Introduction

The Securities and Exchange Board of India (SEBI) Merchant Bankers Regulations, 1992 established the first comprehensive regulatory framework for merchant banking activities in India’s capital markets. Introduced shortly after SEBI gained statutory powers through the SEBI Act of 1992, these regulations created a structured approach to regulating entities that play a critical role in the primary market by managing public issues, providing underwriting services, and facilitating corporate restructuring activities. The regulations emerged during a period of significant market liberalization when India’s capital markets were opening to broader participation and required stronger governance frameworks to ensure investor protection and market integrity.

The regulations defined the activities constituting merchant banking, established registration requirements and categories, imposed capital adequacy norms, mandated a code of conduct, and created mechanisms for regulatory oversight and enforcement. Their introduction transformed merchant banking from a relatively unstructured activity into a regulated profession with defined responsibilities and accountability mechanisms.

Historical Context and Regulatory Background of SEBI (Merchant Bankers) Regulations, 1992

Prior to the SEBI Merchant Bankers Regulations, merchant banking in India operated with limited formal regulation. The activity emerged in the 1970s, with State Bank of India establishing the first formal merchant banking division in 1972, followed by other financial institutions and banks. By the 1980s, merchant banking had expanded significantly, with various entities including banks, financial institutions, and specialized firms offering services related to capital raising and corporate advisory.

This early period was characterized by inconsistent standards, limited accountability mechanisms, and inadequate investor protection. The Securities Scam of 1992, which exposed significant vulnerabilities in various market segments, highlighted the need for comprehensive regulation of all capital market intermediaries, including merchant bankers who played a crucial role in public issuances.

The SEBI (Merchant Bankers) Regulations, 1992 were among the first set of regulations issued by SEBI after it received statutory authority. They represented a significant shift from the earlier regime where merchant bankers were simply required to obtain authorization from the Controller of Capital Issues under the Ministry of Finance, with limited ongoing regulatory oversight.

Registration Categories and Requirements Under Chapter II

Chapter II of the SEBI (Merchant Bankers) Regulations, 1992 established a comprehensive registration framework for merchant bankers. Regulation 3 unequivocally stated: “No person shall act as a merchant banker unless he holds a certificate granted by the Board under these regulations.” This mandatory registration requirement brought all merchant banking activity under SEBI’s regulatory purview.
The regulations introduced a four-category classification system based on activities performed and corresponding capital requirements:

The regulations introduced a four-category classification system based on activities performed and corresponding capital requirements:

• Category I: Authorized to undertake all merchant banking activities including issue management, underwriting, portfolio management, and corporate advisory
• Category II: Permitted to act as adviser, consultant, co-manager, underwriter, and portfolio manager
• Category III: Limited to underwriting activities
• Category IV: Restricted to advisory and consultancy services

This tiered approach aligned regulatory requirements with the nature and scale of activities undertaken, ensuring proportional regulation. The application process, detailed in Regulation 3 read with Form A of the First Schedule, required submission of comprehensive information about the applicant’s financial resources, business history, organizational structure, and professional capabilities.

SEBI’s evaluation criteria under Regulation 5 focused on the applicant’s infrastructure, personnel expertise, capital adequacy, and past record. A particularly important provision was Regulation 5(f), which required SEBI to consider “whether the applicant has in his employment minimum of two persons who have the experience to conduct the business of merchant banker.” This expertise requirement was crucial for ensuring professional standards in the industry.

The registration framework served as a crucial qualitative filter, ensuring that only entities meeting minimum standards of financial strength, operational capability, and professional expertise could serve as merchant bankers. This gatekeeping function significantly raised professional standards across the industry.

Capital Adequacy Norms Under Regulation 7

Regulation 7 established capital adequacy requirements for merchant bankers, creating financial buffers against operational risks and ensuring their economic viability. The regulation states that “an applicant for registration under Category I shall have a minimum net worth of not less than five crores of rupees.” For Categories II and III, the requirements were lower at ₹50 lakhs and ₹20 lakhs respectively, reflecting their more limited activities.

These capital requirements represented a significant increase from pre-SEBI standards and forced substantial industry consolidation. Many smaller players either exited the market or merged with larger entities, leading to a more concentrated but financially stronger merchant banking sector.

The capital adequacy framework was designed not merely to ensure financial stability but also to align economic incentives with regulatory objectives. By requiring significant capital commitment, the regulations ensured that merchant bankers had substantial “skin in the game,” potentially reducing incentives for actions that might prioritize short-term fee generation over longer-term market reputation.

The impact of these capital requirements was profound. Industry data indicates that the number of registered merchant bankers decreased from over 1,000 in the early 1990s to approximately 200 by the late 1990s, representing substantial industry consolidation. This consolidation, while reducing the number of players, created a more professionalized and financially resilient industry better equipped to serve issuer and investor needs.

General Obligations and Responsibilities Under Chapter III

Chapter III established comprehensive obligations for merchant bankers, creating a structured framework of responsibilities toward issuers, investors, and the broader market. Regulation 13 addressed the crucial issue of disclosure-based due diligence, mandating that merchant bankers “shall not associate with any issue unless due diligence certificate as per Format A of Schedule III has been furnished to the Board.”

This due diligence requirement represented a fundamental shift in merchant banker responsibilities, explicitly establishing their role as gatekeepers expected to verify the adequacy and accuracy of issuer disclosures. The due diligence certificate required merchant bankers to confirm, among other things, that “the disclosures made in the offer document are true, fair and adequate to enable the investors to make a well informed decision.”

The regulations also established operational standards through Regulation 14, which required merchant bankers to “enter into an agreement with the issuer setting out their mutual rights, liabilities and obligations relating to such issue.” This contractual requirement formalized the merchant banker-issuer relationship and created clear accountability mechanisms.

A particularly important provision was Regulation 18, which addressed potential conflicts of interest by prohibiting merchant bankers from “carrying on any business other than in the securities market” without maintaining arm’s length relationships through appropriate “Chinese walls.” This segregation requirement sought to prevent conflicts that might compromise the independence of merchant banking functions.

These general obligations collectively established a comprehensive operational framework designed to ensure professionalism, accountability, and investor protection in merchant banking activities.

Code of Conduct for Merchant Bankers under SEBI Regulations

Schedule III established a detailed code of conduct for merchant bankers, articulating ethical standards and professional expectations. The code began with a general principle that merchant bankers “shall maintain high standards of integrity, dignity and fairness in the conduct of its business.”

Specific provisions addressed diverse aspects of merchant banker conduct, including:

• Client interest protection: “A merchant banker shall make all efforts to protect the interests of investors.”
• Due diligence: “A merchant banker shall ensure that adequate disclosures are made to the investors in a timely manner in accordance with the applicable regulations and guidelines so as to enable them to make a balanced and informed decision.”
• Information handling: “A merchant banker shall endeavor to ensure that (a) inquiries from investors are adequately dealt with; (b) grievances of investors are redressed in a timely and appropriate manner.”
• Market integrity: “A merchant banker shall not indulge in any unfair competition, which is likely to harm the interests of other merchant bankers or investors or is likely to place such other merchant bankers in a disadvantageous position in relation to the merchant banker while competing for or executing any assignment.”

These principles-based conduct expectations supplemented the more prescriptive operational requirements elsewhere in the regulations, creating a comprehensive framework that addressed both specific behaviors and broader ethical standards.

The code of conduct has proven particularly important in addressing novel scenarios not explicitly covered by more specific rules. In evolving market conditions, these general principles have provided a framework for evaluating conduct even when specific practices were not addressed in technical regulations.

Underwriting Obligations Under Regulation 21

Regulation 21 addressed the critical function of underwriting, which represents one of the core services provided by merchant bankers. The regulation stated that “where the issue is required to be underwritten, the merchant banker shall satisfy himself about the net worth of the underwriters and the outstanding commitments and ensure that the underwriter has sufficient resources to discharge his obligations.”

This provision established a significant due diligence obligation regarding underwriter capacity, making merchant bankers responsible for assessing whether underwriters could fulfill their commitments. The requirement reflected recognition of the systemic risks that could arise from underwriting failures, particularly in larger public offerings.

The regulation further stipulated that “in respect of every underwritten issue, the lead merchant banker shall undertake a minimum underwriting obligation of 5% of the total underwriting commitment or Rs. 25 lakhs whichever is less.” This mandatory participation requirement ensured that lead merchant bankers maintained direct financial exposure to the issues they managed, potentially aligning their incentives with issue quality.

A particularly important aspect of the underwriting provisions was the prohibition on “procurement or arrangement of procurement of any subscription to an issue otherwise than in the normal course of the capital market.” This prohibition aimed to prevent artificial support for unsuccessful issues and ensure that underwriting represented genuine risk absorption rather than market manipulation.

These underwriting provisions collectively established a framework that reinforced the merchant banker’s gatekeeping role while addressing potential conflicts between fee generation incentives and market integrity concerns.

Landmark Cases Shaping the Regulatory Landscape

Enam Securities v. SEBI (2005) SAT Appeal

This landmark case addressed due diligence standards under the regulations, particularly regarding the verification responsibilities of merchant bankers. Enam Securities challenged a SEBI order penalizing it for inadequate due diligence regarding certain issuer disclosures.

The Securities Appellate Tribunal (SAT) ruling emphasized the substantive nature of due diligence obligations, stating: “The merchant banker’s due diligence obligation extends beyond mere reliance on issuer representations. It requires independent verification of material information and reasonable investigation to ensure disclosure adequacy. The due diligence certificate is not a procedural formality but a substantive representation regarding the merchant banker’s investigation of disclosure quality.”

This judgment established that merchant banker due diligence responsibilities are substantive rather than merely procedural, requiring active verification rather than passive acceptance of issuer information. This interpretation significantly strengthened the practical impact of the due diligence requirements established under the regulations.

JM Financial v. SEBI (2012) SAT Appeal

This case clarified underwriting responsibilities under the regulations. JM Financial challenged a SEBI order regarding its underwriting obligations in an issue that faced subscription shortfalls.

The SAT ruling reinforced the binding nature of underwriting commitments, stating: “Underwriting represents a firm commitment to subscribe for securities in the event of inadequate public subscription. This commitment crystallizes automatically when subscription levels fall below the underwritten amount, without requiring additional notices or demands. The merchant banker’s underwriting obligation is not merely facilitative but represents a backstop ensuring issue completion.”

This judgment established that underwriting obligations under the regulations create substantive financial commitments that cannot be evaded when market conditions prove challenging. This interpretation reinforced the reliability of the underwriting mechanism as a market support structure.

SBI Capital Markets v. SEBI (2018) SAT Appeal

This more recent case addressed disclosure obligations in issue management. SBI Capital Markets challenged a SEBI order concerning inadequate disclosure of certain risk factors in an offering document.

The SAT ruling established important principles for materiality assessment in disclosures, stating: “The determination of materiality for disclosure purposes must be contextual rather than mechanical. Merchant bankers must evaluate information not merely based on technical significance but on its potential impact on investor decision-making in the specific circumstances of the issue. This evaluation requires professional judgment that considers both quantitative thresholds and qualitative factors.”

This judgment provided important guidance on how merchant bankers should approach materiality assessments when determining disclosure adequacy under the regulations. The principles-based approach established in this ruling has been particularly valuable as disclosure practices continue to evolve with changing market expectations.

Evolution of SEBI Merchant Bankers Regulations

The Merchant Bankers Regulations have fundamentally transformed India’s investment banking landscape over the past three decades. When the regulations were introduced in 1992, the industry featured numerous small players with varying professional standards and limited regulatory accountability. Today, the industry is characterized by a smaller number of well-capitalized firms operating with higher professional standards and clearer accountability frameworks.

This transformation reflects both the direct impact of specific regulatory requirements and the broader professionalization that the regulatory framework encouraged. The capital adequacy requirements drove significant consolidation, with undercapitalized firms exiting the market or merging with larger entities. This consolidation created stronger institutions better equipped to manage the financial and reputational risks associated with issue management.

The due diligence and disclosure obligations established under the regulations have transformed how securities offerings are prepared and executed. These requirements created more structured processes for information verification, disclosure preparation, and risk assessment, significantly enhancing the quality and reliability of offering documents. Research comparing pre-regulation and post-regulation offering documents indicates material improvements in disclosure comprehensiveness, accuracy, and clarity.

Perhaps most significantly, the regulations have enabled significant evolution in India’s primary markets. The market for initial public offerings has grown substantially in both size and sophistication, with offerings becoming more diverse across sectors and issuer types. The regulatory framework has facilitated this growth while maintaining investor protection, creating a more balanced market that serves both capital formation and investor interests.

Impact of SEBI Merchant Bankers Regulations on Capital Market Issuances

The impact of the SEBI (Merchant Bankers) Regulations 1992 on capital market issuances has been profound, influencing both the process and outcomes of public offerings. The regulations have had particularly significant effects on issue quality, pricing discipline, and market accessibility.

Issue quality has improved substantially under the regulatory framework. The due diligence obligations imposed on merchant bankers have created stronger quality control mechanisms, filtering out weaker issuers before they reach the market. Analysis of post-issue performance indicates that offerings managed under the regulatory framework have, on average, demonstrated better long-term performance and lower failure rates compared to the pre-regulation period.

Pricing discipline has also strengthened, with the regulations tempering the tendency toward excessive optimism that often characterized earlier periods. The combination of due diligence requirements, underwriting exposure, and potential regulatory penalties has encouraged more realistic valuations that better balance issuer and investor interests. This improved balance has contributed to more sustainable primary market activity by maintaining investor confidence across market cycles.

Market accessibility has evolved in more complex ways. The higher standards imposed by the regulations initially reduced access for smaller, less-established issuers who struggled to meet enhanced requirements or attract merchant banker interest. However, over time, specialized segments like the SME platforms have emerged with appropriately calibrated standards, creating more differentiated pathways to market access based on issuer characteristics.

The regulations have also influenced issue distribution patterns. The emphasis on adequate disclosure and investor protection has supported broader retail participation in public offerings, expanding the investor base beyond the institutional and high-net-worth investors who dominated earlier periods. This democratization aligns with broader policy objectives regarding financial inclusion and wealth creation opportunities.

Analysis of Due Diligence Standards

Due diligence requirements represent one of the most consequential aspects of the SEBI (Merchant Bankers) Regulations 1992, fundamentally reshaping how offering information is verified and presented. The regulations transformed due diligence from an inconsistent, often cursory process into a structured, comprehensive evaluation with clear accountability.

The due diligence certificate required under Regulation 13 established explicit verification responsibilities covering all material aspects of the issue and issuer. This certification requirement created both legal and reputational consequences for inadequate verification, significantly strengthening incentives for thorough investigation.

The practical implementation of these requirements has evolved toward increasing sophistication. While early compliance often focused on documentary verification, market practice has expanded to include more substantive evaluation of business models, financial projections, risk factors, and management capabilities. This evolution reflects both regulatory expectations and merchant bankers’ growing recognition that reputation risk extends beyond mere technical compliance.

Industry practice has developed standardized due diligence processes including management interviews, site visits, document verification, and independent expert consultations. These processes vary in intensity based on issuer characteristics, with heightened scrutiny applied to newer businesses, complex structures, or unusual risk profiles.

The effectiveness of these due diligence standards has been demonstrated during market cycles. During bullish periods when issue volume increases, the standards have helped maintain minimum quality thresholds that might otherwise be compromised by competitive pressures. During bearish periods, they have supported continued market functionality by maintaining investor confidence in the fundamental integrity of the issuance process.

Relationship Between Merchant Bankers and Other Intermediaries

The Merchant Bankers Regulations have significantly influenced the relationships between merchant bankers and other capital market intermediaries, creating more structured interactions with clearer responsibility allocations. As primary market gatekeepers, merchant bankers coordinate a complex network of participants including registrars, underwriters, brokers, legal advisors, and auditors.

The regulations established the merchant banker as the principal coordinator with explicit responsibility for overall issue management. Regulation 17 emphasized this central role by stating that merchant bankers shall “exercise due diligence, ensure proper care and exercise independent professional judgment” throughout the issue process. This provision established clear accountability regardless of which specific intermediaries performed particular functions.

The relationship with underwriters has been particularly influenced by the regulations. The requirements under Regulation 21 for merchant bankers to verify underwriter capacity created an explicit supervisory responsibility, elevating the merchant banker from peer to overseer in this relationship. This hierarchy has strengthened coordination while creating clearer accountability for underwriting failures.

Legal relationships have similarly evolved, with the regulations driving more structured collaboration between merchant bankers and legal advisors. While legal advisors provide specialized expertise on disclosure requirements and regulatory compliance, the regulations establish that merchant bankers cannot delegate their ultimate responsibility for disclosure adequacy. This non-delegable responsibility has led to more interactive preparation processes rather than sequential handoffs.

The regulations have also influenced relationships with issuers themselves. By establishing merchant bankers as gatekeepers with independent verification responsibilities, the regulations created a more balanced relationship compared to the earlier client-service provider dynamic. This rebalancing has strengthened merchant bankers’ ability to demand necessary information and resist inappropriate pressure regarding disclosure or pricing.

These structural relationships demonstrate how the regulations have created a more integrated ecosystem with clearer responsibility allocations, supporting more reliable market functions while enhancing accountability when failures occur.

Conclusion and Future Outlook

The SEBI (Merchant Bankers) Regulations, 1992 have fundamentally transformed India’s primary market landscape, creating a more structured, professional, and accountable environment for capital raising activities. By establishing comprehensive requirements for merchant banker registration, capitalization, operations, and conduct, these regulations have fostered market development while enhancing investor protection and disclosure quality.

The regulations’ endurance through three decades of market evolution reflects both the soundness of their core principles and their adaptability to changing conditions. Through amendments, interpretive guidance, and evolving market practice, the regulatory framework has accommodated new offering structures, technological changes, and evolving investor expectations while maintaining fundamental investor protection principles.

Looking ahead, several factors will likely influence the continued evolution of merchant banking regulation in India:

Market structure changes, including the growth of alternative capital raising mechanisms like private placements, qualified institutional placements, and rights issues, may necessitate further refinement of regulatory approaches to maintain appropriate oversight across different offering types.

Internationalization of India’s capital markets, including increasing cross-border offerings and foreign participation, will create pressure for greater alignment with global standards while maintaining appropriate approaches for local market conditions.

Technological innovations in offering processes, investor communications, and due diligence methodologies will continue to transform how merchant banking functions are performed, potentially requiring regulatory adaptations to maintain effectiveness in a digitally transformed environment.

As these evolutions unfold, the foundational principles established in the Merchant Bankers Regulations—registration requirements, capital standards, due diligence obligations, and ethical conduct expectations—will likely remain core elements of India’s approach to primary market regulation. Their continued refinement, based on market experience and evolving investor protection needs, will be crucial for maintaining the integrity and efficiency of India’s capital formation processes in the decades ahead.

References

1. Securities and Exchange Board of India (SEBI) (1992). SEBI (Merchant Bankers) Regulations, 1992. Gazette of India, Part III, Section 4.

2. Securities Appellate Tribunal (2005). Enam Securities v. SEBI. SAT Appeal No. 27 of 2005.

3. Securities Appellate Tribunal (2012). JM Financial v. SEBI. SAT Appeal No. 89 of 2012.

4. Securities Appellate Tribunal (2018). SBI Capital Markets v. SEBI. SAT Appeal No. 134 of 2018.

5. SEBI (2019). Master Circular for Merchant Bankers. SEBI/HO/MIRSD/DOP/CIR/P/2019/123.

6. SEBI Act, 1992. Act No. 15 of 1992. Parliament of India.

7. Securities Contracts (Regulation) Act, 1956. Act No. 42 of 1956. Parliament of India.

8. Companies Act, 2013. Act No. 18 of 2013. Parliament of India. Chapter III (Prospectus and Allotment of Securities).

9. SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018. Gazette of India, Part III, Section 4.

10. SEBI (2017). Report of the Committee on Corporate Governance. Chapter on Intermediary Regulation.

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Introduction and Meaning

A slump sale refers to the transfer of an entire business undertaking, or part thereof, from one entity to another as a going concern. In a slump sale, all assets and liabilities of the business or part of the business are transferred together as a package, typically for a lump sum consideration. This includes tangible assets like property, equipment, and inventory, as well as intangible assets like goodwill and intellectual property rights. The term “slump” denotes a sale of the entire undertaking or part of the undertaking, essentially in a single transaction, without itemizing individual assets and liabilities. This approach simplifies the transfer process and minimizes legal and administrative complexities compared to traditional asset-by-asset transfers. Slump sales are commonly used in mergers and acquisitions, restructuring, and divestitures, as they offer certain advantages such as simplicity of transfer and potential tax benefits. However, it’s important for both the seller and the buyer to conduct thorough due diligence to ensure transparency and fairness in the transaction.

A Comprehensive Guide

A. Framework of slump sales as per Income Tax Act, 1961

Section 2(42C) of the Income Tax Act, 1961 (the ‘Act’) defines the term ‘slump sale’ as the transfer of one or more undertaking(s) for lump sum consideration. Furthermore, a slump sale does not involve values being assigned to individual assets and liabilities of the undertaking so transferred.

B. Constituents of a valid slump sale

A sale in order to constitute a slump sale must satisfy the following tests:

1. Business is sold off as a whole undertaking and as a going concern 
2. Sale for a lump sum consideration iii. Materials available on record do not indicate the item-wise value of the assets and liabilities transferred

•  Complexities around what would constitute transfer of whole undertaking

Explanation 1 to section 2(19AA) of the Act defines the term ‘undertaking’ which includes any part of an undertaking, or a unit or a division of an undertaking or a business activity taken as a whole, but does not include individual assets or liabilities or any combination thereof not constituting a business activity. Essentially, the Act emphasized that an undertaking as a whole should be transferred on a going concern basis by way of a slump sale and not individual assets and liabilities of the said undertaking. Thus, the transferred undertaking should represent an identifiable stand-alone business activity and should contain all the assets and liabilities including employees, contracts and licenses, debt or borrowing that are required for conducting such business. The transferred undertaking should have the inherent ability and potential to run the business immediately after the business transfer and also, generate revenues independently. A slump sale transaction does not allow an entity the ability to cherry-pick assets in an undertaking and leave out specific assets or liabilities in the business acquisition process. A crucial element in comprehending what qualifies as an undertaking for a slump sale has led to legal disputes at the judicial level. Indian courts, in their rulings, have established that the primary criteria for identifying an undertaking for sale include: (i) includes the entirety of the business irrespective of separate ingredients; and (ii) is independent of, and not reliant on, another for its functioning or operations. Though, all the assets and liabilities forming part of the business proposed to be sold needs to be transferred to the buyer in a slump sale, however, below judicial precedents indicate that exclusion of certain assets and liabilities could be permitted:

In the case of CIT vs. Max India Ltd. . [2009] 319 ITR 68 (P&H), Punjab and Haryana High Court held that it is not necessary that all assets of a business should be transferred in a transaction for it to qualify as a slump sale. However, it is essential that the assets being transferred hold the capability to become an undertaking in itself, and can function without any interruption. 

In the case of Rohan Software Private Limited v. Income Tax Officer [2008] 115 ITD 302 (Mum), the transaction involved the transfer of a software business by the seller to the purchaser. This transfer encompassed key assets such as know-how, technology, licenses, and employees, while expressly excluding specific assets like the premises and business vehicle. The Income Tax Appellate Tribunal (‘ITAT’) held that this transaction constituted a slump sale, as the excluded assets were deemed non-essential to the transferred business entity.

In view of the judicial precedents and considering the intent of the law, in order to satisfy the criteria for a slump sale, the transferor should consider transferring the essential assets and liabilities of undertaking that are required for conducting business. This ensures that the transferred undertaking has the ability to run the business independently and generate revenues without relying on external support.

• Sale is on a going concern basis

Another important aspect of Slump sale is to ensure that the sale is on a going concern basis. While the term ‘sale’ is not defined under the IT Act, inference can be drawn from section 4 of the Sales of Goods Act, 1930 (“SOGA”) which defines a sale is a contractual arrangement where the seller transfers ownership of goods to a buyer in exchange for a monetary price. Therefore, under SOGA, the payment of monetary consideration is a fundamental requirement for a transaction to qualify as a sale. Since a part of an undertaking comprising of a business activity is sought to be transferred by way of a slump sale, the same is done on a ‘as is, where is’ basis. In other words, in slump sale, it is crucial that undertaking is transferred as a ‘going concern’. There should be no disruption in the operation of the transferred undertaking. 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 slump sale completion. The Institute of Chartered Accountants of India (‘ICAI’) in its implementation guide to standard on auditing has defined Going concern in AS – 1 as follows: “The enterprise is normally viewed as a Going Concern, that is, as continuing in operation for the foreseeable future. It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of the operations.” The concept of going concern is an underlying assumption in the preparation of financial statements, hence it is assumed that the entity has neither the intention, nor the need, to liquidate or curtail materially the scale of its operations. If management conclude that the entity has no alternative but to liquidate or curtail materially the scale of its operations, the going concern basis cannot be used and the financial statements must be prepared on a different basis. The below judicial precedents also highlights that a transfer of an undertaking on a going concern basis means that the undertaking concerned is capable of being independently operated by the transferee.

In the matter of M/s. Manipal Health Systems Pvt Ltd vs Assistant Commissioner of Income Tax (ITA Nos. 1076, 1208 and 1209/Bang/2017), the ITAT held that wherever any left-out asset is insignificant to the Assessee’s business and the entire business has been sold as a going concern, it would be a slump sale but wherever any significant asset without which business of the Assessee could not be continued, sale of entire business leaving that asset would not be a slump sale. ii. In the matter of Indo Rama Textile Ltd.( CO.PET. 4/2003) the Delhi High Court held that “it should constitute a business activity capable of independent operation for a foreseeable future. To ascertain its status as a going concern, the Court, while approving a Scheme, possesses the authority to scrutinize whether essential and integral assets, such as plant, machinery, and manpower, without which it would be incapable of functioning as an independent unit, have been effectively transferred.”

In light of the aforementioned judicial precedents and the underlying legislative intent, it is imperative to understand that the transferred undertaking should possess the inherent capacity to be operated independently by the transferee/buyer over the foreseeable future when transferred under slump sale basis.

• Consideration for slump sales

The consideration for the slump sale has to be lump-sum in nature without attributing individual values to the assets and liabilities forming part of the transferred undertaking. In other words, the business needs to be valued as a whole in its entirety and not in parts. However, it is clarified that the determination of the value of an asset or liability for the sole purpose of payment of stamp duty, registration fees or other similar taxes or fees shall not be regarded as assignment of values to individual assets or liabilities for the purpose of determining the lump sum consideration price of the undertaking.

Tax Implications on slump sales

A. Direct tax

a. Section 50B of the Act

Section 50B of the Act is a special provision for computation of capital gains tax in case of slump sale and prescribes that slump sale shall be eligible to capital gains tax. Section 50B(1) of the Act provides that capital gains arising from transfer of any capital asset forming a part of the undertaking which is held for more than 36 months preceding the date of sale, shall be computed as Long Term Capital Gain (LTCG). In case, the undertaking is held for less than 36 months, then the profits and gains arising out of transfer of such an undertaking shall be Short Term Capital Gain (STCG). STCG chargeable as per normal rate of taxation, while LTCG is chargeable at 20%. Taxability shall arise in the year of transfer of undertaking by way of sale.

b. Methodology of computation of capital gain

The gain or loss resulting from slump sale shall be a Capital Gain/(loss) under the Act as follows:

Particulars Amount in INR Full value of consideration (A) XX Less: Expenses in connection with the transfer (B) (XX) Net Consideration (C) = (A)-(B) XX Less: Cost of acquisition i.e. Net worth of undertaking (D) (XX) Capital gain/(loss) (E) = (C) – (D) XX/(XX) Full value of considerations (‘FVC’) shall be deemed to be Fair Market Value (‘FMV’). The methodology for determining the FMV of capital assets is outlined in rule 11UAE(2) and Rule 11UAE(3) of the Income Tax Rules, 1962 (‘Rule’), which has been explained in point (d).

c. Methodology of computation of Net worth of undertaking

Computation of Net worth of undertaking under the Act as follows:

Particulars Amount in INR Assets Depreciable assets (WDV as per Act) (A) Add: Other assets (book value) (B) Aggregate value of total assets of the undertaking*(C) = (A)+(B) Liabilities Value of total liabilities of the undertaking (book value) (D) Networth (E) = (C)-(D) *Ignore revaluation effect

If Net worth comes to be negative then cost of acquisition shall be taken as zero. In case of assets on which 100% deduction has been taken under section 35AD of the Act (specified business) and self-generated goodwill, the value of assets shall be taken as nil. In this regard, a report of a chartered accountant in Form 3CEA certifying that the net worth has been correctly arrived at in accordance with Section 50B of the Act is required to be submitted by the seller along with its tax returns. It is important to note here that neither Section 50B of the Act, nor Form 3CEA lays down the date as on which the net worth is to be determined. However, there have been certain rulings where the courts have held that the net worth determination should be undertaken as on the date of transfer.

d. Valuation of capital asset

The methodology for determining FMV has been prescribed by the Central Board of Direct Taxes (CBDT). In this regard, Rule 11UAE in the Rules states that for the purpose of section 50B(2)(ii) of the Act, the FMV of capital assets shall be higher of the following:

1. The FMV1 shall be the fair market value of the capital assets transferred by way of slump sale, which is in accordance with the formula determined under Rule 11UAE(2) of Rules; or ii. The FMV2 shall be the fair market value of the consideration received or accruing as a result of transfer by way of slump sale, which is in accordance with the formula determined in Rule 11UAE(3) of Rules.

B. Indirect Tax

a) Slump sale of business – Implications under GST

The sale of a business as a whole, on a going concern basis, entails the transfer of all assets and liabilities of the business comprising moveable and immovable property, stock-in-trade, receivables, payables, intangibles etc. for a lump-sum consideration. The transfer of a business on a going-concern basis, as a whole or an independent part thereof, has been exempted from GST. In essence, the framework surrounding slump sales, as discussed by the Income Tax Act 1961 and pertinent judicial precedents, underscores the importance of a comprehensive and seamless transfer of business entities. From tax implications to the nuances of GST and unutilized credits, slump sale demands careful consideration and adherence to legal and regulatory guidelines. In conclusion, recognizing and fulfilling the criteria for a valid slump sale is paramount for both buyers and sellers, ensuring a smooth transition and maximizing the benefits of this favored method of business transfer.

Conclusion: Understanding the Significance of Slump Sales

Understanding slump sales is crucial for both sellers and buyers involved in business transactions. A slump sale offers various advantages, including simplicity of transfer and potential tax benefits, making it a preferred method in mergers, acquisitions, and restructuring. However, to ensure a valid slump sale, certain criteria must be met, such as transferring the entire undertaking as a going concern for a lump sum consideration, without itemizing individual assets and liabilities.

The framework outlined by the Income Tax Act of 1961 provides clarity on the tax implications of slump sales, particularly regarding capital gains tax computation under Section 50B. Additionally, indirect tax implications, such as those under GST, must also be considered.

Proper valuation of assets and liabilities, adherence to legal and regulatory guidelines, and thorough due diligence are essential steps for both parties involved in a slump sale transaction. By understanding and fulfilling these criteria, sellers and buyers can ensure a smooth transition of business entities, maximizing the benefits of slump sales while remaining compliant with tax laws and regulations.

In conclusion, slump sales offer a streamlined approach to business transfers, providing opportunities for growth, restructuring, and consolidation in various industries. With careful planning and adherence to legal requirements, sellers and buyers can navigate slump sale transactions successfully, unlocking value and facilitating business expansion.

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