Budget 2019: How Changes In Income Tax Act Benefit Stressed Companies And Their Investors

Finance Minister Nirmala Sitharaman removed impediments in Income Tax Act that are aimed at benefiting distressed entities.
A sign reading “Pay Your Tax” sits outside the income tax office in Kolkata. (Photographer: Brent Lewin/Bloomberg)
A sign reading “Pay Your Tax” sits outside the income tax office in Kolkata. (Photographer: Brent Lewin/Bloomberg)

Finance Minister Nirmala Sitharaman offered relief to distressed companies and their investors by removing impediments in the Income Tax Act towards such entities.

Here are the Budget 2019 proposals towards enabling quicker resolution of distressed firms:

  • Allowing carry-forward of accumulated losses in closely-held companies.
  • Allowing deduction of unabsorbed losses and depreciation in computation of minimum alternate tax.
  • Exempting investors in stressed assets from capital gains in certain cases.

The key changes in the Income Tax Act relate to transfer of shares and property under sections 50 (CA) and 56(2)(x).

Section 56 of the act says persons may have to pay tax when they receive:

  • Money without any consideration, or as a gift.
  • Property without consideration or for a consideration lesser than its fair market value.

Transfer Of Shares

Section 50 (CA) deals with transfer of unlisted shares. It contains a provision under which a person may have to pay tax when the consideration received by her is less than the fair market value of such shares.

Companies investing in distressed industries are disincentivised due to these two provisions. Shares in distressed companies are valued at a price lesser than their fair market value due to their debt and operational difficulties. As investors invest at lower valuations, they become liable to pay tax on the difference between the fair market value of the shares and the actual price paid by them. Budget 2019 removes this problem by allowing the tax department to exclude the applicability of these sections in certain cases.

Taxing the difference between the price paid by the investor and the fair market value at 30 percent was a high tax cost to the investor, said Daksha Baxi, head of international taxation at Cyril Amarchand Mangaldas, told BloombergQuint. “Similarly, shareholders selling their shares at a lower valuation compared with the fair market value were deemed to have made a capital gain. Granting exemption from this provision is a big relief for investors.”

Carrying Forward Accumulated Losses

Section 79 of the Income Tax Act allows firms to carry forward and set off losses for eight subsequent financial years, subject to restrictions. That may be denied if ownership of a majority shareholding in the company—51 percent of shares—is changed in a financial year. This would hurt strategic investors buying out stressed companies as the tax department would deny claims for set off of accumulated losses.

Budget 2019 allows distressed companies under the Insolvency and Bankruptcy Code to claim accumulated losses. In such cases, the National Company Law Tribunal must allow the principal commissioner or commissioner of income to be heard.

The tribunal may allow a restructuring of ownership in a company or suspension of directors by the central government in cases of oppression and mismanagement.

There were also cases of tax benefits being denied due to changes in shareholding structures due to restructuring. Budget 2019 relaxes the applicability of Section 79 to such companies and its subsidiaries.

“Not allowing carry forward and set off of losses has been a great pain point for companies undergoing resolution under the IBC,” Baxi said. “Such companies are taken over by investors who buy shares from existing shareholders and paying off the creditors,” she said, adding: “Denying them benefit from the previous losses creates a disadvantage.” Through the amendment, it’s being provided that a company undergoing restructuring can carry forward the losses if principle commissioner of Income tax is given an opportunity of being heard, she said.

Deductions Under Section 115JB

Section 115JB deals with minimum alternate tax—or the tax applicable to companies whose income tax payable on their total income for a previous year is less than 18.5 percent of its book profit. In such cases, the profits are considered total income and 18.5 percent tax is levied on it.

However, these provisions didn’t allow companies undergoing restructuring or management change under Section 241 of the Companies Act to deduct unabsorbed depreciation or brought-forward losses while calculating profit. This increased the company’s profit and its tax liability.

Budget 2019 now allows companies to reduce losses brought forward, including unabsorbed depreciation from the book profit, for levying minimum alternate tax. The amendment becomes effective from April next year.

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