Quite a “taxing” Code

  • Blog|Insolvency and Bankruptcy Code|
  • 4 Min Read
  • By Taxmann
  • |
  • Last Updated on 29 June, 2022
India witnessed the dawn of a new era in the banking sector with the introduction of the Insolvency and Bankruptcy Code, 2016 (the Code). The Code, which repeals the erstwhile Sick Industrial Companies (Special Provisions) Act, 1985 (SICA) seems to be an effective and time-bound mechanism for dealing with the problem of ever-escalating non-performing assets (NPAs) and providing our banking system some much needed respite.
The Code is undeniably an ingenious regulation. As per the Code, the Resolution Plan lays down all details of the financial and commercial plan to revive a company in financial woe. Although the Resolution Plan may provide for a feasible commercial solution to the company’s issues, an often forgotten but important aspect is the tax consequences of the Plan. 
The Government has certainly been hands-on in amending other regulations such as SEBI regulations and corporate laws in support of the Code. This has hastened the resolution of insolvency cases by removing various legal impediments. However, one area where the Government is yet to act is the taxation of the cases under insolvency. Often, the steps suggested in the Resolution Plan result in enormous tax outflows, worsening the financial position of an already sick company.

For instance, the Income-tax Act, 1961 (the Act) contains provisions of Minimum Alternate Tax (MAT), which levies tax on the book profits of a company if the tax payable under the normal provisions of the Act is lower than the MAT payable. It is safe to say that almost all plans providing for the revival of sick companies involve the lenders taking a haircut in their loan amount. This results in write back of outstanding liabilities in the books of accounts of the sick company, which may lead to a MAT burden that is almost 20% of the write back amount. In addition, any itemised sale of assets of a sick company may have MAT implications. Although companies registered under the erstwhile SICA regime were exempted from paying MAT until the net worth of such companies turned positive, no such exemption is extended to companies under the Code. Various factions of the industry made many representations to the Ministry of Finance asking for the extension of the above MAT benefit to companies against whom such insolvency proceedings have been admitted under the Code. 

The press release issued by the Ministry of Finance on 6 January, 2018 seems to be a silver lining to the otherwise dark cloud. The Press Release allows companies against whom an application for corporate insolvency process is admitted under the Code to set off the amount of total loss brought forward (including unabsorbed depreciation) from the book profits for the purpose of levy of MAT with effect from assessment year 2018-19. Prior to this press release, a deduction of only the lower of loss brought forward or unabsorbed depreciation as per books was available from book profits. However, there is need for clarity on the time period for which this benefit will be available. It would be interesting to see whether the formal legislative amendment can bridge the gap between the relief provided to companies under SICA and companies admitted for insolvency under the Code.
Another provision in the Act that might hurt investors is section 56(2)(x). As per its provisions, any transfer of asset (including shares) at less than fair value, as computed in accordance with the Income tax Rules, 1962 (the Rules) will lead to tax in the hands of the recipient on the difference between the fair value of such assets and consideration paid. Generally, there is erosion in the net worth of companies facing proceedings under the Code. In case of a listed company, the market price may not reflect the actual fair value of these companies. Therefore, if the bidder acquires the shares of such a company at a value lower than the quoted value of these shares, he would be subject to tax at 30%. Section 56(2)(x) of the Act goes hand in hand with section 50CA. While the former imposes tax on the acquirer, the latter imposes tax on the transferor. The section deems the fair value computed under the Rules as the consideration received and the transferor is required to pay capital gains tax on the same. Levying tax on the seller when he is not even able to recover the fair market value of the shares and on the buyer when he is acquiring shares at less than fair market value is a double whammy to any share acquisition deal under the Code.
In addition, a typical feature of most companies under the Code is mounting losses. It would certainly be desirable that the company gets a tax break by carrying forward and setting off these tax losses, thereby reducing tax exposure to that extent. However, a provision in the Act that hurts the acquirer is section 79. As per this section, any change in the shareholding of a closely held company beyond 49% from the last date of the previous year in which the loss was first incurred would lead to lapse of tax losses. Therefore, any acquisition, whether by way of share transfer or infusion of funds by any third party investors into the company, would lead to change in shareholding in most cases, resulting in lapse of tax losses. This provision primarily hurts private companies and unlisted public companies under the Code. However, it may also affect listed entities in some cases, wherein it is decided to delist the company as per the Resolution Plan. In such cases, even the loss of the listed entity may lapse pursuant to delisting. Section 79 was introduced  as an anti-abuse provision to curb taxpayers’ attempt at transferring losses incurred by a corporate entity through transfer of shareholding. However, for companies registered under the Code, the change in shareholding is for the company’s revival. Additionally, it is effected through the Resolution Plan, which is approved by the National Company Law Tribunal. In such cases, the authenticity of the transaction cannot be doubted. Hence, in an ideal situation, companies under the Code should be exempted from the applicability of section 79.

Therefore, many tax issues linger around the Code, reducing its effectiveness. Like every year, the Government has sought suggestions from industry experts for amendments to be ushered in by the Budget 2018. The press release issued on 6 January, 2018, shows the commitment of the Government to support the Code. Given the impediment of bad debt in the industry and the Government’s strong determination to resolve it, the above tax incentives would be an ideal budget gift for the upcoming financial year. 

Authors: Hiten Kotak, Leader – M&A Tax, PwC India and Falguni Shah – Partner, M&A Tax, PwC India

Disclaimer: The views expressed in this article are personal. It includes input from Nidhi Mehta, Associate Director, M&A Tax, PwC India, and Aaditi Kulkarni, Associate, M&A Tax, PwC India

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