In an earlier post on this blog, it was argued that a survey of Indian jurisprudence reveals that “(a) the application of tax laws and the obligations therein qua the taxable person identified therein cannot be interjected by way of a contract; (b) the proposition in (a), however, does not restrain the parties to a contract to shift the incidence of tax and other tax compliance.”1 Countenancing such arrangements, a recent decision of the Supreme Court adds a nuanced perspective – the distinction between accrued liability versus contingent liability of tax to highlight the extent and manner in which tax incidence can be shifted under such arrangements. This post reviews the decision to advance the proposition and extrapolate the consequences in pragmatic business paradigm.
Dispute before the Supreme Court
The relevant decision of the Supreme Court is in Wave Industries (P) Ltd. v. State of U.P.2 which relates to interpretation of the contract between Wave Industries as purchaser and Uttar Pradesh State Sugar Corporation Ltd. (UPSSCL) as the seller of a sugar mill. The subject sugar mill was a loss-making unit and was sold as part of divestment policy of the State Government. It was sold on “slump sale” basis. The sale was affected by Government undertaking –UPSSCL – which executed an agreement with Wave Industries. The sale deed was executed in October 2010. The dispute related to determination of the entity liable to pay taxes like trade tax, value added tax, centralexcise, entry tax, etc. relating to the period prior to the sale deed. UPSSCL was of the view that, since these liabilities arose after the sale deed, they were to be borne by Wave Industries. Per contra, it was asserted by Wave Industries that the sale deed stipulated a cut-off date, up to which all liabilities were to be borne by UPSSCL and accordingly, it was not liable for these taxes notwithstanding the liabilities fructified after the sale.
The Allahabad High Court, adjudging the rival stands concluded in favour of UPSSCL.3 It was of the opinion that the sale deed clauses characterised certain amounts as “excluded liabilities”, “contingent liabilities”, etc. and a different bargain was stuck in their respect. Accordingly, it concluded, since these liabilities came to be known after the sale deed, they were to be borne by Wave Industries. The High Court inter alia observed as under:
“The impugned order shows that disputed liabilities are as on 30-10-2011 i.e. after the date of signing of agreement. Clause 2.1 of agreement clearly says that seller shall transfer all rights, title, interest, etc. including liabilities ‘except excluded liabilities’ to the purchaser. The term ‘excluded liabilities’ has been defined and it means liabilities claimed till signing date which are retained or settled by the seller. The description of liabilities nowhere shows tax liabilities as part of ‘excluded liabilities’. Further, Clause 2.4 says that all contingent liabilities stand transferred to purchaser and purchaser shall be liable in respect of such and legal cases pending in respect of the unit shall contingent liabilities and after signing date, seller shall have no liability whatsoever. It means that recovery, if any, of such contingent liabilities if enforced before the signing date, it may proceed from the seller but after signing date it would proceed against the purchaser. Clause 4 also fortify the position with respect to transfer of liabilities i.e. ‘except excluded liabilities’, all liabilities shall stand transferred to purchaser.
In that view of the matter, we have no hesitation in observing that disputed liabilities had to be borne by purchaser and authorities below in taking above view, by rejecting petitioner’s representation, have not committed any error.”
Assailing this conclusion of the High Court, which affirmed the tax liability relating to the pre-sale period upon it, Wave Industries approached the Supreme Court.
Decision of the Supreme Court
No new argument was canvassed before the Supreme Court by Wave Industries, and it reasserted it claim that the terms of the sale deed absolved it of any liability. However, its claims received vindication from the Supreme Court. Acknowledging that there was a contradiction in terms amongst the clauses of the sale deed, the Supreme Court applied the “specific overrides general” rule and applied the distinction between “accrued” and “contingent” liabilities to construe the clauses and sustain the claim of Wave Industries.
To appreciate the Supreme Court’s conclusion, it is expedient to review the relevant clauses of the sale deed, which are as under:
8. 2.1 In consideration of the purchase price to be paid by the purchaser to the seller in the manner set out herein and subject to the provisions of this agreement, on the closing date, the seller shall transfer and deliver to the purchaser and the purchaser shall purchase, acquire and accept from the seller, all right, title and interest of the seller in and to the unit, together with all assets and liabilities except excluded liabilities, as a going concern on an as is where is basis collectively (‘the unit’)
2.6 It is hereby further agreed between the parties that all contingent liabilities and legal cases pending in respect of the unit, shall be transferred by the seller to the purchaser and the purchaser is solely liable in respect of such contingent liabilities from the signing date and the seller shall have no liabilities whatsoever in such respect.
8(d) All taxes, levies, cesses, or any charges in respect to the unit/land, whether levied by a government authority, such as municipal or property tax that are due up to the date of agreement (“signing date”) have been paid in full by seller.
9. The seller shall be liable to bear all assessments, rents, rates, taxes outgoing and imposition of whatsoever nature relating or pertaining to the unit up to the signing date and thereafter, the same shall be the liability of the purchaser.
12.1 The purchaser shall save as herein expressly provided, bear, pay and discharge all assessments, rents, taxes, outgoing and impositions of whatsoever nature relating or pertaining to the operations and activities of the unit pertaining to the period after the signing date. The purchaser shall be liable and responsible for all obligations or liabilities arising from or in respect of the operations and activities of the unit of the seller after the signing date.
12.2 The purchaser shall bear, pay and discharge all liabilities, obligations, assessments, rents, rates, taxes, outgoings and impositions of whatsoever nature relating or pertaining to the operations and activities of the after the signing date.
12.3 Save and except as herein otherwise provided, the purchaser shall bear and pay the stamp duty, registration charges and sales tax or any other applicable tax, if any payable, on or in respect of the transfer of the unit.
12.4 Capital gains tax, if any payable in connection with the transfer contemplated under this agreement, shall be borne by the seller4.
The Supreme Court concluded that “Clause 2.6 which speaks of contingent liabilities and legal cases pending in respect of the unit, to be fastened on the purchaser and the seller being absolved of such liability, are generic conditions provided under Clause 2.6 of the slump sale agreement” were neither relevant nor consequential as the substance of the dispute was instead addressed by “Clauses 12.1 and 12.2 of the slump sale agreement read with Clause 9 of the sale deed” which made it clear that “the liability of the purchaser, for the operation and activities of the unit, arose only after the signing date”.
To this end, the Supreme Court applied two legal tests. (A) In order to address the repugnancy arising from Clause 2.6 regarding “contingent liabilities”, upon which emphasis had been placed by the High Court, the Supreme Court relying upon its earlier decision5 observed that the liability had indeed accrued prior to the cut-off date. (B) The tax-specific clauses of the sale deed contrasted with the general clauses made it clear that the parties attached special significance to the cut-off date qua the tax liabilities. Extrapolating these aspects, the Supreme Court observed as under to affirm its conclusion:
“This would suggest that dues relating to the activities and operation of the unit in the period up to 17-7-2010 (signing date), were the liabilities of the UPSSCL while the dues relating to activities and operation of the unit for the period subsequent to 17-7-2010, were to be the responsibility of the purchaser. The liability of the purchaser for the dues relating to activities and operations of the unit for the period anterior to 17-7-2010, could not therefore have been fastened on the appellant in view of the clear provisions made in Clause 9 of the sale deed read with Clauses 12.1 and 12.2 of the slump sale agreement as both are specific in nature.…
Furthermore, in view of the specific and detailed provisions with regard to the distribution of liabilities in respect of the dues whereby duties in respect of the transactions up to the date of agreement are to be borne by the seller i.e. UPSSCL and the buyer is made responsible only for dues in respect of post-sale transactions, we are unable to agree with the impugned order dated 1-11-2017 which erroneously in our view, held that the liabilities for the transactions made prior to the sale agreement, are to be borne by the purchaser.”
The decision serves as a vital pivot for revisiting the law on the subject as also a scope for improvisation. The key aspects which can be drawn from the decision are enlisted below.
- At the outset, it is the inconspicuous aspect which is notable. The decision takes for granted, without any discussion thereon, the ability of the parties to shift the liabilities in relation to the subject-matter of transfer, including tax liabilities. This confirms the premise, canvassed earlier,6 that contractual shifting of tax liability is not judicially unconscionable and party autonomy principle subsumes within its scope, shifting of tax liability amongst the parties under the contract.
- Nonetheless, the decision underscores a critical proposition in extension of the aforesaid premise. It endorses that not just passing of tax incidence is permitted by way of an agreement between the parties, but also it is possible to categorically delineate their respective tax obligations by incorporating legal concepts such as “accrual”, “contingent”, etc., which accentuate, and possible categorically delineate, the bargain struck by the parties in such agreements. Thus, various permutations are possible, including wholesale shifting of tax liability being permitted basis the defined cut-off date inter alia through deployment of legal tests. This aspect giving sufficient leverage and flexibility to the parties to negotiate deal-terms and remain uninfluenced (in respect of their net tax out go) irrespective of the stipulations of the fiscal laws.
- In this case the contingent liabilities were assumed by the seller up to the cut-off date. Theoretically, there may be room for the parties to define an artificial cut-off date which may preceded or succeed the date of the agreement. Such clauses, coupled with the legal consequences of well expounded concepts such as “accrual”, “contingent”, etc., can give further elbow room to the parties to set in a place a mutually acceptable bargain. In fact, such transactions are common in certain spaces, for illustration, sale of cum-dividend shares.7 The decision can, arguably, be usefully relied upon to define party-specific limitations and liabilities qua tax consequences as on mutually agreed specific cut-off dates, which may or may not coincide with date of the agreement. In short, the decision extended a logical and legal basis for bigger scope to distribute tax related parties amongst the parties.
- Even though the sale deed in this case did not carry such a clause, contemporary agreements are additionally endowed with “indemnity” clauses8 which further confirm the same consequences and effectively cull out tax obligations from the realm of fiscal laws to the sphere of contractual bargain. Thus, modern jurisprudence and legal practice firms supports clear bargain amongst the parties even in respect of tax incidence upon the subject-matter of the transaction. A key difference amongst tax liability and tax indemnity clauses, however, remains relevant. In the former case the liability itself does not ensue whereas in the latter case the relief to the party is by way of restitution9 under the law of indemnity.
- To supplement the aforesaid, there is also another takeaway from the dispute; a lesson for draftsmen to be succinct and clear. The contradistinction between the views of the High Court and the Supreme Court on construction of the same clauses, both trying to give primacy to one clause over the other, reveals the importance of consistency and leaving no fissures in the drafting. This decision is a quintessential illustration to the fact that ambiguities and inconsistencies in the drafting can result in the hijacking of the parties underlying intention by imputing a different construction of the agreement clauses.
- In fact, a comparison between two sets of clauses in this case assists this understanding. The first set comprises of Clauses 2.1 and 2.6. The second set comprises of Clauses 8(d), 9, 12.1 and 12.2. Their comparison reveals that, while the first set of clauses incorporate technical expressions (such as “excluded liability”, “contingent liability”) to define the respective obligation of the parties, the second set of clauses are bland and shorn of legal expressions to affix the liability absolutely based on the cut-off date. The difference is indeed stark, unsurprisingly which moved the Supreme Court to conclude that there was a contradiction, compelling it to give primacy to one over another to resolve the dispute. This is yet another lesson for the parties and the contract draftsmen to maintain consistency throughout the agreement, lest it infests the risks of disputes. At another level, at a technical level, had the second set of clauses mirrored the first set by employing technical expressions, it would not be difficult to envisage the Supreme Court sustaining the conclusion of the High Court.
- Staying on the point of drafting, in substance, the Supreme Court reversed the decision of the High Court by weighing the relative contours of the agreement clauses and assigning more weight to some at expense of another. This brings forth a niche aspect often missed in long-drawn agreements, that the courts will not constrain themselves by extending principles of statutory interpretation (such as special overrides general, in this case) to cull out the subjective bargain of the parties to the agreement. This aspect is a red flag for the draftsmen as it indicates that they must ensure that appropriate weightage is assigned to each of the relevant clauses to prevent a party from refusing to abide by the clause citing inherent contradiction, repugnancy, or, as in this case, special conditions overriding general conditions.
- Converse to the aforesaid, the decision vindicates the modern style of contracts, especially those prevalent in long-gestation projects, where “special conditions of contract” are generally attuned to override the “general conditions of contract”. The decision can usefully be relied upon to establish that the special conditions alone require enforcement even if the general conditions of the contract stipulate otherwise.
Another related yet subtle proposition emanating from this decision of the Supreme Court is the inclination of the court to dehyphenate the general clauses of the agreement with those addressing the tax liabilities. The clear finding by the Supreme Court that tax liability related clauses shall not be detracted by the general clauses also strikes a note of caution which compels special focus in drafting the tax incidence and liability related clauses along with, where appropriate, special interpretative definitions and rules to delineate the contractual bargain distinctively for tax liabilities.
† Advocate, Supreme Court of India; LLM (Taxation), London School of Economics
1. Tarun Jain, “Dehyphenating Tax from Contractual Realm: Prioritising ‘Party Autonomy’”, 2022 SCC OnLine Blog Exp 74, 6-10-2022. <https://www.scconline.com/blog/post/2022/10/06/dehyphenating-tax-from-contractual-realm-prioritising-party-autonomy/>.
3. Wave Industries (P) Ltd. v. State of U.P., 2017 SCC OnLine All 4149.
4. Wave Industries (P) Ltd. v. State of U.P., 2022 SCC OnLine SC 1721, paras 8-12.
5. Bharat Earth Movers v. CIT, (2000) 6 SCC 645. “4. The law is settled: if a business liability has definitely arisen in the accounting year, the deduction should be allowed although the liability may have to be quantified and discharged at a future date. What should be certain is the incurring of the liability. It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible. If these requirements are satisfied the liability is not a contingent one. The liability is in praesenti though it will be discharged at a future date. It does not make any difference if the future date on which the liability shall have to be discharged is not certain.” Per Lahoti, J.
6. Tarun Jain, “Dehyphenating Tax from Contractual Realm: Prioritising ‘Party Autonomy’”, 2022 SCC OnLine Blog Exp 74, 6-10-2022. <https://www.scconline.com/blog/post/2022/10/06/dehyphenating-tax-from-contractual-realm-prioritising-party-autonomy/>.
7. See generally, Alexandra Twin, Cum Dividend: Definition, Meaning, How it Works, and Example (31-10-2021) <https://www.investopedia.com/terms/c/cumdividend.asp>.
8. For illustration, see generally, Sachin Mampatta, “Tax Indemnity Clause Leads to Friction Among Buyers & Sellers of Firms”, Business Standard (29-4-2021). Available at <https://www.business-standard.com/article/companies/irritant-for-pe-players-as-m-as-face-friction-over-tax-indemnity-clause-121042901412_1.html>.
9. Contract Act, 1872, S. 125.