Section 79 and its implications on globally
As after prolonged litigation and different interpretations across judicial hierarchies, certain provisions of the Income Tax Act, 1961 (the Act) still require clarifications to ensure that they meet the intent with which the provision was introduced and do not cause undue hardship to taxpayers.It is the provision is section 79 of the Act.
As per section 79 of the Act, in case of a change in shareholding of a company, other than a company in which the public is substantially interested, no loss incurred in any previous year is allowed to be carried forward and set-off, unless shares carrying not less than 51% of the voting power are beneficially held by persons who also held such shares in the year in which the loss was incurred. Note that as per the said provision, only the unabsorbed business loss would lapse on change of shareholding, while this shall not impact the unabsorbed depreciation.
It is important to understand the intention behind the introduction of this provision in the Act. This section was introduced pursuant to the recommendations emanating from the report of the Taxation Inquiry Commission (Mathai Commission), 1953-54 as an anti-abuse provision. The intention of the introduction was to curb taxpayers from attempting to transfer losses incurred by a corporate entity by transfer of shareholding, resulting in avoidance or reduction in tax liability.
However, in its current implementation, the provision often causes undue hardship in certain genuine cases. Some of these instances are listed below:
Bona fide cases in which the change in shareholding is on account of infusion of additional funds for expansion and growth of business and not with an intention of providing exit to existing shareholders.
Any internal group re-organization leading to change in immediate legal shareholders may result in lapse of losses, even if the company continues to remain under the same management and beneficially held by the same ultimate parent.
On the contrary, in some cases, where there is a change of hands globally, the tax authorities are also challenging the carry forward of losses in the step down of Indian subsidiaries.
Apart from the one-off instances in which the judiciary has held in favour of taxpayers, the taxpayers have had to undergo fatigue in the above mentioned situations, although there was no intention to avoid or reduce tax liability.
Additionally, the recent contradictory decisions of different High Courts (Karnataka and Delhi) have led to confusion in the interpretation of the provision. Some critical points laid down by the respective High Courts are as follows:
In the case of CIT v. Amco Power Systems Ltd., the Karnataka High Court observed the following:
The benefit of carry forward and set off of losses shall be available, if the transferor shareholder continued to beneficially (whether directly or indirectly through a subsidiary) hold 51% voting power in the company.
The purpose of introduction of section 79 of the Act was to avoid change in shareholding only with the intention of taking benefit of the existing losses in the company.
The judgement pierces the corporate veil of the company for determining the beneficial shareholding and control over the company – does not take into account the legal nature of the transaction.
In the case of Yum Restaurants (India) Private Limited, the Delhi High Court observed the following:
There was no arrangement or agreement to prove that the beneficial shareholder of the company is the ultimate holding company and not the immediate shareholder.
Just because the transferor and transferee shareholder had a common parent company, it cannot be assumed that there was no change in beneficial ownership, unless specifically proved on facts.
The High Court refused to lift the corporate veil in the absence of any information to prove that the immediate shareholder is not the beneficial owner.
Based on technical and judicial interpretations adopted until date, determining the beneficial ownership of shares is a factual exercise and unless the facts depict otherwise, the immediate shareholder is always understood to be the beneficial shareholder. The “look through approach” or lifting of corporate veil shall be undertaken only in case of sham transaction or if the transaction is undertaken for the purpose of tax avoidance. However, the opposite approaches adopted by both the High Courts might lead to unwarranted litigation for taxpayers at the hands of the tax authorities, depending on the facts of each case.
In the recent budget, section 79 was amended in line with government’s Startup India initiative to provide some relaxation for companies registered as eligible startups. In such cases, no loss incurred by a startup during the first seven years from its incorporation would lapse even on change in shareholding resulting from infusion of new funds. The government recognized that startups need to raise funds for business growth and expansion, and accordingly, provided this relief.
The government should consider further clarifying the application of this section, specifically the issue of legal versus ultimate ownership, and consider providing exemptions for group re-alignments, etc., to help clear the confusion and resolve some issues plaguing global and domestic transactions involving Indian assets.