Insolvency Law: Case For Tax Exemptions?
The tax cost is worrying bidders under the insolvency regime.
Investors, hoping to bid for assets of companies facing insolvency proceedings, have an additional ask – extend the beneficial tax treatment to companies under the insolvency process as granted under the Sick Industrial Companies Act (SICA). Some of these exemptions were codified in the Income Tax Act while others were granted by courts.
SICA vs IBC: The MAT Effect
For instance, Minimum Alternate Tax (MAT) provisions under the Income Tax Act provided an exemption for sick industrial companies, Rakesh Nangia, founding partner at Nangia & Co. explained. As per the tax law, profits earned from the year in which a company was declared sick under SICA and ending in the year in which its net worth increased to the same amount as accumulated losses, were exempted from MAT applicability.
The revival scheme for sick companies would require banks to take a haircut on interest and write-down of the loan amount. The interest was waived, and the loan was reduced to make the unit viable. Under the accounting standards, all these waivers came to the credit side of your profit and loss account which gave rise to a tax liability in the form of MAT. So, there was a specific exemption given under the Income Tax Act because this was not real income but only a waiver.Rakesh Nangia, Founding Partner, Nangia & Co.
But such an exemption is not available to companies under the insolvency regime as yet and needs to be looked into, Siby Antony, chief executive officer at Edelweiss ARC told BloombergQuint.
If a company’s loan today stands at Rs 50,000 crore and under the insolvency process, it gets sized to Rs 25,000 crore, the reduced amount is gain to the company. Under the SICA regime, this notional gain was adjusted against the accumulated losses or there was concession provided under the MAT provisions.Siby Antony, CEO, Edelweiss ARC
For an incoming management or investor under the insolvency regime, this will be a huge liability, Antony added.
This liability is compounded by the change in accounting standards from GAAP to Ind-AS.
The beneficial tax environment under the SICA regime emanated on two fronts – one, the accounting standards i.e. GAAP could be used to mitigate MAT liability in certain cases and where it couldn’t, the exemption provided in the Income Tax law was used by sick companies. But starting 2015, India adopted Ind-AS under which fair value of debts has to be recorded and reassessed every year.
When you get a waiver on the principal and interest amount of the loan, this will, under Ind-AS, hit the credit side of the P&L account. Under GAAP, there was flexibility available where this waiver hitting the P&L side could’ve been avoided. Under Ind-AS, this is not possible which means the book profits goes higher which gives rise to a MAT liability of 20 percent. You’ve not earned any money; you’ve not gained anything but you’ve only recorded the realistic value in your books of account on the basis of certain haircut.Rakesh Nangia, Founding Partner, Nangia & Co.
The lack of MAT exemption and change in accounting standards will become a direct cost for the incoming investor and indirect cost for lenders of the company facing insolvency proceedings, Eshwar Karra, chief executive officer at Phoenix ARC told BloombergQuint.
Let’s hypothetically say that there is Rs 100 of debt in the company and the prospective bidder says that Rs 50 is the sustainable debt going forward. Because this Rs 100 debt will be written down to Rs 50, there will be a incidence of tax on the Rs 50 that is being written-down. If that exemption is not coming to the prospective bidder, he needs to factor it in his pricing and therefore what he initially held as sustainable debt i.e. Rs 50 would then come down to probably Rs 30-40. So the lender will be essentially paying for that.Eshwar Karra, CEO, Phoenix ARC
SICA vs IBC: The Judiciary Effect
Seshagiri Rao, joint managing director at JSW Steel echoed a similar sentiment in his interview to BloombergQuint. In order to make the insolvency regime attractive for an investor interested in distressed assets, the alignment of various laws is essential, he said.
Schemes can involve waiver, write back of loans, restructuring or issue of shares at lower than market price- when these things happen, there is a huge tax liability that would come in under the Income Tax Act.Seshagiri Rao, Joint Managing Director, JSW Steel
The tax liability arising out of most of the transactions referred to by Rao was dismissed by courts in the SICA regime.
For instance, in the JK Corporation Case, the Calcutta High Court in JK Corporation Ltd.’s case had held that that a scheme approved by the Board for Industrial and Financial Reconstruction as per SICA overrides provisions of the Income Tax Act. It also allowed the accumulated loss and unabsorbed depreciation of the sick company to be carried forward by the amalgamated company or set off against its profits.
Similarly, courts have allowed sick companies to carry forward losses and their set off in the event of transfer of shareholding under the SICA regime.
There can be fairly substantial tax liabilities that can accrue, especially in large cases such as Bhushan Steel Ltd. or Essar Steel Ltd., and in a distressed situation, to be writing a cheque upfront for tax liabilities can be a huge cost, Bahram Vakil, founding partner at AZB & Partners said. ‘I do hope that the tax authorities will look at such liabilities with a positive eye’, he added.
Like SICA, the insolvency law also includes a provision that gives it an overriding effect over other laws. Taking inference from the rulings pronounced in the SICA regime, National Company Law Tribunals are expected to take a liberal view by giving necessary directions to the tax department, Nangia said.
A beneficial tax regime, like that under SICA, is not the only ask of investors eyeing distressed companies. Allowing delisting of the target company’s shares via a resolution plan, without following the due process mandated by market regulator SEBI, bidders say, will make the insolvency process more attractive.