Two years ago, the Supreme Court of India in the case of C.I.T. v. Artex Manufacturing Co. (227 I.T.R. 260) considered this point. The facts in this case were that the assessee was a firm which was carrying on the business of manufacturing art silk cloth. A private limited company by the name of A was formed with a view to take over the business of the assessee as a running concern. On March 31, 1966, the assessee and the company entered into an agreement whereunder the assessee agreed to sell to the company the business hitherto carried on by the assessee as a whole going concern. The consideration for the sale was Rs 11,50,400 which was paid and satisfied by allotment of 11,504 fully paid-up equity shares of Rs 100 each according to the original shares of the partners of the assessee.

In pursuance of the agreement, the assessee ceased to carry on the business with effect from April 1, 1966, and the said business stood transferred to the company. In respect of theassessment year 1967-68, the assessee filed its return showing `nil' income. On January 9, 1970, a revised return was filed showing `nil' income, with a note that since the partnership firm was converted into a private limited company as a going concern, there was no income chargeable to tax either under section 41(2) or under section 45 of the Income-tax Act, 1961.

During the course of the assessment proceedings before the Income-tax officer, for the purpose of determination of the purchase consideration, the assets were shown at Rs 41,73,973 out of which the plant, machinery and dead stock, as revalued by H, was Rs 15,87,296. The liabilities were shown at Rs 30,23,573 and the balance amount of Rs 11,50,400 was shown as the purchase consideration. The written down value of plant, machinery and dead stock, according to the assessee's books, was Rs 4,36,896. The difference between Rs 15,87,296, the value of plant, machinery and dead stock as revalued, and Rs 4,36,896, the written down value of plant,machinery and dead stock, according to the assessee's books, came to Rs 11,50,400.

The Income-tax Officer held that the written down value of plant, machinery and dead stock according to the income-tax records was Rs 3,32,276. After deducting the same from the amount of Rs 15,87,296 for which the plant, machinery and dead stock were transferred to the company, the Income-tax Officer held that tax was payable under section 41(2) on the income of Rs 12,56,020.

The Appellate Assistant Commissioner, on appeal, held that the surplus was assessable under the head "Capital Gains" and not under the head "Business". As regards the status of the assessee, it was held that the assessee must be taxed in the status of a "registered firm". The tribunal held that the surplus was taxable as business profit under section 41(2) and that the assessee was assessable in the status of a registered firm. On a reference, the Gujarat High Court held that section 41(2) was not applicable and that the assessee was not assessable asa registered firm.

On appeal by the revenue department to the Supreme Court, it was held that, in the agreement of sale, there was no reference to the value of the plant, machinery and dead stock. However, on the basis of the information that was furnished by the assessee before the Income-tax officer, it became evident that the amount of Rs 11,50,400 had been arrived at by taking into consideration the value of the plant, machinery and dead stock as assessed by the valuer at Rs 15,87,296. Section 41(2) was, therefore, applicable.

The court further held that the liability under section 41(2) was limited to the amount of surplus to the extent of the difference between the written down value and the actual cost. If the amount of surplus exceeded the difference between the written down value and the actual cost, then the surplus amount to the extent of such excess would have to be treated as capital gains for the purpose of taxation. According to the court, the tribunal had not considered this matter.

TheFinance Bill, 1999, has defined "slump sale" by inserting section 2(42-C). This expression is defined to mean transfer of one or more undertakings for a lumpsum consideration without assigning values for individual assets and liabilities.

Explanation 1 to the said clause defines the expression "undertakings".Explanation 2 clarifies that determination of the value of an asset for the sole purpose of payment of stamp duty, registration fees or other similar taxes shall not be regarded as assignment of values to individual assets or liabilities.

Turning to the provisions of section 50-B, the new section seeks to provide that any profits or gains arising from the slump sale effected in the previous year shall be chargeable to income-tax as capital gains arising from the transfer of long-term capital assets and shall be deemed to be the income of the previous year in which the transfer took place.

The proviso to sub-section (1) provides that any profits and gains arising from such transfer of one or moreundertakings held by the assessee for not more than 36 months would be deemed to be short-term capital gains.

Sub-section (2) provides that the net worth of the undertaking or the division, as the case may be, would be deemed to be the cost of acquisition and the cost of improvement for the purpose of sections 48 and 49 in relation to capital assets of such undertaking or division transferred by way of such sale and the provisions contained in the second proviso to section 48 would be ignored.

Sub-section (3) provides that every assessee in the case of slump sale should furnish in the prescribed form along with the return of income, a report of an accountant indicating the computation of net worth of the undertaking or division, as the case may be, and certifying that the net worth of the undertaking or division has been correctly arrived at in accordance with the provisions of this section.

The explanation to the new section defines "net worth" in a case where the undertaking is transferred. This newsection will take effect from April 1, 2000 and will, accordingly, apply in relation to the assessment year 2000-2001 and subsequent years.

While the objective of making the law clear and unambiguous is a salutary one, it must be kept in mind that the benefit of unabsorbed losses and depreciation of the transferred undertaking cannot be carried forward and set-off against the profits of the transferee.

For the transferor, the written down value of the assets transferred will have to be computed separately and reduced from its block of assets. This may create practical difficulties. Another practical difficulty which is likely to be faced is to determine the period for which the transferred undertaking was held by the transferor in order to compute the capital gains tax at the appropriate rate. The date of acquisition of the transferred undertaking may become a bone of contention. It is, therefore, necessary that suitable amendments be made in the draft provisions before the Finance Bill is passed byparliament.

(The author is a Supreme Court advocate)