Sale of businesses or 'sale of undertaking as a going concern' is a pretty frequent occurrence in today's time and age with mergers and acquisitions being the flavour of the season. 'Business sale' is a somewhat flexible method of achieving a hive-off; it is subject to lesser regulatory scrutiny than a demerger. As far as tax implications of such sale is concerned, the law is now pretty much clear, in terms of provisions of Section 2(42C) and Section 50B. Section 2(42C) provides that 'slump sale' means the transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to individual assets and liabilities in such sales. The word 'slump sale' thus originates from the word 'lump sum' - 'lump sum consideration' and in the context of income-tax, is used to recognise 'business sale'.

Section 50B is a special provision for computation of capital gains in case of slump sale. It provides that any profits or gains arising from the slump sale affected in the previous year shall be chargeable to income-tax as capital gains. Further, it provides that in relation to capital assets being an undertaking or division transferred by way of such sale, the 'net worth' of the undertaking shall be deemed to be the cost of acquisition and the cost of improvement for the purpose of computing capital gain under Section 48. 'Net worth' is defined as the aggregate value of the total assets of the undertaking as reduced by the value of the liabilities of such undertaking as appearing in its books of accounts. For computing the net worth, aggregate value of the total assets shall be in the case of depreciable assets, the written down value of the block of assets; and in case of other assets, the book value of such assets. The computation formula is provided in a tabular representation.
 
In connection with this formula, there has been a controversy as to what will be the situation in case net worth is negative, ie liabilities are more than the assets. Will the negative net worth lead to increasing the capital gain beyond the sale consideration; or will the negative net worth be considered as 'nil'. In this precise context, the Mumbai tribunal has recently delivered a decision - (Zuari Industries Ltd v asstt commissioner of income-tax, circle- 2, Margao [2006] 9 SOT 563). The assessee sold its cement division to a company for a lump sum consideration. In this case, the value of the liabilities of the division exceeded the value of assets leading to a negative net worth. The assessing officer was of the opinion that negative net worth was to be added to the sale consideration as per the capital gains computation formula and if based on such mathematical formula, the gains were higher than the consideration, so be it.

The tribunal pointed out that the legislature used the expression 'net worth', which by deeming fiction is to be considered as cost of acquisition and cost of improvement.

The cost of a property, as per dictionary meaning, means the price paid by a buyer to the seller and therefore has to be a positive figure. Hence, in case the liabilities exceed the assets, the net worth of the division for the purpose of computing capital gains cannot be taken as negative, as 'cost of acquisition' can never be negative. At best, it can be taken as nil. The capital gain is always a portion of the consideration, and, therefore, the portion can never be higher than the whole.

On the issue whether the liabilities taken over could be added to the sale consideration and then compared with the value of assets, the tribunal held that it would amount to re-writing the scheme of section 50B which is not permissible in law. Thus the tribunal ruled in favour of the assessee by restricting the gains to the sale consideration and taking the cost of acquisition as nil.

This decision affords clarity on a contentious issue; however, it would be useful that this would be followed by a clarification in the law itself; so that unnecessary litigation can be avoided.

MEHUL BHEDA
The author is principal consultant, PricewaterhouseCoopers(PwC)