As of June 2016, the total amount of gross non-performing Assets (NPAs) for public and private sector banks amounted to approximately ₹6 lakh crore. The economy remained clogged with the whopping amount of NPAs due to lack of any effective mechanism to deal with the same. With the introduction of the Insolvency and Bankruptcy Code, 2016 (the Code), India has witnessed the dawn of a new era in the banking sector. Formed with the aim to monetize NPAs, the Code brings in stringent measures to help complete the entire resolution process in a time-bound manner and with greater efficiency.
As per the Code, the Resolution Plan acts as a one-stop solution by laying down all details of the financial and commercial plan to revive a company in financial woes. However, in an effort to provide for the fulfillment of all commercial objectives, taxation is an area that often ends up taking a back seat.
The Government was quick to bring about necessary changes in the Companies Act and Securities and Exchange Board of India regulations to aid the smooth implementation of the Code. These quick decisions by the Government created many expectations about relief on the tax front from Budget 2018. Various industry experts made several representations to the Ministry of Finance summing up their wish list of tax incentives for companies under insolvency. Hence, all eyes were on Budget 2018 to see how emphatic the Government would be in extending tax benefits to such companies as well as their prospective bidders. The Government did pay heed to the worries of the prospective bidders by bringing in some amendments favourable to the companies facing insolvency.
A worthy relief in the Budget was relaxation in the provisions of section 79 of the Income Tax Act, 1961 (the Act). Section 79 of the Act provide that any change in the shareholding of a closely held company beyond 49% in any financial year vis-à-vis the shareholding on 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 investor into a company admitted under the Code, would lead to change in shareholding in most cases. This would result in lapse of tax losses under this section. This provision not only affects private and unlisted public companies admitted under the Code but also a few listed companies, wherein it was decided to delist the companies as per the Resolution Plan. The proposed amendment to section 79 of the Act provides that this section will not apply to any change in the shareholding of a company, pursuant to a resolution plan, approved under the Code. However, it further provides that a reasonable opportunity of being heard has to be given to the jurisdictional Principal Commissioner of Income Tax or Commissioner of Income Tax. This amendment will come into effect from Assessment Year 2018–19. A typical feature of most companies under the Code is mounting losses. Thus, a major factor while bidding for the distressed assets is the ability to carry forward the tax losses, so that it can be used to set off future profits. This provision enables the acquirers to rightfully utilise the tax losses of the sick company, thereby making the deal more attractive for them.
Minimum alternate tax (MAT) was also an area of concern for the bidders of distressed assets. This provision levies tax on the book profits of a company if the tax payable under normal provisions is lower than the MAT payable. Under the existing provisions of the Act, a deduction of the lower of the loss brought forward or the unabsorbed depreciation (as per books) is available while computing the book profits of the company. The Ministry of Finance relaxed said provision by way of a press release by allowing the deduction of the total amount of book loss brought forward (including unabsorbed depreciation) from the book profits of the company for the purpose of levying MAT for the companies admitted under the Code from Assessment Year 2018–19. Budget 2018 has proposed an amendment to section 115JB, thereby only confirming the relief given in the press release.
The provisions of MAT under the Act provide for a deduction of the amount of profits of a sick company registered under the, now repealed, Sick Industrial Companies (Special Provisions) Act, 1985 (SICA), until the company’s net worth becomes positive. The matters that were earlier dealt in SICA will now be dealt under the Code. Hence, it was expected that the relief that was available to sick companies under SICA would be extended to similar companies admitted under the Code. However, the Government in Budget 2018 has not provided this relief.
Almost all the plans providing for the revival of sick companies involve the lenders taking a haircut in their loan amount. Thus, the resultant write-back in the books of the company is exposed to a MAT of 18.5% (plus applicable surcharge and cess). In some cases, write-back of debt can also lead to normal tax implications under section 41(1) of the Act. Hence, if not for the entire exemption, relief in the form of exemption from the write-back of unsustainable debt was a move everybody wished. However, by denying even this relief, the Budget proved to be futile in bridging the gap between the relief provided to the companies under SICA and the companies admitted under the Code.
Another major concern that remained unaddressed in the Budget was the provision of section 56(2)(x) of the Act. As per its provisions, any transfer of assets (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. Hence, the commercial price at which the acquisition of a stressed company is actually made may significantly vary from the price as computed for the purpose of the Act. Therefore, the difference between the actual consideration and fair value of the shares ends up getting taxed @ 30% in the hands of the bidder. In addition to this, if the seller sells the shares at less than fair market value, then, as per section 50CA, the fair market value will be considered as the full value of consideration for the purpose of computation of capital gains. In a bid to make the tax regime fair-value focused, the above provisions are unfortunately, unfairly affecting the bidders of the companies admitted under the Code.
While the Government has ushered in certain reliefs via the Budget, additional tax burden in the form of MAT and section 56(2)(x) of the Act still remains an issue. It is expected that the Government will usher in these reliefs as well to give the already effective Code a supplementary boost.
*Authors – Falguni Shah, M&A Tax Partner, PwC India and Nidhi Mehta, Associate Director – M&A Tax, PwC India