Fiscal Cost of IBC Cases Is as Critical as the Write-offs!
In its rather chequered existence since 2016, the Insolvency and Bankruptcy Code (IBC) has been the battleground for many contested legal aspects and the Supreme Court repeatedly had to bring peace to keep the process going as the state objective of the law to accomplish debt resolutions in a time bound fashion and preserve as much of the asset value as possible. 
The record so far has been anything but the above, but solace has been drawn from the fact that the other available remedies to restructure debt failed even more dismally.
IBC has been shining by contrast as the debt recovery tribunal (DRT), asset reconstruction company (ARC) and the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest (SARFAESI) Act have shown poorer results.
Strangely, one of the contested fields is where the sovereign itself has been an active litigant! It is the claim for a priority in the recovery of the tax and other dues to different wings of the government.
Practically all the tax and similar revenue legislations since time immemorial had provisions granting primacy to the recovery of the tax dues and, invariably, the laws specified that any such outstanding would be a charge on all the assets of the defaulter.
In the 1970s and 1980s, when financial institutions like IDBI and ICICI were active in the lending space, the lender would, before the release of the loan, seek a clearance from the tax authorities of the borrower that they would have an uncontested right to the security of the assets and that the government would stay its hands in the event of a contest between the two.
Such a certificate was provided under Section 281 of the Income-Tax Act, and such similar provisions under the sales tax law as they then existed, of different states.
Post the liberalisation in the 1990s and later, these were found to be impacting the ease of doing business and abandoned. But the underlying fact of the sovereign’s supremacy to upset the queue in a recovery situation stayed.
The chart herein gives a glimpse of the latest data as given by the government on the outstanding dues to the Union treasury of income-tax and other indirect taxes. 
The situation on unrealised taxes of the Union that comes almost equivalent to its full-year’s share of the revenue is like a business having debtors of almost a year’s sale! The figure has also been growing steadily over the years implying some fundamental issues in tax recovery across various governments.
The data on tax dues of firms that went under the hammer in national company law tribunal (NCLT) is not readily available. It may be a large sum. Firms defaulting on debt are unlikely to discharge any of the statutory payments.
Hence, many IBC cases faced litigation on this front where the tax authorities took the stand that crown debts had priority over all other items. Despite the clarity in the law, some decisions have lent room for some ambiguity.
It looks, based on newspaper reports, that necessary amendments would be carried out to make the position clear. It is only appropriate that this issue should be kept completely out of any potential litigation in the future as the intent of the policy-makers on this is quite clear.
However, a question may arise whether the tax authorities stand any chance of recovery once their priority is stacked below that of the unsecured financial and operational creditors.
Tax is deducted from the amounts paid to employees or, contractors or deposit-holders as interest. The payees would be reckoning the TDS as available to set off against their tax dues. When defaults arise, they are in double jeopardy of not only losing the amount but also suffering the consequence of under-payment of tax.
The above is what is commonly recognised as revenue loss or write-off of taxes owed.
But that is not all! The next level of loss to revenue is the tax foregone on the debts written off by the creditors who fail to recover the full dues under the IBC resolution.
In the instant case, the under-recovery is the difference between the total debts of the company of Rs3,8526 crore, and Rs9,661 crore, being the resolution value that gets distributed among all eligible creditors. The amount is Rs28,865 crore.
This, to the extent the creditors are paying taxes in India, will be eligible to adjust as debt write-off while filing their tax returns. Most of them being banks which are profitable, the write-offs will lead to lower tax payments.
The other facet of this discussion is the tax losses available for set off in the corporate debtor (CD). A business coming up before the bankruptcy court ipso facto has tax losses available to set off against future income.
In all these companies, a key asset item would be the deferred tax asset! Depending on which astrologer the auditor consults, the decision would be made to either reflect it in the revenue statement or keep it to the notes on accounts!
A question that may arise, which is a step removed from the topic under discussion, is whether such available benefits get factored in the value offered for the resolution.
Using the current case as an example, it is clearly not! Interested readers can delve deeper into this to figure out. Nor was it in other cases that had this element like Dewan Housing Finance Ltd (DHFL), Ruchi Soya and Bhushan Steel.
The quantum of such available tax benefit that goes unnoticed and omitted in valuation would be a substantial sum.
While the benefit of adjusting past losses is available for set off to the corporate debtor (CD) when it makes profits, would that stand extend to a resolution applicant taking over the CD under a corporate insolvency resolution process (CIRP)?
The current example covers this aspect, too, and that part of the NCLT order dealing with this is reproduced in full for the benefit of those interested in such details-
The order itself specifies the value of the bonanza for the resolution applicant to obviate any ambiguity later should the tax authorities, who may be legitimately chafing under the burden of tax costs of the IBC cases, play a spoilsport!
Yet another fiscal cost is the capital loss to the equity shareholders who invested in the CD at different points in time. The CIRP results in the equity value being fully written off and the resolution applicant gets 100% of the equity of the CD for the given amount invested to settle the creditors.
It is difficult to know how much such loss is in any given case, as the paid-up capital will not necessarily reflect the actual cost of shares acquired by all the investors. Those who acquired in the secondary market would have done so at highly differing amounts.
The fiscal cost is multi-layered as detailed above. The only portion the tax authorities have been fighting to hold on to is the outstanding demands on their records!
(Ranganathan V is a CA and CS. He has over 43 years of experience in the corporate sector and in consultancy. For 17 years, he worked as Director and Partner in Ernst & Young LLP and three years as senior advisor post-retirement handling the task of building the Chennai and Hyderabad practice of E&Y in tax and regulatory space. Currently, he serves as an independent director on the board of four companies.)
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