“The hardest thing in the world to understand is the Income Tax.” – Albert Einstein
This famous quote seems to hold true even today, 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. One such 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:
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:
In the case of Yum Restaurants (India) Private Limited, the Delhi High Court observed the following:
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.
Views expressed are personal to the author. Article includes inputs from Janardhan Rao Belpu – Director – M&A Tax, PwC India, Kunal Singhaniya – Assistant Manager – M&A Tax, PwC India, Soumya Rastogi – Associate – M&A Tax, PwC India and Sandip Agarwal – Associate – M&A Tax, PwC India.