Business Transfer Why, how and when? - July 2020 - Nishith Desai Associates
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MUMBAI SI LI C O N VALLE Y BAN G A LO RE SI N G A P O RE MUMBAI BKC NEW DELHI MUNICH NE W YO RK
Business Transfer
Why, how and when?
July 2020
© Copyright 2020 Nishith Desai Associates www.nishithdesai.comBusiness Transfer
Why, how and when?
July 2020
ndaconnect@nishithdesai.com
DMS Code - 7541,1:
© Nishith Desai Associates 2020Business Transfer
Why, how and when?
About NDA
We are an India Centric Global law firm (www.nishithdesai.com) with four offices in India and the
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© Nishith Desai Associates 2020Provided upon request only Accolades A brief chronicle of our firm’s global acclaim for its achievements and prowess through the years – Legal500: Tier 1 for Tax, Investment Funds, Labour & Employment, TMT and Corporate M&A 2020, 2019, 2018, 2017, 2016, 2015, 2014, 2013, 2012 Chambers and Partners Asia Pacific: Band 1 for Employment, Lifesciences, Tax and TMT 2020, 2019, 2018, 2017, 2016, 2015 IFLR1000: Tier 1 for Private Equity and Project Development: Telecommunications Networks. 2020, 2019, 2018, 2017, 2014 AsiaLaw Asia-Pacific Guide 2020: Tier 1 (Outstanding) for TMT, Labour & Employment, Private Equity, Regulatory and Tax FT Innovative Lawyers Asia Pacific 2019 Awards: NDA ranked 2nd in the Most Innovative Law Firm category (Asia-Pacific Headquartered) RSG-Financial Times: India’s Most Innovative Law Firm 2019, 2017, 2016, 2015, 2014 Benchmark Litigation Asia-Pacific: Tier 1 for Government & Regulatory and Tax 2019, 2018 Who’s Who Legal 2019: Nishith Desai, Corporate Tax and Private Funds – Thought Leader Vikram Shroff, HR and Employment Law- Global Thought Leader Vaibhav Parikh, Data Practices - Thought Leader (India) Dr. Milind Antani, Pharma & Healthcare – only Indian Lawyer to be recognized for ‘Life sciences-Regulatory,’ for 5 years consecutively Merger Market 2018: Fastest growing M&A Law Firm in India Asia Mena Counsel’s In-House Community Firms Survey 2018: The only Indian Firm recognized for Life Sciences IDEX Legal Awards 2015: Nishith Desai Associates won the “M&A Deal of the year”, “Best Dispute Management lawyer”, “Best Use of Innovation and Technology in a law firm” and “Best Dispute Management Firm” © Nishith Desai Associates 2020
Business Transfer
Why, how and when?
Please see the last page of this paper for the most recent research papers by our experts.
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Acknowledgements
Ipsita Agarwalla
ipsita.agarwalla@nishithdesai.com
Harshita Srivastava
harshita.srivastava@nishithdesai.com
Ruchir Sinha
ruchir.sinha@nishithdesai.com
Parul Jain
parul.jain@nishithdesai.com
© Nishith Desai Associates 2020Business Transfer
Why, how and when?
Contents
INTRODUCTION 01
1. CONSTITUENTS OF A BUSINESS TRANSFER 02
2. LEGAL, REGULATORY & TAX IMPLICATIONS 06
I. Parties to the transaction 06
II. Corporate Authorisations 06
III. Anti-trust clearance 06
IV. Tax implications 08
3. BUSINESS TRANSFER VS. SHARE TRANSFER 10
4. CHALLENGES IN A BUSINESS TRANSFER 13
I. Determining Cost of Acquisition of The ‘Undertaking’ 13
II. Goodwill vs. Non-Compete 14
III. Section 281 Certificate 19
IV. Liability Under Section 170 of The ITAVIS-A VIS Section 281 19
V. Section 56 20
VI. Employee Transfer 20
VII. Nature of Assets 21
VIII. Conclusion 22
© Nishith Desai Associates 2020Business Transfer
Why, how and when?
Introduction
In the context of M&A transactions, how you a court approved demerger. Since, each of these
acquire is as important as what you acquire. The modes of acquisitions will have significant and
structure of a transaction could either make or different implications for the buyer and the
break the deal, especially in a jurisdiction like seller, it is important to choose a structure that
India where the consequences of wrong choice meets the expectations of the parties, complies
of structure could outweigh the benefits of the with applicable legal requirements and most
transaction. Therefore, naturally one of the importantly, is tax efficient.
most fundamental considerations in any M&A
It is generally perceived that acquirers tend
transaction is the mode of acquisition.
to prefer asset purchase over any other mode
The choice of the mode of acquisition can have of M&A. Obviously, who would not want to
far reaching implications for the buyer and the cherry-pick only the desired assets and steer
seller, inter-alia, in terms of, legal compliances, clear of historic liabilities of the target. However,
taxation, successor liability, employee transfer, asset transfer is not a seller’s favorite owing
stamp duty, time and effort for implementation primarily to the tax disadvantage for the seller.
beside the obvious commercial considerations As a midway, parties are now increasingly
involved. Hence, zeroing in on a structure that considering ‘business transfer’ or ‘slump sale’ as
works best for the seller and the buyer would be modes for acquisitions. In recent times, we have
the first step in the deal making process. witnessed a surge in the number of business
transfer transactions and there are multiple
Traditionally, the choice for the acquirer has
reasons for its growing popularity.
been between, acquisition of the company
conducting the business and the acquisition This paper examines, basic structure of a
of the business itself. While the former will be ‘business transfer’, how it differs from other
through the fairly straightforward acquisition of modes of asset sale and the merits and demerits
shares, the latter can be achieved in more ways over other modes of acquisition. In doing
than one; each with its own set of pros, cons and so, we explain the legal, tax and regulatory
complexities. In the Indian context, acquisition implications of a ‘business transfer’ and also
of a ‘business’ can be through, transfer of cover certain key commercial considerations
an entire undertaking as a going concern or that are often heavily negotiated. We also deal
transfer of just the cherry-picked assets that with the nuances of ‘share transfer’ and cover
are required for the business. The transfer of certain tax issues and challenges that may arise
an undertaking itself can be achieved in two on ‘share transfer’.
different ways: one, a ‘slump-sale’ and the other,
© Nishith Desai Associates 2020 1Provided upon request only
1. Constituents of a Business Transfer
The terms, ‘business transfer’ and ‘slump sale’ the profits or gains arising from the business
are used interchangeably in the Indian context transfer be subject to short-term capital gains at
and both refer to transfer and sale of an entire rate of 30% in case of domestic companies and
business undertaking of the seller on a going 40% in case of foreign companies.
concern basis for a lump-sum consideration. In
India, ‘Slump sale’ is purely a tax concept and In light of the definition under Section 2(42C)
the Income Tax Act, 1961 (“ITA”) defines a of the ITA and the judicial interpretation of
slump sale under Section 2 (42C) as follows: this definition over the years, the following are
the fundamental requirements of a business
transfer transaction:
1. Transfer by way of sale: ITA recognizes
“transfer of one or more undertakings multiple forms of transfer under section
as a result of the sale for a lump 2(47) including ‘transfer by way of sale’ and
sum consideration without values ‘transfer by way of exchange’. The definition
being assigned to the individual of slump sale under ITA makes it clear
assets and liabilities in such sales” that transfer by way of sale is what would
constitute a slump sale and not transfer by
any other mode.3
One of the biggest advantages of slump sale An interesting point that has been discussed
over an asset sale is its tax treatment for the and deliberated over the years is whether
seller. Since, individual values are assigned to payment of monetary consideration is
each of the assets in an asset transfer, capital mandatory for a slump sale. While it is settled
gains arising from the sale of assets will also be that transfer without any consideration
ascertained for each asset separately. Therefore, shall not qualify as a slump sale4 there is still
depending upon the holding period for each some ambiguity on whether consideration
asset there could be short term capitals or long in kind would affect the nature of a slump
term capital gains on each asset. sale transaction. There have been attempts
in the past to structure a slump sale in such
In case of a business transfer that meets all
a manner that consideration for the transfer
the requirements prescribed under ITA, any
was paid in the form of shares or other assets.
undertaking that has been held by the seller for
The question is whether such payment of
more than 36 months shall be deemed to be a
consideration in kind would qualify as, sale or
long-term capital asset irrespective of how long
exchange of assets.
the individual assets in the undertaking have
been held by the seller. Accordingly, the entire While the term ‘sale’ is not defined under
profits or gains arising from the business transfer ITA, inference can be drawn from Section
shall be subject to long-term capital gains tax at 4 of the Sales of Goods Act, 1930 (“SOGA”)
the rate of 20%1 if the undertaking has been held which defines sale as a contract whereby
by the seller for more than 36 months.2 the seller transfers the property in goods to
a buyer for a price. Accordingly, under the
Only if the undertaking has been held for
SOGA payment of monetary consideration
not more than 36 months by the seller will
is one of the necessary requirements of
1. All the rates in this paper are exclusive of applicable sur- 3. Avaya Global Connect Ltd. v ACIT (26 SOT 397)
charge and cess 4. ITO v. M/s Zinger Investments (P) Ltd [TS-437-ITAT-
2. Section 50B of ITA 2013(Hyd)]
2 © Nishith Desai Associates 2020Business Transfer
Why, how and when?
a ‘sale’. The Supreme Court of India has at this stage, if the parties are risk averse and
borrowed the requirements of ‘sale’ from want to completely avoid the possibility of
SOGA for the purposes of interpretation of any challenge on the transaction structure
the provisions of the ITA. In the matter of then, it is advisable to include some
CIT v R.R. Ramakrishna Pillai,5 the Supreme monetary consideration for the transferin
Court has confirmed that transfer of an order to ensure that it falls within the ambit
asset for consideration other than monetary of a ‘slump sale’ and governed by section 50B
consideration is an exchange and not sale. of the ITA.
The Delhi High Court, in the matter of 2. Transfer of an undertaking: The subject
SREI Infrastructure Finance Ltd v. Income matter of the transfer is yet another defining
Tax Settlement Commission,6 has ruled characteristic of a slump sale. What has to be
that on transfer of business in exchange of transferred is one or more undertakings of
another asset, there is indeed a monetary the seller. The term, “undertaking” is defined
consideration which is being discharged in under the ITA as follows:
the form of shares. The Court further held
that it would not be appropriate to construe
and regard the word ‘slump sale’ to mean
that it applies to ‘sale’ in a narrow sense and “undertaking” shall include any part of
as an antithesis to the word ‘transfer’ as used an undertaking or a unit or a division
in Section 2(47) of ITA. of an undertaking or a business
A contrary view was taken by the Bombay activity taken as a whole, but does
High Court, in the matter of CIT v. Bharat not include individual assets or
Bijlee Limited.7 The Bombay High Court, liabilities or any combination thereof
upheld the decision of the Income-tax not constituting a business activity”.
Appellate Tribunal that the transfer of a
business undertaking as a going concern
against bonds/ preference shares issued
The parties to the transaction have
was not a sale, but an exchange. Therefore,
the liberty to identify and agree upon
section 2(42C) and section 50B of ITA
the undertaking to be transferred and
relating to the computation of capital gains
the constituents thereto. However, the
were not applicable to such a transfer. The
undertaking agreed to be transferred has to
Court tried to distinguish the Delhi HC
meet the requirements under the ITA.
ruling on the grounds that in case of SREI
Infrastructure Finance Ltd, the consideration The transferred undertaking should
for transfer was both in the form of cash represent an identifiable stand-alone
and shares. Since an element of monetary business activity and should contain all the
consideration was involved, it could not be assets and liabilities including employees,
said that there is no sale. contracts and licenses that are required for
conducting such business. The transferred
There is no absolute clarity on this point as
undertaking should have the inherent
can be seen from the conflicting precedents
ability and potential to run the business
mentioned above. The case of Bharat Bijlee
which is being transferred and also, generate
Limited is now pending before the Supreme
revenues independently without having to
Court and the order of the Supreme Court
rely on any external support.
may put the matter finally to rest. However,
While an asset transfer transaction offers the
ability to cherry-pick assets and liabilities as
5. 1967 66 ITR 725 SC
parties may desire, a slump sale transaction
6. Writ Petition (Civil) No. 1592/2012
demands transfer of all the assets and
7. [TS-270-HC-2014(BOM)]
© Nishith Desai Associates 2020 3Provided upon request only
liabilities that are necessary for conducting a list of transactions which are disregarded as
the business without any exception. transfer for the purposes of section 45 subject
to fulfilment of certain conditions specified
Ideally, all the assets and liabilities forming
therein. Section 50B merely provides for a
part of the transferred business need to
mechanism for computation of capital gains
be transferred to the buyer in a slump
in case of a slump sale. Therefore, provisions
sale but case laws indicate that exclusion
of section 50B cannot override section
of certain assets and liabilities should be
45. Accordingly, provisions of section 50B
permitted so long as the assets and liabilities
should not be applicable in case of transfer of
transferred as part of the undertaking are
capital asset which is exempt under section
sufficient for conducting the business and
47. The Chennai Tribunal in the matter of
generating sustainable revenue on its own
Assistant Commissioner of Income-tax v.
on a standalone basis. This is important
Madan Mohan Chandak9 while dealing with
especially in case of assets and liabilities
succession of a sole proprietary concern by a
of the seller that are shared by multiple
company has held that when there is a specific
divisions of the seller. It is absolutely fine
provision i.e. 47(xiv) in the ITA dealing with
for the seller to retain such shared assets
a particular case, it is not advisable to shift to
and liabilities provided the buyer provides
other similarly worded provision.
substitutes for such retained assets and
liabilities thereby ensuring that the 3. Transfer as a going concern: The single
undertaking is capable of conducting the most important requirement of a slump
transferred business on a stand-alone basis. sale is that the undertaking is transferred
as a ‘going concern’. There should be no
Apart from the considerations above, it is
break or cessation in the operations of the
essential to examine whether certain type
transferred undertaking. The transfer of the
of transfers meet the undertaking test. One
undertaking form the seller and the vesting
such transfer is transfer of investment in stock,
of the undertaking in the buyer together
mutual funds etc. The Bombay High Court
with all the assets and liabilities should be
in the matter of Principal Commissioner of
simultaneous and it should not stop, hinder
Income-tax v. UTV Software Communication
or break the conduct of the business. Hence,
Ltd8 while upholding the Tribunal’s order
it is important for the buyer to ensure that
has held that mere change in shareholding
the buyer has all the requisite infrastructure,
pattern will not make a transaction slump
licenses and preparedness to start running
sale. Accordingly, transfer of shares should
the business simultaneously with the
not result into transfer of ‘undertaking
consummation of the slump sale.
making it a slump sale for Sec. 50B of the ITA.
Another issue which arises is whether the 4. Lump-sum consideration: The
provisions of section 50B apply even in case consideration for the slump sale has to
of a transfer of a capital asset which is exempt be a lump-sum figure without attributing
under section 47 of the ITA. In this regard, it individual values to the assets and liabilities
will be essential to appreciate the construct forming part of the transferred undertaking.
of the provisions of slump sale and capital It is not individual assets that the buyer is
gains under the ITA. Section 45 contains buying but a stand-alone business in entirety.
the charging provision in relation to capital Therefore, the business has to be valued as
gains and provides that any profits or gains a whole and an aggregate consideration for
arising from the transfer of a capital asset is the business has to be arrived at. However,
chargeable to income-tax under the head it is clarified that the determination of
“Capital gains’. However, section 47 provides the value of an asset or liability for the
8. IT Appeal No. 1475 of 2016 9. IT APPEAL NO. 1256 (MAD.) OF 2009
4 © Nishith Desai Associates 2020Business Transfer
Why, how and when?
sole purpose of payment of stamp duty, slump sale agreement cannot lead one to the
registration fees or other similar taxes or fees conclusion that there was a sale of itemized
shall not be regarded as assignment of values assets. Further, in case consideration is to be
to individual assets or liabilities. paid in form of deferred payments / earn out,
a question may arise as to whether deferred
Practically, working capital adjustment may
payments should still be construed as “lump
also be required to be undertaken to account
sum’ consideration to qualify as slump
for the intervening period between the date
sale. In this context, while the dictionary
of execution of business transfer agreement
meaning of “lump sum” regards it as a single
(“BTA”) and the actual date of transfer. The
payment made at a particular time, it can
nature of transaction should not change
be argued that since the object of a slump
from slump sale merely because a working
sale is to agree for a consideration without
capital adjustment is envisaged under the
attributing individual values to assets and
BTA. This issue is squarely covered by the
liabilities, even if such consideration is paid
Bombay High Court in case of Premier
in installments, the “lump sum’ criteria
Automobiles Ltd vs. ITO10 (amongst various
should nevertheless be met.
other issues) wherein it was held that
reference to value of net current asset in the
10. 264 ITR 193 (Bom)
© Nishith Desai Associates 2020 5Provided upon request only
2. Legal, Regulatory & Tax Implications
If not, the memorandum of association of the
I. Parties to the transaction buyer will need to be amended to cover in the
main objects clause, the business being acquired.
Business transfer entails hive-off of one or more
business undertakings from the seller and Business transfer transaction would require
vesting of such hived-off undertakings in the approval of the boards of directors of the buyer
buyer. Naturally, for a hive-off and vesting of an and the seller. Additionally, section 180 of the
undertaking to be possible, the buyer and the Companies Act, 2013 requires an Indian public
seller involved will necessarily have to be juristic company selling whole or substantially the
persons like corporate entities, individuals etc. whole of its undertaking(s) to procure prior
consent of the shareholders by way of a special
Under the Indian exchange control regulations,
resolution11 before giving effect to such sale. For
a non-resident entity is not permitted to conduct
the purposes of section 180 of the Companies
business operations in India without having
Act, 2013, (i) “undertaking” shall mean an
a place of business in India. While a non-
undertaking in which the investment of the
resident is permitted to open a liaison office or
company exceeds 20% of its net worth as per the
a branch office in India for limited short-term
audited balance sheet of the preceding financial
purposes, full-fledged business operations can
year or an undertaking which generates 20%
only be undertaken through an Indian entity
of the total income of the company during
like a company, partnership etc. On account
the previous financial year; (ii) the expression
of this restriction under the exchange control
“substantially the whole of the undertaking” in
regulations, it would not be possible for a non-
any financial year shall mean 20% or more of
resident to directly acquire an Indian business
the value of the undertaking as per the audited
undertaking. Therefore, for a non-resident to
balance sheet of the preceding financial year.
consummate a slump sale or an itemized sale, it
has to first establish an Indian entity and then If the undertaking transferred under the
use such Indian entity for acquisition. Typically, business transfer meets the aforesaid conditions,
the non-resident incorporates a company or a prior consent of the shareholders of the seller
limited liability partnership for undertaking the (if it is a public company) by way of a special
business transfer if the acquirer does not already resolution would also be required.
have presence in India.
In case the buyer or the seller are listed entities
then applicable compliances including
II. Corporate Authorisations disclosures under the Securities and Exchange
Board of India (Listing Obligations and
The charter documents of the seller and the Disclosure Requirements) Regulations, 2015
purchaser should have enabling provisions would also be required.
for sale and purchase of a business divisions,
respectively. This should not be much of a
concern as it is quite standard to cover these
III. Anti-trust clearance
provisions in the charter documents of Indian
If the business transfer qualifies as a
companies. Further, the memorandum of
‘combination’ as defined under the Competition
association of the buyer should clearly mention
Act, 2002 (the “Competition Act”) then such
in its main objects clause, an object covering the
combination would require prior consent of
business acquired pursuant to the slump sale.
11. Special resolution requires approval of shareholders holding
atleast 75% of the shares in value, present and voting in a
shareholders meeting.
6 © Nishith Desai Associates 2020Business Transfer
Why, how and when?
Competition Commission of India (“CCI”) B. Financial thresholds
and would be regulated by the Competition
Competition Act prescribes financial thresholds
Act and the Competition Commission of India
linked with assets / turnover for the purposes
(Procedure in regard to the transaction of
of determining whether a transaction is a
business relating to combinations) Regulations,
‘combination’, and if yes, the CCI approval is
2011 (“Combination Regulations”). CCI
required only for such combinations that exceed
would examine if the combination causes or
the prescribed thresholds.
is likely to cause an appreciable adverse effect
on competition (“AAEC”) in India and would The financial thresholds relevant for a business
decide on the matter accordingly. transfer transaction are as follows:
Test 1 Test 2
Parties to the business transfer, i.e. the buyer The acquirer group to which the acquired
and the seller, jointly have: business would belong after the acquisition12
have or would have:
In India, (i) assets higher than INR 2000
In India, (i) assets higher than INR 8000
crore; or (ii) turnover higher than INR 8000
crore; or (ii) turnover higher than INR 24000
crore; or
crore; or
In India or outside, (i) assets higher than USD
In India or outside, (i) assets higher than USD
1000 million of which assets in India should
4 billion of which assets in India are higher
be higher than INR 1000 crore; or (ii) total
than INR 1000 crore; or (ii) turnover higher
turnover in India or outside is higher than
than USD 12 billion of which turnover in India
USD 3000 million of which turnover in India
should be higher than INR 3000 crore.
should be higher than INR 3000 crore.
If any of the aforesaid financial thresholds
A. Combination are met, the business transfer transaction
A “combination”, for the purposes of the would qualify as a ‘combination’ under the
Competition Act means: Competition Act that requires prior consent of
the CCI for consummation.
an acquisition of control, shares or voting
rights or assets by a person;
C. Mandatory Reporting
an acquisition of control of an enterprise
where the acquirer already has direct or Section 6 of the Competition Act makes void,
indirect control of another engaged in any combination which causes or is likely to
similar or identical business; or cause an AAEC in India. Accordingly, Section
6 of the Competition Act requires the parties
a merger or amalgamation between or
(the acquirer in case of an acquisition) to the
among enterprises.
combination to notify the CCI and obtain its
that exceed the ‘financial thresholds’ prescribed approval prior to effectuating the transaction.
under the Competition Act.
12. A ‘group’ for the above purposes would mean two or more
enterprises which, directly or indirectly, are in position to –
i Exercise of not less than 50% or more of the voting rights in the
other enterprise; or
ii Appoint more than fifty per cent of the members of the board of
directors in the other enterprise, or
iii Control the management or affairs of the other enterprise
© Nishith Desai Associates 2020 7Provided upon request only
The CCI must within 30 days of filing, form Acquisitions of stock-in-trade, raw materials,
a prima facie opinion on whether a combination stores and spares, trade receivables and other
has caused or is likely to cause an AAEC within similar current assets (in the ordinary course
the relevant market in India. The combination of business).
can be consummatedon the earlier of, expiry
of 210 days from the date on which notice
is given to the CCI (assuming CCI has not
IV. Tax implications
rejected the application), or approval of the
transaction by CCI. A. Goods and Services Tax (“GST”)
Pre-Filing Consultation: If the parties to the There should be no GST on sale of the business
transaction need clarity on whether a transaction as a slump sale. This is because what is being sold
would require prior approval of CCI then the is the undertaking or the business on a slump
parties may request in writing to the CCI, for sale basis, and ‘business’ per se does not qualify
an informal and verbal consultation with the under the definition of ‘good’. Accordingly,
officials of the CCI about filing such proposed since a business cannot qualify as a ‘good’, there
‘combination’ with CCI. Advice provided by the should be no incidence of GST on the transfer of
CCI during such pre-filing consultation is not business on a slump sale basis. Similarly, there
binding on the CCI. is no GST in case of share transfer as ‘securities’
are specifically excluded from the definition of
‘goods’ and ‘services’ under the GST law.
D. Exceptions to filing
To facilitate M&A for small companies, an B. Direct Tax
exemption from CCI approval has been granted
One of the downsides of a slump sale as against
to Indian target companies which have assets
an asset sale is the risk of successor liability in
of not more than INR 350 crore or turnover of
case of slump sale as against asset sale, since in
not more than INR 1000 crores respectively
case of a slump sale, the assumption is that the
(“SME Exemption”) in India. The SME
undertaking is being transferred together with
Exemption also exempts acquisitions where
all attendant assets and liabilities.
the value of assets acquired is not more than
INR 350 crore. However, this exemption is Section 17013 of the ITA provides the rule
only available until March 04, 2021. with respect to income tax liability in case of
succession of a business. As a general rule, where
Schedule I to the Combination Regulations
a business is succeeded by any other person, who
specifies certain categories of transactions which
subsequently continues to carry on that business,
are ordinarily not likely to have an AAEC and
the predecessor is assessed for the income of
therefore would not normally require to be
financial years prior to the date of succession
notified to the CCI which, inter alia, include:
and the successor is assessed on the income of
An acquisition of assets unrelated to the the financial years after the date of succession.
business of the acquirer, or acquired solely However, as an exception to this general rule, the
as an investment or in the ordinary course successor is liable for the income tax in respect
of business, not leading to control of the of income attributable to the two financial years
enterprise whose assets are being acquired immediately preceding the date of succession
except when such assets being acquired (including any gain accruing to the predecessor
represent the substantial business operation
in a particular location or for a particular
13. Section 170 of the ITA: (1) Where a person carrying on any busi-
product or service of the enterprise; and ness or profession (such person hereinafter in this section being referred
to as the predecessor) has been succeeded therein by any other person
(hereinafter in this section referred to as the successor) who continues to
carry on that business or profession,—
(a) the predecessor shall be assessed in respect of the income of the previous
year in which the succession took place up to the date of succession;
8 © Nishith Desai Associates 2020Business Transfer
Why, how and when?
from the transfer of the business or profession) in The buyer is not required to withhold tax
the event that the predecessor cannot be found or at the time of payment of consideration for
where the predecessor has been assessed but the purchase of shares if the seller is an Indian
tax cannot be recovered from him. resident.
In case of a share transfer, the income-tax Where a transfer of shares takes place
implications may be different for the incoming between two related parties where one of
investor i.e. the buyer and the existing them is a non-resident, transfer pricing
shareholder i.e. the seller. guidelines shall apply and accordingly, the
transaction shall have to be effected at an
arm’s length price.
i. Income-tax implications for seller
According to section 56(2)(x) of the ITA,
Apart from the implications under chapter
where any person, receives shares of a
2 of this paper, provisions of section 50CA
company, from any person at a consideration
of the ITA provides that where the sales
less than the FMV of such shares, the
consideration on transfer of unquoted shares
difference between the consideration and the
is less than the fair market value (“FMV”),
FMV will be taxable under head income from
computed as per Rule 11UA14 of the ITR, the
other sources in the hands of transferee.
sales consideration is deemed to be the FMV
in the hands of the transferor. Additionally, another major implication of share
transfer is the ability of the target company to
carry forward and set off its business loss (if
ii. Income-tax implications for buyer any). As per section 79 of the ITA, a company
In the case of acquisition of shares, the entire in which public is not substantially interested
consideration paid by the buyer becomes the shall not be eligible to carry forward and set
COA of the shares for the buyer, but there is off the losses incurred in earlier years, if there
no step-up in the cost basis of the assets of the is a change of beneficial shareholding carrying
target company. 51% or more voting power in such company.
However, in case of eligible start-ups as referred
to in section 80-IAC, the carry forward and set off
(b) the successor shall be assessed in respect of the income of the previous
year after the date of succession. provisions would be available where the existing
(2) Notwithstanding anything contained in sub-section (1), when the pre- shareholders sell their holding (but maintain 51
decessor cannot be found, the assessment of the income of the previous
year in which the succession took place up to the date of succession and percent of voting powers) or continue to hold
of the previous year preceding that year shall be made on the successor all the shares which they were holding in the
in like manner and to the same extent as it would have been made on
the predecessor, and all the provisions of this Act shall, so far as may
year in the which the loss occurred, without
be, apply accordingly. satisfying the 51 percent condition.
(3) When any sum payable under this section in respect of the income of
such business or profession for the previous year in which the succes-
sion took place up to the date of succession or for the previous year
preceding that year, assessed on the predecessor, cannot be recovered
from him76a, the 77[Assessing] Officer shall record a finding to
that effect and the sum payable by the predecessor shall thereafter be
payable by and recoverable from the successor, and the successor shall
be entitled to recover from the predecessor any sum so paid.
(4) Where any business or profession carried on by a Hindu undivided
family is succeeded to, and simultaneously with the succession or after
the succession there has been a partition of the joint family property
between the members or groups of members, the tax due in respect of
the income of the business or profession succeeded to, up to the date of
succession, shall be assessed and recovered in the manner provided in
section 171, but without prejudice to the provisions of this section.
Explanation.—For the purposes of this section, “income” includes any gain
accruing from the transfer, in any manner whatsoever, of the business
or profession as a result of the succession.
14. Rule 11UA prescribes primarily the net book value, where
the value of immovable property is fair valued and value of
investment is computed as per Rule 11UA
© Nishith Desai Associates 2020 9Provided upon request only
3. Business Transfer vs. Share Transfer
The term ‘share transfer’ is not defined under the Gains arising from sale of unlisted shares are
ITA. It essentially covers transfer of investments characterized as Capital Gains, irrespective of
in shares/ stock of a company to another person. the period of holding of such unlisted shares,
When share transfer is undertaken with an except in cases where (i) the transaction is
objective to transfer the underlying business considered to be sham or not genuine, (ii)
of the target company, typically, the existing corporate veil is lifted or (iii) the transfer is
shareholders of the target company undertake made along with control and management
a secondary sale of their shares to the incoming of the underlying business. In such cases, the
investor at a pre-agreed consideration. While the CBDT has stated that the Indian Revenue
income-tax implications largely depend upon authorities would take an appropriate view
the manner in which such share transfers are based on the facts of the case.
structured, we have captured the broad income-
The CBDT has clarified that the third
tax implications arising on share transfer in this
exception i.e. where the transfer of unlisted
section below.
shares is made along with control and
The existing shareholder may realize a gain or management of the underlying business
a loss on such share transfer. The taxation of will not be applicable in case of transfer
gains realized on share transfer would depend of unlisted shares by SEBI registered
on whether such shares are held as capital asset Category-I and Category-II Alternative
or as stock-in-trade. In case shares are held as Investment Funds.15
stock-in-trade, profits and gains from transfer
Taxation of capital gains
of shares will be chargeable to tax under head
‘profits and gains from business and profession’. According to section 48 of the ITA, capital gain is
Where the shares are held as capital asset, profits computed by deducting from the consideration
and gains arising from transfer of capital asset received on account of transfer of capital asset:
will be chargeable to tax under head ‘capital
a. the amount of expenditure incurred wholly
gain’ according to section 45 of the ITA. Section
and exclusively in connection with such
2(14) of the ITA defines the term ‘capital asset’ to
transfer;
include property of any kind held by an assessee,
whether or not connected with his business b. the cost of acquisition (“COA”) of the asset
or profession, but does not include any stock- and the cost of any improvement thereto.
in-trade or personal assets subject to certain
Further, in case of long term capital gains
exceptions. Determination of the character
(“LTCG”), the COA is adjusted for inflation
of investment, whether it is a capital asset or
factors16 as declared by the CBDT (‘indexation
stock-in-trade has led to a lot of litigation and
benefit’). The indexation benefit is not available
uncertainty. The Central Board of Direct Taxes
in certain cases being inter-alia LTCG arising to
(“CBDT”) has, vide circulars dated February
a non-resident on transfer of shares an Indian
29 and May 2, 2016, laid down the following
company. Section 49 of the ITA provides for
principles in respect of characterization of
specific provisions for determination of COA
income arising on sale of securities:
In respect of income arising from sale of
listed shares and securities which are held
for more than 12 months, the taxpayer has a
one-time option to treat the income as either 15. F.No.225/ 12/ 2016/ ITA/ II dated January 24, 2017.
Business Income or Capital Gains and the 16. The base year for computing the indexation benefit is April 1,
2001. Accordingly, the capital assets that were acquired on or
option once exercised, is irreversible. before April 1, 2001, the market value as on April 1, 2001 may
be substituted for actual cost while calculating capital gains.
10 © Nishith Desai Associates 2020Business Transfer
Why, how and when?
for certain modes of acquisition and section CBDT has notified17 certain transactions of
55 of the ITA provides the meaning of cost of acquisition of equity shares (like initial public
improvement and COA. offer, offer for sale, merger, shares allotted to
qualified institutional buyers, bonus issue etc)
Capital gains are liable to tax based on:
on which the aforesaid condition of payment of
The duration for which the corresponding STT shall not apply and accordingly, the LTCG
investment has been held prior to sale; and on transfer of such equity shares shall be taxable
at the rate of 10%, as stated above.
The manner in which the sale is effected.
Further, taxability of capital gains in other cases
Gains arising on listed shares held for more than
(i.e. other than long-term capital gains arising
12 months would be classified as LTCG; in any
from transfer of listed equity shares) is provided
other case, such gains would be classified as short
in the table below:
term capital gains (“STCG”). Gains arising on
unlisted securities held for more than 24 months
would be classified as LTCG; in any other case,
such gains would be classified as STCG.
S No. Particulars Taxability
Resident shareholder Non-resident
shareholder
1. Sale of long-term capital assets being 20% with indexation 10% without indexation
listed equity share not taking place on benefit or 10% without benefit
floor of a recognized stock exchange indexation benefit,
whichever is more
beneficial
2. Sale of long-term capital asset being 20% with indexation 10% (no indexation
unlisted equity shares benefit benefit and no benefit
with regard to protection
from foreign exchange
fluctuations)
3. Sale of a short-term capital asset, 15% 15%
being an equity share or unit of an
equity oriented fund on the floor of
recognized stock exchange
4. Sale of a short-term capital asset being 30% 40%
unlisted equity share
LTCG arising from transfer of listed equity According to Section 90(2) of the ITA, taxation
shares in a company on or after April 1, 2018 and of non-residents is governed by the provisions
where such transactions are liable to Securities of the ITA, or the relevant tax treaty entered
Transaction Tax (“STT”) on acquisition and between India and the country of residence of
transfer of such equity shares such LTCG are the non-resident, whichever is more beneficial
taxable at the rate of 10%, without taking into to the taxpayer. Further, under section 90(4)
account the indexation benefit and benefit of of the ITA a tax residency certificate (“TRC”)
foreign exchange fluctuations, if any to the containing the prescribed information issued
extent such capital gains exceed INR 0.1 million. by the home jurisdiction has been made a de
The taxpayers have been granted the benefit of
set up of COA based on the fair value of the listed
equity shares as on January 31, 2018. 17. Notification No. SO 5054(E) dated October 1, 2018
© Nishith Desai Associates 2020 11Provided upon request only
minimus requirement for claiming benefits Finance Ministry, states that the tax authorities
of the tax treaty18 for a non-resident. The should not go beyond the TRC and question
sufficiency of a TRC as evidencing residential taxpayers on their residential status.Further,
status and for claiming benefits of the tax treaty Bombay High Court in a recent decision in case
has also been clarified vide Circular19 issued by of Indostar Capital20 upheld the validity of TRC
the CBDT. Relevant to note that the said Circular of the person claiming the tax treaty benefit and
was issued in the context of TRCs issued by that the principle that TRC should be a sufficient
Mauritian tax authorities for accepting the status document to claim the benefit is in line with
of residence and beneficial ownership for India- settled principles of law as well as circulars
Mauritius tax treaty purposes. Further, a Press issued by CBDT.
Release dated March 1, 2013 released by the
18. In case the particulars prescribed by the Indian Government
do not appear in the TRC, the non-resident taxpayer shall,
in addition to the TRC, submit a declaration in Form 10F
providing such missing details
20. Indostar Capital vs ACIT [(2019) 105 taxmann.com 96
19. Circular No 789 dated April 13, 2000 (Bombay)]
12 © Nishith Desai Associates 2020Business Transfer
Why, how and when?
4. Challenges in a Business Transfer
The ITA also provides that the ‘aggregate value of
I. Determining Cost of total assets of the undertaking or division’ for the
Acquisition of The purposes of computation of the net worth shall
‘Undertaking’ be the sum total of:
a. written down value as determined under
Prior to the Finance Act of 1999, there was an Section 43(6)(c)(i)(C) in case of depreciable
ambiguity on how to ascertain the COA of the assets;
business being transferred on a going concern
b. nil, in case of assets for which the whole
basis and relying on the Supreme Court ruling
expenditure is allowable as a deduction
in BC Srinivasa Shetty,21 where it was held that
under section 35AD of the ITA; and
the charging provisions and the computation
mechanism together form an integrated code c. book value of the assets, for other assets.
and that if the COA is unascertainable, then no
In this regard, a report of a chartered accountant
capital gains tax liability should arise. In the
in Form 3CEA certifying that the net worth
context of a business transfer, a similar view
has been correctly arrived at in accordance
was taken by the Mumbai Tribunal in the case
with Section 50B of the ITA is required to be
of Bharat Bijlee Ltd. vs. ACIT,22 wherein it was
submitted by the seller along with its tax returns.
reiterated that since the COA of a business as
a going concern cannot be ascertained, the It is important to note here that neither Section
computation mechanism fails and as such the 50B, nor Form 3CEA lays down the date as
transaction is not liable to capital gains tax. The on which the net worth is to be determined.
same principle again re-iterated by the Supreme However, there have been certain rulings
Court in the case of PNB Finance Ltd. v. CIT.23 where the courts have held that the net worth
determination should be undertaken as on the
It was only in the Finance Act of 1999 that the
date of transfer.
ITA was amended to provide for the taxability of
a slump sale. Another point of consideration in relation to
determination of COA in slump sale cases is
Under Section 50B of the ITA, which sets out
the manner of treatment of negative networth
the rule for taxation of a slump sale, provides
for computation of capital gains on slump sale.
that the COA of an undertaking or a division
Contrary views have been emerged from judicial
being transferred by virtue of a slump sale shall
precedents on this issue. The Mumbai Tribunal
be its networth, without indexation. Section 50B
in the case of Zuari Industries Ltd. v. ACIT24 and
also defines ‘net worth’ to mean the aggregate
the Delhi Tribunal in the case of PaperBase Co.
value of total assets of the undertaking or
Ltd25 have held that negative net worth should
division as reduced by the value of liabilities of
be ignored and the cost of undertaking should be
such undertaking or division as appearing in
considered as Nil. However, the Special Bench of
its books of account, without accounting for
Mumbai Tribunal in case of Summit Securities
the change in the value of assets on account of
Ltd26 has held that negative figure of net worth
revaluation of assets.
21. AIR 1981 SC 972 24. [2007] 105 ITD 569 (Mum ITAT)
22. ITA No. 6410/ MUM/ 2008 25. [2008] 19 SOT 163 (Del ITAT)
23. (2008) 307 ITR 75 (SC) 26. [2012] 145 TTJ 273 (Mumbai) (SB)
© Nishith Desai Associates 2020 13Provided upon request only
cannot be ignored for working out capital gains the slump sale being qualified as an asset sale;
in case of a slump sale under section 50B. An however, assignment of values to individual
appeal before the High Court is pending on this assets for the computation of stamp duty is
issue both in the case of Zuari Industries Ltd. and expressly permitted under theITA.
Summit Securities Ltd.
Goodwill or Non-Compete
a. If treated as goodwill Implications on buyer
Buyer may be able to claim depreciation in certain
situations.
Strengthens the non-compete provision from an Indian
Contract Act perspective, which largely hinges on the
extent of goodwill acquired.
Implications on seller
Seller should largely be indifferent as he will anyway be
subject to capital gains tax on the same.
b. If treated as non-compete fees Implications on buyer
Buyer may be able to claim depreciation or claim it as
revenue expense based on the nature of non-compete.
GST at applicable rate, which can be agreed to be borne
by a party in a manner decided between the buyer and
seller.
Implications on seller
Seller may have to pay income tax under the head profits
and gains of business or profession on non-compete
fees if the non-compete fee is paid independent of the
business transfer under the provisions of Section 28(va)
of the ITA.
II. Goodwill vs. Non-Compete A. Taxability of non-compete fee
From a seller’s point of view, the treatment of
In any slump sale transaction, there is always
long term capital gains would be beneficial
a debate on how the buyer should regard the
for the seller and available only if the entire
excess paid over the book value of the assets
consideration is treated as a capital receipt,
to the seller. Whether such excess should be
provided that the undertaking as a whole is
characterized by the buyer in the nature of non-
more than three (3) years old (Please refer to
compete fees or goodwill or should such excess be
Chapter 1of this paper.) As against that, from a
simply spread over the assets by recording each of
buyer’s point of view, he may want part of the
the assets at higher value in its books. Each option
consideration to be allocated to non-compete,
has its own set of legal and tax challenges.
which could be characterized as revenue
It is important to clarify that while the buyer expenditure in certain cases, or depending on the
may attach values to the assets in his own books, facts, as capital expenditure towards acquisition
from an Indian tax perspective, it should be of an intangible right, eligible for amortisation.
ensured that in slump sale transactions, a lump On account of such conflicting tax objectives,
sum consideration must be paid by the buyer to one of the most debated issues in slump sale
the seller without assigning values to individual agreements is whether separate considerations
assets or liabilities. Any assignment of values should be attributed to non-compete and to
in the business transfer agreement can lead to business transfer or should the consideration be
14 © Nishith Desai Associates 2020Business Transfer
Why, how and when?
clubbed and no separate allocation should be transfer or asset transfer, by virtue of the proviso
made for non-compete. to Section 28(va) of the ITA, such non-compete
fee shall be charged under the head ‘capital gains’.
Section 28(va)27 of the ITA, introduced by
However, in any other case, such as, where the
the Finance Act, 2002, provides that any
non-compete fee is received independent of
consideration received under an agreement, in
the business / asset transfer, or where the non-
cash or otherwise for (i) not carrying out any
compete fee is received, such amounts shall be
activity in relation to any business; or (ii) not
characterized as business income and taxed at
sharing any know-how, patent, copyright, trade-
the higher rate of 30% (40% in case of a foreign
mark, license, franchise or any other business
company) as against the rate of 20% (provided the
or commercial right of similar nature or
business is held for a period exceeding 36 months)
information or technique that is likely to assist
for income arising out of income.
in the manufacture or processing of goods or
provision for services, should be characterized It can be argued that a non-compete is merely
as business income and hence, should be taxed in the nature of fees paid, which can well
accordingly. However, the section provides be independent of the acquisition of the
an exception for any sum, received, in cash undertaking and to that extent, payment of non-
or otherwise, for transfer of the right to compete fees should not impact the nature of
manufacture, produce or process any article or the ‘slump sale’. However, since non-compete
thing or right to carry on any business, which payments post Finance Act, 2012 came under
should be characterized as capital gains and the ‘service tax’ net, and continues to be within
taxed accordingly. In this regard, Section 55(2) the ambit of GST,29 the feasibility of such option
(a)28 of the ITA provides that the COA of such needs to be weighed carefully.
right shall be the purchase price, where such
On the other hand, from a contract law
right was acquired from a previous owner, or
perspective, enforceability of non-compete
else shall be deemed to be nil.
obligation hinges on the extent of goodwill
In this regard, it may be noted that the courts that the buyer has purchased. Non-compete
have held that only when the non-compete fee is provisions may not be enforceable if no
received as a consideration for the transfer of all goodwill has been purchased as per Section
assets of the business, that is, as a part of business 2730 of Indian Contract Act, 1872. Again, from a
buyer’s perspective, it is always better to allocate
maximum price to goodwill to fortify the non-
27. Section 28(va) of ITA: Any sum, whether received or receivable, compete provisions against the seller. As a
in cash or kind, under an agreement for—
(a) not carrying out any activity in relation to any business; or middle ground, parties may agree not to specify
(b) not sharing any know-how, patent, copyright, trade-mark, licence, any value to goodwill in the contract and may
franchise or any other business or commercial right of similar na-
ture or information or technique likely to assist in the manufacture embed the purchase price of the goodwill in
or processing of goods or provision for services: the total purchase consideration for business
Provided that sub-clause (a) shall not apply to—
(i) any sum, whether received or receivable, in cash or kind, on account transfer to strengthen the argument of ‘slump
of transfer of the right to manufacture, produce or process any arti- sale’ without assigning specific values. Buyer
cle or thing or right to carry on any business, which is chargeable
under the head “Capital gains”;
(ii) any sum received as compensation, from the multilateral fund of the
Montreal Protocol on Substances that Deplete the Ozone layer under
the United Nations Environment Programme, in accordance with the 29. Schedule II, Paragraph 5(e) of the Central Goods and Services
terms of agreement entered into with the Government of India. Tax Act, 2017.
28. Section 55 of the ITA: (2) For the purposes of sections 48 and 49, 30. Section 27 of the Indian Contract Act, 1972: ‘Every agreement
“cost of acquisition”,— by which any one is restrained from exercising a lawful profession,
(a) in relation to a capital asset, being goodwill of a business or a trade trade or business of any kind, is to that extent void. Saving of agree-
mark or brand name associated with a business or a right to man- ment not to carry on business of which goodwill is sold. Exception
ufacture, produce or process any article or thing or right to carry on 1: One who sells goodwill of a business may agree with the buyer
any business, tenancy rights, stage carriage permits or loom hours,— to refrain from carrying on a similar business, within specified
(i) in the case of acquisition of such asset by the assessee by purchase from local limits, so long as the buyer or any person deriving title to the
a previous owner, means the amount of the purchase price; and goodwill from him, carries on a like business therein, provided that
(ii) in any other case [not being a case falling under sub-clauses (i) to (iv) of such limits appear to the court reasonable, regard being had to the
sub-section (1) of section 49, shall be taken to be nil; nature of the business.’
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