India has had a long-suffering history of Non-performing Assets (NPA) which has handicapped the lending power of banks and financial institutions and has adversely impacted new capital investments by private sector halting the economic growth.
Key factors leading to such situation include global slowdown, governance related issues, inefficiencies, sector specific issues, such as raw material linkages, etc. The trend in the stressed assets reveals that major stressed sectors are infrastructure, iron and steel, textiles, aviation and mining.
To resolve the NPA issue and consequential balance sheet problem, the Reserve Bank of India (RBI) and government together introduced a host of schemes such as Strategic Debt Restructuring, Corporate Debt Restructuring, and the Scheme for Sustainable Structuring of Stressed Assets (S4A) etc. Last, the Insolvency and Bankruptcy Code 2016 (IBC) was enacted, which also inter alia aims at resolving these issues.
The RBI had initially announced 12 stressed accounts followed by additional 28 accounts and had issued directions to bankers to resolve these accounts on a priority basis.
While we write this article, there are various companies under the insolvency resolution process and other schemes wherein the bidders have shown interest in acquiring the assets, if bankers agree for a substantial haircut. Even if the banks now appear more amenable to a haircut, there are various bottlenecks from a taxation perspective which increase the overall transaction or acquisition costs.
Many of the companies under IBC or other resolution schemes are listed and any structuring measure such as sale of equity (either from the promoter or from banks which have converted portion of their debt into equity) may have to be undertaken post considering the anti-abuse provisions of Income-tax Act, 1961 such as 56(2)(x).
While the share prices of the companies are heading north on the backing of an expected future turnaround pursuant to change in promoter, which is good for shareholders, but from the new investor’s perspective, buying the shares at the prevalent stock market price to avoid anti-abuse provisions coming into play is unworkable since the prevalent stock market prices do not reflect the true value. The upfront tax cost pursuant to this section has the unfortunate potential of making the transaction economically unviable.
Another key concern resulting from the change in the control and ownership (of closely held companies) is the lapse of tax losses for the companies.
Further, from an accounting perspective, waiver or haircut of loans and accrued interest may lead to a credit in the profit and loss of the companies. From a tax perspective, under the normal provisions of the Act, principal loan waiver, arguments exist that the waiver or write back should not be subject to tax, if the utilization of loan was for capital purposes, the difficulty aggravates under the Minimum Alternate Tax (MAT) provisions.
While there are some judicial precedents which suggest non-taxability of principal loan waiver under the MAT provisions, from an investor’s perspective, the entire issue needs clarity and not being a possible litigation point.
Recently, the Central Board of Direct Taxes (CBDT) came out with a press release for allowing set-off of entire brought forward losses (including unabsorbed depreciation) while computing the MAT taxes, which may provide some relief to companies covered under the IBC. However, the press release does not include other restructuring scheme such as SDR, S4A, etc. Further, it would also be important to note that the possible tax liability on this account would arise upon conclusion of assessment which would be few years post the acquisition.
Above all, transfer of stressed assets are not free from stamp duty, and hence to encourage smooth, cost effective transfers, government should consider relaxing stamp duty on such transfers.
Considering the tax issues discussed above, an investor would prefer clarity and in absence thereof would require further reduction in valuation. This may result into a higher haircut for the banks.
As we write, the government has announced allocation of recapitalisation bonds between various banks to tide over the balance sheet issue. Higher haircut for banks as opposed to current estimates will mean a higher recapitalisation requirement from the government. In other words, the decision rests with the government – whether to impact the right pocket by resolving the above tax issues or to the left pocket by increasing the recapitalisation amount.
From an overall perspective, if India wants to have a smooth and effective resolution process, which will be a win-win situation for everyone, government should consider addressing the above issues in the Union Budget 2018-19.
Updated Date: Feb 01, 2018 10:41 AM