Insolvency and Bankruptcy Code – Emerging tax issues

February 06,2019
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Manish Shah (Partner, Sudit K Parekh & Co)
Shraddha Bedmutha (Manager)

Debt waiver, interest cuts etc. are an integral part of the resolution process under Insolvency and Bankruptcy Code (IBC or Code).  While the Code has dealt with operational aspects, tax implications on such critical aspects are still haunting the companies against whom the corporate insolvency resolution process has been initiated.  In this article we have attempted to cover certain critical tax issues that should to be addressed / clarified by the Government.  

1.Tax Implications on debt waivers / hair cuts against loans and other liabilities:

Under the erstwhile Sick Industrial Companies Act (SICA) regime, the revival schemes often provided specific exemption from taxability under normal tax provisions in view of the overriding powers available under SICA. Specific provisions existed exempting the sick companies from Minimum Alternate Tax (MAT) liability as well.

In absence of such powers and provisions under IBC regime unlike those under SICA, tax implications (under normal as well as MAT provisions) assume significance in varied circumstances including the below:

  • Debt waivers resulting in write back of creditor being reflected as income in Profit & Loss account
  • Write back of External Commercial Borrowings (ECB) also being credited to Profit & Loss account
  • Interest cuts, also resulting in write back of accrued interest liabilities

In the absence of any enabling provisions under the Income tax for MAT companies, any waiver / hair cut in loan would become taxable for MAT. This could be fatal as the company is already reeling under losses and asking them to pay Income tax would act as a body blow for such companies.

2.Impact on MAT computation

The MAT provisions restrict the set off of losses to lower of brought forward book loss or unabsorbed depreciation.  The above restriction resulted in hardship for the companies against whom an application for corporate insolvency process has been initiated.

In view of the several representations received in this regard, the Central Board of Direct Taxes (CBDT) recently issued a press release that FY 2017-18 (AY 2018-19) onwards, companies, against whom an application for corporate insolvency resolution process has been admitted, the amount of total loss brought forward (including unabsorbed depreciation) shall be allowed to be reduced from the book profit. The press release also clarifies that legislative amendment would be made in due course.

This press release implicitly hints that companies under IBC proceedings are covered by MAT provisions; there is no escape from MAT.  Nevertheless, this press release comes as a great relief.

3.Transaction Structuring – Impact on accumulated tax losses

Another key area of tax concern as a part of the resolution process is when certain restructuring measures are adopted such as issuance of shares to the lender in lieu of liabilities, mergers, sale of business etc.  Under SICA regime, the Board for Industrial and Financial Restructuring (BIFR) would often exercise their overriding powers to exempt the sick company from applicability of provisions of section 79 or 72A of Income Tax Act, 1961 (ITA) which dealt with conditions for being entitled carry forward and set off of accumulated tax losses.

Absence of such powers under IBC regime raises a concern on the fate of accumulated tax losses.  The impact on the tax losses under the bare provisions of the ITA for the above illustrative list of restructuring are tabulated hereunder:

Change in shareholding

Merger / Demerger

Business sale

Any change in the equity shareholding beyond 49% would result in lapse of the tax losses.

Availability of tax losses would be subject prescribed under section 72A of ITA.

Brought forward losses of the company would not be available to the acquirer.

4.Transaction Structuring – Valuation Perspective

Apart from the above, any structuring measure such as conversion of debt into equity would have to be taken after taking into consideration the share valuation rules, Transfer Pricing provisions and ECB regulations as the same could have tax implications in the hands of both, the buyer as well as the seller. Under the ITA, there are anti abuse provisions such as section 50C, 50CA, section 56(2)(x) etc. which would come into play.

5.Validity of proceeding during moratorium period

One of the objectives of the Code is to provide an opportunity for reorganisation to the corporate debtors. It is with this intent that a calm period termed as moratorium has been made a part of Code.

Moratorium is a period during which judicial proceedings for recovery, enforcement of security interest, sale or transfer of assets or termination of essential contracts cannot take place against the debtor.

One of the aspects that need clarification in this regards is whether the applicability of the moratorium period extends to all the on-going income tax proceedings or will it apply only to recovery proceedings?

6.Proceedings post liquidation

Once the liquidation is effected, it can be said that the company legally ceases to exist.  In such a scenario, the following issues merit consideration:

-       Whether assessment proceedings can be initiated on a dissolved company?

-       If yes, the next question that would arise is who would represent / authorise to represent the company before the tax authorities?

-       Can a Director or any other Principal Officer in charge of the company be considered liable?

Recently, the CBDT vide instruction[1] addressed the uncertainty on the on-going income-tax proceedings against the large number of shell companies struck off last year. It lists down the situations whereby request/appeal for restoration of name of the struck off company can be made.

Similar amendments should be incorporated in the ITA or necessary clarifications be provided by CBDT on the above issues for the other companies getting liquidated under normal channels and whose names are struck off from the records of ROC

7.Liability of directors

In case of private companies under liquidation, where the tax dues cannot be recovered from the company, every person who was a director of the company at any time during the year shall be jointly and severally liable for the payment of the tax dues.

However, this is subject to the exception that the director is able to prove that the non-recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part.  Thus, it is an onerous responsibility on the directors of the private companies to ensure that all the taxes are duly made good by the company and in an event of default; the directors shall be jointly and severally be liable to meet the same.

8.No Objection Certificate from Income-tax Department

Section 281 of the ITA, requires a taxpayer to obtain permission of the income tax officer prior to creating a charge on or transfer of specified assets.

Even the transfer of stressed assets would require prior permission from the income tax officer. This is certainly to cause hardship to the companies undergoing insolvency proceedings.

To ease the process under IBC for such transfer, it is expected that the finance minister may do away with no-objection certificates required for asset transfers during insolvency proceedings in Budget 2018.

9.Stamp duty on transfer of stressed assets

Transfer of stressed assets is not free from stamp duty implications.  Hence, similar to the above, for easing out the process of purchase and sale of stressed assets, the government must relax / exempt the duty on transfer of stressed assets.

Our views:

It is clear from the above, that the implementation of IBC is likely to give rise to many issues on several fronts and it is expected that the government keeps a track of the same and brings the necessary clarifications for the smooth implementation of this code.  

Many expectations are set for the government to bring parallel amendments in other related laws to enable smooth functioning of the IBC.

The article has also been co-authored by Mr. Nikhil Shah, (Assistant Manager, Direct Tax and Regulatory Services).


[1] Instruction F. No. 225/423/2017-ITA.II