Introduction
The Insolvency and Bankruptcy Code (IBC) was enacted in 2016 with the aim of revolutionizing India’s corporate landscape by expediting debt recovery, facilitating company revival, and ensuring fairness to all stakeholders. Over the past eight years, the IBC has played a significant role in addressing corporate insolvency issues. However, its efficacy has been hindered by various tax-related challenges that continue to persist. This article explores tax challenges in IBC in depth and proposes strategies to overcome them, thereby enhancing the effectiveness of the insolvency framework.
Managing Unresolved Tax challenges within IBC
One of the significant challenges faced in insolvency proceedings under the IBC is the treatment of unresolved tax burdens from the past. Many resolution or liquidation plans approved under the IBC involve scaling back or writing off statutory dues, including taxes, owing to insufficient funds recovered during the process. However, tax authorities often continue to pursue unwarranted actions and litigation against the corporate debtor, despite the binding nature of resolution plans approved by the National Company Law Tribunal (NCLT).
The IBC’s waterfall mechanism prioritizes financial creditors over operational creditors, including the government. This hierarchy has led to disputes between tax authorities and other stakeholders, as tax claims are often treated as operational dues. While the IBC provisions supersede other laws, including tax laws, tax authorities may still challenge resolution plans and pursue aggressive recovery actions. To address this challenge, it is essential for the government to recognize the binding nature of resolution plans approved under the IBC. Tax authorities should refrain from initiating unwarranted actions against corporate debtors once a resolution plan has been approved by the NCLT. Instead, they should cooperate with the insolvency process and work towards the successful implementation of the approved plan. A more collaborative approach between tax authorities and insolvency professionals is necessary to facilitate the revival of distressed companies and maximize value for all stakeholders. Moreover, there is a need for greater clarity on the treatment of tax claims in insolvency proceedings. While the IBC provides a framework for the resolution of tax claims, there is still ambiguity regarding the extent to which tax liabilities can be compromised or extinguished as part of a resolution plan. Clear guidelines from the government on this matter would provide certainty to stakeholders and contribute to a smoother insolvency process.
Uncertainties Regarding First Charge Privileges
Another tax-related challenge in insolvency proceedings under the IBC relates to uncertainties regarding first charge privileges for tax authorities. A 2023 Supreme Court decision in the Rainbow Papers Ltd. case categorized outstanding tax demands as secured debts with first charge privileges for tax authorities, particularly if supported by existing regulations. This decision disrupted the established landscape of creditor hierarchy in insolvency proceedings. The Supreme Court’s decision has raised concerns among stakeholders, as it has the potential to impact the distribution of proceeds in insolvency cases significantly. Resolution plans that do not allocate funds for tax authorities compared to other creditors may face challenges, as tax claims are now treated as secured debts with first charge privileges. Subsequent to the Supreme Court’s decision, the Madras High Court provided some relief in the Aginiti Industrial Parks Pvt. Ltd. case by emphasizing the fact-specific nature of the ruling. However, the lack of clarity on this matter has created uncertainties for stakeholders involved in insolvency proceedings. To address these uncertainties, it is imperative for the government to provide clarity on the treatment of tax claims in insolvency proceedings. Clear guidelines should be issued regarding the priority of tax claims vis-à-vis other creditors, taking into account the objectives of the IBC and the interests of all stakeholders involved. This would help streamline the insolvency process and ensure a fair distribution of proceeds among creditors.
Respecting the Moratorium Period
The moratorium period mandated under the IBC is another area where tax-related challenges arise. The moratorium period aims to halt all legal proceedings, including tax proceedings, against the corporate debtor during the insolvency resolution process. However, there have been instances where tax authorities have continued to undertake actions, such as search and seizure operations, against corporate debtors during this period. The Supreme Court, in the Sundaresh Bhattacharjee case, clarified that tax departments have limited jurisdiction during the moratorium period, restricted to assessing and determining the quantum of tax and other levies. Despite this clarification, instances of tax authorities undertaking coercive actions during the moratorium period persist. Strict adherence to moratorium orders is essential to uphold the spirit of the IBC and ensure a level playing field for all creditors. Tax authorities should respect the moratorium period and refrain from taking any coercive actions against corporate debtors during this period. Any disputes regarding tax claims should be resolved through the insolvency resolution process, in accordance with the provisions of the IBC. Moreover, there is a need for greater coordination between tax authorities and insolvency professionals to ensure compliance with moratorium orders. Insolvency professionals should communicate effectively with tax authorities and educate them about the limitations on their jurisdiction during the moratorium period. This would help prevent unnecessary disruptions to the insolvency process and facilitate the timely resolution of corporate insolvency cases.
Income Tax Regime Amendments for Enhanced Effectiveness
While the IBC has made significant strides in addressing corporate insolvency issues, there is still room for improvement in the income tax regime to enhance the effectiveness of the insolvency framework. Several amendments have been made to the income tax laws in recent years to address specific concerns related to insolvency proceedings. However, further reforms are needed to streamline the taxation of corporate insolvency cases and facilitate the resolution of distressed companies. One area where reforms are needed is the treatment of Minimum Alternative Tax (MAT) provisions for companies undergoing insolvency proceedings. Currently, companies under insolvency may face an unnecessary tax burden due to the application of MAT provisions. Waivers of interest and loan reduction from income should be allowed for such companies within the MAT framework to prevent them from facing additional financial strain during the resolution process. Another area that requires attention is the treatment of losses in the context of insolvency-driven amalgamations and demergers. The current requirements under Section 72A of the Income-tax Act, 1961, for carrying forward losses in such cases are overly rigid and may hinder the revival of distressed companies. Relaxing these conditions, particularly regarding the continuity of business operations, would provide greater flexibility to companies seeking a fresh start through amalgamation or demerger.
Additionally, there is a need to provide clarity on the tax treatment of asset purchases from companies undergoing insolvency proceedings. Entities purchasing assets and goods from such companies should be exempt from Tax Deducted at Source (TDS) provisions to prevent procedural hurdles and facilitate the timely completion of asset sales. Furthermore, companies undergoing insolvency proceedings should be granted an extension for filing tax returns to alleviate the administrative burden on insolvency professionals and ensure compliance with regulatory requirements. The current rule of losses lapsing due to non-filing should also be relaxed for such companies to prevent additional financial strain. Lastly, there is a need for clear guidance on the deductibility of resolution process costs incurred by companies undergoing insolvency proceedings. While the IBC allows for the deduction of certain expenses incurred during the resolution process, there is still ambiguity regarding the eligibility criteria and the extent of deductibility. Clear guidelines from the government on this matter would provide certainty to stakeholders and encourage greater participation in the insolvency resolution process.
Conclusion: Addressing Tax Challenges in IBC
In conclusion, while the Insolvency and Bankruptcy Code has made significant strides in addressing corporate insolvency issues in India, its effectiveness is hindered by various tax-related challenges. To enhance the efficiency of the insolvency framework and ensure a fair and streamlined resolution process, it is imperative for the government to address these challenges through targeted reforms and policy interventions. By providing clarity on the treatment of tax claims, respecting moratorium orders, and implementing necessary amendments to the income tax regime, the government can unlock the full potential of the IBC and facilitate the timely resolution of corporate insolvency cases.
