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Unfolding tax tools to invigorate resolution of companies under IBC

The Insolvency and Bankruptcy Code (IBC), introduced in 2016, was conceived as a game-changer, a potent tool to expedite debt recovery from insolvent companies within a stipulated timeframe. Eight years into its existence, the IBC has witnessed a mixed track record. While it has successfully revitalised some companies grappling with financial turmoil, it has also faced criticism. The aim of the IBC was not only to aid the revival of struggling companies, but also to enhance the quality of lenders’ balance sheets and empower distressed asset buyers.

After its inception, the insolvency regime has undergone several amendments, each aimed at fine-tuning the process in response to the evolving demands of the industry. However, certain lingering issues impede full-scale effectiveness of the IBC and hence, require speedy resolution. This article delves into various tax aspects that require clarification or amendment, which are crucial for streamlining the insolvency process and can benefit all stakeholders.

Demands pertaining to past periods

In many approved resolution or liquidation plans, statutory dues are often diluted or treated as nil, largely due to the insufficiency of funds recovered from the resolution process to satisfy the existing operational and financial creditors adequately. Operational creditors, including the Government, were relegated to a lower priority than financial creditors in the waterfall mechanism. While IBC provisions statutorily override other laws, taxmen continue to engage in unwarranted actions and litigation. It is essential that the revenue refrains from such actions, considering the binding nature of the resolution plan and the fact that the past tax demands need to be extinguished. It is imperative for them to understand that running any business is not child’s play, thus making it even more challenging to reinvigorate a company from the depths of bankruptcy. Hence, rather than obstructing their revival, they should lend a helping hand to such enterprises.

Priority on account of first charge

The 2023 Hon’ble Apex Court decision in Rainbow Papers Ltd. put a dampener on resolutions that did not allocate amounts for tax authorities compared to other creditors. It categorised outstanding tax demands as secured debts on which tax authorities had first charge, especially if such provision is as per the extant regulations, unsettling the existing landscape. The Hon’ble Madras High Court’s subsequent decision in Aginiti Industrial Parks Pvt. Ltd. is reassuring, emphasising that the decision of the Apex Court is fact specific and hence, cannot be applied universally. A clarification from the Government will be worthwhile as it can dispel uncertainties and ensure a fair resolution for all stakeholders, while also giving due regard to the binding nature of resolution plans as well as waterfall mechanism provided in the IBC.

Institution or continuation of proceedings during the moratorium

The moratorium provided by the IBC aims to halt tax proceedings, or coercive actions against a corporate debtor during the moratorium period. The Apex Court in Sundaresh Bhatt emphasised that tax departments only have limited jurisdiction to assess/ determine the quantum of tax and other levies. Even though various circulars issued by the tax administration have echoed this sentiment, it is not uncommon to see actions being undertaken by tax departments, including search and seizure operations while the resolution plan is under progress. There is a need for strict adherence to the moratorium orders to uphold the spirit of the IBC. A unified approach is required to align actions with regulatory guidance.

Income tax regime amendments

While past amendments have been constructive, addressing specific concerns could further enhance the IBC’s efficacy. The income tax regime has seen certain useful amendments in the past. The provision of allowing losses to continue even on change in shareholding, dispensing with the requirement to obtain NOC from the income tax department, reduction of unabsorbed loses and depreciation while calculating MAT liability have been welcomed.

However, it would be great if the following changes are also incorporated:

  • Minimum Alternative Tax (MAT) provisions should provide for interest waiver and loan to be reduced from the income for companies under insolvency, so that such distressed companies are not unnecessarily burdened with tax liability due to waiver of loans.
  • In case of amalgamations triggered under insolvency provisions, the conditions given under Section 72A of the Income-tax Act, 1961, with respect to continuing to hold fixed assets and continuing the business, to enable the carry forward of losses are very rigid for insolvency hit companies seeking rebirth. Thus, some relaxation should be provided. Similarly, the requirement of transfer to be on a ‘going concern’ basis to have a tax-neutral demerger should be relaxed.
  • Entities purchasing assets and goods from companies under IBC should be exempted from the applicability of TDS provisions, as it adds to the procedural hassle of the tax authority first being directed by judicial forum to return the money and the same then being distributed as per waterfall mechanism.
  • The time period for filing of return should be extended for companies under IBC, or at least the condition for losses to lapse in case of non-filing of return should not be applied for such companies.
  • Clarity on deductibility of insolvency resolution process costs should be provided. While generally, revenue expenses are considered as an expense in the year in which they are incurred, amalgamation related expenses are allowed over a period of five years. Considering the challenges that an entity coming out of bankruptcy proceedings will inevitably experience, it may be worthwhile allowing these expenses as revenue expenses so that more and more solvent entities are encouraged to apply for revival of sick companies under the IBC.

Availability of Input Tax Credit (ITC) to successful bidders

The ITC availed by a corporate debtor is considered as an asset in the books of account. The bidder considers it as a relevant asset while determining the amount of bid. While the ITC is intended to smoothly transition to the successful bidder on a clean slate basis, there have been instances where the tax authorities have challenged the claim of ITC for past periods. The issue is pending before the Apex Court.

However, CBIC might consider issuing a clarification on ITC being available, subject to least possible checks to prevent unscrupulous taxpayers from taking undue advantages, so that unnecessary hurdles can be avoided.

Concluding remarks

As we navigate the complex realm of IBC, addressing the tax intricacies will not only fortify the resolution process, but also enhance the overall effectiveness.

IBC stands as a beacon of hope, and the nuances within the tax framework should be addressed as soon as possible. A proactive approach from the tax authorities will not only strengthen the resolution process, but also boost the confidence of investors and distressed asset buyers. The time for tax reforms within the IBC is now, signalling towards a new era of resilience, efficiency and prosperity in the corporate insolvency ecosystem.