Archive for month: February, 2022

By Devika Agrawal, Executive, Vinod Kothari and Company

devika@vinokothari.com

Background

The preamble to the Insolvency and Bankruptcy Code, 2016 (‘Code’) enlists value maximisation as one of its key objectives. In line with the said objective, the Code included ‘Going Concern Sale’ (‘GCS’) of the corporate debtor or the business of the corporate debtor in liquidation, vide the Amendment dated 22nd October, 2018^[1] in the Liquidation Process Regulations, as one of the modes of sale. The underlying intent of introducing GCS in liquidation was to maximise value. It was expected that introduction of GCS in liquidation would give a breather and will be looked forward to by Corporate Debtors undergoing liquidation process, however, the statistics presented by the Quarterly Newsletter of the IBBI, for the quarter ended 30th September, 2021^[2] give a different view as only six out of the 1419 orders for commencement of liquidation, were closed by a sale as a going concern under liquidation process. For an enhanced understanding of a GCS, our Articles on the topic can be referred to.^[3]

One probable reason for lesser use of GCS may be tax considerations attached to such sale, (for example, questions concerning write back of liabilities, continuation of tax benefits, carry forward of losses and unabsorbed depreciation). Besides, given how different GCS in liquidation is from a conventional GCS and a GCS in CIRP, acquirers often face issues in accounting for assets acquired under a GCS in liquidation. Further, there remains uncertainty with respect to the accounting for and recording of transactions. In this article the author attempts to discuss accounting and tax issues in GCS in liquidation.

GCS in liquidation vs. conventional GCS vs. GCS in CIRP

As stated above, it is important to note that a GCS in liquidation is different from a conventional GCS and a GCS in CIRP by way of a resolution plan. The difference lies not just in the circumstances under which a GCS takes place in each of the said three modes but also the manner of treatment of assets, liabilities, profits, losses and share capital. The accounting and tax considerations depend on the same. When one talks about accounting and taxation, it becomes important to see what happens to each component when a transaction takes place.

A snapshot of the treatment of these components under different modes of sale specified above has been tabulated below.

Sl. No	Basis	GCS in liquidation	Conventional GCS	GCS by way of a Resolution Plan in CIRP
1.	Transfer of liabilities	All liabilities are settled from the sale proceeds, in accordance with Section 53. Thereafter, pending liabilities, if any stand extinguished.	Liabilities associated with the assets  are transferred to the acquirer.	Liabilities are in the form of claims on the CD. They are paid off in a manner provided for in the Resolution Plan as approved by CoC.
2.	Valuation of Assets	The successful auction bidder pays a lump sum, without assigning values to individual assets.   In a GCS in liquidation, the value of assets may be  comparatively lower because it bears the burden of a failed resolution process.	The buyer pays a lump sum, without assigning values to individual assets.	The buyer pays a lump sum, without assigning values to individual assets.
3.	Carry forward of losses	The benefit of carry forward of losses has not been provided for the purpose of a GCS in liquidation. However, in certain rulings[4], the Hon’ble NCLT has allowed carry forward of losses, but again, subject to approval of IT Authorities. See discussion below.	The Income Tax Act, 1961, does not allow carry forward and set off of losses when a business is sold as a going concern.	Section 79(2)(c) of the Income Tax Act, provides an incentive to resolution applicants and has allowed the benefit of carry forward losses where a change in shareholding takes place pursuant to a resolution plan.
4.	Profits	Profits during liquidation, if any, get subsumed in the liquidation estate, and distributed in accordance with section 53.	Assets and liabilities are transferred on a particular date.	As consented to between CoC and resolution applicant – see para 68 of Committee of Creditors of Essar Steel Limited v. Satish Kumar Gupta (SC).

At this juncture, having discussed the difference between the above mentioned modes of sale, it becomes important to discuss the accounting and taxation concerns which may have become the probable reasons for lesser use of GCS in Liquidation.

Accounting Concerns 

Preparation of books of accounts in liquidation – Obligation of the Liquidator or Auction purchaser?

Section 35 of the Code enlists the duties and powers of the liquidator appointed under the Code, which has to be read with the provisions of the Liquidation Regulations.

Liquidation is a terminal process and as such, it is a settled principle that during the liquidation process, the liquidator does not prepare any balance sheet or profit and loss account.  Instead, reg. 15(3) requires the liquidator to prepare a  receipt and payments account on a cash-basis. Hence, the question of any preparation of profit and loss account or balance sheet does not arise.

However, after a GCS is completed, sale consideration is received and a sale certificate is issued by the liquidator in favour of the auction purchaser, the corporate debtor is transferred to the auction purchaser. At this juncture, an important question that raises its head is, who would be responsible to prepare the books of accounts of the corporate debtor post the completion of a GCS – Liquidator or an Auction purchaser.

Once the sale is completed, it becomes the responsibility of the acquirer to take all the necessary steps viz-a-viz the corporate debtor. It was held in the case of Gaurav Jain Vs. Sanjay Gupta (Liquidator of Topworth Pipes & Tubes Pvt Ltd)^[5]:  

“The Corporate Debtor survives, only the ownership is transferred by the Liquidator to the purchaser. All the rights, titles and interest in the Corporate Debtor including the legal entity is transferred to the purchaser. After the sale as a ‘going concern’, the purchaser will be carrying on the business of the corporate debtor.”

Thus, it may be concluded that once the corporate debtor is transferred to the acquirer, it should become the responsibility of the acquirer to prepare the books of accounts and annual financial statements of the Company. The Liquidator remains responsible only for the preparation of the receipts and payments account until the liquidation process is over.

However, the situation can get tricky when GCS takes place in the middle of a financial year. In such a situation, the following questions need to be answered for a smooth completion of GCS of the CD in liquidation.

• What date should be considered as the date of sale?
• Who prepares the financial statements for the entire financial year in which the sale takes place?

On the first question, one may note Schedule I of the Liquidation Regulations which states:

“On payment of the full amount, the sale shall stand completed, the liquidator shall execute a Certificate of sale or sale deed to transfer such assets and the assets shall be delivered to him in the manner specified in the terms of sale.”

Hence, ideally, the date on which sale certificate is issued should be taken as the date of sale.

On the second question, say, the sale takes place on 15th January, 2022. Should the acquirer prepare the financial statements for the entire FY 2021-22? Or, should the liquidator provide completed financial statements to the acquirer as on 31st March, 2022?

As indicated earlier, after sale, the responsibility to prepare financial statements, is that of the acquirer. Before sale, the liquidator does not prepare any balance sheet/profit and loss statement. Hence, the acquirer shall prepare financial statements from the period 15th January to 31st March, 2022 to close the accounts of the financial year.

Given how liabilities and assets are dealt with in a GCS in liquidation, the accounting shall be done as follows:

Asset Side:

In a GCS, the buyer pays a lump sum amount as sale consideration, without assigning values to individual assets. Therefore, the valuation of individual assets of the corporate debtor after completion of sale as a going concern shall be the responsibility of the acquirer. The acquirer puts a value on the assets of the corporate debtor, which is his bid price – it may, therefore, spread the purchase consideration paid by him to various assets of the corporate debtor as is commonly done in case of a slump sale.

Liabilities side:

All liabilities of the corporate debtor, including the share capital becomes a claim on the liquidation estate. As such the same are settled in terms of sec. 53 of the Code. Therefore, the question of carryover of any liabilities of the corporate debtor onto the books of the entity, acquired under GCS, does not arise. 

In the matter of Gaurav Jain v. Sanjay Gupta (Supra), it was held by the Hon’ble NCLT, Mumbai bench that,

“The Applicant shall not be responsible for any other claims / liabilities / obligations etc. payable by the corporate debtor as on this date to the Creditors or any other stakeholders including Government dues. All liabilities of the Corporate Debtor as on the date stands extinguished, as far as the Applicant is concerned.”

“Creditors of the corporate debtor which include creditors in any form or category including government departments shall stand extinguished qua the Applicant”

[Emphasis Supplied]

As it has been discussed, there is no case of remission or cessation of liability, as it becomes a claim on the liquidation estate and not the corporate debtor. Thus, the question of writing off liabilities does not arise, let alone the taxability of the same under section 41(1) (a) of the Income Tax Act, 1961.

Note that, in certain cases, by agreement, buyers may take over certain liabilities. In that case, the acquired liabilities too, will appear on the new balance sheet.

Share Capital:

As for the share capital of the Corporate Debtor, the existing shares shall stand cancelled without there being any payment to the shareholders, since such shareholders assume the nature of claimholders upon commencement of liquidation, who shall be paid  in terms of sec. 53 of the Code, only if proceeds from liquidation estate are that sufficient.

As regards recording of capital by the auction purchaser, the corporate debtor issues new shares to the extent of the share capital. It is understood that the consideration received from the acquirer will be split into share capital and liabilities, based on the capital structure that the acquirer decides.

Reference may be drawn from the IBBI Discussion paper dated 27th April, 2019,^[6] which discusses the modalities of a GCS and says as follows;

“The consideration received from the sale will be split into share capital and liabilities, based on a capital structure that the acquirer decides. There will be an issuance of shares by the corporate debtor being sold to the extent of the share capital. The existing shares of the corporate debtor will not be transferred and shall be extinguished. The existing shareholders will become claimants front he liquidation proceeds under section 53 of the Code”

[Emphasis Supplied]

Tax Considerations

Tax issues under GCS would arise as a result of confusion surrounding the following:

• Carry forward and set off of losses and unabsorbed depreciation – Section 115JB and Section 79(2)(c) of Income Tax Act, 1961.
• Writing off Liabilities

Carry forward and set off of losses and unabsorbed depreciation – Section 115JB and Section 79(2)(c) of Income Tax Act, 1961

• Carry Forward and set off of losses and unabsorbed depreciation – Section 115JB

Section 115JB of the Income Tax Act, 1961,^[7] provides for levy of a minimum alternate tax (MAT) on the “book profits” of a company. For the purpose of computation of book profits, the said section allows a deduction in respect of the amount of loss brought forward or unabsorbed depreciation, whichever is less as per the books of accounts.

However, for companies whose application for CIRP under the Code has been admitted by the AA, a carve out has been provided. Accordingly, an aggregate of unabsorbed depreciation and loss brought forward shall be allowed to be reduced from the book profits, if any.

The Act provides that;

“(iih) the aggregate amount of unabsorbed depreciation and loss brought forward in case of a—

 (A) company, and its subsidiary and the subsidiary of such subsidiary, where, the Tribunal, on an application moved by the Central Government under section 241 of the Companies Act, 2013 (18 of 2013) has suspended the Board of Directors of such company and has appointed new directors who are nominated by the Central Government under section 242 of the said Act;

(B) company against whom an application for corporate insolvency resolution process has been admitted by the Adjudicating Authority under section 7 or section 9 or section 10 of the Insolvency and Bankruptcy Code, 2016 (31 of 2016).”

[Emphasis supplied]

It can be clearly deduced from the provisions of the said section that the above mentioned carve out has been provided specifically for the purpose of a Resolution Plan during CIRP and not for a GCS in liquidation. 

• Carry forward of losses – Section 79(2)(c)

Additionally, Section 79(2)(c) of the Income Tax Act, 1961 (‘Act’)^[8], provides that the benefit carry forward of loss cannot be taken where there has been a change in shareholding. However, to provide an incentive to resolution applicants, the Income Tax Act has allowed the benefit of carry forward losses where such change in shareholding takes place pursuant to a resolution plan. 

However, no such exemption has been provided for the purpose of a GCS in liquidation. Hence, there exists uncertainty w.r.t the same. At this juncture, reliance may be drawn to certain NCLT rulings^[9], wherein such benefit has been allowed by the Adjudicating Authority, subject to the approval by the concerned Income Tax Authorities under the relevant provisions of the Act.

Conclusion

While the process w.r.t. conduct of GCS has been explained by the Liquidation Regulations, the above discussed points have not been explicitly mentioned or ascribed in any guidance note or standards. Due to these uncertainties, these questions have often been subject to litigation, which leads to further delays. Hence, the need of the hour is a clear set of rules and standards, addressing the questions discussed above, as a result of which GCS is expected to gain further traction and deliver better results.

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^[1] The Insolvency and Bankruptcy Board of India (Liquidation Process) (Second Amendment) Regulations, 2018

^[2] IBBI Quarterly Newsletter, July – September, 2021

^[3] Enabling Going Concern sale in Liquidation – by Resolution Service Team, Vinod Kothari & Company

  Liquidation sale as a Going Concern – The concern is Dead, Long Live The Concern, authored by Vinod Kothari

  Concerns on Going Concern Sale under IBC – to be or not to be, authored by Parth Ved

  Sale of Legal Entity as an asset: A step towards value maximisation, authored by Megha Mittal

^[4]Nitin Jain Liquidator of PSL Limited vs. Lucky Holding Private Limited

^[5] Gaurav Jain (Supra)

^[6] Discussion Paper dated 27th April, 2019

^[7] Section 115JB of Income Tax Act, 1961

^[8] Section 79 of the Income Tax Act, 1961

^[9] Gaurav Jain (Supra)

Nitin Jain Liquidator of PSL Limited vs. Lucky Holding Private Limited