Planning a business transfer? There could be multiple reasons why you would have already decided to transfer a business—exiting, carving out to another group company, sale to a JV company and so on. Having taken a strategic decision, it becomes imperative to determine and minimise the cost associated with business transfer. Tax in such a scenario becomes synonymous with transaction cost. Have you thought that a business transfer could be structured efficiently from direct and indirect tax perspective? You could be a large company transferring a small business—and a hybrid sale structure could help you achieve commercial objectives in a tax efficient manner.
Talking about direct taxes, it is known that there exist two methods for determining income tax liability on business transfers. The widely known method is taxability on slump sale basis and the other one being sale on itemised basis. Slump sale refers to a scenario where a bunch of assets and liabilities constituting a business are transferred for a lump-sum consideration (without values being ascribed to each asset). Traditionally, business transfers have been achieved by having lump-sum consideration for the business. Under slump sale, net worth of undertaking is regarded as a cost base. A reduced rate of 20% (excluding cess and surcharge) should be available if the undertaking is held for more than three years.
The other (more attractive) method to achieve a business transfer could be where values are ascribed against each asset in the transfer agreement. The fundamental difference is that the sale price for the fixed assets/intangible and the sale value of assets is reduced from the block of assets, as opposed to the net worth principle discussed earlier. Such transfer of assets thus results in taxation at a comparatively higher tax rate which is 30% (excluding surcharge and cess).
Let’s take the case of a large company having huge asset base, selling small business under the slump sale scenario, and there would be a cash tax outgo. However, if one was to follow the second method, there would be reduction in asset base and, as a result, reduction in annual depreciation and tax break on depreciation. This would mean there would be no cash tax outgo as in the case of slump sale but a long-term reduction in tax break on depreciation of assets. To expand this a little, the tax impact of the sale is spread over a longer period, though the impact is