Non-performing assets (NPA) plague the whole banking system in India. In this regard, one landmark reform by the government was the introduction of the Insolvency and Bankruptcy Code, 2016 (IB Code). The introduction of the IB Code was one of the reasons behind India’s recent upliftment in World Bank’s ‘Ease of Doing Business’ ranking from 130th to 100th.
The IB Code was introduced to consolidate and amend the laws relating to reorganisation and insolvency resolution of corporate persons for maximisation of the value of assets. In fact, prior to the IB Code, India did not have a single law dealing with all aspects of a company in financial distress. There were multiple laws, each of which applied to a particular legal process, type of company or group of creditors, etc. In particular, the Sick Industrial Companies (Special Provisions) Act, 1985 (SICA) was introduced by the government along with Board for Industrial and Financial Reconstruction (BIFR) in the wake of sickness in the country’s industrial climate prevailing in the eighties and was only confined to manufacturing undertakings. The main objective of SICA was to determine sickness or potential sickness (where at least half of the net worth of the entity is eroded) and expedite the revival of potentially viable units or closure of unviable units. The SICA was repealed after the introduction of the IB Code.
The Income-tax Act, 1961 (Act) recognised these sick industrial companies covered under section 17 of the SICA and provided certain exemptions for such companies. One significant relief to such companies was that the profits of these companies, for the year commencing when the company becomes sick until the year in which the net worth was less than the accumulated losses, were exempt from minimum alternate tax (MAT). Second, the transfer of land by this company, made under a scheme sanctioned under the SICA, was also exempt from capital gain tax on fulfilment of certain conditions. These two were thoughtful parameters aimed at providing temporary relief and helped corporates in quick revival. The need of the hour is similar incentives to companies under the IB Code.
Under the new IB Code, insolvent companies undergo the Corporate Insolvency Resolution Process (CIRP), wherein the Committee of Creditors (CoC) appoints a resolution professional. The role of the resolution professional is to manage the company during the moratorium period and to also present the various revival options to the CoC for approval. The finalised option is presented to the National Company Law Tribunal (NCLT) for its approval. As the insolvent companies have excess liabilities over assets, the approved resolution plan may include write back of some of the debts of the company foregone by the creditors or may involve the sale of assets for payment of debts or a combination of the two.
However, currently there are no exemptions available under the Act for companies under the insolvency proceedings, similar to companies covered under the SICA. Thus, various stakeholders, including bodies such as Assocham, approached the Central Board of Direct Taxes (CBDT) for providing tax relief to companies against whom insolvency proceedings have been initiated. In fact, Assocham had requested that where any outstanding liability, inclusive of any accrued interest has been waived in accordance with the approved Resolution Plan in the CIRP, such waiver/ write back should not be subject to normal tax and MAT provisions. Further, exemption was also sought from capital gain provisions under the Act in case of companies under the IB Code, which transfer its capital assets under an approved Resolution Plan in the CIRP. It is very critical to have clear regime so that more buyers come forward to bid for such companies and value to the creditors is maximised.
After the stakeholders representations, the CBDT recently announced that in case of companies, against whom an application for CIRP has been accepted, the amount of total loss brought forward (including unabsorbed depreciation) as per the books, shall be allowed to be reduced from the book profits for the purpose of MAT computation. As per the existing provisions, a company is allowed to utilise either brought forward losses or unabsorbed depreciation, as per the books, whichever is lower.
Taking a simple example, if a company had a debt of INR 1,000 crores and the waiver of debt was INR 800 crores, the write back would be of INR 800 crores. Now, assuming that brought forward losses and unabsorbed depreciation were INR 400 crores and INR 150 crores, respectively, as per the books. Under the earlier provisions, INR 150 crores would be allowed as deduction and MAT of 18.5% (plus applicable surcharge and cess) would be applicable on the net income of INR 650 crores (800 crores – 150 crores). However, after the suggested amendment, the company against whom an application for CIRP has been accepted, can claim a deduction of INR 550 crores and MAT would still be payable on net income of INR 250 crores (800 crores – 150 crores – 400 crores). However, the relief requested by the companies was of the entire amount of loan write back, i.e., INR 800 crores in the present case.
The above proposed amendment is half-baked, providing only partial relief. Hence, the following exemptions need to be examined for a company against whom an application for CIRP has been accepted and a Resolution Plan has been approved:
1. Normal tax – Exemption on amount of write back of debts of creditors by the company under the normal tax provisions of the Act;
2. MAT – Exemption on amount of write back of debts of creditors by the company from MAT;
3. Stamp duty – Exemption of stamp duty on transfer of assets by the company;
4. Capital gain on transfer of assets – Exemption of capital gain on transfer of assets by the company;
5. Recipient taxation – Recipient or the buyer buying assets from the company should be exempted from the provisions of section 56 of the Act;
6. Automatic delisting – In case of listed companies falling under the IB Code, automatic delisting of the company should be done as the listing price may be inflated in comparison to the actual equity value.
As stated earlier, the objective of the IB Code was to maximise the value of the assets. However, the tax liability on such companies would in essence lead to reduction in the value of assets of the company and render the whole process of insolvency resolution ineffective. As the saying goes, if the glass is half-filled, it is still half-empty. Similarly, although the CBDT proactively proposes to amend the tax law to accommodate companies facing insolvency proceedings under the IB Code, yet the proposed amendment is inadequate and there is a need for introduction of a special regime covering all the above suggested amendments.
Authors: Hiten Kotak, Leader – M&A Tax, PwC India and Annu Gupta – Partner, M&A Tax, PwC India
Disclaimer: The views expressed in this article are personal. It includes input from S Shriram – Assistant Manager, M&A Tax, PwC India, and Poojita Oberoi, Analyst, M&A Tax, PwC India.
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