Benefit of set off of brought forward losses could not be denied to the amalgamated company if there is no change in control and management of amalgamated company pre and post merger

Delhi bench of the Income-tax Appellate Tribunal (the Tribunal), in the case of DCIT Vs. Select Holiday Resorts Pvt. Ltd. (ITA Nos. 1184 & 2460/Del/2008) (Judgment Date: 23 December 2010, Assessment Years: 2004-05 & 2005-06) held that where a parent company merged with its subsidiary, the benefit of brought forward and set off of losses under Section 79 of the Income-tax Act, 1961 (the Act) claimed by the amalgamated company, cannot be disallowed on the grounds that there was a change in the shareholding of more than 51 percent of the share capital of the subsidiary company since there was no change in control and management of amalgamated company pre and post merger.

Facts of the case

• M/s. Indrama Invetsment (P) Ltd. (IIPL) was an investment-holding company and held 98 percent of the share capital of the taxpayer. Further, four individuals of the promoter family (the promoters) held 100 percent of the shareholding in IIPL.
• IIPL merged with the taxpayer. Pursuant to the merger, the shareholding of IIPL in the taxpayer was cancelled and shares were issued to the promoters.
• For the relevant previous year, the taxpayer claimed set off of brought forward business loss of INR 4.47 crores.
• Pre and post merger, there was no change in the control and management of the taxpayer.

Taxpayer’s Contention

• The taxpayer argued that before the merger the promoters inter se held the entire shareholding of IIPL, which in-turn held 98 percent of the shareholding in the taxpayer. Thus, the promoters held shares in the taxpayer through IIPL
• Pursuant to the merger, shares were allotted to the promoters who then held more than 51 percent of the shareholding of the company directly. Thus, in effect, the beneficial shareholders of taxpayer continued to remain same.
• Thus, though there was a change in the shareholding pattern of the taxpayer pursuant to the merger, it could not be regarded that there was a violation of the shareholding condition provided under Section 79 of the Act.

Revenue’s Contention

• The Assessing Officer (AO) contended that there was a change in shareholding of the taxpayer since 51 percent of the shareholding of the taxpayer was no longer held by the shareholder who held such shares in the year in which the loss was incurred.
• The change in shareholding resulted in violation of the conditions laid down in Section 79 of the Act for the allowability of set off of carried forward business loss.
• The AO disallowed the set off of brought forward losses.

Aggrieved by the disallowance, the taxpayer filed an appeal with the Commissioner of Income Tax (Appeals) [CIT(A)].

CIT (A)’s observations

• The CIT(A) referred to the Supreme Court’s decision in case of CIT v. Italindia Cotton Co. P. Ltd. (174 ITR 160) wherein the Apex Court held that every change in shareholding need not fall within the provision of Section 79 of the Act. In closely-held company, 51 percent shareholding is considered to be the requirement for retaining control and management over the company. Thus, the Supreme Court discussed that the basic intent of the section was that when shareholding changes for acquiring control over a company which incurred losses with a view to reducing a tax liability, section 79 would apply to suppress the mischief.
• Through 100 percent of the shareholding in IIPL, the promoters held the control and management of the IIPL as well as the taxpayer. The taxpayer submitted the list of directors prior to the merger and post-merger which indicated that the control and management remained in the same hands.
• The CIT(A) referred to CBDT Circular No. 528 of 1988 (the Circular). The Circular notifies amendments to the Act introduced by the Finance Act, 1988. Para 26.3 of the aforesaid Circular provides that for the avoidance of hardship to taxpayer’s in genuine cases the benefit of carry forward and set off of brought forward business loss will not be denied in case where change in shareholding up to 51 per cent or more of the voting power takes place in the event of death of any shareholder and the provision was included by way of first proviso to Clause (a) of Section 79 of the Act.
• The CIT(A) also observed that in case of death of a living person, the shares held by him get transferred to his legal heirs. Similarly, when a company ceases to legally exist, the benefit of assets held by it, inclusive of shares of another company, will be conveyed to the company’s shareholders like in the instance of the taxpayer.
• The CIT(A) discussed that though there was a substantial change in the shareholding of the taxpayer, there was no change in the control and management of the company.

The CIT(A) concluded that in the peculiar facts of the case, Section 79 of the Act cannot be applied and the business losses of earlier years are eligible to be carried forward and set off.

Tribunal’s rulings

• The Tribunal agreed with the conclusions of the CIT(A) and observed that it was only because of the merger of IIPL into the taxpayer that the former ceased to exist and shares were allotted to the shareholders of IIPL.
• The Tribunal seconded the CIT(A)’s remarks that there was no change in the management of the taxpayer since the group of people earlier in control remained in control post-merger.
• The Tribunal also endorsed the CIT(A)’s comparison while referring to the Circular.

The Tribunal upheld the ruling of the CIT(A).

Our comments

The observations of the Tribunal appear to have been formed on the basis that the board of subsidiary is considered to be effectively controlled by its parent and its shareholders. In other words, the decision effectively implies piercing the corporate veil for the purpose of determining who has control over the company. Where a parent merges with a subsidiary and more than 51 percent of the shares in the merged company are held by the beneficial owners holding majority in the erstwhile parent company, it follows that the conditions under Section 79 are not applicable.

In the case of Amco Power Systems Ltd v. ITO [2009] 23 DTR 361 (Bang), similar observations were made by the Bangalore Bench of Income-tax Tribunal.

Additionally, the Tribunal has extended the interpretation of first proviso to Section 79 of the Act and considered merger as akin to a death of shareholder. Therefore, merger/amalgamation being a peculiar transaction warrants thoughtful application of extant tax laws such that the taxpayer’s interests are not unduly vitiated.