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Transferee Acquiring A Business As A Going Concern, Liable To Pay Income Tax For The Period Prior To Acquisition

Acquisition of business involves the acquisition of inherent tax exposure of the target company or business so acquired pertaining to the period prior to such acquisition. A question that arises is that how can a transferee be made liable to pay income tax of a business for the period before they even acquired it? What is the extent of such 'period' for which the liability accrues?

Transfer of Business as a Going Concern: Slump Sale.
The terms, 'business transfer' and 'slump sale' are used interchangeably in the Indian context and both refer to transfer and sale of an entire business undertaking of the seller on a going concern basis for a lump-sum consideration. In India, 'Slump sale' is purely a tax concept and the Income Tax Act, 1961 defines a slump sale under Section 2 (42C) as follows:

'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 in such sales'.

The single most important requirement of a slump sale is that the undertaking is transferred as a 'going concern'. There should be no break or cessation in the operations of the transferred undertaking. The transfer of the undertaking form the seller and the vesting of the undertaking in the buyer together with all the assets and liabilities should be simultaneous and it should not stop, hinder or break the conduct of the business. Hence, it is important for the buyer to ensure that the buyer has all the requisite infrastructure, licenses and preparedness to start running the business simultaneously with the consummation of the slump sale.

Income Tax Liabilities in a Slump Sale.
For Seller
Taxability of slump sale in the hands of a seller is clearly spelled out by the provisions of section 50B of the Income Tax Act, as follows:
  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.'
For Buyer
When it comes to taxability of slump sale in the hands of a buyer, the law seems to be ambiguous. With uncertainty, sometimes, the tax officer relies on section 170 of the Income Tax Act to treat such slump sale as succession of a business and thereby apply the relevant provisions of the Income Tax Act in the case of a buyer.

Section 170 of the Income Tax Act governs the taxation in case of succession of a business as follows:
  1. Where a person carrying on any business or profession (such person hereinafter in this section being referred to as the predecessor) has been succeeded therein by any other person (hereinafter in this section referred to as the successor) who continues to carry on that business or profession:
    1. the predecessor shall be assessed in respect of the income of the previous year in which the succession took place up to the date of succession;
    2. the successor shall be assessed in respect of the income of the previous year after the date of succession.
  2. Notwithstanding anything contained in sub-section (1), when the predecessor cannot be found, the assessment of the income of the previous year in which the succession took place up to the date of succession and of the previous year preceding that year shall be made on the successor in like manner and to the same extent as it would have been made on the predecessor, and all the provisions of this Act shall, so far as may be, apply accordingly.
  3. When any sum payable under this section in respect of the income of such business or profession for the previous year in which the succession took place up to the date of succession or for the previous year preceding that year, assessed on the predecessor, cannot be recovered from him, the Assessing Officer shall record a finding to that effect and the sum payable by the predecessor shall thereafter be payable by and recoverable from the successor, and the successor shall be entitled to recover from the predecessor any sum so paid.
     
  4. Where any business or profession carried on by a Hindu undivided family is succeeded to, and simultaneously with the succession or after the succession there has been a partition of the joint family property between the members or groups of members, the tax due in respect of the income of the business or profession succeeded to, up to the date of succession, shall be assessed and recovered in the manner provided in section 171, but without prejudice to the provisions of this section.

    Explanation: For the purposes of this section, "income" includes any gain accruing from the transfer, in any manner whatsoever, of the business or profession as a result of the succession.'

Courts applying S.170 of Income Tax Act to cases of transfer as slump sale.
ITO vs Archroma India Pvt. Ltd
[2020 - Mumbai Tax Appellate Tribunal, Division Bench]

Brief Background
Taxpayer, an Indian private limited company, entered into a Business Transfer Agreement (BTA) with an unrelated Indian private limited company (transferor) for purchase of an undertaking on a slump sale basis. As per the BTA, the taxpayer acquired various assets including goodwill from the transferor company. Consequently, the taxpayer ascertained the fair value (FMV) of these assets and added them to the existing Written Down Value (WDV) of respective block of assets and claimed depreciation. The tax officer treated the slump sale amounted to succession and hence the provisions of Section 170 of the Act gets attracted.

The taxpayer filed an appeal before the First Appellate Authority against the order of Tax Officer. The First Appellate Authority referring to the contention raised in the ruling of Saipem Triune Engineering Pvt. Ltd3 agreed that the taxpayer's case was not that of succession.

Tribunal Ruling
Before the Tax Tribunal, the main controversy involved was whether the provisions of Section 170 of the IT Act, which pertains to succession of business, gets attracted in case of business transferred on a slump sale basis. After hearing both the parties, the Mumbai Tax Tribunal held:

'In the present case we find that the assessee had acquired the said assets under slump sale. There is a business transfer agreement and by way of this agreement the assessee has purchased an undertaking under slump sale. In our considered opinion the facts in the present case clearly show that the assessee company has acquired the assets under a business transfer agreement. Hence it has succeeded the transferee company. The provisions of section 170 are clearly applicable on the facts of the present case.'

Oriental Fire & General Insurance vs Commissioner Of Income Tax
[2000 - Delhi High Court, Division Bench]

Brief Background
For assessment year 1972-73, the transferee (oriental fire & general insurance) was assessed as the successor of the business of the old company (Bharat General Reinsurance Co. Ltd.). The old company was carrying business until and before 13.05.1971. On and from 1.1.1974, the old company stood transferred to and vested in the transferee company.

By applying section 170 of the Act assessment was made by the assessing officer holding that the assessee was a successor of the old company. The assessment was assailed before the Appellate Assistant Commissioner of Income Tax, who affirmed the views of the assessing officer.

Delhi High Court Ruling
The High Court, while deciding on the issue of the date of applicability of 'succession' upheld the application of S.170 ITA in case of transfer of business. It observed:

'Section 170(2) has been referred to contend that at least from 13-5-1971, the assessee was to be treated as a successor. Learned counsel for the assessee, on the other hand, submitted that the operation of the scheme as referred to above became operative only with effect from 1-1-1974, and from that date the assessee became the transferee company.

.. Succession implies that there is an end of an entity carrying on the business, and its place has been taken by an entirely new entity to run in continuity and as a going concern, the same business. Substantial identity and continuity of the business must be preserved.

.. Succession has a recognised connotation. The tests of change of ownership, integrity, identity and continuity of a business have to be satisfied before it can be said that a person "succeeded" to the business of another. Section 170(1) of the Act prescribes not merely for liability to tax, but also the process of computation of tax.'

Banyan & Berry vs Commissioner of Income Tax
[1995 - Gujarat High Court, Division Bench]

Brief Background

M/s Banyan and Berry was a partnership firm formed through a deed of partnership. The firm was transferred to Banyan and Berry Construction Pvt. Ltd. company through a transfer deed dated 16.04.1983. The partnership firm, through the transfer deed, transferred all the assets and liabilities of the firm together with the goodwill thereof with the intention that the firm's business may be taken over as a running concern by the company. The Income Tax Tribunal, Ahmedabad referred the matter to Gujarat High Court asking if the firm was liable to be taxed after the transfer or not.

Gujarat High Court Ruling
The High Court, while applying S.170 to the fact of transfer of business observed:
'Section 170 deals with the succession of business otherwise than on death, that is to say, where a business is succeeded, as a going concern by one 'assessee entity' to 'another assessee entity' that entity under the Act ceases to be an the assessee in respect of business which has been succeeded by another, and the successor assessee becomes the assessee for the purpose of taxing the income arising from such business.

This assumes that business is not discontinued. Under the scheme of s. 170 where persons carrying on business has been succeeded thereon by any other person, who continues to carry on that business, the predecessor is assessed in respect of income up to the date of succession and the successor is assessed in respect of the income since the date of succession.

This apart, from other provisions make it clear that in the case of succession, there is a water tight compartment of period income upto which is assessable in the hands of the transferor, namely, upto the date the business is carried on by it. Section 170 also does not envisage that when a transfer of business takes place, the transferor or the predecessor must cease to exist.'

Conclusion
Based on the above discussed legal provisions and judicial pronouncements, the position of law regarding the liability of a transferee to pay income tax pending against the transferred business, as before the date of acquisition becomes clearer.

As a general rule, where a business is transferred by any other person, who subsequently continues to carry on that business, the transferee is assessed for the income of the Fiscal Years prior to the date of transfer and the transferor is assessed on the income of the Fiscal Years after the date of transfer. However, in cases where the transferor cannot be found or where any tax liability is not recoverable from the transferor (for example, on account of the inadequacy of assets). In case the provision is triggered, the buyer may be held liable for the tax liabilities of the transferor for a specific period, i.e. for the financial year in which the transfer of business takes place and the financial year immediately preceding the date of the transfer.

End Notes:
  1. The Income Tax Act, 1961
  2. ITO vs Archroma India Pvt. Ltd (I.T.A. No. 306/Mum/2019 and I.T.A. No. 6919/Mum/2018 and C.O. No. 07/Mum/2020)
  3. Oriental Fire & General Insurance vs Commissioner Of Income Tax (2000 244 ITR 631 Del)
  4. Banyan & Berry vs Commissioner of Income Tax (1996 222 ITR 831 Guj)

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