Monetization and Transferability of Business Losses: The Next Indian Business Revolution

o Capital subsidy
o Interest subsidy
o Low cost subsidy
o Tax Relief
o Cost setoff subsidy
o Investment Partnership
o PPP Model
o Tax Holidays (SEZ/FTZ/ETZ)
o Foreign tax credits
o Goods & Service Tax
o Duty Drawback
o Custom duties
o FTP

B. Self-generated by business houses

o Business Losses
o Speculative Losses
o Unabsorbed Depreciation
o Minimum Alternate Tax [MAT]
o FTP – MEIS/SEIS

Monetization and transferability of self-generated tax credits – Present Scenario

At present there is no direct way for monetization & transferability of self – generated tax credits from one company to another company. However, companies do this indirectly through the route of M&A (mergers and acquisitions) and amalgamations.

Merger and acquisitions (M&A) are general term refers to the consolidation of companies or assets through various type of financial transactions. Merger is the combination of two companies to form one, while Acquisitions is one company taken over by the other. A merger is a corporate strategy of combining different companies into a single company in order to enhance the financial and operational strength of both organizations. After the merger, the acquired company ceases to exist and becomes part of the acquiring company.

Amalgamation is defined as the combination of one or more companies into a new entity. In includes:

i. Two or more companies join to form a new company

ii. Absorption or blending of one by the other

Amalgamation is done between two or more companies engaged in the same line of activity or has some synergy in their operations. The companies may also combine for diversification of activities or for expansion of services.

Amalgamation is different from Merger because neither of the two companies under reference exists as a legal entity. Through the process of amalgamation a completely new entity is formed to have combined assets and liabilities of both the companies.

Current Indian Laws on Accumulated Losses

Process, Timings and Costing in case of Mergers and Demergers

Monetization and transferability of self-generated tax credits – Future Approach

Today, India's business environment is growing rapidly, youth entrepreneurs are doing new inventions day to day and giving innovative solutions to the society. To encourage this, Government had launched start-up India and stand-up India schemes. Thousands of start-ups formed and they developed innovative solutions, but the bitter truth is that only few from them able to succeed in adopting their solution by society. Reasons of failure can be many, like lack of experience, business understanding, low market response, inadequate guidance on solutions prepared. Outcome of failure is very horrifying i.e. more than 90% start-ups closed within a period of 2-3 years, some are trying to recover and looking for outside investments and those supported by investors are trying to rebuild themselves by restructuring.

Now the biggest concern is those 90% entrepreneurs, who has tasted bitter success and put up their hands to make second attempt. This will result in slowing down economic growth and business environment and disequilibrium will arise, which can't be filled till long time.

To encourage such entrepreneurs, Government should bring some really effective measures, so that they can able to re-stand and contribute in nation building.

In any company past years business loss is the main credit, which may be set off from future incomes. However in reality more than 80% companies unable to absorb this loss and their losses becomes sunk at the end.

Such business losses shall be allowed to be sell in the open market, like selling goods, services, incentives, certificates, scrip's etc, either within the same industry & sectors or may be different.

Current laws doesn't allow selling of business losses, neither there is be any provision for selling business losses directly to any other Company. Few companies does this indirectly by mergers & acquisition, but it is time consuming, costly and cumbersome process involving lots of complexities, hence very few percent deals becomes successful.

If companies (either start-up, MSME, large) are allowed to sell their previous year's business losses on fulfilment of certain conditions, it could become boon for them. On minutely analysing the facts conclusion is, most tax credits are being monetized except business losses.

It may also be possible that this measure may not support very much to companies, but yes can able to add cash flows in their worst situations to some extent, which can become very crucial for them at that time.

Also, this will reduce the possibilities of takeovers and unwanted mergers & acquisitions. Mostly business owners doesn't want to sell business, because they believe on their ability to revive it at some point of time in near future, but due to several reasons they are forced to sell.

One major reason is eroded picture of their financial statements, which make the situation unfavourable among investors and bankers and they doesn't get funding.

Selling business losses solution, can be a proven mile stone. This may become future approach which will give a new backbone to loss generating companies.

Future Illustrative Roadmap for Monetization and transferability of self – generated tax credits

Creation of separate Act

Government should make a separate law on this, which can give right directions and guidance to companies, so that everyone can follow uniform approach.

Creation of Central Department followed by branches in major metros

Government should also create a central department for creation of database of such companies. This central department shall make a single platform for all buyers and sellers and will assist them in getting the deals done. Also, buyers and sellers also not have to look the active market for the same and will get the single facility at one place which will ease them to make trading.

Illustrative Conditions to be fulfilled

o Income tax return of loss year should be filed within due date

o Income tax return of loss year should be processes by Income Tax Department

o Maximum carried forward period should be only unexpired period for buying company

o GST credit of different years to be available in the year of set off of losses

o Buying Company should be allowed to adjust upto certain percentage of purchased losses in 1st year.

o At least for the next ten years, the buyer company cannot buy new losses from the same seller company.

o Time period of utilization of scrip shall be 2 Years from date of purchase

o Multi transfer facility must be there if in case a unit could not utilize full credits in 2 years

o Non applicability in case of proprietorship, partnership, HUFs or any unincorporated body

o Due diligence, certifications and reports to be obtained from professionals

Illustrative Inclusions and Exclusions in calculation of transferable tax losses

o Losses generated from any type of transactions held between holding/subsidiaries/associates/related parties (within India or Outside India) during the said financial year(s) should be excluded

o Expenses unpaid for more than 3 years should be added to losses

Additions (which will reduce the losses to be sold)

o Trade Payables greater than two year
o Bad debt expenses less than one year
o Revaluation/Impairment losses
o Provisions created
o Any expenses which is not directly related to business activities

Deductions (which will increase the losses to be sold)

o Subsidies received from government
o Compensation received from government
o Sale of scrips, certificates etc from government
o Any other income not generated directly from business activities

Benefits of Monetization and transferability of tax credits

I. Loss selling Company

• Reduce somewhat Working Capital Crisis
• Effective utilization of expiring and unabsorbed business losses
• Protecting the Company from being acquired by others
• Reduce dependency on bank loans (working capital loans, Cash Credit, Overdrafts)
• Improvement in financial positions of the Company
• Improvement in financial statements of the Company

II. Loss buying Company

• Reduction of direct taxes burden
• Acquisition of company not required separately for tax savings
• Minimal legal complexities, comparing with mergers & acquisition
• Utilize additional resources of the company to its fullest

III. Government

• Additional Tax Generation
• Increase in taxpayer base
• Lower scams and collapses
• Overall Economic Improvements
• Saving industry from dying
• Saving companies to become sick units
• Lower relief packages and bailout plans
• Less burden on banks for funding to MSME, Start-ups, loss making companies

IV. Professionals

• Increase in work flow and client base
• Increase of due-diligence practice
• Finding right targets
• End-to-end business loss sale process assistance
• Ensuring effective implementation and adherence of laws

Illustration (by considering only one scenario)

M/s PQR Private Limited is an IT Hardware Development Company, which was formed in the year 2011. In the initial year they raised funds of Rs 10 Crores by issuing Equity Shares, so that they can manage their research, development and business operations. Due to various factors like cut-through competition, rapidly changing technology, lack of effective policies, market conditions and dynamic business environment, company failed to maintain the cutting edge technologies and not able to generate good customer, sufficient profits and cash flows too.

Due to these factors they are facing losses since their inception till now and not reached upto break-even point.

Apart from this Company is also facing cash flow crisis and unable to meet working capital requirements and facing difficulties in managing their business operations.

Business Losses and unabsorbed depreciation details of M/s PQR Private Limited are as follows:

Current year Profit & Loss of M/s PQR Private Limited is as follows:

Note: For the ease of calculation Depreciation as per income tax act will be assumed same as companies act.

M/s XYZ Private Limited is an IT Hardware Development Company. M/s XYZ Private Limited is a peer Company of M/s PQR Private Limited. It is having good customer, sufficient profits and cash flows.

Current year Profit & Loss of M/s XYZ Private Limited is as follows:

Management of M/s PQR Private Limited is planning to overcome this situation in upcoming financial year i.e. 2020-2021 and they have explored two options for this.

i. Segregating business in two Divisions i.e. Division A (Existing Business of Hardware Development) and Division B (Software Support Services). Division B will be started from proceeds received by demerging of Division A. Ms XYZ Private Limited is willing to buy Division A.

ii. Selling business losses to M/s XYZ Private Limited and other peer companies and use that proceeds, in rebuilding existing business and starting new business.

If Ms PQR Private Limited opt Option 1 then they have to further wait for next one year for completion of demerger scheme, which also includes costs, time as well as complexities. Further there may be possibility that 3/4th creditors and shareholders may disagree with this scheme, which may result in fail of demerger scheme.

Second side, If M/s PQR Private Limited sell business losses to M/s XYZ Private Limited, then they can use its proceeds instantly in various purposes.

Suppose Ms PQR Private Limited goes with Option II and sell the business losses of two years on March 31 2020 to Ms XYZ Private Limited as follows:

What is the impact on both companies before and after the transaction?

Comparison of pre and post selling scenario of M/s PQR Private Limited and M/s XYZ Private Limited will be as follows:

After adjustment of business losses both companies will gain positive cash inflows.

Outlook

We believe that if a suitable law is made to sell business losses, it can prove to be a boon for the Indian economy.

In today's era, it is very important to protect the interests of entrepreneurs (especially new entrepreneurs) so that they can stand up to the difficulties of running a business and successfully carry on the business.

The Indian business class is divided into many parts such as those institutions which have been trading since very old times, they are stable, they have experience, technology, rich cash flow etc. and that can handle themselves at every stage Huh. There are other institutions that are trying to stabilize themselves, increase cash flow, and be full of modern technology. And the third organization that is trying to get its feet in the market right now so that it cannot get out of the market.

Therefore, to overcome all these complications, the government should bring suitable measures as soon as possible so that the institutes get timely solutions and they can use them at the right time.

The illustration we have given above is only a single scenario. Apart from this, many more scenarios can be created by taking business losses as the basis and organizations can be benefited.

We have positive hope from the government that after considering this suggestion, they will prepare a strong structure on it and implement it in India as soon as possible. We are also ready and willing to debate and talk more on this subject and want to have a draft as soon as possible, and take the opinion of the people and implement it.

You Tube Video Link - https://www.youtube.com/watch?v=UxyZjnn0AOg