[Opinion] Income Tax Quandaries in the IBC – Budget 2023 Expectations

Authored by Subham Kumar & R. Sarath Karthick | Chartered Accountant

Table of Contents

1. Exemption on Write-back of liabilities

2. Exemption on transactions at less than Fair Valuation of shares

3. Extinguishment of existing tax proceedings

4. Exemption from No Objection Certificate (NOC) from Tax authorities

5. Safeguard of Tax Losses

6. Deductibility of CIRP costs

7. Allowability of interest payable on conversion into equity

8. Shield from GAAR

The Insolvency and Bankruptcy Code, 2016 (IBC) has revolutionized India Inc’s insolvency resolution process, replacing DRTs and other courts that had left previous restructuring and winding up process stagnated. However, the process is still evolving and testing waters as challenges faced by the involved parties are slowly but steadily getting addressed.

Though there are steps taken by government to align the tax laws in respect to IBC, however there are grey areas or tax exposure which if addressed can stimulate more resolutions under the IBC proceeding for insolvent companies. From the upcoming budget 2023, there is expectation that following key aspects are addressed from an IBC perspective:

1. Exemption on Write-back of liabilities

Waiver of liabilities by creditors which is one of most important element of resolution plan, may lead to significant tax implications in the hands of the Company. Following are the tax consequences:

a. In case of remission of any trading liability, the same will be taxable as business income. However, based on Apex court decision in the case of Mahindra and Mahindra, if such waiver is in the form of cash/money, it cannot be taxed as perquisite under Section 28(iv).

b. However, even such waiver in form of cash/money or capital loan may be taxable in the purview of income from other source.

Considering the objectives of IBC and hardship for the acquirer, an exemption for such waiver under resolution plan will be a welcome move.

2. Exemption on transactions at less than Fair Valuation of shares

Any acquisition of shares at less than the fair market value (FMV), difference in the FMV of such shares as prescribed by tax rules and actual consideration is taxable in the hands of acquirer as income from other source. Tax provision prescribes the following methodology to compute FMV for such shares:

a. Listed Shares: The FMV for such shares is prescribed as quoted in the stock exchange on the date of transaction.

b. Unlisted Shares: In case of equity shares, FMV is computed basis the tax book value (including fair value for the immovable assets and investments, if any) subject to the adjustment and FMV of other than equity shares is computed basis the open market value.

In addition to the taxability on the acquirer on transaction at less than FMV, in case of unlisted shares or listed shares which are not frequently traded, the seller is also taxed on the deemed consideration prescribed on the transaction. The above provision being anti-abuse provision is to discourage non-bonafide transaction, however these provisions act as major obstacle on successful acquisition of insolvent companies. Accordingly, specific exemption should be provided to the resolution applicants and shareholders of Corporate debtor from the applicability of the above provisions if undertaken pursuant to resolution plan.

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3. Extinguishment of existing tax proceedings

It is now well settled that in case of crystalised tax demands or claims, the same is to be dealt in accordance with resolution plan. However, the ambiguity continues in case of open tax proceedings. There are judicial precedents which held that any claim which is not part of resolution plan will stand extinguished. However, in absence of specific provision under tax law, tax authorities may continue to raise demand for the past operations. Accordingly, specific provision providing extinguishment of any open tax proceeding in respect of period prior to the acquisition will provide certainty to the acquirer.

4. Exemption from No Objection Certificate (NOC) from Tax authorities

Existing tax provision specifies that in case of Seller have any open tax proceedings, it shall procure NOC from tax authorities. If not done, such transaction carry risk of being regarded as void if any tax demand from such tax proceedings are not settled by Seller. Such a requirement obtaining No Objection Certificate from the tax authorities during the IBC proceedings may be unfeasible. Therefore, a need to provide for specific exclusion from complying with Section 281 in case of transaction undertaken pursuant to resolution plan.

5. Safeguard of Tax Losses

Tax provisions has granted a relaxation to Company that is undergoing structuring in pursuant to resolution plan approved under the IBC, after affording a reasonable opportunity of being heard to the Jurisdictional Principal Commissioner or Commissioner. However, there is no guidance on the approach and the entire process in this regard is blurred. It will be imperative to lay down procedure and process for such opportunity is provided to the stakeholder to avoid future tax litigation on carry of tax business losses.

Moreover, the Companies that have become debt-ridden or cash strapped would be an outcome of poor performance of multiple years, in which case the unabsorbed losses are running out of time for carry forward in future since the maximum time is eight years. Hence, a fresh lease of life should be granted for IBC restructured entities to enable the acquirers to actually avail the benefit of set-off against profits in future once the business is revived and profitable.

6. Deductibility of CIRP costs

The costs can be incurred towards fee for resolution professional, raising interim funds, etc. The allowability of the same remains a grey area. Hence, a clarification in this regard is much expected. The recommended treatment may be similar to that of pre-incorporation expense u/s 35D where the benefit is amortized and allowed over 5 years.

7. Allowability of interest payable on conversion into equity

Finance Act 2022 has amended the tax provisions and provided that any deduction of any sum, being interest payable on loan or borrowing from specified financial institution/NBFC/scheduled bank or a cooperative bank shall not be allowed even in cases where such interest is converted to a debenture or any other instrument by which liability to pay is deferred to a future date.

In situations where the Corporate Debtor enters restructuring arrangements with Financial Institutions for conversion of such outstanding interest will discourage the acquirer as well as corporate debtor to restructure the liability with equity. It will provide more flexibility, if such transactions effected pursuant to resolution plan is allowed to claim such interest as allowable expenditure in the year of such conversion of interest into equity.

8. Shield from GAAR

General Anti Avoidance Rules (GAAR) is an anti-tax avoidance measure in India is to curb tax evasion and tax leaks. Though, the circular on GAAR specifies that GAAR is not applicable on any transaction sanction by court or authority if such court or authority has explicitly or adequately considered the tax implications. For a transaction which is under IBC, there are enough safeguard to ensure that it passes the commercial test, however in absence of specific exclusion, the risk of invoking GAAR cannot be ruled out. It will give lot of clarity and assurance to the stakeholders, if specifically clarified that GAAR is not applicable on any transaction undertaken pursuant to resolution plan.

As time is of essence in the insolvency resolution process, the Government may proactively take steps to address the gaping holes thereby bridging the incongruence between both the vital legislations. This will undoubtedly provide quicker and efficient routes for insolvent companies to revive and incentivise in true spirit to the acquirer to help them make such companies profitable again.

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