Introduction
Section 79 of the Income Tax Act, 1961 (“Act”),[1] is an important anti-abuse provision. It provides that in a situation where there is a change in shareholding of a company in which the public is not substantially interested (closely held companies), carry forward and set off of losses is only permissible if 51% of the at least 51% of the voting rights continue to be beneficially held by the same persons as on the last day of the year in which the loss was incurred.
The Hon’ble Supreme Court in CIT v. Italinda Cotton Co. (P.) Ltd.[2] stated that the objective of the provision is the prevent persons from claiming a reduction in their tax liabilities on the profits earned in companies which had sustained losses. They observed that it is not unusual for a group of persons to acquire a company which had suffered losses in the expectation that the company would earn profits and they would benefit from the reduction of tax liability on account of the set off of losses carried forward from earlier years. The mischief that was sought to be addressed by this provision was that in an acquisition where there was a mere artificial transfer of control or ownership, without any continuity in economic interest or management of the company, the acquirer should not be allowed to take benefit of accumulated losses.
With respect to Section 79 of the Act, an issue has recently emerged regarding the eligibility to set off carried forward losses in situations where the shares carrying 51% of the voting rights of a closely held Assessee company, originally held by one immediate holding company (which itself is a subsidiary of an ultimate holding company), are transferred to another immediate holding company under the same ultimate holding company. The central question becomes whether such transfer in shareholding from one immediate holding to another (both being under the same ultimate holding company) would disentitle the closely held Assessee company from claiming set off of the carried forward losses. Essentially, the core issue is concerned with the interpretation of the expression “beneficially held”. The debate centres on whether the term should be restricted to immediate or direct ownership, as reflected in the company’s register of members, or whether it should extend to the ultimate or indirect beneficial owner who exercises actual control over the voting rights. This debate is not merely academic it has significant implications for corporate restructurings, group reorganisations, and the legitimate use of carried-forward losses. The absence of a clear statutory definition of “beneficial ownership” in the context of Section 79 has led to divergent judicial opinions, resulting in uncertainty for taxpayers and authorities alike. It is against this backdrop that we analyse the divergent judicial opinions and the interplay with Company law to arrive at a reasoned understanding of the provision.
Judicial Precedents
The Judicial discourse on Section 79 of the Act consists broadly of two cxAxategories of cases, i.e., decisions that emphasise immediate/direct ownership of shares (category 1) and decisions that advocate for a substance over form approach, looking at the ultimate beneficial ownership (category 2).
Category 1- Immediate/Direct Ownership
Various judicial forums have interpreted “beneficial ownership” under Section 79 to mean immediate or direct ownership. This means that the person who is the registered shareholder is considered the beneficial shareholder unless there is cogent evidence to the contrary. In this approach, the legal form is given primacy, and the evidentiary burden lies on the Assessee to demonstrate that the true beneficial owner is someone else.
This approach has been adopted by the Hon’ble Delhi High Court in Yum Restaurants v. ITO 2016[3] wherein the court held that even though the transfer of shareholding is between two immediate holding companies of the same ultimate holding company, it cannot be presumed that there is no change in beneficial shareholding. The Assessee has to demonstrate that even though the shares are registered in the name of the immediate holding company, the ultimate holding company is the beneficial owner. Similarly, in Aramex India v. DCIT[4] relying on the case of Yum Restaurants, the ITAT Mumbai remanded the matter back to the AO for examining whether there was any agreement or arrangement to establish that the beneficial owner would be the ultimate holding company.
Lastly, we also take a look at ACIT v. WSP Consultants[5] wherein relying on Just Lifestyle Pvt. Ltd. v. DCIT[6] the ITAT Delhi held that, Section 79 of the Act will apply only in case of change in immediate shareholding of the company and that the registered shareholder shall be the beneficial owner of the shares unless the shares are held in the capacity of nominee/agent or trustee.
The presumptive rationale behind the same is that the register of members is an authoritative record of shareholders, and in the absence of a declaration or arrangement to the contrary, the registered shareholder is deemed to be the beneficial owner.
Category 2- Ultimate Beneficial Ownership
In contrast with the above, a series of judicial decisions have adopted a more substantive approach, focusing on the concept of ultimate beneficial ownership. They have recognised that the objective of Section 79 of the Act is to prevent the misuse of loss set-off provisions through changes in control, which may not always be reflected in the register of members. According to this perspective, in cases where shares are transferred between entities within the same group or under the same ultimate holding company, and the ultimate control remains unchanged, Section 79 of the Act should not operate to deny the set-off of losses. This approach seeks to preserve genuine group restructurings where the economic interest remains with the same parties.
The Hon’ble Delhi High Court in CIT v. Select Holiday Resorts[7] considered a case wherein, due to the amalgamation of the holding company with the Assessee company, the shareholder of the holding company was given the shares of the Assessee company. The Court observed that the beneficial shareholder of 98% of the shares of the holding company and the Assessee continued to be the same, hence, Section 79 of the Act will not apply. Similarly, The Karnataka High Court in CIT v. AMCO Power Systems[8] observed that the shareholding pattern is distinct from the voting power in a company, and Section 79 of the Act pertains to beneficial holding of voting rights. In this case an ultimate holding company reduced its direct shareholding from 55% to 6% but it also indirectly held 45% through its wholly owned subsidiary, the HC observed that since the ultimate holding company has a wholly owned subsidiary with control over its BOD, it cannot be said that the ultimate holding company had reduced its voting power to less than 51%. Essentially, the Court gave due consideration to indirect control and not merely the immediate/direct control. We find that a similar position has been adopted in the following cases
1.in M/S BancTec TPS India v. PCIT[9] wherein ITAT Mumbai held that Section 79 pertains only to beneficial ownership of shares, it was observed that since the holding company directly held 42.19% shares and indirectly (through another company) held 57.81% shares, the Tribunal observed that the holding company beneficially hold 100% shares in the company and Section 79 will not apply.
2. In Hiranandani Health Care v. CIT(A),[10] there were two shareholders of the Assessee- the immediate holding company and the ultimate holding company, who, as a group, held 51% of voting power in both years. ITAT Mumbai observed that since the ultimate holding company is also the parent entity of the immediate holding company, an increase in the shareholding of the immediate holding company will not result in any change in the voting power of the shareholders combined. Essentially, considering that the ultimate holding company still had the requisite beneficial voting rights. Hence, Section 79 was not applied.
3. In CLP Power India v. DCIT[11] initially, the ultimate holding company directly held the shares of the Assessee company; thereafter, it transferred the shares with 100% rights to its wholly owned subsidiary. In this regard, ITAT Ahmedabad observed that in effect the beneficial ownership of the Assessee company remained with the same holding company, hence, the provisions of Section 79 of the Act will not apply.
4. In DCIT v. Clear Channel Communication[12] the Assessing Officer was of the view that only registered shareholder are to be considered, but ITAT Mumbai clarified that the same is not applicable as the provision uses the term “beneficially held”. Therefore, in view of this judgement it can be said that for the purposes of Section 79, it is the ultimate beneficial ownership that is to be considered and not the registered or immediate ownership of shares.
5. In Wadhwa & Associates Realtors v. ACIT[13] In this case two individuals were earlier holding 67% of voting rights in the Assessee company through two companies, one of them being a wholly owned subsidiary of the other. Later, the two individuals became the direct beneficial owners of 100% of the voting rights. ITAT Mumbai ruled that the test is to ascertain whether the two individuals were the beneficial owners of the requisite voting rights on both the relevant days (last day of year of loss and the last day of the previous year), the same was found to be true and hence, Section 79 of the Act was not applied. In arriving at this conclusion, the Tribunal referred to the case of Amco Power Systems, Select Holiday Resorts and Italinda Cotton Co. (P.) Ltd. ITAT Mumbai also distinguished the decision of the Delhi HC in the case of Yum Restaurants India (P.) (Ltd.). It held that in Yum Restaurants, the Assessee did not produce any evidence to show that Yum USA is the beneficial owner and Yum USA is not a shareholder on any of the two days as mandated by Section 79 of the Act. It was also observed that the Delhi HC did not frame the question of law on this issue. Therefore, it cannot be said that the decision of the Delhi HC is on the interpretation of Section 79. Lastly, it was also observed that the Delhi HC in the case of Select Holidays Resorts has itself held that set off cannot be denied if the management remains the same despite the change in shareholding.
The rationale behind these decisions seems to be that the expression beneficial occurring in Section 79 of the Act cannot be simply interpreted as immediate/direct/registered shareholding.
Perspective from Company Law
The debate on beneficial ownership under Section 79 of the Act cannot be fully understood without reference to company law, particularly Section 89 of the Companies Act, 2013 (“CA, Act”). Section 89 of the CA Act mandates that any person whose name is entered in the register of members as the holder of shares but who does not hold the beneficial interest in such shares to make a declaration under Form MGT-05 to the company specifying the details of the real beneficial owner.
This raises an important question- whether in absence of such a declaration, the registered shareholder should be deemed to be the beneficial owner?
It is considered that unless a declaration is made under Section 89 indicating that the registered shareholder is not the beneficial owner, the presumption is that the person named in the register holds both legal and beneficial ownership. Furthermore, it is important to note that he Income Tax Act does not explicitly mandate the application of Section 89 for determining beneficial ownership under Section 79. However, the principles underlying Section 89 of the Act can be instructive for judicial authorities when evaluating the beneficial ownership of voting rights for tax purposes or if the declaration has been filed the same can be used as a piece of evidence to establish the identity of the real beneficial owner in terms of the decision in Yum Restaurants. Therefore, the Courts and Tribunals may take into account the provisions of Section 89 when faced with disputes over beneficial ownership, especially where there is evidence of arrangements or agreements affecting the true ownership of shares. the logic of requiring a declaration in cases of split legal and beneficial ownership provides a useful framework for resolving disputes under Section 79 of the Act.
Conclusion
A harmonious reading of Section 89 of the Companies Act, 2013, and Section 79 of the Income Tax Act, 1961, supports the view that the registered shareholder should be deemed the beneficial owner unless there is evidence to the contrary, such as a declaration or arrangement indicating otherwise. This approach finds support in the first set of judicial precedents, which recognize the primacy of the register of members in the absence of contrary evidence. However, this reasoning is most appropriately applied in the context of companies incorporated under the Companies Act, 2013, and may not extend to foreign companies, where different rules and evidentiary standards may apply.
With respect to the second category of cases, the concept of beneficial ownership has been interpreted by the Courts and Tribunals primarily following the concept of control (direct and indirect) over the Assessee company. But, if the standards and requirements of Section 89 of the Companies Act, 2013, are applied it will give rise to legal certainty in this regard as it will provide a specific threshold that will decide whether Section 79 of the Act will be applicable in a particular situation or not.
The debate on beneficial ownership under Section 79 is far from settled. The ambiguity in the statutory language, coupled with divergent judicial opinions, means that each case must be evaluated on its own facts, with due regard to both the legal form and the underlying economic reality. The principles enshrined in company law, particularly the requirement for declarations in cases of split ownership, provide a useful guide for resolving disputes, but cannot be applied mechanically in the tax context. Ultimately, the purpose of Section 79 is to prevent tax avoidance through artificial changes in control, not to penalize genuine business restructurings within the same group. A substance-over-form approach, supported by evidence and guided by the principles of company law, offers the most balanced and equitable solution.
[1] Section 79.
[2] [1980] 40 Taxman 126A (SC), Para 10.
[3] [2016] 66 taxmann.com 47 (Delhi).
[4] [2019] 112 taxmann.com 172 (Mumbai – Trib.).
[5] [2022] 140 taxmann.com 65 (Delhi – Trib.).
[6] ITA No. 2638/Mum/2012.
[7] [2013] 35 taxmann.com 368 (Delhi).
[8] [2015] 62 taxmann.com 350 (Karnataka).
[9] ITA No. 2336/Mum/2019.
[10] [2023] 157 taxmann.com 551 (Mumbai – Trib.).
[11] [2018] 93 taxmann.com 326 (Ahmedabad – Trib.).
[12] [2018] 98 taxmann.com 487 (Mumbai – Trib.).
[13] [2018] taxmann.com 37 (Mumbai – Trib.).
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Thanks sir, for sharing article and relevant case laws