Income tax through the prism of Insolvency and Bankruptcy Code

The Insolvency and Bankruptcy Code, 2016 (‘IBC’), as stated in the preamble of the code, has been enacted as a legislation for consolidating and amending the laws relating to reorganisation and insolvency resolution in a time-bound manner for maximization of value of assets , promote entrepreneurship, availability of credit including alteration in the order of priority of payment of government dues. The provisions of IBC have an overriding effect over other enactments in case of any inconsistency. To give teeth to the IBC, amendments have been made under several legislations including the Companies Act, Income Tax Act, The RDBFI Act, SARFAESI Act, etc.

Given this backdrop, it is relevant to examine the interplay of IBC vis-à-vis the Income Tax Act and its impact on the latter. This understanding assumes significance as it impacts the interests, rights, obligations and duties not only of the taxpayer and the income tax authorities, but also other stakeholders such as the creditors, resolution applicant, resolution professional, liquidator, etc.

Does the IBC prevail over tax laws?

The primary question-whether IBC prevails over the Income Tax Act can be analysed in light of S. 238 of IBC which states to the effect that provision of IBC overrides all other enactments to the extent inconsistent. The provision provides as under:

“The provisions of this Code shall have effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law.”

In this context, the overriding effect of IBC over the Income Tax Act has been examined by the Hon’ble Supreme Court in the case of Pr. Commissioner of Income Tax Vs. Monnet Ispat and Energy Ltd, wherein the court has ruled that S. 238 of IBC will override anything inconsistent contained in any other enactment, including the Income Tax Act. This has significant impact on regular tax matters as can be inferred from judicial development over the period.

Suspension of tax proceedings and institution of appeals during moratorium

The IBC provides for a period of moratorium from the date of admission of resolution application by the Adjudicating Authority i.e. the National Company Law Tribunal (NCLT). The moratorium is declared u/s 14 of IBC which prohibits-

“the institution of suits or continuation of pending suits or proceedings against the corporate debtor including execution of any judgement, decree or order in any court of law, tribunal, arbitration panel or other authority”.

Such moratorium has effect till the completion of the corporate insolvency resolution process or approval of resolution plan or passing of order for liquidation of corporate debtor.

In context of tax laws, it merits consideration that the moratorium also applies to tax proceedings, appeals and litigations (pending or new) during the period. The position has been upheld by the Hon’ble Delhi High Court (affirmed by the Hon’ble Supreme Court) in PR. COMMISSIONER OF INCOME TAX-6, NEW DELH v. Pr. Commissioner of Income Tax Vs. Monnet Ispat and Energy Ltd.

It is however relevant to note that in certain cases, for instance, as was in the case of Deputy Commissioner of Income Tax Vs. Bhuvan Madan RP for Diamond Power Infrastructure Ltd. & Anr, considering the necessity of the assessment arising out of search proceedings and findings of irregularities by the Corporate Debtor (which may have led to huge tax demand), the prayer of the tax authorities was accepted to the extent of only conducting assessment. The continuation of proceedings was considered necessary to protect the interest of the exchequer. The NCLT however directed that tax authorities may file their claim as operational creditor with the resolution professional for examining the claim in accordance with the provisions of the code.

The short point being that tax proceedings including litigation before appellate forums would need to be kept in abeyance during the moratorium period. In certain cases, and as an exception to the general rule, continuation may be permitted subject to necessary direction by the NCLT. However, such proceedings cannot culminate in enforcing recovery of outstanding taxes during the moratorium period which can only be claimed in the manner prescribed for operational creditors.

Downward settlement of crystalized tax liability under resolution plan

One significant impact of IBC on income tax law is regarding the recovery of tax due. As part of the resolution process, the resolution applicant (for simplicity – the potential acquirer) is required to submit a resolution plan for the revival of the corporate debtor, which on approval by the NCLT is binding. The resolution plan provides for, amongst others, the payment of debts of operational creditors which cannot be less than the amount to be paid to such creditors in the event of a liquidation of the corporate debtor.  In other words, the resolution plan would typically provide for a haircut of the outstanding dues towards various stakeholders including operational creditors and resultantly also the dues of the tax authorities (regarded as operational creditors).

The significance and magnitude of this can be judged from the facts in the case of Pr. Director General of Income Tax (Admn. & TPS) & Ors. Vs. Synergies Dooray Automative Ltd. & Ors. wherein NCLT (Hyderabad) approved the resolution plan under which the income tax liability/ demand in respect of the corporate debtor amounting to Rs. 338 Crores was settled for 1% of the ‘crystallized demand’ to a maximum of Rs.2.58 crores. In the appeal filed against the order of the NCLT, The NCLAT (Delhi) ruled that statuary dues are operational creditors and equated with similarly situated ‘operational creditors’. There was accordingly no infirmity in settlement of tax dues pursuant to approved resolution plan thereby approving a significant write-off of statutory dues.

Tax during liquidation

Another interesting issue recently arose in the case of LML Limited Vs. Office of Commissioner of Income Tax, Mumbai [NCLT Allahabad Bench] regarding payment of capital gain tax on sale of assets of the corporate debtor in liquidation. The question was whether such capital gain tax would form part of ‘liquidation expense” and hence payable in priority of other claims such as of secured creditors & workmen compensation etc, as per waterfall mechanism u/s 53 of IBC. The NCLT ruled that capital gain tax would not form part of liquidation cost and hence can only be recovered in the order of priority specified u/s 53. The NCLT took note of the amendment in section 178(6) of the Income Tax Act providing overriding effect of IBC and also S. 238 of the IBC ruling that the provision of the code shall have an overriding effect on any other enactment. While one may debate whether capital gain liability arising in the circumstances is ‘liquidation expense’ or not, however if the determination is held to be correct, there can be significant impact on recovery of taxes by the exchequer consequent to overriding effect of IBC.

In somewhat relatable situation, in Om Prakash Agarwal Vs. Chief Commissioner Of Income Tax  (TDS) & Anr., the question arose with respect to applicability of TDS on sale proceeds received by the liquidator under section 194 (IA) [TDS of 1% applicable on transferor of immoveable property]. The Principle Bench, NCLT held in favour of the tax authorities observing that the overriding effect u/s 238 is applicable to the issues between the creditor and the debtor but not to TDS deductions. It held that deduction of TDS does not tantamount to payment of government dues in priority to other creditors since it is not a tax demand for realisation of tax dues. It observed that the liquidator is not asked to pay TDS and it is the duty of the purchaser to credit TDS to the account of income tax authorities.

In conclusion, the above highlights some of the nuances of law and the issues involved relating to aspects of tax proceedings, recovery of tax, tax deduction, attachment of assets, etc. Ordinarily, the conventional wisdom on tax laws would generally lead one to assume the overarching dominance of the tax laws and administration against all others claims and proceedings. Given much has changed with the advent of IBC, an isolated analysis of the income tax law will be entirely inadequate while dealing with tax matters. Both legislations prescribe severe implications in case of defaults under either law making it that much more relevant to examine the tax laws through the prism of IBC.

Contributed by Yatin Sharma.

Yatin can be reached at yatin.sharma@aureuslaw.com.

Receipt of amalgamated company’s shares in lieu of shares held as ‘stock-in-trade’ is realization of income (Delhi High Court)

The Delhi High Court (HC) in a recent decision in the case of Commissioner Of Income Tax vs M/S Nalwa Investment Ltd has examined an important question-whether any income accrues to a shareholders (holding such shares as ‘stock in trade’) upon receipt of shares of the amalgamated company in lieu of shares held in the amalgamating company. In the lower appellate proceedings, the Income Tax Appellate Tribunal (ITAT), had taken a view that no profit accrues unless the shares held are either sold or transferred otherwise for consideration, irrespective of the nature of holding (i.e. whether held as ‘investment’ or ‘stock-in-trade’). In other words, the ITAT held that no taxable event arose on receipt of share in the amalgamated company and hence it would not matter whether such shares are held as ‘investment’ or ‘stock in trade’ without going into the issue of characterization of shares. Impliedly, event of taxability was co-related to the transfer of shares of the amalgamated company.

The conclusion drawn by the ITAT was regarded erroneous by the HC considering the law settled by the Supreme Court (SC) in the case of Grace Collis. The SC in the matter has ruled that upon amalgamation, the shares held by the shareholders of amalgamating company are ‘extinguished’ and covered under the scope of ‘transfer’ u/s 2(14) of the Income Tax Act, 1961 for the purpose of capital gain [though exempted u/s 47(vii)].

However, the important debate of relevance that arose in the matter was whether any income would arise if the shares were held as ‘stock in trade’ (i.e. not as capital asset and thus outside the scope of capital gain.). It was argued by the assesses that if the shares are held as stock-in-trade, the receipt of shares of the amalgamated company could not lead to income in the hands of assessee since there can be no addition of any notional accretion/notional profit under the head ‘profit and gain of business or profession’ u/s 28 of the Act. Only profit on realisation of stock- in-trade by way of sale can be brought to tax under that head.

The HC accepted the basic proposition that no notional gains can be taxes in case of ‘stock-in-trade’. However, the HC observed that in the instant case, the assessee had received shares of amalgamated company in lieu of amalgamating company, the new shares did not represent the same stock in the inventory of the assesses and such shares would be valued entirely on different fundamentals. Further, under the scheme of amalgamation, the dissenting shareholders receive the value of their shareholding while the approving shareholders receive the same value in the form of shares of the amalgamated company and taxation principles would apply equally irrespective of the status of the shareholder. Accordingly, upon receipt of new shares (against shares in amalgamating company), there was actual realization of income and not notional accretion/profit. In arriving at the conclusion, the HC drew support from the decision of the SC in the case of Orient Trading Co. Ltd., (which was in context of exchange of shares) and certain English case laws on the subject referred to by the SC.

In conclusion, the HC has opined on an important principle of taxation relating to extinguishment of shares held as ‘stock in trade’ consequent to amalgamation. While the principle that no income arises by mere holding of inventory on account of notional gains is well established, however, extinguishment of shares and receipt of new shares in lieu thereof would be a case of ‘actual realization’ of income and not ‘notional income’ as clarified by the HC.  The ruling bears significance for taxpayers engaged in the business of stock trading who receive shares in a scheme of amalgamation in lieu of shares held in amalgamating company prompting a review of the tax position.

Contributed by Yatin Sharma. Views are personal.

Yatin can be reached at yatin.sharma@aureuslaw.com.

UN expert committee proposes new Article for taxation of Income from Automated Digital Services

The digital industry will remain vulnerable to tax challenges until an acceptable global mechanism of taxation is uniformly adopted across countries. While steps for global consensus is underway, in the interim, several countries have adopted own practices to garner their share of tax. Principally, the right to tax the new digital economy cannot be questioned. However uncoordinated independent actions by countries would lead to unsurmountable economic and fiscal challenges for global digital companies.

India is amongst the first countries to impose Equalization levy, a mechanism of digital tax being an outcome of BEPS Action 1 Report: Addressing the Tax Challenges of the Digital Economy. Several countries including France, United Kingdom, Italy, Austria, Belgium, Norway, Malaysia etc. have either implemented or are in the process of implementing digital tax over the next 1-2 years in absence of broader consensus. India had introduced Equalization Levy (EL) in 2016 covering predominantly advertising services which has recently (effective April 2020) been substantially expanded to  ‘e-commerce supply or services’ (i.e. online sale of goods owned by the e-commerce operator or provision of services provided by the e-commerce operator or facilitation of online sale of goods or services). It will be reasonable to assume that EL is a transitory levy and will be replaced by a uniform basis of taxation under the tax laws upon consensus being reached amongst nations.

In this direction, the Drafting Group of developing country members of UN Tax Committee has recently (July 2020) presented for debate draft new Article 12B (with explanatory commentary) to address tax challenges of digitalised economies for insertion in the UN Model Tax Convention. Interestingly, the draft has been jointly forwarded by India’s Joint Secretary (Foreign Tax & Tax Research), Department of Revenue on behalf of the drafting group for further consideration. Though technically, this may not represent India’s formal position, however given the close involvement at the drafting stage, it may well reflect India’s view on the acceptable mechanism for addressing the digital tax challenge and its coverage.

The Drafting Group has proposed insertion of new Article 12B – INCOME FROM AUTOMATED DIGITAL SERVICES in UN Model convention to deal with the TAX TREATMENT OF PAYMENTS FOR DIGITAL SERVICES. The proposed Article provides for the taxability of income from ‘automated digital services’ arising in a Contracting State and paid to a resident of the other Contracting State at an agreed percentage (to be established through bilateral negotiations) of gross revenue.  Alternatively, it provides an option to the recipient to subject its ‘qualified profits’ from ‘automated digital services’ to taxation at domestic law rates. ‘Qualified profit’ for the purpose has been deemed at 30% of the profitability ratio (applied on gross revenue) of the multinational group or of the ‘automated digital business’ segment, if available.

Put simply, 30% of the multinational groups ‘automated digital business’ segment profitability (or overall profitability where segment profit cannot be determined) will be deemed as taxable profit and subject to tax at applicable domestic tax rates.

Taxability in case of PE will be outside the scope and subject to general PE taxation. Likewise, income falling within the ambit of FTS will be taxable under the relevant FTS Article.

The proposed Article defines ‘income from automated digital services’ to means “any payment in consideration for any service provided on the internet or an electronic network requiring minimal human involvement from the service provider.” The explanatory commentary has illustrated the following services as falling within the purview of ‘automated digital services’

  • Online advertising services – placing advertisement on a digital interface; purchase, storage and distribution of advertising messages, advertising monitoring and performance measurement.
  • Online intermediation platform & Social media services – providing digital interface for enabling interaction between users, including for the sale, hire, advertisement, display or other offer by users of particular goods, services, user-generated content or other property to other users.
  • Digital content services- automated provision of data in digital form, such as computer programs, applications, music, videos, texts, games and software.
  • Cloud computing services – standardized on demand network access to information technology resources.
  • Sale or other alienation of user data – provision of data to a third-party customer, where the data is generated by users of a digital interface, and is collected, compiled, aggregated or otherwise processed into data through an automated algorithm.
  • Standardized online teaching services – provision of an online education programme provided to an unlimited number of users, not requiring live presence of an instructor or significant customization on behalf of an instructor to a particular user or limited group of users

On the other hand, customised services provided by professionals and online teaching services; services providing access to the Internet or to an electronic network; broadcasted services; composite digital services embedded within a physical good irrespective of network connectivity (internet of things) have not been regarded as ‘automated digital services’.

The scope also excludes online sale of goods and services other than ‘automated digital services’ i.e. the sale of a good or service completed through a digital interface where: (i) the digital interface is operated by the provider of the good or service; (ii) the main substance of the transaction is the provision of the good or service; and (iii) the good or service does not otherwise qualify as an ‘automated digital service’.

At first sight, the approach being recommended seems equitable giving flexibility for adopting revenue based gross taxation (rates bilaterally negotiated between contracting countries) or 30% taxation of ‘qualified profits’ (profitability ratio of digital business segment). Nevertheless, finer aspects would need to be addressed, specifically in relation to ‘qualified profit’ approach.

For instance, countries would need to arrive at a consensus on accepting global financial statement (accounting policies as adopted) without any flexibility for country specific adjustment for profit and revenue determination. Taxpayers could perhaps be obligated to make segment reporting for ‘automated digital business’ to capture appropriate profit of such business, prevent cross subsidization and neutralizing exceptional items. A loss scenario would need to be addressed. A consequence of ‘qualified profits’ approach will also be a skewed allocation of profit in favour of price sensitive economises which may contribute lower profits compared to developed markets commanding higher price realization for services. Further, global companies are supported by development centres and back offices around the world and pay local taxes. Imposing taxes based on ‘qualified profit’ without factoring local taxes already paid in the larger scheme of things would lead to double taxation. Some of these challenges will need to be ironed out.

From an Indian context, the proposed ambit of ‘automated digital services’ includes automated provision of computer program/software. This may well mean that the Indian tax authorities may finally get to tax software (under treaty provisions), a matter which is sub-judice before the Apex Court. But what about software sales other than through digital means? Logically, there should not be a different treatment, however the proposed scope does not specifically provide for such taxation.

Further, the ambit of proposed Article excludes sale of a good or service through a digital interface (other than those categorised as ‘automated digital services’). This would suggest that sellers/providers of goods and services, say for example a seller of books or tangible product listed on the intermediation platform will not be covered under the ambit of the Article. It may not matter whether the platform is operated by the seller itself or whether it is a third-party marketplace platform. On the other hand, if for instance, the sale is of computer program/software (whether through own or other market-place platform), the same will fall within the ambit of proposed Article (being covered under ‘automated digital services’ category). Importantly, from an Indian context, the scope is much restricted vis-à-vis the Indian EL in the current form which on literal reading applies to all online sale of goods and services whether through own operated electronic facility or third-party marketplace. The coverage proposed under the Article seems more logical than what is presently provided under the Indian EL regime.

In conclusion, there may not be a flawless solution for digital taxation given the constant technological advancement, cross border nature of business and complexity of business models. As one debates this further, more issues will be identified and would need to be addressed. Nevertheless, a framework for discussion is now in place and hopefully a consensus may not be far away – a much needed tax legislation for the digital economy.   

Contributed by Yatin Sharma. Views are personal.

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Yatin can be reached at yatin.sharma@aureuslaw.com

Deciphering the IBC Ordinance 2020

With a view to aid struggling businesses in wake of the COVID-19 pandemic and consequent nation-wide lockdown, Government of India has introduced two major amendments under the Insolvency and Bankruptcy Code, 2016 (“IBC / Code”). It has suspended functioning of Sections 7, 9 and 10 for 6-months and further granted exemption to transactions which may be deemed as wrongful trading transactions under Section 66(2), during this period. These amendments were brought into effect vide the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 dated June 5, 2020 (“Ordinance”). The Ordinance can be accessed here.

Section 10A – Analysis

Sections 7 and 9 relate to insolvency proceedings against corporate persons by financial creditors and operational creditors. Section 10 relates to insolvency proceedings initiated by corporate debtor against itself.

By way of this Ordinance, Section 10A has been introduced under IBC. It states that in relation to Sections 7, 9 and 10, no application to initiate corporate insolvency resolution process (“CIRP”) shall be filed for defaults occurring on or after March 25, 2020 till a period of 6-months. It stipulates that this period may be extended, but not beyond 1-year. The Ordinance further clarifies that no application could ever be filed in relation to defaults for aforementioned period. Further, Section 10A would not apply to defaults occurring prior to March 25, 2020. 

Hence, Section 10A stipulates three things; one, default occurring between March 25, 2020 and September 25, 2020 or March 25, 2021 (if extended) (“exempt period”) would not be considered as default. Two, for this period, no corporate person could ever be brought under ambit of IBC. Three, defaults occurring prior to March 25, 2020 would not be affected by Section 10A, and fresh proceedings therein may be filed.

Remedy suspended for exempt period, claim remains intact 

The introduction of Section 10A would effectively eliminate defaults committed during the exempt period from being considered for the purposes of bringing a corporate person under IBC in future. However, the question which arises is whether this would mean that claims arising vis-à-vis defaults committed during such exempt period would stand extinguished completely. For this purpose, it becomes pertinent to understand claim, debt and default as provided under IBC, which has been explained in the diagram herein below:

The Ordinance however, categorically states that filing of petitions for defaults committed during the exempt period is not allowed. It does not state that those amounts can never be claimed or cannot be ‘debt’ under IBC.

Therefore, when default continues beyond the exempt period, and aggregate amount of default (after eliminating default amount during exempt period) comes upto INR 1 crore, the creditor can initiate insolvency proceedings. However, this exclusion could be interpreted to be applicable only vis-à-vis filing of applications and it may not have an impact on claims filed before the Resolution Professional (“RP”) once CIRP has commenced.

Hence, it would appear that merely the remedy available to a creditor for bringing a corporate person under IBC has been suspended with respect to defaults during the exempt period. The creditor’s right to claim amounts in relation to these defaults would remain intact.

No effect on other proceedings under IBC or parallel remedies

Section 10A only suspends the functioning of Sections 7, 9 and 10 of IBC for the exempt period. It does not touch upon other proceedings under the Code, which may continue to function normally. For instance, proceedings already pending under these aforementioned sections wherein CIRP has been admitted or application is reserved for orders; applications required/ made during the course of CIRP; initiation of liquidation proceedings under Section 33; initiation of insolvency resolution process against personal guarantors under Sections 94 and 95 and initiation of bankruptcy against personal guarantor under Section 121, etc.

Additionally, the remedies available to a creditor other than under IBC may still be availed. Viz. a suit for recovery under provisions of the Code of Civil Procedure, 1908; proceedings under Recovery of Debts and Bankruptcy Act, 1993, proceedings under Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002, etc. would not be affected by promulgation of the Ordinance.

Section 66(3) – Analysis

Section 66 of IBC allows the Adjudicating Authority (“AA”) to declare any third persons (in case of fraudulent trading transactions) and directors/ partners (in case of wrongful trading transactions) liable for such transactions. Under the said section, the AA is empowered to pass orders to this effect upon an application by the RP under Section 66(1)(2).

Vide the Ordinance, a new provision in the form of Section 66(3) has been inserted. It states that if a wrongful trading transaction as stipulated under Section 66(2) has taken place during the exempt period, the RP cannot not file an application before the AA to hold the directors/ partners liable for those transactions.

This would be applicable in the event CIRP is commenced against a corporate person in future (i.e. post exempt period and if default is INR 1 crore, after deducting default amount for exempt period) and is ongoing/ liquidation has commenced.

Under the current unprecedented circumstances, directors/ partners may take certain decisions in the financial interest of their businesses, which could be deemed as wrongful trading transactions, should the entity enter into CIRP in future. However, the insertion of Section 66(3) provides a blanket protection to the directors/ partners for such transactions entered into during the exempt period.

Conclusion

The suspension of Sections 7, 9 and 10 may provide relief to stressed businesses being adversely impacted due to COVID-19. It appears that this suspension would go hand-in-hand with the extended moratorium granted by the Reserve Bank of India (“RBI”) vide press release dated May 22, 2020. The press release can be accessed here. Hence, it would appear that financial creditors would benefit under this scenario.

The brunt of the amendment may be faced by operational creditors or financial creditors who are home buyers. Further, for continuing defaults beyond the exempt period, it may prove difficult to establish aggregate default of INR 1 crore. To proceed under IBC, such creditors would either have to file application jointly (in case of financial creditors meeting requirements under Section 7(1)) or wait till aggregate debt becomes INR 1 crore or CIRP is initiated as a result of some other creditor’s application.

In the alternate they would be required to approach other forums, and the multiplicity of proceedings in various forums may lead to confusion and may prove counter-productive for all stake holders.

[1] The Ordinance can be accessed here.

[2] The press release can be accessed here.

Contributed by Sayli Petiwale, with inputs from Vineet Shrivastava, Astha Srivastava.  

Sayli can be reached at sayli.petiwale@aureuslaw.com.

Creation of Payments Infrastructure Development Fund 

The Reserve Bank of India (“RBI”) on June 5, 2020 announced creation of a Payments Infrastructure Development Fund (“PIDF”) of INR 500 crores.[1] This would boost the deployment of Point of Sale (“PoS”) devices in tier-3 to tier-6 centres and north eastern states. It would also help in enhancement of PoS infrastructure (both physical and digital modes) in these underserved areas.

In this regard, the initial funding of INR 250 crores would be provided by the RBI. The remaining amount of INR 250 crores would be contributed by card issuing banks and card network companies. Also, contributions would be provided by banks and card network companies in the PIDF to cover operational expenses. The RBI may further contribute towards the yearly shortfalls, if required. The PIDF would be governed through an Advisory Council and managed and administered by the RBI.

This step would encourage the development of digital payments ecosystem in the underserved areas of the country. The deployment of PoS devices would support businesses to accept payment through digital/ e-modes, which in turn would help in reduction in cash transactions.

Contributed by-

Astha Srivastava

[1] The press release in this regard could be accessed here.

From Yatin’s Desk: Delhi High Court rules on respondent’s right in absence of filing cross appeal or objections

Taxpayers are often faced with a dilemma regarding filing an appeal when though on merits the matter is decided in their favour, on validity of the proceedings (issue of jurisdiction), Revenue’s position is accepted by the appellate forum. For instance, in a reassessment matters, if the taxpayer has obtained relief on merits with regard to the additions made, while the appellant authority upholds the validity of reopening in favour of the Revenue, question arises  – what should be the strategy with regard to future litigation?

A common-sense approach would suggest that there is no purpose of filing an appeal give the overall outcome being in favour of the taxpayer. But what if the Revenue is in appeal against the favourable order of the lower appellate authority which has provided relief on merit? In such a situation can the taxpayer at the stage of appellate hearing challenge the lower appellate authorities order with respect to the ground decided against it (upholding jurisdiction i.e. validity of proceedings) or is such opportunity lost in case the taxpayer has not filed a cross appeal/objections against the appeal preferred by the Revenue.

This interesting issue has recently been examined by the Hon’ble Delhi High Court (HC) in the case of Sanjay Sawhney v. Principal Commissioner of Income Tax. In a detailed reasoned order in favour of the taxpayer, the HC has held that the taxpayer was entitled to agitate the jurisdictional issue relating to the validity of the reassessment proceedings even in absence of cross appeal/objections by the taxpayer. The HC examined scope of Rule 27 of the Appellate Tribunal Rules, 1964 (ITAT Rules) which enables the respondent, even if he may not have appealed to support the order appealed against on any of the grounds decided against him.

In the facts of the case, pursuant to a search action, the return filed by the taxpayer was reassessed and income enhanced by the Assessing Officer (AO). Before the first appellate authority [CIT(A], the taxpayer besides challenging the additions made by the AO on merits also raised legal grounds challenging the validity of the reassessment proceedings. The CIT(A) while upholding the reassessment proceedings as being valid, on merits, allowed the appeal in favour of the taxpayer and deleted all the additions made by the AO. The CIT(A) order was contested by the Revenue before the Income Tax Appellate Tribunal (ITAT). In the proceedings before the ITAT, the appellant- assessee made an oral application under Rule 27 of ITAT Rules and urged additional grounds against the findings of the CIT(A) upholding validity of the proceedings.  The ITAT disagreed with taxpayer and on a technical ground refused to consider the legal ground challenging validity of proceedings {as upheld by the CIT(A)} premised on Rule 27 of the ITAT Rules considering no application had been filed by the taxpayer.

The Court took note that Rule 27 of the ITAT Rules, as it stands today, does not mandate the application to be made in writing, distinguishing such requirement which is prescribed under the draft Appellate Tribunal Rules 2017 (not notified yet) proposing to insert a proviso to Rule 27, providing for an application to be made in writing. The Court observed that Rule 27 embodies a fundamental principal that a Respondent who may not have been aggrieved by the final order of the Lower Authority or the Court, and therefore, has not filed an appeal against the same, is entitled to defend such an order before the Appellate forum on all grounds, including the ground which has been held against him by the Lower Authority, though the final order is in its favour. Not having filed a cross objection does not lead to an inference that the Respondent– assessee had accepted the findings in part of the final order, that was decided against him. 

In the case before hand, the HC accordingly held that the jurisdictional issue sought to be urged by the appellant under Rule 27 is interlinked with the other grounds of appeal, and its adjudication would have a direct impact on the outcome of the appeal. The validity of the proceedings goes into the root of the matter and for this reason, the assessee should not be precluded from raising a challenge to that part of the order which was decided against him by the CIT(A). The Court however clarified that if there is an issue which is decided against a respondent [in appeal], and the decision on the said issue has no bearing on the final decision of the CIT (A), then invocation of Rule 27 to challenge the correctness of the same cannot be sustained. Such issues can be challenged only way of filings a cross appeal/objection.

The decision sheds light on an important right of the respondent which is often marred in controversy. It is however relevant to note that this right does not enable reigniting a settled matter (in absence of an appeal/cross objection) but will be available only for an issue which has a bearing or a nexus on the matter appealed. An issue of jurisdiction clearly falls in this category.

A vital principle of natural justice has been explained by the court which will come as a relief to taxpayer effected by such litigations. Nevertheless, as a course, it may be prudent to exercise the option of cross objection wherever possible to obliterate needless dispute.     

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From Yatin’s Desk: Enhanced threshold of Rs. 1 crore for initiation of Corporate Insolvency Resolution applies prospectively

The Government of India (GoI) has announced various relief measures with respect to statutory and regulatory compliance matters across various sectors and Special Economic Package to counter the impact of COVID -19 on the economy. One notable relief measure announced related to enhancement of threshold for triggering corporate insolvency resolution from Rs.1 lac to Rs. 1 crore. This measure was taken to prevent many companies, more specifically MSME’s, from being pushed into insolvency on account of financial distress due to virtual shut down of businesses due to lockdown. The GoI, acting with speed, issued necessary notification on the 24th of March enhancing the monetary limit.     

The monetary change has initiated a debate on the fate of corporate insolvency applications filed but pending admission by the National Company Law Tribunals (NCLT) as on the date of notification. Under the scheme of IBC, Corporate Insolvency Resolution Process (CIRP) is initiated on the date when the applicant (who could be a financial creditor/operational creditor or the corporate debtor itself) files an application with NCLT for initiating CIRP. However, CIRP only commences on the date of admission of application by the NCLT.

In perhaps first such decision, the Hon’ble Kolkata Bench of NCLT in the case of Foseco India Limited v. Om Boseco Rail Products Limited had the occasions to examine whether the minimum default limit to Rs. 1 crore will be applicable to applications pending for admission as on the date of notification. The NCLT took note of the settled law that statute is presumed to be prospective unless it is held to be retrospective, either expressly or by necessary implication. Further, the amendment brought by the notification nowhere mentioned that its application will be retrospective. Accordingly, the NCLT has ruled that the amendment shall be considered as prospective and not retrospective, thus admitting the application for CIRP.

While the NCLT did not refer to any ruling to propound the view, it will be useful to take note of the ruling of Hon’ble Supreme Court in the case of K. Sashidhar vs Indian Overseas Bank. The ruling had interpreted the effect of lowering the voting threshold of Committee of Creditors (CoC) from 75% to 66% by Act No. 26 of 2018 w.e.f. 6 June 2018 in context of Sec 30(4) of the IBC. The court had held that the amendment is to modify the voting share threshold for decisions of the CoC and cannot be treated as clarificatory in nature. It changes the qualifying standards for reckoning the decision of the CoC concerning the process of approval of a resolution plan. The rights/obligations crystallized between the parties in terms of the governing provisions (at the point of time) and can be divested or undone only by a law made in that behalf by the legislature. There is no indication that the legislature intended to undo the decisions of the CoC already taken prior to 6 June, 2018. In view thereof, the 75% threshold as was applicable on the date of passing of the resolution plan by the CoC was considered sacrosanct.

The ratio of the ruling of the SC would directly lend support to the decision in the case of Foseco India Limited. Thus, taking recourse to protection under the enhanced threshold of Rs. 1 crore in respect of application pending for admission as on the date of notification may not be rewarding for corporates exploring this as a escape route.  

Suspension of fresh initiation of CIRP

On a related note, another aspect that requires consideration is regarding the announcement made by the Finance Minister as part of the Special Economic Package announced over May 13 to 17 with regard to suspension of fresh initiation of insolvency proceedings up to one year (though with a qualification – ‘depending upon the pandemic situation’). The announcement was made on May 17. Based on media reports, apparently the government has promulgated an ordinance for suspending initiation of new CIRP which is pending Presidential assent, however fine print is awaited. This leaves an ambiguity whether CIRP can be initiated in the interim. Going by the intent, one needs to be cautious of any adventurism in initiating new CIRP. It may not be out of place to assume issuance of retrospective notification effective May 17th (date of announcement). Doing otherwise may only show the GoI in bad light which is best avoidable given the situation.

Regarding the fate of applications already filed (i.e. CIRP ‘initiated’ but ‘not admitted’), it may be reasonable to infer that the suspension may not have an impact on such applications. This is considering the use of expression “suspension of fresh initiation of insolvency proceedings”. CIRP’s initiated, though pending for admission as on 17th May 2020, may therefore continue, unless the notification prescribes otherwise. Interestingly, if the government was to take a liberal call and suspend all CIRP applications pending admission by NCLT as on the date of announcement (17th May), it may provide reprieve to numerous corporates whose fate is left hanging in balance due to defaults, including those whose CIRP’s are admitted by NCLT post effective date of notification. This may well be wishful thinking.

It will be worthy of the Government to notify the suspension at the earliest to settle the debate.  

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