Tax Policy for Losses of IBC Companies - A Case of Treading in Turbulent Waters?

The Insolvency and Bankruptcy Code, 2016 ('the IBC' or 'the Code') has been a revelation, both in its original and revised form. It envisages an integration of different legislative measures into one holistic legislation for companies against whom the Corporate Insolvency Resolution Process has been initiated under the IBC ('IBC Companies'). Over the period of its implementation, the IBC and other allied laws have seen many changes, most of which have been well directed for achieving the broader objective of resolving distressed companies.

From an income-tax perspective, the revival process of IBC Companies entailed a considerable quantum of waivers by lenders and operational creditors, leading to tax liability under both normal as well as Minimum Alternate Tax (MAT) provisions and significant impact on carry forward of brought forward book and tax losses. While the IBC and other allied laws have seen multiple changes to give an impetus to the successful resolution of insolvency cases, tax implications on many critical aspects need consideration.

The Finance Act, 2018 saw some clarity being provided by the Government giving a much-required relief to the such Companies, however they were far from meeting the industry requirements. It seems that the battle is only half won with the complexities far outpacing the challenges. In this article we have attempted to cover critical tax issues relating to carry forward of tax and book losses in relation to such Companies.

Minimum Alternate Tax ('MAT')

Per the provisions of the Income Tax Act, 1961 ('the Act') while computing tax under the MAT provisions, a reduction from the book profit is allowed in respect of business loss brought forward (excluding depreciation) or unabsorbed depreciation as per the books of account, whichever is lower. This has an adverse impact on companies that have a significant amount of accumulated book loss but not necessarily an equal amount of loss available for set-off in view of the extant provisions allowing the deduction of the lower of book loss and unabsorbed depreciation.

For IBC Companies, the Finance Act 2018 relaxed the above provisions to allow the total of loss brought forward and unabsorbed depreciation to be reduced from the book profit. The amendment followed a CBDT circular on the subject.

However, it is interesting to note that the amended provision uses the words, “aggregate amount of unabsorbed depreciation and loss brought forward” and not “aggregate amount of unabsorbed depreciation and loss brought forward as per books of accounts.” This nonetheless appears like an obvious oversight considering the overall scheme of things.

It is also interesting to note that the amendment made by Finance Act, 2018 does not provide for complete exclusion of waiver amount or a blanket exemption from computing the book profits for IBC Companies, unlike a complete relief from MAT provided under the Act, to such distressed companies under the erstwhile Sick Industrial Companies (Special Provisions) Act, 1985 ('SICA'). For IBC Companies, there may be situations where the amount of loan and interest waiver is more than the brought forward book losses and depreciation. Given the quantum of loans in such Companies which have been and would be referred to the NCLT under the IBC, absence of complete MAT exemption will significantly dampen their revival plan. There is an urgent need for introduction of a blanket exemption from MAT to facilitate successful resolution of such Companies.

Carry forward of tax losses

Another key area of tax concern as a part of the resolution process is when certain restructuring measures are adopted such as mergers etc.

In case of an amalgamation of a company with any other company, the Act provides that the amalgamated company (transferee company) shall, be entitled to carry forward the accumulated losses and unabsorbed depreciation of the amalgamating company (transferor company). To obtain the benefit of such carry forward of tax losses, compliance of stringent conditions related to mergers would be required. 

The conditions for carry forward of tax losses, inter-alia, include the following:

-The amalgamating company must be owning an 'industrial undertaking'

-The surviving company must hold atleast 75% of the book value of fixed assets of the amalgamating company for a minimum period of 5 years from the date of amalgamation;

-The surviving company must continue the business of the amalgamating company for a minimum period of 5 years from the date of amalgamation;

-The surviving company shall achieve the level of production of at least 50% of the installed capacity of the undertaking before the end of 4 years from the date of amalgamation.

Complying with the above conditions could pose serious practical difficulties. If the revival plan entails a merger, it may not be possible to comply with all the prescribed conditions for a variety of reasons (such as no feasibility of achieving the required level of minimum production or the IBC Company not owning an 'industrial undertaking', etc), which may lead to a conflict and defeat the objective of reviving the IBC Companies.

It is also worthwhile to mention that under the SICA regime, the Board for Industrial and Financial Restructuring ('BIFR') would often exercise their overriding powers to exempt the sick company from complying with such conditions for being entitled to carry forward and set off of accumulated tax losses. However, no such powers have been conferred under the IBC with the NCLT to exempt such Companies from complying with such conditions

It is essential that such stringent conditions are made more liberal for Companies who wish to seek revival pursuant to the IBC.

Change in shareholding of a closely held company

The provisions of the Income-Tax Act restrict closely held companies from carrying forward and setting off losses in case beneficial shareholding of the companies changes by more than 49% in the year in which the loss is considered to be set off vis-a-vis the year in which the loss is incurred.

In the current context, one area of concern for IBC Companies has been eligibility to carry forward losses where, inter-alia, restructuring measures such as merger, acquisition of shares by the acquirer, issuance of shares to the lender in lieu of settlement of liabilities, etc. are adopted. The Finance Act 2018 provided relaxation for continuity of losses when there is a change in shareholding of a closely held company as a result of resolution plan approved by the NCLT, after affording a reasonable opportunity of being heard to the jurisdictional Principal Commissioner or Commissioner. This amendment mainly aimed at removing the hurdle in restructuring and rehabilitation of IBC Companies and brought relief to acquirer/lenders. However, it is unclear whether future restructuring by an acquirer shall also be provided relaxation in terms of continuity of losses.

While the amendment provided that the above relief will be available only after jurisdictional Principal Commissioner or Commissioner is afforded a reasonable opportunity of being heard, it would be interesting to see how the same is approached by the NCLT during the course of IBC proceedings.

-After being afforded an opportunity of being heard, will a separate order be required to be passed by the Principal Commissioner?

-Will the NCLT be the appropriate authority to decide on eligibility or otherwise of the IBC Companies to carry forward such tax losses?

-Will the order of the NCLT be final and binding in this regard? Can a further appeal be made or a Writ Petition be filed against the order of the NCLT?

One will have to wait to see practically the outcome of the NCLT proceedings, where the Principal Commissioner raises objections on eligibility of such company to carry forward losses.

Concluding thoughts

The IBC has been a landmark legislation and it will continue to evolve. While some of the matters listed above came across as areas, which require more thought and consideration, the issue that IBC deals with is such that there will always be other unforeseen challenges. It is only rational for the government to look at the bigger picture whilst developing tax policy for IBC Companies. One would hope that clarification on above issues is provided sooner, to facilitate successful resolution of insolvency cases.