Divestment Provisions – Need for Revamping
The reasons for need for revamping the divestment provisions,
comprising Demerger & Slump Sale provisions, in the Income Tax Act are twofold:-
1. The
existing demerger provisions are not kept in pace with other amendment (section
43CA) in the Act.
2. There
is no clarity on the taxation on transfer of undertaking dehors demerger
provisions.
Background
·
Past
Case Law
In PNB Finance 307 ITR 75 (SC), (assessment year involved – 1969-70)
Supreme Court held that an Undertaking is a capital asset and provides two methods
for computing the gain attributable to sale of undertaking:-
a) Piecemeal
Approach - If the facts permit, do the item-wise earmarking of entire sales
consideration and then determine the capital gain/Business Income (for stock)
for individual assets comprised in an undertaking.
b) Global
Approach – Determine the cost of undertaking, taking into account tangible and
intangible assets and then determine the gain on sale of undertaking (sale
Consideration – cost of undertaking) on aggregate basis.
c) If
both the approach does not work, then computation mechanism fails and there is
no taxable capital gains.
·
Amendment
in Income Tax Act by Finance Act 1999
Finance Act 1999 introduced
the provisions of demerger and slump sale in the Income Tax Act simultaneously.
Among other aspects following facets merits attention:-
1. For
tax neutral demerger, one of the condition of section 2(19AA) is that Transfer
of assets and liabilities of an undertaking should be done at book value.
2. The
definition of Capital asset u/s 2(14) is not amended to explicitly provide that
an undertaking is a capital asset. Section 50B charge profit & gains on slump
sale (as defined u/s 2(42C)) to capital gains and also provide mechanism for
computation of capital gain on slump sale.
Does it mean that Finance Act 1999 impliedly overrule the apex court
ruling in PNB finance to the effect that an Undertaking is not a capital asset,
because had the undertaking being considered as Capital asset, Section 45 would
have been sufficient to Charge profit & gains on slump sale as capital gain
and there would not been need for separating Charging Section i.e 50B for slump
sale.
3. In
the context of demerger, the Act envisages piecemeal treatment as under:-
a) Only
gain on capital assets under demerger is exempt u/s 47, as asset are to be
transferred at book value, so there could be gain on transfer of capital asset,
as book value of assets may be more than cost of acquisition of capital asset.
b) There
is no provision for exemption of business profit on transfer of stock under
demerger, as this situation is not possible because stock is to be transferred
as book value.
c) There
are separate provisions for determining the cost of acquisition, cost of asset
and WDV of assets in the hands of resulting company.
·
Other
Amendments in Act, post Assessment Year to which decision of SC in PNB Finance
relates
1. Section
55(2)(a)
provides for cost of acquisition of specified intangibles to be NIL, in
case same is self-generated
2. Section
50D deems the consideration for capital asset to be FMV, where the same is not
ascertainable or cannot be determined.
Requirement for Revamping divestment Provisions
Ø Need to sync Section 43CA (Inserted by
Finance Act, 2013) with Demerger Provisions
a) Section
43CA provides that if on transfer of land or building or both, being stock in
trade, sales consideration is less than value adopted for stamp duty (Stamp
duty value), then Stamp duty value shall be deemed as sales consideration.
b) Suppose
in an undertaking land is appearing as stock in trade. Upon demerger of said
undertaking, following conundrum will arise:-
i)
If assets of an undertaking are transferred at
book value, then 43CA will deem stamp duty value as sale consideration of stock
and profit on transfer of stock will be subjected to tax.
ii)
If stock is transferred at stamp duty value, the
condition of section 2(19AA) will not be satisfied.
iii)
Thus in afore-mentioned both the situations, the
demerger will not remain tax neutral
c) Operation
of section 43CA makes entire demerger provision non-operational vis-à-vis
against its vowed objective of being tax neutral. The Memorandum explaining the
finance bill, 1999 provide that principle behind Demerger Provisions are to
ensure that Demerger should be tax neutral and should not attract any
additional liability to tax. On principles of Harmonious Construction, section
43CA shall be deemed as not impeding operation of demerger provisions.
d) Clarity
on issue is desired so avoid litigation and maintained the principle of tax
neutral Demerger.
Ø Need clarity on computation Capital Gains on
transfer of Undertaking If Demerger Conditions u/s 2(19AA) are not satisfied - This
is more particularly in the case, where undertaking is transferred under
demerger for lump sum consideration.
Various possible conservative & aggressive
views could be envisaged for computation of capital gains, summarized as
under:-
·
Based
On principles enunciated in PNB Finance to be read with provision of Section
55(2)(a) and section 50D
In said ruling,
apex court advocated piecemeal and global approach for computation of capital
gain upon transfer of an undertaking. When running business constituting an undertaking
is sold, the sale price is often determined with reference to profit generating
capacity of business. If business has high growth potential as compared to
peers, then said business commands high profit multiple vis-à-vis comparable.
There at times situation, whereby the value of undertaking is derived from its
tangible assets, more pronounced in the case, where substantial real estate is
involved. However situation is more vexed where the former case is involved.
The conservative and aggressive views for computation of capital gains could
run as under:-
a) Conservative view - The ability of running business to command
more price as compared to similar infrastructure set-up novice business could
be attributed to following intangibles:-
i)
Business Contract in hand (Right to carry on
business)
ii)
Goodwill, brand name or brand value arising from
rendering quality service with commitment through trained & organized work
force resulting in established customers and favorable supplier further
entailing continuing stream of business. The said benevolent factor is lacking
in newly start up business.
Since the
cost of afore-said self-generated afore-said intangible is NIL, as per section
55(2)(a), the computation of capital gains will be as under:-
i)
Piecemeal Approach – The entire sale
consideration of undertaking could be bifurcated to tangible asset and
afore-said intangibles as per section 50D. Thereupon, the capital gain on each
of the capital asset could be computed.
ii)
Global Approach – Since cost of afore-said
intangible is NIL, the aggregate of cost of tangible assets and other assets
appearing in books will constitute the cost of undertaking and resultant capital
gain of undertaking can be computed.
b)
Aggressive
Approach
i)
All intangibles involved in the business cannot
be culminated into Goodwill and brand value, as section explanation (ii) to
section 92B envisage Goodwill, general business going concern value as intangible
different from other enumerated intangible therein i.e Process Patent,
Technical documentation, automated database, industrial design, product patent,
trade secrets, engineering drawings, customer list, favorable supplier
contracts, trained & organized work force etc.
ii)
Since section 55(2)(a) does not explicitly
provide NIL cost of afore-said intangible and there is no other mechanism in
the Act for computation of their cost, thus cost of such intangible cannot be
determined.
iii)
In the absence of cost of various intangibles,
the computation of capital gain on piecemeal or global approach cannot be
worked out and hence on account of failure of computation methodology, capital
gain cannot be charge to tax.
·
Interpretation
of Statute
i)
Finance Act 1999 introduces provisions relating
to tax neutral demerger and taxable slump sale simultaneously.
ii) The
said Finance Act does not provide any modes-operandi for computation of capital
gains in case demerger conditions are not compiled with.
iii) Thus
one holding conservative view may
take the entire divestment provisions (Demerger & Slump sale provisions) as
integrated code, whereby if conditions of demerger are not satisfied, then
provisions of slump sale will be applicable. This way of reasoning is to read
demerger provision in a way as not to render it nugatory, because without any
enforcement mechanism (computation methodology in the instant case), Provision
of statute granting exemption from tax on satisfaction of certain conditions
has no force.
iv) To
buttress the above contention and to negate the view that the words “sale” as
used in section 2(42C) should not be
confined to its legal meaning, following reasoning may be advanced:-
a) The
words “sale” is not defined in the Act and when meaning of word is not defined,
its meaning must be taken it its legal sense or dictionary meaning or its
popular or commercial duly integrated
with contextual requirement.
b) In
Gannon Dunkerley v. State of Madras [1958] 9 STC 353 (SC), Apex court was
required to interpret the word “sale of good ” as used in List 48 of part II of
Seventh Schedule to Government of India Act , 1935. It was held that Word
“sale” in that entry should be taken as per meaning of Sale of Good Act, 1930
and must have essential ingredient - agreement to sell for a price and property passing therein pursuant to that agreement
c) In
the said judgment itself, Apex Court had occasioned to interpret the word Sale
in Entry 31 of said schedule read as:- is "
Intoxicating liquors and narcotic drugs, that
is to say, the production, manufacture, possession, transport, purchase
and sale of intoxicating liquors, opium and other narcotic drugs. ".
It was held that word sale as used in
this entry is wide enough to cover exchange or barter, as a result a law
therefore prohibiting any dealing in intoxicating liquor, whether by way of
sale or barter or gift, will be intra vires the powers conferred by the opening
words without resort to the words sale and purchase
d) The
reasoning advanced by Court was "The
scheme of the drafting is that there is in the beginning of the Entry words of
general import, and they are followed by words having reference to particular
aspects thereof. The operation of the general words, however, is not cut down
by reason of the fact that there are sub-heads dealing with specific aspects.
The subsequent words and phrases are not intended to limit the ambit of the
opening general term or phrase but rather to illustrate the scope and objects
of the legislation envisaged as comprised in the opening term or phrase."
e) Thus definition of the word is to be
apprehended in the context in which it is used.
f) Section
2(42C) defines slump sale as “transfer of undertaking as a result of sale----.” The meaning of word Transfer is
not to be imported from section 2(47) defining Transfer, for following
reasoning:-
Ø The
definition of Transfer u/s 2(47) is with relation to Capital Asset. The
Undertaking is not embrace in definition of Capital asset u/s 2(14).
Ø Only
when transaction is slump sale, then only gain pursuant to is deem as capital
gain u/s 50B
Ø Thus
sequencing of the Act is that , first one need to arrive at whether there is
slump sale and if yes, then gain is taken as capital gain.
g) Thus
word sale in section 2(42C) is not be taken as one of the mode of transfer but
to be considered as word illustrating opening and general term TRANSFER in consonance with the scope and object of entire divestment
provisions.
v) However
One holding aggressive view will extend
following reasoning:-
a) There
do exist numerous precedents wherein the definition of word sale in the context
of slump sale is taken in term of Sale of Good Act, 1930 and has held that
Transfer of assets under scheme of arrangement in pursuance of Court order is
not a sale.
b) The
definition clause under Act has to read in consonance with charging section. If
section 50B considered profit & gains on slump sale as Capital gain, then
related word “Transfer” as used in Section 2(42C) shall be considered in the
realm of Capital asset and hence its meaning should be draw from section 2(47),
wherein sale is only one mode of Transfer. Thus if undertaking is transferred
pursuant to court order, the same is not sale and hence provision of section
50B will not be applicable.
c) Thus
transfer of undertaking for lump sum consideration under demerger, the same is
not taxable, as there is no computation methodology.
Thus at
present Act is riddled with full of ambiguity relating to divestment provisions,
which need to be whittled down with requirement of growing economy.
