The net worth of an undertaking transferred is deemed to be the cost of acquisition and cost of improvement for the purpose of calculating the capital gains.
Section 50-B of the Income-Tax Act, 1961, is a special provision for computing capital gains chargeable to tax in the case of a slump sale. Such capital gains are deemed to be long term where the undertaking has been owned and held by the assessee for more than three years, irrespective of the period for which each individual asset of the undertaking has been held.
Therefore, Section 50-B would prevail over the general provisions of the law. Sections 48 and 49 have been made applicable, subject to some modification, for computing capital gains in the case of a slump sale.
Defining net worth
The net worth of the undertaking transferred is deemed to be the cost of acquisition and cost of improvement for calculating the capital gains. The net worth is to be computed in accordance with Explanations 1 and 2 of Section 50-B.
As per Explanation 1, net worth has been defined as the aggregate value of total assets of the undertaking as reduced by the value of liabilities of such undertaking as appearing in the books of account.
Explanation 2 provides that the value of depreciable assets shall be taken as the written-down value (WDV) determined under Section 43(6)(c) of the Act, while the value of non-depreciable assets will be taken as per the books. The net worth so computed is to be certified by the report of the accountant as defined in Section 288(2).
The word worth as per the dictionary meaning means value of goods or asset or property.
No person would buy any property that is worthless. Further, the word worth is qualified by the word net which would mean the net value of the property that is being sold or purchased. At best, the value of the property can be nil but there is no concept of negativity with reference to the expressions net worth or cost acquisition. Had the legislature also intended negative cost of acquisition, it would have used the words by deducting from or adding to, as the case may be in Section 48 of the Act instead of the words by deducting from actually used by it.
Negative cost not intended
The language used by the legislature in Section 48 shows that it never intended a negative cost of acquisition. Since net worth in Section 50-B is deemed to be the cost of acquisition as per sub-section (2) thereof, it must also have been intended by the legislature to be a positive figure.
Therefore, the expression reduced by used by the legislature in Explanation 1 to Section 50-B has been used in the sense that net worth should be arrived at a positive figure or at best be reduced to nil. Consequently, where the liabilities are more, then the value of assets as computed under Section 50-B, the net worth, would be considered as nil.
Where an asset is saddled with liability, there are two ways of considering the value of the liability while computing the capital gain. First, the sale consideration should be increased to the net amount realised by the vendor. Second, the value of the liability can be deducted from the value of assets while determining the cost of acquisition as provided in Section 50-B.
The legislature, in its wisdom, having opted for the second option, it is not open for the Revenue to contend that such liability should again be added to the sale consideration realised by the vendor.
In Zuari Industries Ltd vs CIT (298 ITR AT 97), the assessee was engaged in the business of manufacture and sale of chemicals, fertilisers and allied products as well as cement and furniture.
It sold its cement division located in Andhra Pradesh to Zuari in which 50 per cent stake was held by the assessee against lump-sum consideration of Rs 75.98 crore paid by way of allotment of 7,59,80,000 fully paid-up equity shares of face value of Rs 10 each under the scheme of arrangement approved by the Bombay High Court. This scheme was effective from April 1, 2000. In the return filed for the assessment year 2001-02, it stated that the net worth of the cement division, as per computation done under Section 50-B of the Act, was a negative figure of Rs 150.46 crore.
As such, in the absence of cost, which was necessary for computing capital gain, the relevant section for computing the capital gains did not apply.
Thus, the consideration received amounted to a capital receipt, not chargeable to tax. The claim of the assessee was rejected by the assessing officer (AO). He computed the capital gains at Rs 226.443 crore. This was upheld by the Commissioner (Appeals).
The Income-tax Appellate Tribunal (ITAT) held that Section 50-B was introduced by the Finance Act, 1999 with effect from April 1, 2000. Prior to this, there were disputes as to whether transfer of business or an undertaking by way of slump sale constituted transfer of capital asset and whether there was any cost of acquisition of such business or undertaking or division.
After the insertion of Section 50-B, profits on transfer of such asset are chargeable to tax under the head capital gains and the cost of acquisition for the purpose of Section 48 would be the net worth as computed under Section 50-B.
The profit arising on the transfer of the cement division by way of slump sale was chargeable to tax under the head "capital gains". The value of assets as per books of account was much more than the value of liabilities. The Tribunal observed that no prudent person would have acquired the unit unless the value of assets or benefit attached to the division was more than the liabilities. The division was purchased since the value of assets was more than the liabilities.
The Tribunal opined that it was because of the artificial provision of Section 43(6)(c) of the Act that the value of depreciable assets had to be computed at a substantially low figure, which resulted in the value of assets being less than the liabilities. However, on that account, the net worth should not be reduced below "nil" since this would be contrary to the scheme of the section itself.
Therefore, the "net worth" of the cement division should be taken as "nil" which would be deemed to be the cost of acquisition for the purpose of computing the capital gains under Section 48. The assessing officer was directed by the Tribunal to assess the capital gain at Rs 75.98 crore.
This is an interesting view taken by the Tribunal which is bound to be contested in the High Court, and subsequently the apex court. Possibly the Government may consider making a clarificatory amendment to the provision to avoid protracted litigation.
H. P. Ranina (The author is a Mumbai-based advocate.)