer of immovable properties. Generally, anything embedded in, or attached to, the earth (such as land or buildings) is considered immovable property and any transfer of the same can attract significant stamp duties. So, in any business transfer arrangement that seeks to transfer plant and machinery together with the land, and such plant and machinery is embedded in, or attached to, the earth, the same will be treated as immovable property and its transfer will be stampable accordingly.
While land/buildings are considered immovable property, whether machinery that has been installed becomes immovable property depends on the degree and permanency of the attachment, and the purpose of installing and attaching the machinery. For instance, the Supreme Court has held that a fertilizer plant, sold as part of a slump sale along with land and building, is immovable property as it was always intended that the plant remains permanently affixed to the land and building being transferred. However, this finding was specific to the facts of that case (Duncans Industries Ltd vs State of UP, AIR 2000 SC 355). Further, the Supreme Court also rejected the contention of the seller that the plant and machinery was transferred by delivery. The court held that unless the machinery was physically removed from the factory and delivered to the buyer at some other location, it would not be considered to be a sale of goods, which are transferred by delivery. Therefore, it would be construed that the sale deed for the immovable property should have also been stamped with the value of the plant and machinery.
2. Taxation Laws
2.a. INCOME TAX ACT, 1961
S. 50B was introduced w.e.f. A.Y. 2000-01, which lays down a special provision for computation of capital gains in case of slump sale. S. 50B provides for computation of capital gains on slump sale of ‘undertaking or division’. An ‘undertaking’ may be owned by a corporate entity or a non-corporate entity, including a professional firm as S. 50B refers to ‘assessee’ without any specific exclusion of a non-corporate entity.
Taxability of gains arising on slump sale:
S. 50B provides the mechanism for computation of capital gains arising on slump sale. On a plain reading of the Section, some basic points which arise are :
1. S. 50B reads as ‘Special provision for computation of capital gains in case of slump sale’. Since slump sale is governed by a ‘special provision’, this Section overrides all other provisions of the Act.
2. Capital gains arising on transfer of an undertaking are deemed to be long-term capital gains. However, if the undertaking is ‘owned and held’ for not more than 36 months immediately before the date of transfer, gains shall be treated as short-term capital gains. It is important to note that Circular No. 779, dated 14-9-1999, issued at the time of introduction of S. 50B, has used the words ‘held’ instead of ‘owned and held’ used in the text of S. 50B. It is not clear whether this difference in terminology is of any significance.
Where an undertaking was acquired by an assessee under a will, and such an undertaking is transferred by him as a slump sale within a year, the undertaking will be classified as short-term or a long-term asset based on the period for which the previous owner ‘owned and held’ the undertaking [S. 49(1)(ii)].
3. Taxability arises in the year of transfer of the undertaking. The undertaking will be deemed to be transferred on execution of the agreement and registration thereof coupled with the handing over of possession of the undertaking to the transferee. However, if the year of the agreement of the undertaking and registration thereof and the year of its possession fall in two different previous years, then the previous year in which the possession of the undertaking is handed over to the transferee will be considered as the year of transfer.
4. Capital gains arising on slump sale are calculated as the difference between sale consideration and the net worth of the undertaking. Net worth is deemed to be the cost of acquisition and cost of improvement for S. 48 and S. 49 of the Act.
5. As per S. 50B, no indexation benefit is available on cost of acquisition, i.e., net worth.
6. In the year of transfer of the undertaking, the assessee has to furnish an accountant’s report in Form 3CEA along with the return of income indicating the computation of net worth arrived at and certifying that the figure of net worth has been correctly arrived at. Although the certification of computation is based on the information and explanations obtained by the accountant, the essence of the form is on reporting that the computation is ‘true and correct’ rather than ‘true and fair’.
7. In case of slump sale of more than one undertaking, the computation should be done separately for each undertaking. This is substantiated by Note 5 to Form 3CEA, which requires the computation of net worth of each undertaking to be indicated separately.
8. In case of slump sale in the nature of succession of a firm or a proprietary concern by a company, capital gains made on slump sale may be entitled to exemption u/s.47(xiii) and (xiv), respectively, provided the other conditions of these Sections are satisfied. In case of violation of conditions of S. 47(xiii) or (xiv) in any subsequent year, the benefit availed by the firm or the sole proprietor will be taxable in the hands of the successor company in the year in which the violation takes place as per S. 47A(3).
Besides, if the successor company violates the conditions of S. 47(xiii) or (xiv) by transferring that undertaking under a slump sale within three years of conversion, the undertaking will be classified as a short-term capital asset as per S. 50B. Then, the company would have to pay for the loss of tax benefit due to violation of conditions, as well as tax on the short-term capital gains arising on the slump sale.
9. Gains made by a foreign resident from the alienation of a permanent establishment or a fixed base in India by way of slump sale, shall be taxable in India as per S. 50B read with Article 13 (Capital Gains) of the UN/ OECD Model Convention on Double Taxation Avoidance Agreement.
2.b. VALUE ADDED TAX
The term ‘slump sale’ connotes the sale of an entire business undertaking, comprising of various assets net of liabilities for a lump sum or ‘slump’ consideration. Courts have held in a catena of judgments that the taxing authorities in case of a slump sale can not split the sale consideration and attribute it to different assets. Further, under the VAT and Sales Tax laws the term “business” is not covered under the definition of goods and accordingly no VAT implication would trigger on the transactions involving the transfer of business as a whole. The Allahabad High Court also upheld the same view in the case of Sri Ram Sahai vs. Commissioner of Sales Tax (1963) 14 STC 275 (All) and the Madras High Court in the case of Monsanto Chemicals Of India (P.) Limited V. The State of Tamil Nadu (1982) 51 STC 278 (Mad).
In the case of Coromondal Fertilizers Limited vs. State of AP and Spectra Bottling Co. v. State of AP,(1999) 112 STC 1 AP also the High Court of Andhra Pradesh held that sale of business would not be construed as sale in the course of business and hence would not be subject to sales tax.
If the position was reasonably clear-cut that a sale of a factory would attract only stamp duty and would not attract VAT, that would probably be acceptable to industry. However, all such transactions have several items of plant that are embedded in the ground and many other items that are movable in the factory. Even with respect to the items that are embedded in the ground, there would be many that can easily be removed and transported to any other location if required.
Therefore, a person entering into such a transaction has to face considerable uncertainty on the extent to which VAT is applicable on the transaction, along with the prospect of double taxation, since stamp duty would also be applicable.
2.c. SALES TAX
As discussed in the previous section, no sales tax payable on the transfer of a business as a going concern, including the transfer of a whole unit or division of any business under the value-added tax laws or the local sales tax laws. This is based on the rationale that the sale of an entire business cannot be equated with the sale of movable goods, the latter being subject to sales tax. The prevalent view in relation to sales tax in the case of a slump sale is that such sale would not attract sales tax since a business is not considered to be “goods” under sales tax laws.