Companies may prefer slump sales route post LTCG tax cut in Budget

Slump sales may gain favour among companies after the tweak in taxation post the Budget.

The tax rate on long-term capital gains on a business transfer or slump sales stands reduced to 12.5 per cent from 20 per cent earlier. Short term capital gains will continue to be taxed at the maximum marginal rate.

“The reduction in tax rates to 12.5 per cent is significant,” said Binoy Parikh, Executive Director at Katalyst Advisors. “Slump sales may increasingly be opted by companies especially when cash needs to be redeployed within the transferor company.”

Strategic JV

Slump sales may also be used more often now for entering into a strategic joint venture or facilitating staggered private equity buyouts where the transferor continues for a couple of years and then exits later through sale of shares, added Parikh. The lower rate of 12.5 per cent on sale of shares would facilitate JV structures, he said.

The Budget rationalised the holding periods into two buckets to determine what constitutes a long-term holding -- 12 months for all listed securities including units of business trusts and 24 months for all other asset classes. The holding period for slump sales under Section 50B, however, has remain unchanged at 36 months.

“The longer holding period of 36 months for a business transfer to be classified as long term capital gains may be an oversight. We will need to wait to see whether this is corrected in the Finance Act,” said Vaibhav Gupta, Partner, Dhruva Advisors.

There are other forms of business restructuring such as mergers or demergers which are tax neutral and cash neutral, since shares are issued to the shareholders of the transferor companies. ⁠However, the elongated approval process from SEBI and NCLT makes a slump sale through a Business Transfer Agreement more attractive as it does not require NCLT or SEBI approval.

Advantages

“Commercially, the cash consideration from a slump sale is received by the transferor company and not its shareholders, and this cash can be redeployed in other businesses of the transferor or for debt repayment or M&A activities. Distributing this cash to the shareholders would require the company to issue dividends, resulting in the outgo of additional dividend tax. So, a slump sale would make sense if the cash needs to be redeployed in the transferor company,” said Parikh.

From a transferee company’s perspective, any intangibles recognised over and above the net assets would be available for tax amortisation. Alternatively, if business assets acquired like plant/ machinery/ building are recorded at fair values then additional depreciation should be available to the transferee company since slump sale is taxable.

The Finance Act 2021 broadened the definition of what constitutes a slump sale. Earlier, only transfer of a business undertaking through a ‘sale’ was considered as slump sale. This was amended to include transfer of an undertaking through any means. Earlier, the capital gains tax was calculated as the difference between the sale consideration and the ‘net worth’ of the undertaking. Post amendment, the difference between the fair market value and the ‘net worth’ are subject to capital gains tax.

In a slump sale, a business undertaking is transferred by one party to another as a going concern for a lumpsum consideration, without attributing specific values to assets and liabilities. Several global transactions also comprise of a slump sale element to execute the transfer of the Indian business to the buyer’s affiliate in India.