Talking about direct taxes, it is known that there exist two methods for determining income tax liability on business transfers. The widely known method is taxability on slump sale basis and the other one being sale on itemised basis. Slump sale refers to a scenario where a bunch of assets and liabilities constituting a business are transferred for a lump-sum consideration (without values being ascribed to each asset). Traditionally, business transfers have been achieved by having lump-sum consideration for the business. Under slump sale, net worth of undertaking is regarded as a cost base. A reduced rate of 20% (excluding cess and surcharge) should be available if the undertaking is held for more than three years.
The other (more attractive) method to achieve a business transfer could be where values are ascribed against each asset in the transfer agreement. The fundamental difference is that the sale price for the fixed assets/intangible and the sale value of assets is reduced from the block of assets, as opposed to the net worth principle discussed earlier. Such transfer of assets thus results in taxation at a comparatively higher tax rate which is 30% (excluding surcharge and cess).
Lets take the case of a large company having huge asset base, selling small business under the slump sale scenario, and there would be a cash tax outgo. However, if one was to follow the second method, there would be reduction in asset base and, as a result, reduction in annual depreciation and tax break on depreciation. This would mean there would be no cash tax outgo as in the case of slump sale but a long-term reduction in tax break on depreciation of assets. To expand this a little, the tax impact of the sale is spread over a longer period, though the impact is at 30% as opposed to 20%. This could be very attractive for multinationals selling a comparatively smaller part of assets which constitutes a business.
Exploring this idea further, what could be the other points to be borne in mind for efficiency. The most important one is whether such transfer of business, with values ascribed to each asset, would attract indirect taxes Based on the various judicial precedents available, it is reasonable to contend that VAT should not apply on transfer of business. While what constitutes a business transfer has not been defined under the VAT laws, a parallel can be drawn from the Income-Tax Act.
An interesting question arose in the case of Eicher Motors before the Madras High Court where there was transfer of business; however, values were ascribed to individual assets, meaning an itemised sale from income tax perspective. The indirect tax authorities regarded the same as sale of assets liable to VAT. The Madras High Court observed that the contract for sale of assets was a composite one and was resulting in transferring business on a going concern basis. The issue has been decided in the favour of the taxpayer and held as sale of business not liable to VAT. Going by this, where the intention is to transfer the business as a going concern, merely because values have been ascribed to assets, should not impair the position from a VAT perspective. This could be said to be a hybrid sale structure, where for income tax purposes the business transfer is regarded as an itemised sale, but for indirect tax purposes the same would be exempt on the grounds of it being a business transfer not liable to VAT.
Having said that it could be efficient to evaluate business transfer through itemised sale, it is important to note that in certain cases despite values being ascribed to individual assets, income tax authorities have regarded sale of business as slump sale. Thus, the detailing of the proposed business transfer would be importantwhether or not there exists a rationale to values allocated to assets. A valuation report to support the values allocated could provide a backing to the business transfer document.
God is in the detailto achieve the hybrid sale structure, evaluate what is being transferred, how much is being transferred for what consideration. Having ticked all boxes, there could be proximity to achieving a hybrid sale structure. In a world of fuel-efficient hybrid engines, one could aim to achieve business transfers through hybrid structures in a tax efficient manner!
The author is associate director, Transaction Tax, EY.
Views are personal