India: The interplay of India’s new insolvency code with income tax law

India overhauled its insolvency and bankruptcy regime by enacting the Insolvency and Bankruptcy Code, 2016 (IBC). The IBC is landmark legislation and represents a transformation of the insolvency regime in India.

The insolvency resolution under the IBC envisages the invitation of resolution plans from potential bidders for the revival of a stressed debtor. These resolution plans, amongst other things, provide for the restructuring of the stressed corporate debtor. 

So far as the distribution of proceeds arising out of resolution of the corporate debtor is concerned, the IBC sets out a clear priority where the secured financial creditors rank highest and the dues of other unsecured creditors and government dues rank lower. Like other government dues, tax dues are also considered unsecured dues of an operational creditor and rank lower than the dues of the financial creditors. This has been confirmed in a string of judicial precedents.

Furthermore, the IBC provides that the resolution plan approved under the IBC shall be binding on government authorities (including tax authorities); therefore, once the amount of waiver in respect of the unsecured creditors as per the resolution plan is approved by the bankruptcy court this is also binding on the tax authorities in respect of any tax dues.  

Analysis

As with any transaction, resolution under the IBC also has income tax implications. The resolution plan under the IBC could provide for the restructuring of a corporate debtor by way of sale of assets, merger, demerger, acquisition of shares, providing for a waiver in respect of the amount payable to financial and operational creditors, etc. Income tax implications of some of these aspects are examined below:  

Where any outstanding liability, in respect of the entity for which the resolution plan is approved (i.e. corporate debtor), is waived in accordance with the approved resolution plan, such waiver/write-back, especially liability in respect of operational creditors, may be subject to tax under both normal and minimum alternate tax (MAT) provisions. The MAT liability could be mitigated by electing into the newly introduced concessional 25.12% corporate tax regime, or by a set-off of brought-forward losses. However, no specific exemptions are provided for normal tax in respect of companies under the IBC. Where a past deduction was allowed in respect of any operational debt, write-back of this would be taxable subject to relief (if any) on account of brought-forward tax losses. As regard write-back of financial debt, companies need to rely on certain judicial precedents to claim exemption from taxation.

Typically, for computation of book profits for the levy of MAT, a company is entitled to set off brought-forward business losses or unabsorbed depreciation, whichever is lower. Consequently, where either the business losses brought forward or unabsorbed depreciation is nil, then no deduction is allowed. With a view to providing relief to companies under the IBC, it has been provided that a company whose application is admitted under the IBC would be eligible to set off aggregate of brought-forward losses and unabsorbed depreciation.

In case of a closely held company, carry-forward and set-off of losses is allowed only if there is a continuity in the beneficial owner of the shares carrying at least 51% voting power. In case of a company seeking insolvency resolution, it is expected that ownership of shares carrying more than 51% of voting power would change, thus leading to a lapse of the existing brought-forward business losses. Towards this end, the Indian tax law provides that if a company’s resolution plan is approved under the IBC, then such a company would be eligible to set off losses even if there is a change in shareholding beyond the threshold. 

The Indian tax laws provide for fair value taxation in case of transfer of shares of a company (other than quoted shares) at less than the fair market value (FMV) of such shares computed as per tax rules. Similarly, for the transferee, the deficit between the FMV and the actual consideration is deemed as income and taxed at the applicable tax rate. In case of distressed assets and companies, the share sale/acquisition is likely to be below the FMV. This could lead to tax implications both for the transferor and the transferee. The government has an enabling power under the law to exempt certain classes of persons; however, to date no notification has been issued.

So far as the restructuring of the corporate debtor is concerned by way of merger/demerger, it should be possible to structure this so that it is tax neutral for the corporate debtor, its shareholders, as well as the acquirer under the IBC process. 

As can be seen from the above, several forms of relief have been provided for under the Indian tax laws, which facilitate the resolution of insolvent companies through the IBC process. 

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