In 2000, a law was brought in so that the tax losses by companies having industry (hotel, telecom, shipping, banks) could carry forward their tax shelter to the merged company if it complied with some restrictive conditions.
By KS Mehta
The finance minister deserves accolades for her timely and dynamic credit policy for healthy as well as stressed SME units, and authorising banks to make policy for large units, with an overseeing committee for loans of over Rs 1,500 crore. As NPA levels may touch 15%, we also need an immediate action plan on archaic tax laws; RBI policy on takeover financing with flexibility to banks to tweak it; 12 months of temporary suspension of takeover rules for listed companies by Sebi and for unlisted companies share purchase under companies law; and amendments to four archaic critical tax sections that are anti-revival.
Insolvent companies and stressed assets, arising from economic downturn, can either be beyond redemption by existing inefficient promoters, or,can be turned around by efficient existing promoters, but with substantial infusion of equity funds. Both are national assets capable of providing large employment, profits and tax revenues under good management. These stressed assets occur in all sectors and in all sizes. A policy to encourage incapable promoters to sell and capable ones to revive is in the national interest. Former RBI Governor Raghuram Rajan pithily said the reality is that we need to spend on those firms which will benefit the economy going forward.
Losses and unabsorbed depreciation (tax shelter) are largely reflected in increase in current liabilities and loans. These have to be paid out from fresh capital brought in, or from future profits. Where the fresh capital-raising results in change of over 51% in new shareholding pattern compared to previous equity holding pattern, old business loss is not deductible from future taxable profits under Section 79 of the I-T Act. Hence, companies suffer higher tax on future profits and from residual profits pay out liabilities, and the time and cost of revival go up.
In the case of start-ups or other companies where new investors have faith in existing management’s ability, retain them, and give control, even there, this law applies if the old shareholders lose 51% ownership.
Should this law (framed in 1961) not be restructured to facilitate the revival of business units? This law applies to companies in industry, services, technology or trade. The only exception is if the company is listed on the stock exchange or is a subsidiary of such a company. It has delayed revival or led companies to liquidation with banks losing money and people losing jobs. Section 79 has no place in 21st century fiscal law.
The government now has an overarching GAAR law (anti-avoidance), under which shadowy transactions done without a commercial justification (only for tax avoidance) can be punished. The omnibus Section 79 penalises genuine revival transactions also.
A revival strategy for stressed companies is merger with healthy companies. In 2000, a law was brought in so that the tax losses by companies having industry (hotel, telecom, shipping, banks) could carry forward their tax shelter to the merged company if it complied with some restrictive conditions. The law needs amending to become a tool for revival of units. It requires that the merged company continue to be in the same business, achieve 50% production, and hold three-fourths of the plant for a minimum five years. A strictly hypothetical example here: M Auto was facing low capacity utilisation; it planned to manufacture ventilators by merging a loss-making ventilator company with itself, and then it dropped the ventilator production plan because the government did not approve the ventilator design. If it had converted the merged plant also to auto component production, it would be in violation of tax law condition. Will this help or hinder revival of employment and loans repayment? Is this condition sensible in today’s fast-changing technology era? The only test should be of continuing to provide employment to at least 50% of the workforce for three years, except if they take VRS, and to utilise production facilities for the manufacture of goods. A contemporary law is essential.
This law also provides for tax shelter on merger or demerger of banks only when it is with other government banks, hotels, shipping company, computer software manufacturer, telecom services, and the business of generation or distribution of power. Today, services contribute over 55% of GDP, and yet are not extended this revival tool. Indeed, the entire business sector should be covered for fast turnaround.
To enable new, efficient managements to take over stressed units and turn these around, a RBI model framework policy on takeover financing, subject to amendments by banks, will enable banks to move boldly on this front without the fear of CBI or vigilance.
Infrastructure projects, in operation or not fully completed, or with cost overruns, need a special look. If these are sold as a running project, their tax holiday will continue as per the Supreme Court. But if those merged or demerged under a scheme of arrangement, they lose their entitlement to tax holiday under the tax laws; Section 80 IA cannot be justified. It is imperative to revisit these laws for infrastructure projects and restore benefits if new or current promoters revive them in a given timeframe.
Laws have been framed to tax the price at which shares are issued as income, if the issue price is higher than the computation, under the rules. The government has granted exception to some start-ups from such a tax on share price, but what about the turnaround cases where new investors’ valuations are higher than the tax valuation rules and even in a situation of competing investors? The companies will have to pay tax instead of putting the money to economic purposes. Absurd?
Under the IBC law, NCLT can give exemptions. The same exemptions, if extended to stressed units as per RBI definition, can lead to faster turnaround. Banks could certify the categorisation.
The author is managing partner of SS Kothari Mehta & Co