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

CA SANKET GARG , Last updated: 11 May 2020
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The world is on the brink of moving at exponential speed towards Fourth Industrial Revolution. The Fourth Industrial Revolution builds on the digital revolution, representing new ways in which technology becomes embedded within societies and even the human body. The Fourth Industrial Revolution is marked by emerging technology breakthrough in a number of fields, including robotics, artificial intelligence, nanotechnology, quantum computing, biotechnology, The Internet of Things (IoT), decentralized consensus, 3D printing and autonomous vehicles. The biggest hopped-for impacts of the Fourth Industrial Revolution are to improve the quality of life, reduce inequality of the world's population and raise income level.

In order to optimally leverage the Fourth Industrial Revolution for progress and prosperity, we need government frameworks, protocols, and policy systems that ensure inclusive and equitable benefits. In order to achieve this, we need to design normative and regulatory approaches to ensure that it is human-led and human-centred.

India, the world's largest & diverse economy with a population of 1.14 billion people has seen a decade of 7%+ growth. “The advent of the Fourth Industrial Revolution can help India leapfrog traditional phases of development and accelerate its transition to a developed nation. Deploying these technologies optimally and strategically can create a potent mix of resources and infrastructure that can yield better quality, more sustainable growth. With more than 50% of its population under the age of 27, India's role is also going to be pivotal in shaping the global Fourth Industrial Revolution agenda in a responsible, scalable and inclusive manner. – By Borge Brende, President of the World Economic Forum

The economy of India can be categorized by the presence of a number of major sectors including manufacturing industries, agriculture, textile & handicrafts and services. India is today the hub of billion-dollar firms and a hot investment destination. Every day many companies are incorporated in India. But at the end of three years, only one in 10 survive and entrepreneurs keen to close a failed venture. The top five factors in failure were lack of consumer interest in the product or services; funding or cash problems; personnel or staffing problems; competition from rival companies; and problems with pricing of the product or services.

In such dynamic economic environment, credits and incentives are a valuable elements of a company's tax planning approach. Government gives tax credits in order to promote or encourage investments in economic development and increasingly to support businesses.

The problem encountered of these credits was underutilization by the taxpayers. Sale, or transferability, of tax credits can be one possible solution. The transferability of tax credits enables a company with a low tax burden to utilize part of the credit and to sell the remainder of the credit to a company facing a larger tax liability.

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

Transferability keeps tax credit programs attractive to businesses regardless of tax liability while preventing the credit from going to waste.

What are tax credits?

Tax credit is a tax incentive designed to incentivize or encourage a particular economic activity which allows certain taxpayers to subtract the amount of the credit they have accrued. It may also be a credit granted in recognition of taxes already paid.

A tax credit is permission to reduce the amount of income that is subject to tax. A tax credit is not the same as a tax deduction.

Tax credits in India and their utilization

A. Directly granted by Central/State Government

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

Sr No.	Type of Loss	Set Off Against Income (In same Assessment Year)	Set Off Against Income (In subsequent Assessment Year)	Can be carried forward for
1	House Property: a. Let out property b. Self-occupied Property (On account of interest on borrowed capital)	Income from House property head or any other head	Income from House property	Next 8 Assessment Years
2	Business or Profession (Non-Speculation other than Depreciation)	Business Income Head; or any other head except salaries (non-speculative)	Business Income Head (non-speculative)	Next 8 Assessment Years
3	Short-term capital loss	Capital gains	Capital gains	Next 8 Assessment Years
4	Long-term capital loss	Long-term capital gain	Long-term capital gain only	Next 8 Assessment Years
5	Business (Speculation)	Speculation Profit	Speculation Profit	Next 4 Assessment Years
6	Running and Maintaining Race Horses	Such income only	Such income only	Next 4 Assessment Years
7	Other sources	Other sources or any other head	No carry forward	N. A.
8	Depreciation	Business Income Head; or any other head except salaries	Business Income Head; or any other head except salaries	Indefinite period
9	Losses by specified Businesses under section 35AD	N. A.	Business income of specified business	Indefinite period
10	Mergers a. Accumulated losses (PGBP Only) b. Unabsorbed depreciation	N. A.	N. A.	Next 8 Assessment Years
11	Demergers a. Accumulated losses (PGBP Only) b. Unabsorbed depreciation	N. A.	N. A.	Business losses – unexpired period Unabsorbed depreciation – indefinite period
12	Slump Sale	N. A.	N. A.	N. A.

Process, Timings and Costing in case of Mergers and Demergers

Particulars	Description
Process	1. Examination of object clause 2. Intimation to stock exchange 3. Approval of the draft merger proposal by the respective board 4. Application to High Courts 5. Dispatch of notice to share-holders and creditors 6. Holding of meetings of shareholders and creditors 7. Petition to High Court for confirmation and passing of HC orders 8. Filing the order with the registrar of Companies 9. Transfer assets and liabilities 10.Issue of shares & debentures
Timings	10 – 11 Months
Costing (expected)	Minimum 25 – 30 Lakhs
Complexities	High

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:

Sr No.	Financial Year (of which loss pertains)	Business Losses	Maximum carried forward period (Financial Year)	Unabsorbed depreciation	Maximum carried forward period (Financial Year)
1	2011-2012	4,000,000	2019-2020	900,000	Indefinite
2	2012-2013	3,600,000	2020-2021	800,000	Indefinite
3	2013-2014	3,200,000	2021-2022	700,000	Indefinite
4	2014-2015	3,000,000	2022-2023	600,000	Indefinite
5	2015-2016	2,600,000	2023-2024	500,000	Indefinite
6	2016-2017	2,200,000	2024-2025	650,000	Indefinite
7	2017-2018	1,900,000	2025-2026	720,000	Indefinite
8	2018-2019	1,500,000	2026-2027	640,000	Indefinite
9	2019-2020	1,800,000	2027-2028	540,000	Indefinite
	Total	23,800,000		6,050,000

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

Particulars	For the year ended March 31, 2020 Rs

Income:
Revenue from operations	89,500,000
Other income	500,000
Total revenue (I)	90,000,000

Expenses:
Purchase of trading goods/services	51,300,000
(Increase)/Decrease in inventory	4,500,000
Employee benefits expense	18,000,000
Other expenses	15,300,000
Depreciation and amortization expense	540,000
Finance costs	2,160,000
Total expense (II)	91,800,000

Loss for the year (I-II)	(1,800,000)

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:

Particulars	For the year ended March 31, 2020 Rs

Income:
Revenue from operations	25,000,000
Other income	5,000,000
Total revenue (I)	30,000,000

Expenses:
Purchase of trading goods/services	7,500,000
(Increase)/Decrease in inventory	1,500,000
Employee benefits expense	6,000,000
Other expenses	4,500,000
Depreciation and amortization expense	900,000
Finance costs	600,000
Total expense (II)	21,000,000

Profits for the year (I-II)	9,000,000

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:

Sr No.	Financial Year (of which loss pertains)	Business Losses	Maximum carried forward period (Financial Year)	Selling Price (to M/s XYZ Private Limited) 25% of loss	GST Applicability on Sale of Business Loss
1	2011-2012	4,000,000	2019-2020	1,000,000	Yes
2	2012-2013	3,600,000	2020-2021	900,000	Yes
	Total	7,600,000		1,900,000

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:

Particulars	M/s PQR Private Limited		M/s XYZ Private Limited
	Pre-selling	Post-selling	Pre - buying	Post-buying

Income:
Revenue from operations	89,500,000	89,500,000	25,000,000	25,000,000
Sale of Business Losses	-	7,600,000	-	-
Other income	500,000	500,000	5,000,000	5,000,000
Total revenue (I)	90,000,000	97,600,000	30,000,000	30,000,000

Expenses:
Purchase of trading goods/services	51,300,000	51,300,000	7,500,000	7,500,000
Purchase of Business Losses		-	-	7,600,000
(Increase)/Decrease in inventory	4,500,000	4,500,000	1,500,000	1,500,000
Employee benefits expense	18,000,000	18,000,000	6,000,000	6,000,000
Other expenses	15,300,000	15,300,000	4,500,000	4,500,000
Depreciation and amortization expense	540,000	540,000	900,000	900,000
Finance costs	2,160,000	2,160,000	600,000	600,000
Total expense (II)	91,800,000	91,800,000	21,000,000	28,600,000

Profits for the year (I-II)	(1,800,000)	5,800,000	9,000,000	1,400,000

Adjustments of balance past losses	-	(5,800,000)	-	-

Net Taxable Profits for the year	-	-	9,000,000	1,400,000

Direct Taxes Payable:

Income Tax Payable @ 27.82%	-	-	2,503,800	389,480

(Increase)/Decrease in Income Tax Payable	-	-	-	2,114,320

Indirect Taxed Payable:
GST payable on sale of business losses	-	380,000	-	-
ITC available in 1st year	-	-	-	380,000

Cash Flow Analysis
Proceeds/(Outflow) from business losses	-	1,900,000	-	(1,900,000)
Less: Direct taxes (payable)/benefits	-	-	-	2,114,320
Less: Indirect taxes (payable)/benefits	-	(380,000)	-	380,000
Net Inflow/(Outflow)		1,520,000		594,320

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.

Allowing the sale of business losses can prove to be a great option.

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