Abheet Sachdeva & Amol Khanna

While the debate on the effect of the IBC, the role of Regulator/ Government, locus standi of promoters, and the shape of the new normal of business environment in the country following implementation of IBC, is yet to find a common ground, IBC has taken-off leaving some of the largest names of Indian corporates orphaned, eagerly awaiting adoption by new parents.

The idea behind the introduction of the Code was to establish a comprehensive framework and provide a platform for resolving the mounds of NPAs which have contributed to the sluggish growth of the economy. Furthermore, corrective financial actions are helpful to revive the operations, albeit under a new owner, which shall not only help preserve the business but also aid in protecting jobs and the interest of all other stakeholders associated with the company.

A resolution in IBC hence results in many financial consequences ~ like reduction in loan and/or other financial liabilities, transfer of shares/ business for a consideration etc. To facilitate such actions, wide powers have been granted under IBC making it a complete code in itself which is self-sustainable and supreme in many aspects. As a result, IBC could lead to far reaching implications under other statutes, one such being the Income-Tax Act, 1961 [IT Act]. Any exercise leading to an impact on the financial statements opens up a pandora’s box of tax implications that may emanate from the steps and the process involved at large.

Necessity is the mother of all inventions –  this is apt to the genesis of IBC, which has provided a much-needed shot in the arm to fight the menace of bad loans and bring some ease to the ever-increasing financial claustrophobia plaguing the economy. At the same time, it is imperative to ensure that the allied laws such as the Income-Tax keep pace with this change and elicit a positive response to support such new beginnings. Bearing this in mind, Government has made amendments in the Income-Tax law to address certain issues like continuity of tax losses of the company admitted to IBC, changes in the MAT computation etc. However, as it would have it, many aspects are yet to be addressed which leaves companies with not much choice but to rely upon the ‘complete code’ concept of IBC and this choice is not free from litigation. Mentioned below are some such aspects which warrant a specific relief from taxes and hence necessitate amendments to the Income-tax Act, 1961:

  • Section 41 of the IT Act: This section deals with taxability on recoupment (by way of remission or cessation) of loss or an expenditure or trading liability, wherein an allowance / deduction on account of the same has been claimed in any past years’ assessment. The benefit so obtained shall be deemed as the business income of the year in which such remission/ cessation take place and shall be liable to tax accordingly.

A perusal of the bare Section suggests that in cases where the lenders take a hair-cut of trading debts, there would arise tax implications in the hands of the company to the extent of cessation/ remission of such a trading liability.

Continuing the discussion, there have been instances where waiver of working capital / trading loans have also been covered within the swipe of Section 41 of the IT Act. The judiciary has been divided on this matter and while there are arguments which suggest that such waivers should not be taxed u/s 41 of the IT Act, the Bombay High Court in case of M/s Solid Containers Ltd [2009] 178 Taxman 192 (Bombay) and the Delhi High Court in case of Rollatainers Ltd [2011] 15 taxmann.com 111 (Delhi), placing reliance on the Apex Court Ruling in the case of CIT vs T.V. Sundaram Iyengar and Sons Ltd. (1996), 222 ITR 344 (SC), have held that if the amount received in the course of trading transactions is not taxable in the year of receipt as being of a capital character, the amount changes its character when it becomes assessee’ s own money, because of limitation or by any other statutory or contractual right.     

The situations discussed above are absolutely unwarranted, as what is to be borne in mind is that quantum of debt repayment/ loan waiver is commercially negotiated between the bidder/ new owner and the creditors and that the company has no say in the same. In line with the IBC agenda, taxing a financially crippled entity would further exacerbate the liquidity woes of the company and hence a specific carve out (on the lines of one introduced u/s 79 of the IT Act) of such situation should find a mention under the IT Act.

  • Section 28(iv) of the IT Act: The provisions of Section 28(iv) of the IT Act characterize the value of any benefit or perquisite arising from business activities as taxable business profits. While several Indian tribunal/ courts have held that only benefits not in the nature of cash or money would be taxable under the provisions of Section 28(iv), the Madras High Court in the case of CIT v. Ramaniyam Homes (P.) Ltd. [2016] 68 taxmann.com 289 (Madras) took a contrary view and held that waiver of a loan availed for acquiring capital asset would tantamount to acquiring a benefit or perquisite arising from the business. The view adopted by the Madras High Court propelled a debate as the judgment does not provide a detailed explanation as to why section 28(iv) applies to monetary considerations. Also, it is silent on the issue as to how a capital receipt can be made subject to tax. This contrary ruling had re-ignited the debate on an otherwise acceptable position.

The dispute around whether cash /money waiver is to be considered for the purposes of Section 28(iv) has been put to rest by the Hon’ble Supreme Court in the case of Mahindra And Mahindra Ltd [2018] 93 taxmann.com 32 (SC). In the facts of the case, a loan was availed by the Indian company for acquisition of capital assets, which was later waived-off. Dispute arose if the cessation of this loan liability would be treated as income in the hands of assessee in terms of Section 28(iv) of the IT Act. Alternatively, whether the same would be subject to tax in terms of Section 41(1) of the IT Act. The Apex Court in the matter held that in order to invoke the provisions of Section 28(iv) of the IT Act, the benefit which is received has to be in a form other than money.

As regards applicability of Section 41(1) of the IT Act, it was held that the essential condition to be satisfied is that there should be an allowance or deduction claimed by the assessee in an assessment for any year in respect of loss, expenditure or trading liability and subsequently, the creditor remits or waives any such liability. The Supreme Court further highlighted that in the facts of the case at hand, the liability in question was not a trading liability and hence the same would not fall under Section 41 (1) of the IT Act.

This issue attracts similar ramifications as discussed in the case of Section 41 of the IT Act . Hence, appropriate safeguards in the form of exceptions/ provisos may be introduced in the IT Act to ring-fence the liability of the company.

In addition to the situations / impacts as discussed above, the amount of hair-cut suffered by the creditor may lead to multifarious consequences under the IT Act. For e.g. the Tax office may treat this amount as income from other sources in terms of Section 56(2)(x) of the IT Act. As for waiver of loans availed for capex, write-offs on account of the same may lead to adjustment/ reduction in the capitalization value of the relevant block of asset and may consequently impact the tax depreciation claim. Furthermore, depending upon the treatment adopted in the books of the company, taxability may arise under the MAT provisions. Given that the Code itself is in a nascent stage, it is too soon to predict, let alone finding an appropriate treatment that is to be adopted, the far-reaching tax implications that may arise for IBC covered cases.

  • Section 50CA and 56(2)(x) of the IT Act: Section 50CA of the IT Act provides for a situation wherein deemed sales consideration equivalent to fair market value [FMV] of shares is adopted in the hands of the seller, in case of transfer of unquoted shares at a value which is less than FMV (computed as per Rule 11UA of the IT Rules) of such shares. The tax FMV is thus considered the full value of consideration for the purpose of arriving at the capital gains tax in the hands of Seller. A similar taxing mechanism has been devised for the buyer/ acquirer by way of introduction of Section 56(2)(x). The Section inter-alia provides that in case where any person (say bidder) receives from any person or persons (say promoters of company admitted to IBC  and / or company itself), any property (say either shares of the company under IBC or investments as held by such company) for nil consideration/ consideration which is less than FMV of such shares (the FMV to be computed in terms of the prescribed mechanism as per Rule 11UA of the IT Rules), the difference between the FMV and the consideration so discharged, shall be deemed to be income in the hands of the recipient and the same shall be liable to tax accordingly.

A careful perusal of the section(s) would suggest tax implications in case of value mismatch, as the price discovery would be as per market forces. Unless suitable remedies are introduced in the statutes, the said provisions would only magnify the difficulty in securing funding for the debt laden companies. The objective at hand is twin-fold as the idea is not to promulgate unreasonable valuations of assets on one hand and at the same time avoid loading the company with tax burden.

Section 56(2)(viib) of the IT Act: Section 56(2)(viib) of the IT Act provides where a closely held company, receives in any year, from any person being a resident, any consideration for issue of shares, in excess of the fair market value (as per Rule 11UA of the IT Rules) of such shares, the excess amount so received, shall be deemed to be income in the hands of the recipient entity and shall be liable to tax accordingly. The Section however, carves out specific exemptions in cases where the funds are received from a venture capital company or a venture capital fund. Further, to act as pedestal to support the funding needs of the dynamic start-up environment in the country, the DIPP vide its notification has enunciated conditions which are to be met by such start-ups, to raise funding without triggering the provisions of Section 56(2)(viib).

Similar constructive steps would be more than welcome for IBC cases, where bidder may agree to infuse funds at a premium, which may aid in satisfying the core purpose of IBC – revival of company and maximization of creditors’ recovery. Any tax levied on the target entity under IBC would be a primary liability for the company and secondary for the new owner and this may play a spoilsport to a healthy recovery.

Section 170 of the IT Act: Section 170 of the IT Act deals with taxability in case of succession of business. It provides that in case of succession of business of an assessee, the tax liability on income arising upto the date of succession is to be borne by the Predecessor, post which it shall be the liability of the Successor. It further explains that where in case the Predecessor cannot be found, the Successor shall be liable to discharge the tax liability arising on the income of the Predecessor for a specified period (being the income of the year in which the succession took place, upto the date of succession and income of the immediately preceding year)

Section 281 of the IT Act: Section 281 of the IT Act inter-alia provides that where during the pendency of any proceedings under the IT Act or after its completion but before the service of notice by a tax recovery officer (for a pending demand), any person (say Corporate Debtor) transfers any of its specified assets viz. land, building, machinery, plant, shares, securities and fixed deposits in banks, then such transfer shall be void to the extent of any tax payable by such Seller. The implication is that the tax authorities could seek recourse to the specified assets transferred, if income-tax claims are not settled by Seller/ Transferor relating to the proceedings pending as on the date of the transfer. The liability is thus primary for the Seller and secondary in nature for the Buyer. The transfer shall, however, not be void provided such transfer is made for adequate consideration and without notice of pendency of any proceedings or without notice of tax payable, or a prior permission is obtained by Seller/ Transferor for such transfer from the concerned Tax Officer (referred to as the ‘certificate u/s 281’)

These sections were introduced to plug loopholes wherein the seller/ predecessor would escape tax liability by parting with asset/ business. However, for tailor-made situations like IBC, this could hamper the resolution process at large. The fact that an asset has been admitted under IBC itself serves as a check point that the company would have unsettled liabilities, including those pertaining to Income-Tax. Unlike transactions undertaken in the normal course of business, where the buyer would seek appropriate representations & warranties and indemnities to cover the historical risks (including those pertaining to Income Taxes), for cases under IBC, such safeguards may not be available. Additionally, one may take a view that if not for an opportunity under IBC, the dues (including Income-tax) may continue for an infinite period. The Taxman may hence devise a mechanism to provide a much-needed revival opportunity to the companies under IBC, which may contribute to the exchequer in times to come.

In addition to the above, there are similar provisions under the IT Act, which if applied unaltered, would lead to tax implications arising under the Insolvency process, thus making the process redundant. However, the law- maker has to put in place appropriate checks and balances so that the provisions are not abused by promoters, companies harbouring mala-fide intentions.

The need of the hour is thus to strike a healthy balance between the two regimes, which help achieve the objective of the Code (maximization of creditors recovery) as well as safeguarding the interest of the stakeholders without overburdening them with the tax levies.    

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