Income tax issues in IBC
-Vinod Kothari and Sikha Bansal | finserv@vinodkothari.com
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Open in new tab Analysing Current Issues in Liquidation under IBC & Future Reforms
– Sikha Bansal & Barsha Dikshit, Partner | resolution@vinodkothari.com
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Supreme Court ruling revives the quandary, holds tax authorities to be secured creditors
Sikha Bansal, Partner, Vinod Kothari & Company
Neha Sinha, Executive, Vinod Kothari & Company
corplaw@vinodkothari.com
Introduction
Lawmakers might have put the best of efforts to frame the law in the clearest possible way, however, there may still be possibilities of diverse readings (and thus, diverse interpretations). Such a scenario is often addressed by the judiciary which, as and when circumstances arise, determines the questions arising out of law. However, there is also a possibility where the judiciary itself would render diverse interpretations on the same subject matter. This would, of course, lead to confusion and chaos.
A similar situation arose in the recent case of State Tax Officer v. Rainbow Papers Limited,[1] wherein the Hon’ble Supreme Court (‘SC’) dealt with the question as to whether the provisions of the Insolvency and Bankruptcy Code, 2016 (‘IBC’), specially section 53, overrides section 48 of the Gujarat Value Added Tax Act, 2003 (‘GVAT’). Section 48 of GVAT is a non-obstante clause and creates a statutory first charge on the property of the dealer in favour of tax authorities against any amount payable by the dealer on account of tax, interest or penalty for which he is liable to pay to the Government.
SC held that if the resolution plan excludes statutory dues payable to government or a government authority, it cannot be said to be in conformity to the provisions of IBC, and as such, not binding on the government. As such, the same must be rejected by the Adjudicating Authority. Further, section 48 of GVAT is not inconsistent with IBC and hence, it was held that IBC does not override GVAT. The SC went on to rule that by virtue of the ‘security interest’ created in favour of the Government under GVAT, the State is a ‘secured creditor’ as per the definition in IBC. Hence, as workmen’s dues are treated pari passu with secured creditors’ dues, so should the debts owed to the State be put at the same pedestal as the debts owed to workmen under the scheme of section 53(1)(b)(ii).
In the most humble view of the authors, the conclusions as above may not in consonance with the well-settled jurisprudence around the subject matter of conflict between IBC and tax statutes and the question of priorities between these, and may also not fit well with the construct of the IBC, the intent of the lawmakers and the Bankruptcy Law Reform Committee (‘BLRC’), as well as several judicial precedents set by SC itself, as discussed below. A plethora of rulings, including by SC itself, go on to hold that crown debts would be subordinate to the dues of secured creditors, and none of these rulings ever equated tax dues to secured dues. The authors thus, analyse the SC ruling in light of the construct of the IBC, intent of the lawmakers and policymakers, and various past precedents and offer their views as to how this ruling has actually reopened a can of worms and how it may impact success of ongoing and future resolution processes.
Accounting and Tax considerations in Going Concern Sale in Liquidation
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.
[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
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
[6] Discussion Paper dated 27th April, 2019
[7] Section 115JB of Income Tax Act, 1961
[8] Section 79 of the Income Tax Act, 1961
Nitin Jain Liquidator of PSL Limited vs. Lucky Holding Private Limited
Comments on proposed changes to the Corporate Insolvency Resolution and Liquidation Framework under Insolvency and Bankruptcy Code, 2016
– Team Resolution (resolve@vinodkothari.com)
On 23rd December, 2021, the Ministry of Corporate Affairs has issued proposed changes to the Corporate Insolvency Resolution and Liquidation Framework under Insolvency and Bankruptcy Code, 2016[1] and has solicited comments on the same.
While we discuss the proposed amendments in details below, a bird’s eye view of the proposed amendments gives an indication towards a more creditor-friendly approach, wherein the creditors have been bestowed with extended powers such as right to initiate insolvency proceedings, as well as have become less burdened with the the proposed amendment of only producing IU records at the time of application. At the same time, the roles and responsibilities of the RPs/liquidators seem to have been further widened by making RPs and liquidators also responsible for investigation of avoidance proceedings.
Other ancillary amendments like commencement of look-back back period, timeliness in approval of resolutions plans follow the trend of making the resolution process free of loopholes as and when they are identified.
Below we discuss the proposed amendments in detail –
Micro-consultative mode in liquidation: Will liquidations become more efficient?
[Sikha Bansal is Partner at Vinod Kothari & Company and can be reached at resolution@vinodkothari.com]
This article was first published on IndiaCorpLaw Blog and can be read here
IBBI recently came up with IBBI (Liquidation process) (Second Amendment) Regulations, 2021 (‘Amendment Regulations’) making certain important changes in the provisions pertaining to liquidation process under Insolvency and Bankruptcy Code, 2016 (‘IBC). One important amendment pertains to ‘Stakeholders Consultation Committee’ (‘SCC’) covered under regulation 31A of the IBBI (Liquidation Process) Regulations,2016 (‘Liquidation Regulations’).
The provisions relating to SCC were inserted vide IBBI (Liquidation Process) (Amendment) Regulations, 2019 (‘2019 Amendments’), read with Circular dated 26th August, 2019 (’IBBI Circular’). It required that the liquidator shall constitute an SCC (consisting of representatives of stakeholders entitled to distribution under section 53) within 60 days of the liquidation commencement, to advise the liquidator on the matters relating to sale under regulation 32.
While the obligation of the Liquidator to constitute the SCC within 60 days still remains the same, however, the role of SCC has been enlarged vide the Amendment Regulations, as discussed below –
Inter-se Ranking of Creditors – Not Equal, but Equitable
-Megha Mittal, Associate and Prachi Bhatia, Legal Intern
Insolvency laws, globally, have propagated the principle of equitable distribution as the very essence of liquidation/ bankruptcy processes; and while, “equitable distribution” is often colloquially read as “equal distribution” the two terms hold significantly different connotations, more so in liquidation processes – an ‘equitable distribution’ simply means applying similar principles of distribution for similarly placed creditors.
Closer home in India, the preamble of the Insolvency and Bankruptcy Code, 2016 (‘Code’/ ‘IBC’) also upholds the principles of equitable distribution – thus balancing interests of all stakeholders under the insolvency framework. Judicial developments have also had a significant role in holding such equity upright[1]. However, in the recent order of the Hon’ble National Company Law Appellate Tribunal, in Technology Development Board v. Mr. Anil Goel[2], the Hon’ble NCLAT has refused to acknowledge the validity of inter-se rights of secured creditors once such security interest in relinquished in terms of section 52 of the Code.
In what may potentially jeopardize interests of a larger body of secured creditors, the Appellate Authority held that inter-se arrangements between the secured creditors, for instance, first charge and second charge over the same asset(s), would not hold relevance if such secured creditors choose to be a part of the liquidation process under the Code – thus placing all secured creditors at an equal footing. The authors humbly present that the instant order may not be in consonance with the established and time-tested principles of ‘equitable’ treatment of creditors. The authors opine that contractual priorities form the very basis of a creditor’s comfort in distress situations – as such, a law which tampers with such contractual priorities (which of course, are not otherwise hit by avoidance provisions) in those very times, will go on to defeat the commercial basis of such contracts and demotivate the parties. This, as obvious, cannot be a desired outcome of a law which otherwise delves on the objective of ‘promotion of entrepreneurship and availability of credit’. The authors have tried putting their perspective in this article.
An Odd Scheme: Case for exclusion of schemes of arrangement from scheme of liquidation
Sikha Bansal, Partner
The Article below has also been published on the IndiaCorplaw Blog, see here
The concerns around section 230 schemes in the background of insolvency proceedings under the Insolvency and Bankruptcy Code, 2016 (IBC) have been partly addressed with the ruling of Supreme Court (SC) in Arun Kumar Jagatramka v. Jindal Steel and Power Ltd. The SC has held that the prohibition contained in section 29A should also attach itself to a scheme of compromise or arrangement under section 230 of the Companies Act, when the company is undergoing liquidation under the auspices of IBC. Reason being: proposing a scheme of compromise or arrangement under section 230 of the Companies Act, while the company is undergoing liquidation under the provisions of the IBC, lies in a similar continuum.
Earlier, there were several rulings of NCLAT which allowed schemes of arrangement during liquidation – for instance, see S.C. Sekaran, Y. Shivram Prasad, etc. After such rulings, the IBBI (Liquidation Process) Regulations were amended to include Regulation 2B, which also state that “a person, who is not eligible under the Code to submit a resolution plan for insolvency resolution of the corporate debtor, shall not be a party in any manner to such compromise or arrangement.” Read more →
Recent trends in IBC
Resolution Division
The field of Insolvency in India has of late seen constant change in order to adapt the ever moving global scenario. Being one of the topics that has been trending ever since its inception and with the possible introduction of several new concepts including subjects like pre pack insolvency and some recent amendments due to the pandemic, a compilation on the following topics in our presentation providing a brief glance through on the same has been made-
- Amendments due to COVID 19
- Separate Insolvency process for MSME’s
- Expected introduction of pre pack insolvency framework
- Assignment of NRRA
- Group Insolvency
- Developments in Going Concern Sale
http://vinodkothari.com/wp-content/uploads/2021/01/Recent-trends-in-IBC.pdf
Dissolution without Resolution- A disguised Strike-off under IBC?
–Megha Mittal
In a first of its kind, the Hon’ble National Company Law Tribunal, Bengaluru Bench vide its order dated 16th November, 2020, in the matter of Synew Steel Private Limited[1], has ordered for direct dissolution from CIRP, thereby waiving off the mandatory requirement to undergo the liquidation process.
The said order was inspired by the fact that the corporate debtor had nil assets, which in turn made it certain that the liquidation process would not have been successful. Hence, to save the unfruitful costs that would have been incurred, the corporate debtor was allowed a direct dissolution.
In this article, the author makes a humble attempt to analyse this rather path-breaking order, and the implications it may carry.