Over the last few years, a large number of Indian companies have seen a sharp rise in their overall debt. The servicing of this debt has become a nightmare for these companies and as a result, lenders – primarily banks and other financial institutions – have been compelled to classify these debts as non-performing assets (NPAs).
Accordingly, there was a need to ensure that the Indian banking system recognises financial distress sooner than later and takes pragmatic steps to resolve it and ensures best possible resolution for the lenders and investors.
In May 2016, the Insolvency and Bankruptcy Code, 2016 (IBC) was enacted to tackle issues faced by sick companies in the context of insolvency and winding up.
The finance minister has also enacted certain relaxations for stressed companies under the Union Budget 2018 relating to utilisation of brought forward losses under the MAT (minimum alternate tax) scenario as well as pursuant to change in shareholding. Such amendments were considered as a welcome move by the stakeholders as this may ease out some of the genuine hardships faced by stressed companies
Though the IBC would ensure reviving of stressed accounts coupled with the above relaxations under the Income Tax Act, certain tax provisions could still act as roadblocks and cause an additional burden for the already stressed companies. An amendment in the Interim Budget 2019 would be considered as a welcome move by some of these companies as well as lenders/investors and would also result in smooth revival of such stressed companies.
Some such key provisions are discussed below:
Conversion of loan into equity
As per the revised framework issued by the Reserve Bank of India (RBI), conversion of outstanding debt including unpaid interest into equity shares should be at a fair value as per usual valuation norms and marked to market. Equity instruments, whether classified as standard or NPA, shall be valued at market value, if quoted, or else at break-up value (without considering the revaluation reserve, if any) as ascertained from the company’s balance sheet as on March 31 of the immediate preceding financial year. In case balance sheet as on March 31 of the immediate preceding financial year is not available, the entire portfolio of equity shares of the company held by the bank shall be valued at Rs. 1.
Accordingly, companies under IBC may face certain MAT hurdles on conversion of loan into equity. For such companies, under the Indian Accounting Standards (Ind AS) regime, conversion of loan into equity, per se, may not have any income-tax implications under the normal provisions of the IT Act. However, one would also need to evaluate the MAT implications on account of such conversion in the hands of companies under Ind AS regime. As per Companies Act, 2013, shares cannot be issued for a value less than the face value. Accordingly, in case of companies whose fair value is less than face value per share, there may be MAT implications on account of notional gain which may need to be recorded in the profit and loss account (P&L). In view of the above, relaxation of MAT implications in the hands of companies under Ind AS regime would certainly benefit all the stakeholders and reduce the tax burden.
Conversion of interest payable to banks and financial institutions
Under the provisions of the IT Act, deduction of interest on loan from banks and financial institutions is only allowed on payment basis. Considering that the conversion of unpaid interest into equity may not be considered as actual payment, there is a possibility that the deduction may not be allowed to the companies in the year in which such interest has been converted into equity. Although it may be possible to argue that conversion of equity is towards settlement of the interest liability, litigation cannot be ruled out on account of divergent rulings on this aspect.
Write-off of unsustainable portion of debt
In case of sick companies, there may be unsustainable portion of debt which may not be served even after such sick companies are revived. This may cause hardship to such sick companies and they might have to shell out additional taxes. Such waiver of unsustainable portion of debt may have MAT implications since the waiver would be routed through P&L account. Further, there is a risk that such waiver may also be taxed under the normal provisions of IT Act depending on the nature of the loan, considering certain judicial precedents in this regard.
Acquisition of distressed companies under IBC
Distressed companies can be attractive acquisition targets, as their price often reflects the difficulties the company faces. Accordingly, the acquirer has an opportunity to acquire such assets at a lower value and revive these distressed companies using the business expertise. The mode of acquisition of such distressed companies may be either through share acquisition from the existing promoters and lenders (post conversion of loan into equity) or through business acquisition by way of slump sale/demerger.
In case the shares of the companies are acquired, one would need to analyze if such acquisition has any implications from income-tax perspective on account of the provisions under Section 50CA (for unlisted shares) in the hands of the seller and Section 56(2)(x) (for unlisted as well as listed shares) in the hands of the acquirer. In case the shares are transferred/acquired at a value lower than the value as per the prescribed mechanism, there may be tax implications in the hands of the seller and / or the acquirer as the case may be. For example, in case of a listed company, whose market price is INR 20 and the shares are acquired for less than the market price, say INR 15, the difference of INR 5 will be taxable in the hands of the acquirer as income from other sources. Accordingly, though these acquisitions would be commercially driven, they may unintentionally get taxed under these provisions.
In case the acquisition of stressed assets is structured by way of demerger and Ind AS is applicable, there is an ambiguity on the tax neutrality of demerger considering that the provisions of IT Act require assets and liabilities to be recognized at book values whereas Ind AS requires recording the assets and liabilities at fair value. Accordingly, there may be tax implications in the hands of the companies as well as the shareholders of the demerged entity.
As highlighted above, there are various aspects from income-tax perspective which need to be analyzed while restructuring distressed companies to avoid protracted litigations with the tax authorities. Accordingly, it would be necessary to align the tax laws with IBC such that the stress on such distressed companies is reduced.
As a welcome move, Securities and Exchange Board of India (SEBI) has already aligned the Takeover Code to include the exemption for conversion of loan dues into equity and acquisition of such shares from lenders under IBC.
Just as how the government is promptly reacting to new circumstances as well as situations and amending the law wherever it considers necessary, it is essential to also look at the income tax law and bring about an equitable level of relaxation for cases qualifying under IBC. The objective of the government to issue the IBC is revival of companies. But revival of the habitat and the environment of these companies cannot be achieved fully without addressing the tax concerns. This may lead to a situation where the company may not be able to revive to the extent it is expected to.