THE process of mergers and acquisitions has gained considerable importance in today's corporate world where in order to keep pace with the existing competitive environment and looking on to gain on the synergy effect, companies worldwide either opt for friendly mergers or acquire other companies in a hostile takeover bid.
M&A process is thus extensively used for restructuring the business organizations. The Indian economic reform since 1991 has opened up a whole lot of challenges both in the domestic and international spheres. The increased competition in the global market has prompted the Indian companies to go for mergers and acquisitions as an important strategic choice.
Effects of the mergers and acquisitions have been diverse across the various sectors of the Indian economy. Accordingly, the tax aspect involved in the M&A process is now of paramount importance to the parties involved.
A most common methodology which is adopted during M&A is to purchase the business of the target company.
One of the most important questions to ask in such a purchase or sale of a business is whether or not it is only the assets that are being sold by the target company or the target company is sold as a ‘going concern'. The answer to that question can have profound implications to both buyer and seller.
In the itemized sale of individual assets which can be separately identified and valued, the purchaser not only chooses or cherry picks the assets that are subject to the acquisition but is also at a liberty to assume the obligations and liabilities (if any) of the selling company.
Contrary to the above scenario, in a sale of a company as a ‘going concern' all of the assets and liabilities of the target company are, in effect, the indirect subject matter of the transaction because by buying the company, the end result is that the purchaser owns the company that owns the assets and also assumes all of the liabilities and obligations of the target company.
Thus, in general terms it may be more advantageous for the purchaser to buy assets on an itemised basis while it may be, conversely, more advantageous for the vendor to sell shares.
The resolution of this conflict is usually done through pricing and other negotiated terms. Quite often, it is the income tax and indirect tax consequences that are determinative of the way the M&A transaction proceeds.
In India, from an Indirect tax perspective, sale of goods is subject to levy of VAT or CST depending upon the fact whether such a sale of goods is a local sale i.e. sale occurs within the State or is an inter-State sale which takes place outside the State.
The terms ‘goods' and ‘sale' is defined under the State specific VAT laws as well as under the CST laws. ‘Goods' are typically defined to mean and include any moveable assets and intangibles including trademarks, patents, designs and copyrights etc, but does not include newspaper and actionable claims. ‘Sale', broadly is defined to include transfer of property against a consideration and includes grant of right to use goods
Thus, depending on the State of transaction and nature and description of assets sold, itemised sale of assets, wherein each asset is separately identifiable and individually valued may trigger VAT/ CST implications at the applicable rate. It is pertinent to mention here that t he purchaser of the assets would in such a scenario be entitled to avail input tax credit of VAT charged by the seller, subject to fulfilment of certain prescribed conditions
Further, in case of a sale of company as a ‘going concern' it is germane to note that baring a few States such as Andhra Pradesh & Uttar Pradesh, where the specific State VAT laws explicitly provide for an exemption from the levy of VAT on the sale of business as a ‘going concern' or on a slump sale basis, most of the State VAT laws are silent on the applicability of VAT on such a slump sale.
The term ‘slump sale' is not defined under any of the State specific VAT laws or under the CST laws.
However, Section 2 (42 C) of the Income Tax Act, 1961 defines the word ‘slump sale' as under:
“Slump sale means the transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to individual assets and liabilities in such sales”
From the above definition it can be observed that the ITA recognizes a slump sale as a transfer of an undertaking i.e. a part or a unit or a division of a company, which constitutes a business activity when taken as a whole. In other words, a slump sale would mean a transfer of an entire business for a single consideration without assigning any value to individual assets and liabilities. Also, under the slump sale concept, the business is sold on a ‘going concern basis'' i.e. after the transfer of all assets/ liabilities, contracts, employees, the business would be able to carry on its activities as earlier.
Thus, the term ‘slump sale' connotes the sale of an entire business undertaking, comprising of various assets net of liabilities for a lump sum or ‘slump' consideration. Courts have held in a catena of judgments that the taxing authorities in case of a slump sale can not split the sale consideration and attribute it to different assets. Further, under the VAT and Sales Tax laws the term “business” is not covered under the definition of goods and accordingly no VAT implication would trigger on the transactions involving the transfer of business as a whole. The Allahabad High Court also upheld the same view in the case of Sri Ram Sahai vs. Commissioner of Sales Tax (1963) 14 STC 275 (All) and the Madras High Court in the case of Monsanto Chemicals Of India (P.) Limited V. The State of Tamil Nadu (1982) 51 STC 278 (Mad).
In the case of Coromondal Fertilizers Limited vs. State of AP and Spectra Bottling Co. v. State of AP,(1999) 112 STC 1 AP also the High Court of Andhra Pradesh held that sale of business would not be construed as sale in the course of business and hence would not be subject to sales tax.
Further, in a scenario where only a unit or a particular branch of the target company is sold, Courts have held (The Deputy Commissioner of Sales Tax (Law) vs. Dat Pathe reported in 1985 (059) STC 0374 Kerala), The Deputy Commissioner of Commercial Taxes vs K. Behanan Thomas reported in 1977 (039) STC 0325 Madras), Lohia Machines Limited vs. Commissioner of Sales tax, U.P reported in 1998 (110) STC 0305 – Allahabad) that if a person is carrying on his business through different units/branches separately identifiable from each other, transfer of one unit / business as a going concern having separately identifiable assets, liabilities, income and expenditure would be considered as transfer of business as a ‘going concern and accordingly not attract any VAT/Sales tax liability
Further, where the buyer purchases the assets of the target company in entirety but only few of the liabilities are transferred it is apposite to mention the ruling of the, the Kerala High Court in the case of Zacharia vs. State of Kerala reported in 1977 (039) STC 0221wherein it was held that:
“The mere fact that the seller had undertaken to settle liabilities which had accrued prior to the sale of the business would not by itself show that the seller had not transferred the business as a whole. So long as there is nothing to suggest that any part of the assets was retained by the seller or any amounts standing to the credit of the business were taken over by the seller, it cannot be suggested that the business as a whole was not transferred.”
Thus, in pursuance with the judicial pronouncements as laid out above it may be concluded that in the case wherein all the assets are transferred in the business other than the liabilities, then the same would also qualify as a sale of business as a whole and consequently the sale transaction may not attract the levy of any VAT.
In light of the judicial precedents laid out above, it may be concluded that a ‘sale of business' transaction; wherein the liabilities are retained by the transferor shall also be treated as sale of the entire business. However, it is very important to look into the terms of agreement and provisions of the VAT laws of the concerned state to conclude the applicability of VAT.
It is imperative to mention here that in the case of State of Tamil Nadu Vs. T.M.T. Drill (Private) Ltd. reported in 1991 (082) STC 0059 Madras; it has been held that a business will not be considered to be sold “as a whole / going concern” unless the entire assets of the business are transferred. If certain assets are retained and are not transferred, then the business would not be deemed to be transferred as a whole / going concern and consequently, the turnover resulting from such a sale / transfer will not be exempt under the provisions of the VAT laws.
Further, as discussed above in the case of Zacharia vs. State of Kerala reported in 1977 (039) STC 0221 Kerala; it was held that retention of certain liabilities while transferring the business by the transferor would not devoid the transaction to be categorized as “sale of business” transaction; wherein the whole business is transferred.
From a conjoint reading of the above two legal precedents, it may be concluded that the business may be considered to be transferred as a ‘going concern' even in case where only substantial assets involved in the business are transferred but no liabilities are taken over. Thus, in case only substantial assets are transferred such sale may not be subject to VAT / CST implication.
However; at this juncture, what is to be construed as ‘substantial assets' still remains as a point of deliberation and is of paramount importance to analyse the Indirect tax implications on a M&A transaction.