Delhi Income Tax Appellate Tribunal (ITAT) in the case of Select Holiday Resorts Pvt. Ltd. [52 DTR 14] on Section 79 (Section) which contains provisions restricting carry forward of past year losses under the Income Tax Laws (ITL) ruled that the Section has no applicability to a case of amalgamation of 98% shareholder company with the Taxpayer where the amalgamated and the amalgamating companies are held by the same set of shareholders with whom control of the taxpayer continues to remain. The ITAT further held that since the amalgamating company ceased to exist post amalgamation, a change in shareholding upon amalgamation can be regarded as a change arising in a situation akin to death of a shareholder which is specifically excluded from applicability of the Section.
Background and facts
- Under the ITL, a taxpayer is eligible to carry forward business loss for eight years. In case of a closely held company, the Section creates disability to carry forward and set off business loss when there is a change in shareholding such that 51% of the voting power is not beneficially held by the same set of shareholders who held such voting power at the end of the year to which the loss relates. However, change in shareholding as a result of death of a shareholder is excluded while considering 51% parity of the voting power.
- The Taxpayer, an Indian private limited company, had incurred losses up to financial year 2003-04.
- During financial year 2004-05, IIPL, an Indian company, merged with the Taxpayer.
- As a result of the merger, the shareholding of IIPL in the Taxpayer was cancelled and shares of the Taxpayer were issued to the shareholders of IIPL.
- Since the merger resulted in a change in the shareholding of the Taxpayer and breached 51% parity required by the Section, the Tax Authority disallowed set off of unabsorbed business loss brought forward from earlier years. The first appellate authority allowed the Taxpayer’s appeal and held that the Section was not applicable as control and management of the Taxpayer continued to remain with the same set of shareholders who controlled and managed the Taxpayer earlier, through IIPL. Furthermore, since IIPL ceased to exist post merger , the situation was akin to death of a shareholder which is specifically excluded from applicability of the Section.
- Post amalgamation, the shareholding continues to be with the same set of shareholders who were beneficial holders of shares of the Taxpayer prior to the amalgamation.
- The shareholders who held shares in the Taxpayer indirectly, through IIPL, now held such shares directly, though there was no change in the beneficial ownership.
Tax Authority’s contentions
- As a result of the merger, share capital of 98%, which was held earlier by IIPL, was reduced to nil.
- As a change in the shareholding was beyond the permissible limit, set off of carried forward business loss was not permitted.
The ITAT upheld the first appellate authority’s order and largely agreed with the reasons provided by it. The ITAT concluded that:
- IIPL held 98% shares in the Taxpayer, whereas, 100% shares in IIPL were held by shareholders who had control and management of IIPL as well as the Taxpayer. Due to the merger of IIPL with the Taxpayer, IIPL ceased to exist, as a result of which, shares of the Taxpayer were allotted to the shareholders. The management of the Taxpayer remained with the same set of shareholders who had earlier exercised control.
- Post merger, the boards of IIPL and the Taxpayer remained the same as before the merger. There is admitted change in the shareholders of Taxpayer , holding more than 51% shares, because earlier IIPL, was appearing in the list of shareholders and now individuals. who were the majority shareholders. However, there was no change in control and management of the Taxpayer because the management continued to be with the same persons who were shareholders of the holding company, IIPL.
- The provisions of the Section are not applicable to the Taxpayer because the intention of the Section is to prohibit the benefit of losses incurred by a company to some other group of persons acquiring its control and management merely for tax benefit.
- Reliance was placed on Circular No, 528 dated 16 December 1988 issued by the Central Board of Direct Taxes, which explains the insertion of the provision in the Section which excludes applicability of the Section to a change in the shareholding pursuant to death of a shareholder. When IIPL was merged with the Taxpayer, it ceased to exist and this is akin to death of a shareholder. In case of death of a shareholder, the shares held by him get transferred to his legal heirs. Similarly, when a company legally ceases to exist, the benefit of assets held by it will pass on to its shareholders.
- In the peculiar facts of the case, the Section is not to be applied and the losses of earlier years are eligible to be set off with the profit of previous years.
Comments – This ruling provides useful guidance on the scope of limitation provisions contained in the Section. It emphasizes that the Section is inapplicable if the same group of persons continues to control and manage the company. This ruling is also significant to the extent that the benefit of exclusion provided for change arising on account of death of a shareholder is also extended to cases of corporate reorganization involving amalgamation.