Can purchase consideration adjustments in business acquisitions affect their classification as a ‘slump sale’ under the Income Tax Act, 1961?
The purchase price in a business sale is typically based on the business’s assessed value, subject to adjustments outlined in the Business Transfer Agreement (BTA). Such adjustments are commonly stipulated by the parties in the BTA.
Since business transfers involve procuring several consents prior to transferring the business, there is typically an interval between the date on which the business is valued and the actual date of the transfer.
Purchase consideration adjustments in BTAs account for changes in the business’s financial position between valuation and transfer, including variations in working capital (inventory, receivables, payables), cash, and debt.
Slump Sales and Lump-Sum Payments
Often parties involved in acquisitions of Indian businesses structure the acquisition to qualify as a ‘slump sale’ in order to avail tax benefits provided under the Income Tax Act, 1961 (IT Act).
The IT Act defines slump sales as the transfer of undertakings on going concern basis for a lump sum consideration. Consequently, one of the key conditions to be met for a business transfer to qualify as a ‘slump sale’ is that the payment in a slump sale should be a lump sum amount without any allocation to specific assets and liabilities of the business being transferred.
Interpretation by Indian Courts
A strict interpretation of Section 2(42C) of the Income Tax Act suggests that purchase adjustments could undermine a transaction’s ‘slump sale’ status, as these agreements attribute specific values to assets and liabilities fluctuating between valuation and transfer dates.
Indian courts have taken a more pragmatic approach in interpreting the impact of such adjustments on the slump sale nature of the transfer instead reviewing whether the transaction as a whole meets the conditions of a slump sale.
In Premier Automobiles Ltd. v. ITO, the price agreed to be paid under the Slump Sale Agreement was an aggregate of INR 210 crores plus an amount to be decided after execution corresponding to the value of the net current assets. The Bombay High Court, while viewing the transaction holistically, held that such purchase consideration adjustments do not impact the slump sale nature of the business transfer on the basis that: (i) the purchase consideration included not only the value of fixed assets but also goodwill and business advantages like licences and quotas; (ii) the value of the net current assets as on the closing date could necessarily not have been quantified as on execution date; and (iii) there was no profit element linked to the value of the net current assets.
The Bombay High Court held that merely because the purchase price included adjustments based on changes in current assets, it cannot lead to the conclusion that the transaction was a sale of itemized assets and not a slump sale. The court ruling emphasized the principle that such transactions should be interpreted by adopting commercial principles.
Similarly, in Commissioner of Income Tax, Mumbai v. Polychem Ltd., the purchase consideration in the BTA was subject to an audit of the accounts as on the closing date and was to be adjusted for inter alia variance in the current assets and current liabilities. The Bombay High Court, while reiterating its finding in Premier Automobiles Ltd. v. ITO, held that such adjustments would not impact the slump sale nature of the transaction which should be tested in context of the entirety of the transaction.
In Summary
Indian courts, in alignment with the commercial nature of business transfers, have adopted a pragmatic approach in assessing the impact of commonly used purchase consideration adjustments on the classification of a transaction as a slump sale. The courts evaluate the transaction in its entirety, focusing on whether it involves the transfer of a business undertaking as a going concern.
Parties should, however, be mindful that adjustments outlined in BTAs must avoid linking consideration adjustments to assets with a profit element, such as fixed assets (e.g., land or machinery) acquired between the execution of the BTA and the closing date. Such adjustments risk being interpreted as allocating a portion of the consideration to the value of these additional assets, potentially affecting the slump sale characterisation.
Bharucha & Partners – Mita Sood, Harshit Kumar and Muskaan Aggarwal
