The Taxation Predicament of Slump Exchanges

[C. H. Anvita and Anirudh Venkatesh are 4^thYear BA LLB (Hons.) students from School of Law, Christ (Deemed to be University, Bengaluru]

Background

The Mumbai bench of the Income Tax Appellate Tribunal (“ITAT”) has, in two sequential decisions in the months of January and May, 2018[1] (in which, the latter case reiterated the reasoning and decision of the former), reignited discussions on the peculiar issue of the taxability of “slump exchanges” as distinguished from “slump sale” transactions. However, prior to discussing these decisions, certain basic terms must be mentioned. First, for the purposes of the Income Tax Act, 1961 (“ITA”), a “slump sale” is defined under section 2(42C) to mean the transfer of one or more undertakings as a result of a sale for a lump sum consideration without values being assigned to the individual assets and liabilities in such sales. In contrast to this, a “slump exchange” is best described as a sale of an undertaking in return for a consideration in kind that is in the form of shares or debentures of the transferee company or an investment or asset held by the said company.

Secondly, under section 50B the ITA has provided a mechanism to compute the cost of acquisition of transferred undertakings. Section 45 of the ITA subsequently levies a charge on the computations under the aforementioned section. However, the crucial term, “sale” has not been defined under the ITA. This has been the reason of much controversy in distinguishing a slump sale from a slump exchange. The courts, in cases such as CIT vs. Motors and General Stores P. LTD. (66 ITR 692, 2005), CIT vs. Bharat Bijilee Ltd. (365 ITR 258, 2014) and ITO vs. Zinger Investments (P) Ltd. (2013) have resorted to use the definition of the term “sale” as appearing in section 54 of the Transfer of Property Act, 1882 and section 4 of the Sale of Goods Act, 1930. In CIT vs. Bharat Bijilee Ltd., the Court held that where the transferor of an undertaking receives consideration in kind (say in the form of shares, debentures or assets and investments of the transferee company), and not in monetary form, the transaction is in the nature of an exchange and such transactions do not qualify as a “slump sale” under the ITA.

The ITAT Decisions

The ITAT in these recent cases have discussed this predicament under two heads, namely:

(i) defining the words ‘sale’ and ‘exchange’ and deciding whether the transaction in the current case falls under section 50B of the ITA; and

(ii) whether this case is within the purview section 45 of the ITA.

Regarding the first point, the court, in the case of CIT v. Motor & General Stores (P) Ltd defined the terms ‘price’, ‘sale’ and ‘exchange’ by placing reliance on the definitions given under the Transfer of Property Act, which are as follows:

1. “Sale is a transfer of ownership in exchange for a price paid or promised or part paid and part promised”;
2. “Price is the money consideration for sale of goods”; and
3. “Exchange is when two persons mutually transfer the ownership of one thing for the ownership of another, neither thing or both things being money only”

The Court held that presence of money consideration is an essential element in a transaction of sale. If the consideration is some other valuable consideration and not money, the transaction may be termed as exchange or barter but it is not a sale. In the case of Bennett Coleman & Co. Ltd., the transaction that occurred was held to be an exchange and not sale because the consideration was not money but equity shares and debentures. Therefore, the provisions of section 50B of the ITA was not attracted. The same conclusion was arrived at in the cases of CIT v. Bharat Bijlee Ltd. and CIT v. Motor & General Stores (P) Ltd.

With respect to the second point, the decision in the Bennett Coleman Casewas in line with the reasoning in CIT v. B.C. Srinivasa Setty ([1981] 128 ITR 284). In the latter case, the Supreme Court held that the “asset” must be one that falls within the contemplation of section 45. It is further held that the charging section and the computation provisions together constitute an integrated code. The reasoning provided by the Supreme Court for calling it an integrated code is as follows:

Section 45 is a charging section. For the purpose of imposing the charge, Parliament has enacted detailed provisions in order to compute the profits or gains under that head……………. All transactions encompassed by section 45 must fall under the governance of its computation provisions. A transaction to which those provisions cannot be applied must be regarded as never intended by section 45 to be the subject of the charge……………… The character of the computation provisions in each case bears a relationship to the nature of the charge. Thus, the charging section and computation provisions together constitute an integrated code. When there is a case to which the computation provisions cannot apply at all, it is evident that such a case was not intended to fall within the charging section.

 Based on this, the ITAT held that when the computation provision cannot apply, as was apparent in this case, such a situation would not fall within the ambit of section 45.

Conclusion

Slump sale is one of the modes of ensuring that a business continues to function as a going concern, targeting companies that have entered a debt trap or unable to handle their liabilities. As a result of this, the acquirer company is conferred tax benefits under the ITA. However, the subjective predicament of distinguishing between slump sale and slump exchanges has resulted in a situation where on the one hand the acquirer company is completely absolved of capital gains tax (“CGT”) liability as discussed in the cases above and on the other hand this results in a situation where it can be misused by companies as a means of tax avoidance. The debate here is the identification of whether a transaction of sale of undertaking is considered a sale or an exchange, which varies depending on the circumstances.

According to the current law, a sale of undertaking involving the exchange of business of one company with the shares or debentures of another company in lump sum is not recognized as a slump sale and as such CGT cannot be levied on the transferee company for the gains made by it in the transaction. However, without further clarity on the matter, the concept of slump exchange can either be used as a means of fostering quicker and more efficient rescue of debt trapped companies or it can be used to avoid tax liabilities emerging thereunder. Thus, the decision of a higher court is necessary to ensure proper interpretation of the concept.

– C. H. Anvita and Anirudh Venkatesh

[1] Bennett Coleman & Co. Ltd, Mumbai v. Asst Cit Rg, Mumbai, [2018] 168 ITD 631 (Mum); Oricon Enterprises Ltd. v. Asst Cit, Mumbai, (2018) 170 ITD 231 (Mum)(Trib.).