“…..in a taxing Act one has to look merely at what is clearly said. There is no room for any intendment. There is no equity about tax. There is no presumption as to tax. Nothing is to be read in, Nothing is to be implied. One can look fairly at the language used” is a famous passage from Rowlatt J. which has been consistently quoted by the Indian Courts in many judgements. However, it is very rare that any tax issue has attained finality in India. Every tax case is seen as a cause of potential litigation at various levels.
While corporate group reorganization or share acquisition, section 79 is one of the significant provisions of the Income-tax Act, 1961 which comes into play as soon as there is a change in more than 51% of shareholding of a closely held company with unabsorbed losses. Section 79 provides that where there is a change in the shareholding of a closely held company, no loss incurred in any year prior to the previous year shall be carried forward and set off against the income of the previous year, unless the shares of the company carrying not less than 51% of the voting power were beneficially held by the persons who beneficially held shares of the company carrying not less than 51% of the voting power as on the last day of the year or years in which the loss was incurred.
Every acquisition of control over a company provides a source of both direct and indirect financial benefits as well as power over its policies and activities. On the other side, there can be cases where the change in effected only with a view to avoiding or reducing some liability to tax. The change is effected not for business or commercial reasons but in order that the tax liability may be avoided or reduced. In that event, the change in the shareholding will tend to bring about the result which section 79 was designed to prevent. The intent behind introducing section 79 was explained by the Hon’ble Supreme Court in the case of Italindia Cotton Co. P Ltd1, wherein the Hon’ble Court observed that the object sought to be served by the enacting section 79 appears to be to discourage persons claiming a reduction on their tax liability on the profits earned in companies which had sustained losses in the earlier years. Today as the section operates, it also acts an impediment in the genuine commercial business transactions.
The provision, further, provides for certain exceptions where the losses are allowed to be set-off, noted below:
(a) where a change in the said voting power and shareholding takes place in a previous year consequent upon the death of a shareholder or on account of transfer of shares by way of gift to any relative of the shareholder making such gift;
(b) where there is a change in the shareholding of an Indian company which is a subsidiary of a foreign company as a result of amalgamation or demerger of a foreign company subject to the condition that 51% shareholders of amalgamating or demerged foreign company continue to be the shareholders of the amalgamated or the resulting foreign company;
(c) where there is change in the shareholding pursuant to a resolution plan approved under the Insolvency and Bankruptcy Code, 2016;
(d) where there is a change in the shareholding of an eligible start-ups;
(e) where there is change in the shareholding pursuant to resolution plan approved by the Tribunal under section 242 of the Companies Act, 2013.
The controversy here is regarding the denial of set off of losses by invoking provisions of section 79 by the Revenue Authorities, on account of change in the shareholding of a closely held company, even if shares representing more than 51% of the voting power are beneficially held within the same group i.e. internal group reorganisation. This controversy stems from the literal interpretation of the section. The controversy is further fuelled by catena of judicial precedents leading to uncertainty over the issue.
In the case of Select Holiday Resorts P Ltd.2, a family was holding 98% of the shares of the assessee company through a holding company. Pursuant to merger of the holding company into the assessee company i.e. subsidiary company, the holding company legally finished and the family became the direct shareholders of the assessee company. Hon’ble Delhi High Court equated the event with the death of a shareholder and held that provision of section 79 will not apply as the beneficial shareholding pre and post-merger remained same and the change in more than 51% shareholding was due to merger of the two companies.
The Karnataka High Court in the case of AMCO Power Systems Ltd3 held that as the purpose of the provision is to prevent misuse of losses by transferring ownership, it should be restricted to cases of transfer of ‘beneficial shareholding’. A transfer of shares of the loss-making company by the shareholder-company to its subsidiary is not hit by Section 79 of the Act
However, subsequently, the Hon’ble High Court of Delhi in the case of Yum Restaurants India (P) Ltd4 held that transfer of 100% shares in the assessee company from one holding company (Yum Asia) to another holding company (Yum Singapore) resulted in change in the beneficial ownership of the assessee company and therefore brought forward losses was not allowed to set off even though the ultimate beneficial owner (Yum USA) remained same. It further held that the fact that they were subsidiaries of the ultimate holding company, did not mean that there was no change in the beneficial ownership.
Hon’ble Mumbai bench of Income-tax Appellate Tribunal (‘ITAT’) in the case of Wadhwa & Associates Realtors (P) Ltd5 held that ownership of shares with the same person is not contemplated for denying set off of loss under section 79. In the present case, two individual shareholders were holding more than 50% shareholding of the assessee company through series of company in the years in which the losses were incurred. Thereafter, the shareholder became the direct shareholder in the assessee company. The ITAT allowed the set off of losses against the income of the current year and laid down certain important principles,
(1) What is more important for the purpose of section 79 is exercise of ‘voting power’ and not holding of shares. It lays emphasis on the ‘voting power’ beneficially held by the same persons as on the last day of the previous year when the loss is incurred and on the last day of the previous year when the set off is claimed. If the intention of the Legislature was to lay down the condition of the shareholding then there was no need to satisfy ‘voting power’.
(2) The word used in section 79 is ‘held’ and not ‘owned’. This indicates that ownership of shares with the same person is not contemplated for denying the set off of the loss. Furthermore, the word preceding ‘held’ is ‘beneficially’ which is an adjective/adverb for the word ‘benefit’. Therefore, what is to be seen is whether the benefit of voting rights is with the same persons.
(3) The phrase ‘beneficially held’ would contemplate wider meaning to cover a situation wherein if a person is able to influence voting rights to the extent of 51 per cent in the company seeking set off through chain of holding, then same would be sufficient not to disentitle the set off of the loss.
Hon’ble Ahmedabad bench of ITAT in the of CLP Power India (P) Ltd.6 held that section 79 has no application in the absence of change in the beneficial voting power. Even after transfer of shares in the assessee company by its ultimate holding company to its another subsidiary, beneficial ownership of the assessee company continued to vest with the same holding company and therefore provisions of section 79 would not apply.
To summarise the above, the actual controversy is whether beneficial ownership is more important for the purpose of section 79 or legal ownership. Therefore, more clarification by way of a suitable amendment is required in the Law.
1. (1988)147 ITR 160 (SC)
2. (2013) 217 Taxman 110 (Delhi HC)
3. (2015) 379 ITR 375 (Karnataka)
4. (2016) 380 ITR 637 (Delhi HC)
5. (2018) 92 Taxmann.com 37 (Mumbai-ITAT)
6. (2018) 93 Taxmann.com 326 (Ahmedabad-ITAT)