ISSUE I : ITAT rules: slump sale surplus – A capital gain

ITAT rules: Slump sale surplus – a capital gain


Slump sale is one of the widely used ways of business acquisitions. Given the high figures involved in such transactions, taxation is one of the key elements of consideration for both the buyer as well as the seller. In India, “slump sale” concept was incorporated in the Income Tax Act, 1961 (“IT Act”) by the Finance Act, 1999 with the inclusion of section 2(42C). The term ‘slump sale’ is defined as transfer of one or more undertakings as a result of the sale for a lump-sum consideration without values being assigned to the individual assets and liabilities. With increase in slump sale deals, several rulings and judicial precedents have emerged over the years.

The recent ruling1 of the Income Tax Appellate Tribunal (“ITAT”) in the case of Assistant Commissioner of Income-tax, New Delhi v. Smt. Sangeeta Wij, on slump sales is noteworthy as in this case, the ITAT has held that lump-sum consideration received by the seller in a slump sale transaction is a capital receipt. The amount cannot be treated as compensation for conforming with non-compete obligations. This bulletin provides a synopsis of the case and analyzes its practical implications.

1.0  Facts of the case

The seller (assessee), also the proprietor of S.D. Engineering Consultants was engaged in providing consultancy services. The seller formed a company ICT-SD Engineering Consultants Private Limited (“Company”) with the buyer and transferred all the assets and liabilities of the business as a going concern to the buyer vide Memorandum of Understanding dated October 31, 2007 followed by an agreement dated December 4, 2007 (“Agreement”). The total consideration was INR 12,000,000 inclusive of goodwill, receivables, work in progress and all other rights and entitlements pertaining to the business. As per the Agreement, the sale was for a lump-sum consideration without value being assigned to individual assets. The capital gain of the seller was calculated at INR 11,526, 275 and the net worth at INR 473,725.2 To minimize capital gains tax, the seller also invested in property. The good will was valued at INR 4,800,000 in the buyer’s balance sheet.

The seller was appointed as the whole-time Director of the Company for a minimum period of five (5) years. It was agreed if the seller was relieved before the expiry of five years,

she would be adequately compensated and that she shall not carry out any activity or encourage, directly or indirectly in any other business, directly or indirectly related to the business of the Company. However, the seller was at liberty to do any business whatsoever after quitting or leaving the Company.

The complete documentation regarding the sale of business, property was furnished before the Assessing Officer (“AO”). Upon scrutiny, the AO held that the seller had received the amount of INR 12,000,000 as “compensation for not carrying on any business activity in relation to any business”, which, should be chargeable as profits and gains of business, under section 28 (va)3 of the IT Act. Hence, in the opinion of the AO, the compensation was not a capital receipt liable for capital gains, but was a business receipt, received against discontinuance of the proprietary business of the seller. Consequently, the AO treated the amount as business income and added it to the assesee’s total income.

The seller filed an appeal before the Assistant Commissioner of Income Tax (“CIT”) who struck down the said order and held that the AO was not justified in changing the treatment of income from capital gains under Section 50B (special provision for computation of capital gains in case of slump sale)4 of the IT Act to business profits under Section 28 (va)(a) there under. As a result, the AO filed an appeal against the order of the CIT before the ITAT, which is discussed below.

2.0 Contention of the Parties

2.1 Contentions of the AO

Challenging the order, the AO contended

  • It had lifted the veil over the Agreement and added the amount of INR 12,000,000 in the total income of the assessee based on the Agreement. The amount was paid for discontinuation of the seller’s business. Specifically, the AO relied on the fact that the assessee was appointed as the Whole-time director of the Company and was prohibited from engaging in any activity, directly or indirectly, related to the Company.
  • The net worth of the proprietary concern being of INR 473,725 as on 31 October, 2007 gave rise to a goodwill of INR 11,526,275 which had been grossly over-valued and not been substantiated by the financial statement of the proprietorship concern

Therefore, the AO contended the compensation of INR 120,00,000 was not a capital receipt liable for capital gains, but a business receipt in the shape of compensation for not carrying out any activity relating to the business of the Company and, thus, liable to tax under section 28(va)(a) of the IT Act.

2.2 Contentions of the seller/assessee

The assessee relied on the Agreement and contended it was a slump sale in compliance with the provisions of section 50 B of the IT Act. The assessee furnished the requisite documents needed under the section i.e. report of the Chartered Accountant in Form 3 CEA determining the net worth, long term capital gain, and also detailed the exemption availed under section 54 F of the IT Act. The assessee contended:

  • The consideration of INR 12,000,000 was for transfer of business as a going concern

i.e. a slump sale as defined under the IT Act.

  • There was absolutely no competition in the business carried on by the assessee and the buyer. The buyer was engaged in the business of providing consultancy services in the field of airports, highways and bridges. On the other hand, the assessee’s business related to building projects including metro stations, rail stations, hospitals, schools and industrial projects.

Therefore, the assessee contended that the present case falls squarely under Proviso (i) to Section 28 (va) of the Act, wherein, any sum received on account of transfer of the right to carry on any business is not taxable there under, the same being taxable under the head “capital gains”.

3.0 ITAT Ruling

Upon reviewing the contents of the Agreement and the arguments of the parties, the ITAT held:

  • The recitals in the Agreement were specific, clear and unambiguous. The contention that AO has “lifted the veil” over the Agreement does not carry weight as the AO tried to re-write the agreement, which is wholly impermissible in law. The intention of the parties to the Agreement is to be gathered from the form and contents of the document, taken in their entirety. The amount of INR  12,000,000 was indeed the consideration and not the compensation and is clearly borne out from the stand taken by the parties to the Agreement, their respective audited balance sheets and the statutory reports filed in support of the claim of slump sale.
  • The case is covered by the Proviso (i) to section 28 (va) as contended by the assessee. This Proviso provides that section 28(va)(a) shall not apply to any sum received on account of transfer of a right to carry on business, which is chargeable as capital gains. Herein, what was transferred was a right to carry on business and, thus, application of the main section 28(va)(a) is foreclosed and forbidden, by the use of the words “shall not” in the Proviso.
  • The employment of the assessee as whole-time Director involved the normally prevalent non-compete condition that she would not engage in any other activity related to the business of the Company. There was no material on record to indicate that the payment of INR 12, 000,000 constituted non-compete fees.
  • The amount of INR 11,526,275 (which was the amount remaining after deducting the net worth amount of INR 473,725 from the total consideration of INR 12,000,000) arrived at by the AO as representing the value of good-will was long term capital gains within the meaning of section 50B of the IT Act.

Thus, the ITAT upheld the order of the CIT and held that the amount was received by the assessee for transferring her right to carry on business as consideration amount and not as compensation. The CIT was right in removing the addition of INR 12,000,000 made by the AO in calculating the total income of the assessee.

4.0  Analysis & practical implications

Section 50B of the IT Act is an important provision for slump sale transactions. It was specially introduced to stipulate the mechanism for computing capital gains in case of slump sales. The profits or gains arising from slump sale are chargeable under the head “capital gains”. It provides for the mechanism to compute ‘net worth’. The benefit of indexation is not available in the case of slump sale and the profit or gain on slump sale is regarded as long‐term or short‐term depending upon the period of holding of the undertaking being transferred.5 Clearly, once it is established that a transaction is a slump sale, the income arising from such sale will be taxed under this section.

Section 28 is a wide section dealing with taxation of profits and gains of business income. Section 28(va) specifically deals with non-compete fees. However, the proviso clarifies that sum received for transfer of business is chargeable only under the head of “capital gains” and not as business income. Therefore, the scope of the two sections is distinct. However, its interplay in slump sale deals and, thus, the tax implications are sometimes unavoidable.

Often times, while negotiating slump sale transactions, where assets and liabilities are not individually assigned values, treatment of non-compete fees becomes challenging.

Clearly, slump sale necessitates a lump-sum consideration. The seller would want the entire consideration to be a lump-sum figure to treat it as capital receipt while the buyer would like to allocate consideration for non-compete to claim revenue expenditure. Attributing specific value for non-compete will alter the nature of the transaction (to asset purchase) and, thus, the tax treatment for both the buyer and the seller. Thus, it is important for parties to slump sale transactions to be cautious while drafting business transfer agreement.

The best approach would be to include the non-compete fees in the overall consideration amount and not indicate separately. In this manner, the nature of the “slump sale” will remain intact and taxation will be based on section 50B of the IT Act. This will be in line with the ITAT ruling wherein the income from business transfer has been treated as capital gains for the seller, non-compete obligation is covered in the Agreement and, further, amount towards goodwill is recorded in the books of the buyer in the following assessment year.


With the latest ITAT ruling, it has been re-affirmed that income tax authorities do not have the right to lift the veil of a document or re-write it merely to suit the purpose of the revenue. Secondly, and more importantly, unless the facts suggest otherwise, consideration for sale of business as a going concern is a capital receipt chargeable to tax as capital gains and cannot be arbitrarily treated as compensation for non-compete under Section 28(va) of the IT Act. Therefore, to steer clear of any disputes and/or unwanted tax issues, buyers and sellers should carefully negotiate and draft business transfer contracts.

Authored by:

Priyatha Rao

1 Order dated May 25, 2012
2 Under Explanation 1 of section 50B of the IT Act, “net worth” is the aggregate value of total assets of the undertaking or division as reduced by the value of liabilities of such undertaking or division as appearing in its books of account. Provided that any change in the value of assets on account of revaluation of assets shall be ignored for the purposes of computing the net worth. Explanation 2 – For computing the net worth, the aggregate value of total assets shall be, (a) in the case of depreciable assets, the written down value of the block of assets determined in accordance with the provisions contained in sub-item (c) of item (i) of sub-clause (c) of clause (6) of section 43; (b) in the case of capital assets in respect of which the whole of the expenditure has been allowed or is allowable as a deduction under section 35AD, nil; and (c) in the case of other assets, the book value of such assets.
3 Per the section -“The following income shall be chargeable to income-tax under the head “Profits and gains of business or profession” (va) any sum, whether received or receivable, in cash or kind, under an agreement for (a) not carrying out any activity in relation to any business. The proviso further adds that sub-clause (a) shall not apply to (i) any sum, whether received or receivable, in cash or kind, on account of transfer of the right to manufacture, produce or process any article or thing or right to carry on any business, which is chargeable under the head “Capital gains”.
4 (1) 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: Provided that any profits or gains arising from the transfer under the slump sale of any capital asset being one or more undertakings owned and held by an assessee for not more than thirty-six months immediately preceding the date of its transfer shall be deemed to be the capital gains arising from the transfer of short-term capital assets. (2) In relation to capital assets being an undertaking or division transferred by way of such sale, the “net worth” of the undertaking or the division, as the case may be, shall be deemed to be the cost of acquisition and the cost of improvement for the purposes of sections 48 and 49 and no regard shall be given to the provisions contained in the second proviso to section
(3) Every assessee, in the case of slump sale, shall furnish in the prescribed form along with the return of income, a report of an accountant as defined in the Explanation below sub-section (2) of section 288, indicating the computation of the net worth of the undertaking or division, as the case may be, and certifying that the net worth of the undertaking or division, as the case may be, has been correctly arrived at in accordance with the provisions of this section.
5 More than 36 months will render it a long-term capital asset.

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