By- KS Mehta
The Insolvency and Bankruptcy Code’s (IBC’s) welcome objective is expeditious revival of stagnating industrial investment, whether operating or capital work in progress, and recovery of bank loans to the extent justified by revival. The insolvency resolution law and the tax laws must work in tandem towards this objective. Revival requires strong management with external and internal financial resources. Tax laws which militate against the revival process need urgent revision; it will also reduce the loan write-off. It is reported that government is working at remedial measures. I present a hypothetical case. A-Limited started power production five years ago, suffered a loss of Rs 1 crore in the first year; earned book profits of Rs 21 crore in the second year and paid minimum alternate tax (MAT) of Rs 4 crore and incurred business loss of Rs 30 crore in the next three years. Thus, on March 31, 2017, it had a net business loss of Rs 20 crore. It is not quoted on any stock exchange. In the insolvency resolution process, the equity control of the company is proposed to be taken over; or, it will be merged with another company, B-Limited. How do the tax laws impact A-Limited?
Where majority ownership of companies (non-listed on stock exchanges) changes, the brought-forward losses lapse. Resultantly, if A-Limited (the company in revival) earns Rs 10 crore in the third year of revival, but has a balance-sheet losses of Rs 20 crore, it will still pay regular tax of Rs 3 crore—thus depleting resources for higher production or bank loan repayments. Thus, it is denied a level playing field vis-à-vis a listed company (Section 79 of Income Tax, or I-T, Act). Such companies have to pay out income tax without setting off past losses, and the money remaining for working capital or past liabilities will get reduced substantially. If A-Limited were listed, losses would not lapse.
MAT provisions are at a high rate of 20%. Even if A-Limited were a listed company, its third year book profits of `10 crores will mandatorily attract 20% MAT, inspite of past Rs 30 crore business loss as only the lower of depreciation or loss is allowed to be set off, and A-Limited has no unabsorbed depreciation. BIFR registered companies were exempted; similar provisions needs to be introduced. MAT should allow set off of entire book loss, whether unabsorbed depreciation or business loss. Currently, only the lower of the two are allowed set off, putting it on a par with the old company law provisions for dividends. The company law has now been amended, prohibiting payment of dividends unless entire book loss is wiped off.
For faster revival if A-Limited were to merge with B-Limited, A-Limited’s MAT credit of `4 crore paid in the second year, may not be available in the merged company, as per the current view of tax officers. A clarificatory provision is called for. It will remove conflict with the company law where all assets will pass in a merger under high court orders. MAT credit is an asset.
A financial restructuring generally results in partial reduction of loans. The law should provide that this will not become part of business profits, and will also not be subject to MAT. Tax holiday for 10 years was provided to all infrastructure units; but by an amendment, this tax holiday is withdrawn if A-Limited merges with another company, leading to accelerated tax thus depleting finance (Sec. 80-1A of the I-T Act). Tax laws on mergers and demergers should be extended to LLP, partnership firms and AOP. LLPs have been adopted as the implementation vehicle for infrastructure projects. SMEs mainly operate as firms or LLPs. They contribute to creation of employment, a key goal.
Lastly, the set off period for MAT credit or old business loss set off should start from the date the resolution order is passed.
Under tax laws, MAT-paid credit can be carried forward upto 10 years of payment; business loss set off is restricted to 8 years from the year it is incurred and tax holiday for infrastructure is for 10 years in a block of 15 years from commencing production. These periods, for insolvency companies, should start from the year the insolvency resolution process is initiated, whether it remains the same company or after merger with another.
If the industrial unit is sold as a slump sale by the loss-making company to the stronger company, the loss-making company will suffer capital gains which cannot be set off against brought-forward business loss, and if the company is in the infrastructure space, it may also lose its tax holiday status. Thus, internal financial resources for bank payments or higher capacity utilisation are impacted. Tax laws need amendments in view of the IBC process and intent.