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Different Perspectives on Taxability of Retained Consideration during Slump Sale.

Updated: Feb 9

by Avar Lamba *

Introduction

A slump sale, which refers to the transfer of an entire business, or a unit of such business, is often used by businesses and MNCs to transfer their undertaking(s) as a whole in a case where transferring individual assets would result in immoderate utilisation of time and resources.

S. 45 of the Income Tax Act imposes a charge on profits or gains arising from the transfer of a capital asset, and as per S. 50B, capital gain in case of a slump sale is calculated as a difference of the full value of the consideration received and the net worth of the business, and the gain is taxable for the previous year (PY) in which the transfer took place. The section, while comprehensive, doesn’t account for the manner of accrual of consideration the payment of which may be deferred due to retention in an escrow account. An escrow account refers to a writing, deed, money, stock, or other property delivered by the grantor, promissor, or obliger, into the hands of a third person, to be held by the latter until the happening of a contingency or performance of a condition.
Contemporary slump sale contracts have started incorporating provisions for retention of a portion of the full value of consideration in an escrow account, and its subsequent release upon fulfilment of certain conditions. This has led to disquietude as to the taxability of retention money, i.e., whether the amount set aside in escrow is to be taxed in the year in which it has been retained, or in the year in which it has been released from the account.
This dilemma regarding the preferable approach has led to two divergent viewpoints, with one being favourable to the government due to immediate taxability of consideration that may be deferred, and the other being in the interest of the taxpayer who can avoid paying tax on an amount he has not actually received.

Taxability in PY in which consideration is released from escrow

The Hon’ble Supreme Court in Commissioner of Income Tax v. Simplex Concrete Piles (P.) Ltd. has held that retention money can be said to accrue in the year in which it is actually received and not in the year of retention. Furthermore, it has been held in the case of Commissioner of Income Tax v. Shoorji Vallabhdas that Income Tax can be levied only on the real income of an assessee, and this interpretation was expanded by the Hon’ble Supreme Court in E.D. Sasson & Co. Ltd. v. Commissioner of Income Tax, wherein it was stated that tax can be levied only on the income upon which the assessee has an inherent right to receive. In this regard, it can be said that retention of a portion of the sale consideration in escrow would mean that the income never actually came into the assessee’s hands as its very accrual would depend upon contingent fulfilment of conditions, thus, culminating in the non-existence of a right to receive. Therefore, levying a tax on such an amount could be considered a charge imposed on the hypothetical income of the assessee, which is against the postulates of the Income Tax Act.

Taxability in PY in which Consideration is Retained

Another bone of contention concerning this issue is that the retention of the amount in an escrow account may be treated as an act of the parties subsequent to the determination of the full amount of consideration, and thus, can be treated as a case of mere application of income, This is because on a combined reading of Commissioner of Income Tax v. Bharat Petroleum Corporation Ltd. and Commissioner of Income Tax v. Dinesh Kumar Goel, it becomes clear that the right to receive will be vested with the assessee as soon as the final consideration is fixed and a legally enforceable debt arises in the context of a creditor-debtor relationship. Hence, the same can be said to be a charge levied on the real income of the assessee and would be taxable in the year of retention itself.

Judicial Contemplation

Various judicial forums have contemplated the manner of accrual of the consideration retained in an escrow account. The Hon’ble Bombay High Court in Dinesh Vazirani v. Principal Commissioner of Income Tax held that it is only the amount that finally comes into the hands of the assessee after release from the escrow account, which is to be offered to tax, and not any other amount that is transferred directly to the escrow account, and subsequently withdrawn without ever accruing to the assessee. The same principle was reiterated in the decision of Universal Medicare v. Deputy Commissioner of Income Tax, wherein a part of the sale consideration as a consequence of a slump sale of a division of an undertaking was retained in an escrow account.
However, the contrast in judicial standpoint can be encountered in the decision of T.A. Taylor v. Assistant Commissioner of Income Tax, wherein a portion of sale consideration from a slump sale was retained in an escrow account. The Hon’ble Chennai ITAT held that profits or gains arising from a slump sale can be correctly computed only if the total consideration arising to an assessee on account of such sale is reckoned, and there is no provision that allows the assessee to segregate the consideration as per the slump sale agreement in accordance with the year of receipt.
A similar finding was given by the Hon’ble Madras High Court in Carborandum Universal Limited v. Assistant Commissioner of Income tax wherein retention of a portion of sale consideration in escrow was held to be an application of income, and thus, the amount was taxed in the PY in which it was retained. But, an SLP against this decision [SLP (C) No. 17978/2022] is pending before the Hon’ble Supreme Court.

Analysis & Conclusion

The two perspectives about this issue represent a broad horizon of possibilities, with each culminating into a separate set of probabilities for both the department as well as the assessee. Imposing a charge on the retained portion of the consideration in the year of release from escrow will allow the assessee a relief as to the payment of tax on the amount he has an enforceable right upon. But it also has the possibility of opening the floodgates for tax avoidance as large portions of sale consideration could be retained in escrow and not be brought to tax in the year of retention. This can ensue if the conditions upon which the release of the retained amount is contingent are not fulfilled, as then it could result in a large amount of money never being brought to tax, as it would never be treated as having accrued to the assessee.
While there is a comprehensible likelihood of this provision being used to avoid payment of tax, the mere possibility of misuse of a provision, as stated in Commissioner of Customs v. Dilip Kumar & Company, would not warrant an interpretation that is disadvantageous to the assessee. But at the same time, the verbatim of S.50B does state “in the previous year in which transfer took place” which goes to show the intention of the legislature to tax the profits in the year in which they have arisen, and consequentially, if this interpretation is followed, then retention of the amount after finalising the full value of consideration would become insignificant anyways.
Looking at this issue from another vantage point, it is ascertainable that taxing the amount which has been set aside, in the year of retention would be an instance of imposing a tax on the hypothetical/notional income of the assessee, as the amount never actually came into the assessee’s hands, and instituting such a charge would be arbitrary considering the fact that the amount will be nevertheless be brought to tax in the year of release, thus making this concern revenue neutral. Furthermore, it is pertinent to note that the effectuality of non-attainment of conditions resulting in the amount never being released does exist, but to deem the same as accrued income of the assessee in the year of retention due to such a possibility would be contrary to the basic principles of taxability of Income Tax, as the eventuality of it accruing to the assessee is out of his control, and until the amount hasn’t accrued, there is no enforceable right to receive the same.
It is safe to say that this issue heavily requires the Hon’ble Supreme Court’s consideration and judicial extrapolation to sieve through the various interpretations and come to a reasonably apprehensible conclusion to settle a question that has caused significant legal discourse throughout the country.

*Avar Lamba is a fourth year student at University School of Law and Legal studies, GGSIPU at the time of publication of this blog.

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