Section 79 stipulates that in case of a Company, not being a company in which the public are substantially interested, shall not be allowed to carry forward and set-off the losses against the income of previous year, unless on the last day of the previous year, the shares of the company carrying not less than fifty-one per cent of the voting power were beneficially held by persons who beneficially held shares of the company carrying not less than fifty-one per cent of the voting power on the last day of the year or years in which the loss was incurred.
Interpretation : In the case of a closely held company (generally private limited company), where a substantial change in shareholding has taken place in the current financial year (where the shareholding has changed more than 49%), no loss incurred in any year prior to the current financial year shall be carried forward and set off against the income of the current financial year.
Rationale for introducing Section 79 : It was introduced as an anti-abusive provision intended to curb the taxpayers attempts at acquiring loss making Company and claim / enjoy the tax benefits of such losses while conducting profitable business. Hence, it is worthwhile to note that the section explicitly uses terminology “person who beneficially held shares”. This aims to safeguard those cases wherein substantial ownership has been transferred within the same group i.e. the ultimate ownership does not undergo change. Pls refer below illustration elaborating the said rationale :
As evident above, despite change in registered ownership of Company D i.e. from Company B to Company A, ultimate beneficial ownership still vests with Company A.
However, it is pertinent to note that there are numerous case laws in favour and handful in contradiction to this (summarised below). Thus, ambiguity still exists in context of Carry forward and set off of losses under such circumstances.
Delhi High Court in case of Select Holiday Resorts (P) Ltd, vs CIT held that if “it is clear that there is no change in the management of the Company which remained with the same family (set of persons) who was earlier exercising control. The assessee submitted a list of directors on the Board of the two companies prior to merger as well as the directors on the Board of merged company. It remained in the same hands. Thus, the Ld. Commissioner of Income Tax (Appeals) is correct in holding that change in more than 51% was due to merger in two companies. There was no change in control and management.”
High Court of Karnataka in case of CIT v. AMCO Power Systems Ltd have held that “The purpose of Section 79 of the Act would be that benefit of carry forward and set-off of business losses for previous years of Company should not be misused by any new owner, who may purchase the shares of the Company, only to get the benefit of set-off of business losses of the previous years, which may bear profits in the subsequent years after the new owner takes over the Company. For such purpose, it is provided under the said section that 51% of the voting power which was beneficially held by a person or persons should continue to be held, then only such benefit could be given to the Company.”
The benefit of carry forward losses was allowed in the above cases and the same has also been affirmed in case of CIT v. Italindia Cotton Co. (P) Ltd and Just Lifestyle Pvt Ltd v. DCIT.
On the contrary, Delhi High Court in case of Yum Restaurants (India) Pvt. Ltd. held that “there was indeed a change of ownership of 100% shares of Yum India from Yum Asia to Yum Singapore, both of which were distinct entities. Although they might be AEs of Yum USA, there is nothing to show that there was any agreement or arrangement that the beneficial owner of such shares would be the holding company, Yum USA. The question of ‘piercing the veil’ at the instance of Yum India does not arise. In the circumstances, it was rightly concluded by the ITAT that in terms of Section 79 of the Act, Yum India cannot be permitted to set off the carry forward accumulated business losses of the earlier years.”
Conclusion : Though industry-wide practise has been to avail the benefit of carry forward & set-off of losses in case wherein the ultimate beneficial ownership has not undergone change but the probability of litigation cannot be ruled out considering the fact that contrary judgements has been delivered by the High Court.
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