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Introduction
India’s Insolvency and Bankruptcy Code (IBC), enacted in 2016, represents a progressive legal framework aimed at revitalising distressed companies and ensuring timely debt recovery. A key principle underlying the IBC is the “clean slate principle,” which allows corporate debtors to be absolved of past liabilities following the approval of a resolution plan. This concept is crucial for attracting resolution applicants and facilitating the restructuring of distressed assets.
However, the interplay between the IBC and tax laws, such as the Central Goods and Services Tax Act, 2017 (CGST Act) and the Income Tax Act of 1961, introduces complexities that can hinder the IBC’s objectives. These complexities primarily arise in the post-resolution plan phase, where ambiguities in tax law provisions can create challenges for both corporate debtors and successful resolution applicants.
This article will delve into the challenges posed by the intersection of tax laws and the IBC, specifically focusing on the uncertainties surrounding tax claims in the resolution process and their impact on the clean slate principle.
The Clean Slate Principle and Tax Claims
The IBC’s clean slate principle, enshrined in Section 31, is fundamental to its efficacy. It ensures that once a resolution plan is approved, it binds all stakeholders, including tax authorities. This means that tax claims not included in the resolution plan are extinguished, providing the successful resolution applicant with a fresh start.
The Supreme Court in Ghanashyam Mishra and Sons (P) Ltd. v. Edelweiss Asset Reconstruction Co. Ltd.1 (Ghanashyam Mishra) affirmed this principle, holding that government dues, including tax claims, are considered ‘operational debt’ and are extinguished if not part of the approved resolution plan. This ruling reinforced the IBC’s intent to provide a clean slate to resolution applicants, preventing unexpected claims from derailing the revival of distressed companies.
However, this position was later challenged by the Supreme Court’s decision in State Tax Officer v. Rainbow Papers Ltd.2 In this case, the court treated the government as a secured creditor, asserting that statutory dues should be prioritized in the resolution plan. This ruling contradicted the clean slate principle established in Ghanshyam Mishra and created uncertainty regarding the treatment of government dues in the IBC process.
The Supreme Court’s dismissal of review petitions against the Rainbow Papers decision has further solidified this deviation, raising concerns about its potential impact on the IBC framework.
Challenges Arising from Tax Law Ambiguities
To understand the challenges, it is important to examine the mechanism of the post-resolution plan phase. The Corporate Insolvency Resolution Process (CIRP) starts with the admission of the CIRP Application (Section 7,8 & 9 of IBC) by the Adjudicating Authority, coupled with the imposition of Moratorium and Public Announcement (Section 13 of IBC), after which CIRP commences with the negotiations between the Committee of Creditors (CoC) and the Resolution Professional (RP). The problem crops up when the successful summation of claims and the disbursal thereof lead to interference by the tax authorities when their tax dues remain unsettled in an Assessment Year, which means that the tax dues stand extinguished by virtue of the terms of the Resolution Plan.
The Clean Slate principle, after the approval of the Resolution Plan, subsumes all the claims made by the Creditors, including the Tax Authorities as operational creditors, whereby the uncrystallised claims stand extinguished because of the binding nature of the Resolution Plan. Beyond the conflicting judicial interpretations, specific provisions within tax laws also create ambiguities in the context of the IBC.
Anti-Profiteering Rules and Resolution Plans: Section 171 of the CGST Act contains anti-profiteering rules, which mandate that any reduction in tax rates or input tax credit benefits must be passed on to the recipient of goods or services. This provision can conflict with the clean slate principle if resolution plans are construed to fall under its ambit. For instance, if a corporate debtor is a supplier and a creditor is a customer, the reduction or extinguishment of claims under a resolution plan could leave the creditor without recourse under the anti-profiteering rules.
Taxability of Claims Under Resolution Plans: The Income Tax Act 1961 includes provisions, such as Section 41(1)(b), that deem certain remissions or cessations of liabilities as taxable income. However, it is unclear whether settled claims under a resolution plan fall within the scope of these provisions. The treatment of extinguished claims under a resolution plan in comparison to loan waivers also adds to the ambiguity.
GAAR Provisions and Resolution Plans: The General Anti-Avoidance Rules (GAAR), introduced to prevent tax evasion, could potentially conflict with the IBC. While the Central Board of Direct Taxes (CBDT) has clarified that GAAR does not apply to arrangements sanctioned by the National Company Law Tribunal (NCLT), including resolution plans, uncertainties remain. For example, deferred tax liabilities under a resolution plan might be construed as an impermissible avoidance arrangement under GAAR.
Minimum Alternate Tax (MAT) and Resolution Plans: The applicability of the Minimum Alternate Tax (MAT) to waived tax liabilities under a resolution plan is another area of concern. Although the Income Tax Act includes insolvency applications filed with the NCLT in the definition of book profits for MAT calculation, it is unclear whether the waived tax liability would be subject to MAT in the hands of the successful resolution applicant.
Judicial Interpretations and the Path Forward
Judicial decisions have attempted to address some of the conflicts between the IBC and tax laws, but inconsistencies and ambiguities persist.
The Ghanshyam Mishra ruling supported the clean slate principle, prioritizing the IBC over tax claims not included in the resolution plan. However, the Rainbow Papers decision introduced a conflicting perspective by treating the government as a secured creditor and emphasizing the priority of statutory dues.
Subsequent decisions, such as Paschimanchal Vidyut Vitran Nigam Ltd. v. Raman Ispat Pvt. Ltd.3, have attempted to reconcile these conflicting views by reiterating the importance of the waterfall mechanism under Section 53 of the IBC, which prioritizes secured creditors over government dues.
Despite these efforts, the legal landscape remains uncertain. The dismissal of review petitions in the Rainbow Papers case4 has further complicated the situation, potentially emboldening tax authorities to pursue tax claims aggressively against entities undergoing insolvency resolution.
To address these challenges and ensure the effective implementation of the IBC, legislative clarity is crucial. Amendments to the CGST Act and the Income Tax Act are needed to explicitly address the treatment of tax claims in the context of resolution plans. These amendments should clearly define the priority of government dues, the permissible timing for raising tax claims, and the treatment of belated claims.
Conclusion
The IBC has been instrumental in transforming India’s insolvency resolution framework, but the ambiguities arising from the interplay with tax laws threaten to undermine its objectives. The conflicting interpretations of the clean slate principle and the uncertainties surrounding the treatment of tax claims create challenges for both corporate debtors and resolution applicants.
Legislative intervention is necessary to provide clarity and harmonise the IBC with tax laws. By establishing clear rules for the treatment of tax claims in the insolvency resolution process, India can ensure the continued success of the IBC in reviving distressed companies and promoting economic growth.
