Budget 2019-20: The special waiver from Section 56 (2)(x) of the Income Tax Act — in force since Finance Act 2017-18 — may be announced in the forthcoming Budget, according to a source.
Budget 2019 India: In a move that could boost investor interest in firms under insolvency process and thereby quicken their resolution process, they may be exempted from having to pay tax on the differential between the (usually lower) acquisition value and the fair market value (FMV) of the bankrupt firm’s shares. The special waiver from Section 56 (2)(x) of the Income Tax Act — in force since Finance Act 2017-18 — may be announced in the forthcoming Budget, according to a source.
“We have been receiving representations regarding section 56(2)(x) from the industry and an exemption for companies under the insolvency and bankruptcy code (IBC) is being looked at,” the source said. He added that while an effort is on to introduce the change in the Budget, it might materialise a few weeks after it also.
“An exemption for IBC cases makes sense as the acquirer not only has a liability to pay off lenders but also needs to pump in capital towards revival of the company. Any potential tax liability makes the acquisition much less appealing,” Amrish Shah, partner, Deloitte Haskins & Sells LLP, said. He added that without an explicit exemption, the acquiring firms can be open to different interpretations, which can lead to potential tax issues arising from the acquisition.
An analyst on condition of anonymity said in many cases where a tax demand has been faced by the acquirers of insolvent firms, the firms have explored ways to work around the problem but they fear the tax liability could come back to haunt them later if the tax department decides to invoke General Anti-avoidance Rules (GAAR).
Huge difference between the FMV and acquisition value is practically a norm under the insolvency process as lenders try to avoid liquidation of the firms to the extent possible. For instance, the face value of Electrosteel shares was brought down to Rs 0.20 apiece from Rs 10 after the company was acquired by Vedanta in June last year and the money owed by the firms to the lenders was converted into equity.
In the case of acquisition below FMV, Section 56(2)(x) deems the acquirer to have benefited from lower valuation. It was introduced as an anti-abuse provision to tax receipt of property for inadequate consideration.
Tax experts said that Section 56(2)(x) was one of three original sticking points in IBC. The Central Board of Direct Taxes (CBDT) last year removed one of these irritants when it allowed firms to reduce their book profits by carrying forward the insolvent firm’ losses, a facility that enabled them to mitigate their minimum alternate tax (MAT) liability. Further, earlier this year, the Supreme Court said that the haircut taken by a lender under the insolvency resolution process would not be considered as income of the acquirer company and so cannot be taxed.
The recovery through the Insolvency and Bankruptcy Code (IBC) route stood at Rs 70,000 crore last fiscal, or 43% of the default amount, according to a Crisil report. This means creditors had to take a 57% haircut. However, it was still twice the Rs 35,500 crore recovered in FY19 through earlier resolution mechanisms like the Debt Recovery Tribunal and Lok Adalat, the report said.