[Kailash Nath P S S is an Advocate practising at Hyderabad and is a Chartered Accountant by qualification]
Following the outbreak of COVID-19 in India, the Central Government declared it as an epidemic and declared a lockdown from 21 March 2020 by invoking the provisions of the Disaster Management Act, 2005 and the Epidemic Diseases Act, 1897. Accordingly, the overall economic activity has virtually come to a standstill, and business entities are facing tremendous uncertainty. There is a drastic decline in business revenues, coupled with unproductive fixed overheads being incurred on account of the lockdown, which are all likely to result in considerable losses to the business community. Non-performance of commercial contracts are likely to get aggravated with parties invoking the force majeure clause or other contractual remedies to excuse performance of the contracts. The International Monetary Fund (IMF) slashed India’s growth estimate for the financial year 2021 to 1.9% on account of the COVID-19 pandemic and the UN estimates the global GDP to shrink by almost one percent in 2020.
The Central Government has recently announced a package of ₹1.76 lakh crore for enhanced social welfare measures. While the current focus is on preserving lives and providing social security to the needy, there should be an equal focus on providing the necessary stimulus to the economy by easing the financial stress to enable revival of the economy to place it back on track. This includes measures that involve maintaining adequate liquidity in the system, making available adequate credit facilities, interest subventions, deferment of debt repayment obligations and easing compliance burden. The Reserve Bank of India (RBI) has announced special refinance facilities for a total amount of ₹50,000 crore to NABARD, SIDBI and NHB to enable them to meet sectoral credit needs. The Central Government is further proposing setting up a ₹1 lakh crore dedicated fund to address the problems of MSMEs.
The Ministry of Finance has announced a host of relief measures to the industry relating to statutory and regulatory compliances for income tax, goods and services tax (GST), customs, financial services and corporate affairs, ranging from extending the return filing due dates, to reducing interest rates on belated payment of taxes. In addition to the above, the Department of Revenue announced issuance of all pending income-tax refunds up to ₹5 lakh and GST and customs refunds immediately with a view to provide relief to the business entities and individuals to benefit around 14 lakh taxpayers and around 1 lakh business entities, including MSMEs. However, these measures only ease the compliance and regulatory burden.
The Finance Minister stated at the 101st meeting of the Development Committee Plenary of the World Bank that the Central Government will be announcing fresh relief measures and economic stimulus to fight the impact of the COVID-19 pandemic. With these steps expected to be announced soon, it is an opportune moment to consider providing the benefit of ‘carry back losses’ under the Income Tax Act, 1961 (“Act”).
Carry back business losses – Another way forward
As the name indicates, ‘carry back losses’ is a provision in tax laws whereby a business may be allowed to ‘carry back’ the loss it incurred in a particular assessment year to the previous assessment years, to be set off against the profits and gains of the previous years. This results in a lower tax liability for the year to which the loss of a particular year is “carried back” as it reduces the tax liabilities for that previous year. Such a reduction in tax liability for that previous years can generate a tax refund for the existing business entities for that previous year because of this newly reduced tax liability as, after the carried back loss is applied, it will be as though the business overpaid its taxes for those earlier years.
However, the Act does not provide for ‘carry back of losses’ but only permits carry forward and set-off of losses (with profits and gains) in the future years. The concept of ‘carry back’ loss is antithetical to the concept of ‘carry forward’ losses as provided under the Act. Section 72 of the Act permits an assessee incurring a loss from business to carry forward such loss to the following assessment year, to be set off against the profits and gains, if any, of any business carried on by such assessee in the subsequent assessment years. However, such loss can be carried forward for up to a maximum of eight assessment years immediately succeeding the assessment year for which the loss was first computed.
Thus, as can be seen, a benefit of ‘carry back’ loss confers a right of refund on the assessee immediately in the year in which the loss has first occurred, while a right to carry forward a loss results in a lower or nil outflow of cash towards tax in the future. With the need of the hour being infusion of liquidity in the economy, introducing a ‘carry back’ loss provision would definitely be beneficial to the business entities given the present state as it results in an immediate cash inflow to an assessee at present as opposed to a nil or lower tax outflow in the future, as there is likely to be a great deal of uncertainty relating to earning substantial profits in the immediate future.
Adoption of concept of ‘carry back’ losses at global level
India is an active member of the Organisation for Economic Co-operation and Development (OECD), having actively participated in negotiations and adoption of the Action Plans on Base Erosion and Profit Shifting (BEPS) and Multilateral Instruments (MLI). In a recent publication titled Emergency tax policy responses to the Covid-19 pandemic, one of OECD’s suggested tax policy measure is ‘increasing the generosity of loss carry-forward provisions’, which is to turn loss-carry forward provisions into a loss-carry backward provision, where businesses could opt to receive a one-off cash payment that equals their accumulated tax losses multiplied by the statutory corporate income tax rate.
The United States enacted the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) in response to the pandemic to provide an economic stimulus to businesses and individuals. Under the CARES Act, net operating losses (NOLs) arising in tax years beginning after December 31, 2017 and before January 1, 2021 (e.g., NOLs incurred in 2018, 2019, or 2020 by a calendar-year taxpayer) may be carried back to each of the five tax years preceding the tax year of such loss, as a result of which corporate taxpayers with eligible NOLs may now be able to claim a refund for tax returns from prior tax years.
The New Zealand Government introduced a temporary loss carry-back rule to allow refunds of prior year taxes for businesses that will incur losses in the 2020 and 2021 calendar years. However, a 2020 or 2021 tax loss can only be carried back to the immediately preceding income year, i.e., a 2020 loss can only offset profits in 2019, and a 2021 loss can only offset profits in 2020. Refunds can be claimed on the basis of anticipated-losses, and an excess refund (as per actuals) will be recoverable with interest.
Other economies such as Czech Republic, Norway and Poland have also introduced carry back losses provisions in the wake of the pandemic. Yet others such as the United Kingdom, Canada, Singapore, Germany, Japan and Netherlands contain carry back loss provisions in their legislations, with jurisdiction-specific restrictions on the same.
India’s brush with ‘carry back’
As stated above, the Income Tax Act does not provide for any carry back of losses. The only mention of ‘carry back losses’ in the Act is in rule 128 which pertains to foreign tax credit rules, which provides for the manner of availing credit in India for the amount of any foreign tax paid by an assessee in a country or specified territory outside India. Under the said rule, an assessee is required to furnish a report (Form 67 – Claim of Foreign Tax Credit) in a case where the carry backward of loss of the current year (in a territory outside India) results in refund of foreign tax for which credit has been claimed in any earlier previous year or years.
A Direct Tax Law Committee which was constituted in 1977 and which was headed by Shri. C.C. Choksi to examine the legal and administrative measures for simplification and rationalisation of direct tax laws opined (at page 563) that the provision of a general right to carry back business losses is not favoured. A subsequent Report of the Task Force on Direct Taxes headed by Dr. Vijay L. Kelkar, in December 2002, made a curious observation that a scenario of carry forward of losses would not reflect the ‘true value’ of losses as the present value of losses deducted in the future will be less than the value of those losses if they could be currently used, as they are not carried forward with an interest adjustment. The Report further noted that tax refunds are not offered for losses as it entails significant costs, and difficult transitional issues.While the Committee did not arrive at any definitive conclusion regarding the concept of ‘carry back losses’ in the Indian context or otherwise, it ultimately recommended business losses to be allowed to be carried forward indefinitely, against the existing system of carry forward benefit for a limited period of eight years.
The system of ‘carry back’ losses, a new concept in India, would definitely come with its own challenges. However, the same can be overcome with necessary safeguards to suit the Indian scenario. The provision of carry back losses and the consequential cash refunds can be made available to assessees satisfying certain monetary thresholds (like prescribed turnover or asset base, etc.), and the tax refunds can be capped at a certain limit or for a maximum permissible time period for which losses can be carried forward. In all, it is an idea worth exploring in the current scenario as part of the stimulus package in a different format.
– Kailash Nath P S S