Asked March 25, 2014

Regulatory Approvals: In transfer of a business undertaking

  • 1 Answer

X is a Pvt Ltd. Co. (incorporated and listed in India), as a part of its restructuring process wants to transfer a “business undertaking” at Ranchi, Jharkhand. Situation 1. What would be the relevant laws and regulations governing a transaction, where the undertaking is directly transferred by X to Y Pvt Ltd (incorporated and listed in India)? Situation 2. In case X wants to transfer the same undertaking to Z LLC (incorporated and listed in the USA), what would be the necessary regulatory approvals and clearances required (in India) for such a transaction?

Answer 1

Under the 1956 Act, an ordinary resolution of shareholders was sufficient for public companies to sell/lease or otherwise dispose of whole or substantially the whole of the undertakings.

However, there is ambiguity regarding the definition of the terms “undertaking” and “substantially the whole of undertaking.”

In attempting to define an “undertaking,” the 2013 Act has introduced the additional restriction of a minimum threshold, which should not be read independent of the primary requirement – that the transfer in question is in actuality that of an undertaking. The 2013 Act defines the following terms as:

• “Undertaking” to mean one in which investment in the company exceeds 20% of its net worth according to its audited balance sheet of the preceding financial year or an undertaking that generated 20% of the company’s total income during the previous financial year

• “Substantially the whole of the undertaking” in any financial year to mean that 20% or more of the value of the undertaking according to its audited balance sheet of the preceding financial year. The shareholders of all companies are required to pass special resolutions for such disposals, irrespective of whether these are private or public organizations.

The following illustrations depict the interpretation in relation to compliance with rules pertaining to special resolutions being obtained in light of the definitions of “undertaking” and

“substantially the whole of the undertaking” under 2013 Act.

Case 1: Special resolution

A Co has two units, Unit A (generating 80% of its total income) and Unit B (generating 20% of its total income).

A Co intends to transfer part of Unit B (comprising 20% of the value of Unit B) to B Co. Based on an initial interpretation of Clause 180 of the 2013 Act, the transfer mentioned above would require a special resolution in spite of the fact that a part of a unit of A Co, which generates only 4% of its total income, is to be transferred.

Case 2: No special resolution

A Co has two units, Unit A (generating 81% of its total income) and Unit B (generating 19% of its total income).

Unit B is to be transferred to B Co.

Based on an initial interpretation of Clause 180 of the 2013 Act, the transfer mentioned above does not require a special resolution in spite of the fact that a unit, which generates 19% of the total income of A Co, is to be transferred. Apart the materiality test mentioned above, which was introduced in the definition of undertaking, the unit or part of the unit intended to be transferred will still have to fulfil the requirement of being an “undertaking.”

In various cases in the past, courts have interpreted undertakings as the business or activity of companies as a whole. Furthermore, they have opined that transfer or sale of shares cannot be interpreted as the transfer of an undertaking, even if the controlling interest in a company is transferred or when the shares transferred are the only assets or a substantial portion of the assets of the company. The aspects mentioned above have still not been clarified under the 2013 Act. It has been seen that a significant number of transactions typically follow a two-step process wherein the sellers “push” the business intended to be divested into subsidiaries, and thereafter sell their shares to potential investors. In such cases, the first step of transfer of a business from a holding to a subsidiary may be regarded as a related party transaction, and there are strict provisions in relation to consent being obtained through special resolutions by a holding and a subsidiary. These will need to comply with the provisions pertaining to related party transactions once these are notified. This may have an impact on the flexibility of conducting transactions involving transfers of undertakings. This provision has been notified, and therefore, transactions involving transfer of undertakings are required, to ensure compliance with the provisions given above.

The aspect of growth, progress and huge profits are the key driver and utmost concern for any business. Understandingly the approach is always to increase the size of the business. This can be done either through the organic way that is through the gradual progress or through inorganic ways, which is quick but fraught with liabilities. When it comes to inorganic mode of accelerating the growth of a business is acquisition of the assets of an undertaking or business thereof as a going concern. The transfer of the undertaking concerned as going concern is called “Slump sale”. Slump sale is one of the methods that is widely used in India for corporate restructuring where the company sells its undertaking. The main reasons of slump sale are generally undertaken in India due to following reasons. One, slump sale helps the business to improve its poor performance. Two, it helps to strengthen financial sheet of the company. Third, it helps the company to eliminate the negative synergy and facilitate strategic investment. Lastly slump sale helps to seek tax and regulatory advantage associated with it.


The concept of “slump sale” was incorporated in the Income Tax Act, 1961 by the Finance Act, 1999. Section 2 (42C) of The Income Tax Act, 1961, recognises ‘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 simpler words slump sale means transfer for entire business unit for a single consideration without assigning value to individual assets and liabilities. Under the slump sale the business is sold on a ‘going concern basis’ that is there is going to be transfer of all assets/ liabilities, contracts, employees, etc so that the business would be able to carry on its activities as earlier.

The definition of slump sale is exhaustive and only covers transfers of an undertaking as a result of sale. The term transfer has wide meaning therefore transfer is exclusively defined under Section 2(47) to include sale, exchange, relinquishment, extinguishment of right, etc.

Gains on transfer of the ‘undertaking’ – Liable to tax Any profit and gain arising from the slump sale in the previous year, is chargeable to income-tax as capital gains arising from the transfer of the undertaking.

In a scenario where only a unit or a particular branch of the target company is sold, Courts in the cases of The Deputy Commissioner of Sales Tax (Law) v. Dat Pathe , The Deputy Commissioner of Commercial Taxes v. K. Behanan Thomas and Lohia Machines Limited v. Commissioner of Sales tax, U.P  have held that if a person is carrying on his business through different units/ branches separately identifiable from each other, the 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.

In a slump sale where the transferor entity will close down its business by completing the sale, the transaction may attract VAT in some states. VAT on slump sale is applicable only where the state legislation relating to VAT explicitly provides for the same. Stamp duty in slump sale is paid only on transfer of immovable assets and no sales tax is payable on transfer of business but however VAT is attracted on such transfers only in few states.

The second case whereby an Indian Listed Company wants to sell its undertaking to the LLC listed in USA, the same could be done by means of Mergers. Current laws only permit inbound mergers (foreign companies merging with Indian ones) and not the other way around. The 2013 Act proposes to allow both — inbound and outbound cross-border mergers between Indian companies and foreign ones. It provides for the merger of an Indian company into a foreign one, whether its place of business is in India or in certified jurisdictions (to be notified by the Central Government from time to time), subject to the NCLT’s and RBI’s approval.


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