Issue for Consideration Any loss incurred in the case of a company in which the public are not substantially interested (“closely held company”), in any year prior to the previous year shall not be carried forward and set-off, if there is change in the persons beneficially holding shares of such company with 51% voting power. In other words, the persons holding such voting power as on the last day of the previous year in which such set off is claimed are the same as the persons in the year or years prior to the previous year in which the loss was incurred.
The limitation contained in section 79 is relaxed in cases of change in the voting power in the following cases – (a) death of the shareholder, (b) gift to any relative of the shareholder, or (c) amalgamation or demerger of a foreign holding company, subject to prescribed conditions.
The relevant part of section 79 reads as “Notwithstanding anything contained in this Chapter, where a change in shareholding has taken place in a previous year in the case of a company, not being a company in which the public are substantially interested, 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- (a) 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.”
It is common to come across cases wherein shares of a closely held company carrying 51% of voting power or more are held by another company (‘immediate holding company’), which company in turn is the subsidiary of yet another company (‘ the ultimate holding company’). An interesting controversy has recently arisen as regards application of section 79 in cases where shares with such voting power held by the immediate holding company are transferred to yet another immediate holding company of the same ultimate holding company.
Can such a change of shareholding from one subsidiary to another subsidiary company of the same holding company disentitle the closely held company from setting-off the carried forward loss, is a question that the courts have been asked to examine. While the Karnataka High Court has held that the closely held company shall be entitled to set-off the carried forward losses, the Delhi High Court has recently prohibited such set-off, ignoring its own decision in an earlier case.
AMCO Power Systems Ltd .’s case
The issue arose before the Karnataka High Court in the case of CIT vs. AMCO Power Systems Ltd. 379 ITR 375, wherein the court was asked to consider the question: “Whether the Tribunal was correct in holding that the assessee would be entitled to carry forward and setoff of business loss despite the assessee not owning 51% voting power in the company as per Section 79 of the Act by taking the beneficial share holding of M/s. Amco Properties & Investments Ltd.?”
Admittedly, up to the assessment year 2000-01, all the shares of the company Amco Power Systems Ltd. were held by AMCO Batteries Ltd.(‘ABL’). In the assessment year 2001-02, the holding of ABL was reduced to 55% and the remaining 45% shares were transferred to its subsidiary, namely AMCO Properties and Investments Limited (‘APIL’). In the assessment year 2002-03, ABL further transferred 49% of its remaining 55% shares to Tractors and Farm Equipments Limited (‘TAFE ‘) and consequently ABL retained only 6% shares, its subsidiary APIL held 45% shares and the remaining 49% shares were with TAFE . Similar shareholding continued for the assessment year 2003-04. For easy understanding, shareholdings of the company for the relevant assessment years is given in the chart below:
For the assessment year 2003-04, the company filed its return of income on 28.11.2003, wherein NIL income was shown, after setting off losses brought forward from earlier years. The return of income was processed u/s. 143(1) of the Income-tax Act, 1961, and the returned income was accepted on 6.2.2004. Subsequently, the case was taken up for scrutiny, and assessment u/s. 143(3) of the Act was completed. The income of the company for the year was determined at Rs.1,34,03,589/. The assessment order did not allow the set off of losses of the earlier years, by invoking section 79 of the Act.
Aggrieved by the order of assessment passed u/s. 143(3) of the Act, the company preferred an appeal before the Commissioner (Appeals), inter alia, for denial of set-off of brought forward business loss, on the ground that the provisions of section 79(a) of the Act were not complied with. The Commissioner (Appeals) order confirmed that the company was not found to be entitled to set-off of the brought forward losses, considering the change in beneficial holding of 51% or more, as provided u/s. 79 of the Act.
Being aggrieved by the order of the Commissioner (Appeals), the company filed an appeal before the Income Tax Appellate Tribunal, challenging the denial of the benefit of set-off of brought forward losses. The Tribunal allowed the appeal of the company, by allowing the benefit of set-off of brought forward losses. The Tribunal, in accepting the submission of the company, held that 51% of the voting power was beneficially held by ABL during the assessment years 2002-03 and 2003-04 also, and the company was thus entitled to carry forward and set-off the business losses of the previous years.
In appeal to the Karnataka High Court, the Revenue urged that, up to the assessment year 2001-02, there was no dispute that ABL continued to have 51% or more shares as its shareholding, as in that assessment year, ABL was holding 55% shares, and its subsidiary APIL was holding 45% shares. For the assessment year 2002-03, when ABL transferred 49% shares (out of its 55%) to TAFE , ABL was left with only 6% shares, meaning thereby, it was left with less than 51% shares. It was contended that, consequently, its voting power was also reduced from 55% to 6%, and the remaining 94% was divided between TAFE and APIL at 49% and 45% respectively. As a result the company was disentitled to claim carry forward and set-off of business losses in the assessment years 2002-03 and 2003-04. It was further submitted that even though APIL was a wholly owned subsidiary of ABL, both companies were separate entities, and could not be clubbed together for ascertaining the voting power. By transfer of its 49% shares to TAFE , the shareholding of ABL was reduced to 6% only. Thus, the provisions of section 79 of the Act were attracted for denial of the benefit of carry forward of losses to the company.
On behalf of the company, it was submitted that it was not the shareholding that was to be taken into consideration for application of section 79, but it was the voting power which was held by a person or persons who beneficially held shares of the company, that was material for carry forward of the losses. It was thus contended that as ABL was holding 100% shares of APIL, which was a wholly owned subsidiary of ABL, and fully controlled by ABL, even though the shareholding of ABL had been reduced to 6%, yet the voting power of ABL remained more than 51%. As such, the provisions of section 79 of the Act would not be attracted in the present case.
The Karnataka High Court noted the fact that ABL was the holding Company of APIL, which was a wholly owned subsidiary of ABL. The Board of Directors of APIL were controlled by ABL, a fact that was not disputed. The submission of the company that the shareholding pattern was distinct from voting power of a company, had force, in as much as, what was relevant for attracting section 79 was the voting power.
The High Court further noted that the purpose of section 79 of the Act was that the benefit of carry forward and setoff of business losses for previous years of a company should not be misused by any new owner, who might purchase the shares of the company, only to get the benefit of set-off of business losses of the previous years against the profits of the subsequent years after the take over. It was for such purpose, that it was provided that 51% of the voting power, which was beneficially held by a person or persons, should continue to be held for enjoyment of such benefit by the company. The court observed that though ABL might not have continued to hold 51% shares, it continued to control the voting power of APIL, and together, ABL had 51% voting power. Thereby, the control of the company remained with ABL as the change in shareholding did not result in reduction of its voting power to less than 51%. Section 79 dealt with 51% voting power, which ABL continued to have even after transfer of 49% shares to TAFE .
The Karnataka High Court noted that the Apex court, while dealing with a case u/s. 79(a) in CIT vs. Italindia Cotton Private Limited, 174 ITR 160 (SC), held that the section would be applicable only when there was a change in shareholding in the previous year, which might result in change in control of the company, and that every such change of shareholding need not fall within the prohibition against the carry forward and set-off of business losses. In the present case, the Karnataka High Court observed that though there might have been change in the shareholding in the assessment year 2002-03, yet, there was no change in control of the company, as the control remained with ABL, in view of the fact that the voting power of ABL, along with its subsidiary company APIL, remained at 51%.
The court also relied on the observation of the apex court in that case to the effect that the object of enacting section 79 appeared to be to discourage persons claiming a reduction of their tax liability on the profits earned in companies which had sustained losses in earlier years. The Karnataka High Court held that, in the case before them, the control over the company, with 51% voting power, remained with ABL. As such, the provisions of section 79 of the Act were not attracted. The court accordingly confirmed the finding of the Tribunal in this regard.
Yum Restaurants (India) Private Limited’s case
The issue came up again recently before the Delhi High Court in the case of Yum Restaurants (India) Private Limited vs. ITO in ITA No. 349 of 2015 dated 13th January, 2016 for the Assessment Year 2009-10.
The assessee, Yum Restaurants (India) Private Limited (‘Yum India’), was a part of the Yum Restaurants Group, whose 99.99% shares were held by its immediate holding company Yum Restaurants Asia Private Ltd.(‘Yum Asia’), with its ultimate holding company being Yum! Brands Inc. USA (Yum USA). 99.99% of shares of Yum India, initially held by ‘Yum Asia’, were transferred, pursuant to restructuring within the group, after 28th November 2008, to Yum Asia Franchise Pte. Ltd. Singapore (‘Yum Singapore’). The group decided to hold shares in Yum India through Yum Singapore and, therefore, the entire share holding in Yum India, was transferred from one immediate holding company, viz., Yum Asia, to another immediate holding company, Yum Singapore, although the ultimate beneficial owner of the share holding in Yum India remained the ultimate holding company viz., Yum USA.
The total income of Yum India was proposed to be assessed at Rs.40,65,40,535 in the draft order framed by the AO. In doing so, the AO, inter alia, disallowed the set off and carry forward of business losses incurred till AY 2008-09. By its order, the DRP upheld the conclusions reached by the AO and rejected Yum India’s submission as regards set off and carry forward of business losses. On the basis of the DRP’s order, the AO completed the assessment and assessed the income of Yum India.
In appeal to the ITAT , Yum India challenged the disallowance of the carry forward of business losses. By its order, the ITAT upheld the disallowances of the carry forward of business losses of earlier years. The ITAT referred to the change in immediate share holding of Yum India from Yum Asia to Yum Singapore and held that, by virtue of section 79 of the Act, since there had been a change of more than 51% of the share holding pattern of the voting powers of shares beneficially held in AY 2008- 09 of Yum India, the carry forward and set off of business losses could not be allowed.
In the appeal filed by Yum India to the Delhi High Court, the company challenged the order of the ITAT , questioning the denial of the carry forward of accumulated business losses for the past years and set off u/s. 79 of the Act.
The Delhi high court noted that the AO did not accept the contention of Yum India, that since the ultimate holding company remained Yum USA, it was the beneficial owner of the shares, notwithstanding that the shares in Yum India were held through a series of intermediary companies.; In his view, section 79 required that the shares should be beneficially held by the company carrying 51% of voting power at the close of the financial year in which the loss was suffered; the parent company of Yum India on 31st March 2008 was the equitable owner of the shares but it was not so as on 31st March 2009; accordingly, Yum India was not permitted to set off the carried forward business losses incurred till 31st March 2008.
The court also noted that, in dealing with the issue, the ITAT had in its order analysed section 79 of the Act and noted that the set off and carry forward of loss, which was otherwise available under the provisions of Chapter VI, was denied if the extent of a change in shareholding taking place in a previous year was more than 51% of the voting power of shares beneficially held on the last day of the year in which the loss was incurred. The ITAT had noted that, in the present case, there was a change of 100% of the shareholding of Yum India. Consequently, there was a change of the beneficial ownership of shares, since the predecessor company (Yum Asia) and the successor company (Yum Singapore) were distinct entities.The fact that they were subsidiaries of the ultimate holding company, Yum USA, did not mean that there was no change in the beneficial ownership. Unless the assessee was able to show that notwithstanding shares having been registered in the name of Yum Asia or Yum Singapore, the beneficial owner was Yum USA, there could not be a presumption in that behalf.
Having examined the facts as well as the concurrent orders of the AO and the ITAT , the Delhi high court found 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 Associated Enterprises of Yum USA, there was 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 did not arise. In the circumstances, it was rightly concluded by the ITAT that in terms of section 79 of the Act, Yum India could not be permitted to set off the carried forward accumulated business losses of the earlier years.
Consequently, the Court declined to frame a question at the instance of Yum India on the issue of carry forward and set off of the business losses u/s. 79 of the Act.
Observations:
A company is required to show that there was no change in persons beneficially holding the shares with the prescribed voting power on the last day of the previous year in which the set off is desired. The key terms are; ‘beneficial holding’ and ‘ holding voting power’, none of which are defined in the Act nor in the Companies Act. The cases of fiduciary holding are the usual cases which could be safely held to be cases of beneficial holding. The scope thereof however should be extended to cases of holding through intermediaries, where the ultimate beneficiary is the final holder, who enjoys the fruits of the investment.
This principle can be applied with greater force in cases where the control and management rests with the ultimate holding company. Again ‘holding of voting power’ is a term that should permit inclusion of cases where the shares are held through intermediaries, and the final holder has the exclusive power to decide the manner of voting. If this is not holding voting power, what else could be?
Both the terms collectively indicate the significance of the control and management of the company. In a case where it is possible to establish that there has not been any change in the control and management of the company, that the control and management has remained in the same hands, the provisions of section 79 should not be applied.
The Apex court, in Italindia Cotton Private Limited’s case (supra), held that section 79 would be applicable only when there was a change in shareholding in the previous year which might result in change of control of the company, and that every change of shareholding need not fall within the prohibition against the carry forward and set-off of business losses. The findings of the Apex court have been applied favourably by the Karnataka High Court in AMCO’s case (supra) to hold that, though there might have been a change in the shareholding in the assessment year 2002-03, yet, there was no change of control of the company., The control remained with ABL in view of the fact that the voting power of ABL, along with its subsidiary company APIL, remained at 51%. It is this reasoning that was perhaps missed in the case of Yum India (supra).
In another similar case, Indrama (Investments) Pvt. Ltd., (‘IIPL’) a company held 98% of the shares of one Select Holiday Resorts Private Ltd.(‘SHRPL’) and the balance shares of SHRPL were held by four individuals, who inter alia held 100% shares of IIPL. On merger of IIPL into SHRPL, the shares held by IIPL stood cancelled and the four individuals became 100% shareholders of SHRPL. The claim of the set off of carried forward of loss of prior years by SHRPL was rejected by the AO for assessment years 2004-05 and 2005-06, by application of section 79, holding that there was a change of shareholders holding 51% voting power.
The appeal of SHRPL was allowed by the Commissioner(Appeals) and his order was upheld by the ITAT in ITA No. 1184&2460?Del./2008 dt. 23.12.2010 in the case of DCIT vs. Select Holiday Resorts Private Ltd. The appeal of the Income tax Department to the Delhi High Court was dismissed by the court, reported in 217 Taxman 110. The Special Leave Petition of the Income tax Department was rejected by the Supreme Court. The high court, in this case, equated the case of transfer of shares on a merger, with that of the transmission of shares to the legal heir on death, to hold that there was no change of voting power for attracting provisions of section 79 to enable the AO to deny the set off of the carried forward losses.
The ratio of the decision of the court in SHRPL was not brought to the attention of the ITAT as also of the high court in Yum Restaurant’s case. Also the findings of the Karnataka high court in AMCO’s case(supra) were not brought on record. We are sure that had the judicial development on the subject been brought to the attention of the Delhi High Court in the case of Yum Restaurants (supra), the outcome would have been different.
Section 79 has been amended by the Finance Act, 1988 by the insertion of the first Proviso, that excludes cases of change in shareholding consequent to death or gift. The scope of the amendment has been explained by Cir. No. 528 dated 16.12.1988 and in particular by paragraph 26.3. The CBDT clarifies that the objective behind the amendment is to save the genuine cases of change from the hardships of section 79 of the Act. Kindly see Circular No. 576 dated 31.08.1990. The section has been further amended by the Finance Act, 1999, by insertion of the second Proviso to provide for exclusion of cases involving change in shareholding of an Indian subsidiary on account of amalgamation or demerger of a foreign company – again to save genuine cases of change from hardship of section 79 of the Act.
Clause(b) of section 79(now deleted) provided for nonapplication of section 79 in cases where the change was not effected to avoid payment of taxes or for reduction of taxes. The objectives behind introduction of section 79 and the development in law thereon, as also the amendments made therein from time to time, clearly show that the right to set off of carried forward losses of prior years should not be denied in genuine cases. Kindly see CIT vs. Italindia Cotton Private Limited, 174 ITR 160 (SC), where the court observed to the effect that, the object of enacting section 79 appeared to be to discourage persons claiming a reduction of their tax liability, on the profits earned in companies after take over, which had sustained losses in earlier years.
The Delhi High Court, in Yum India’s case(supra), importantly observed that the company had failed to show that there was any agreement or arrangement that the beneficial owner of such shares would be the holding company, Yum USA. In our opinion, the situation otherwise could have been salvaged, had the company produced evidence to demonstrate that the beneficial owner of shares was Yum USA.
It may not be proper, in our considered opinion, to be swayed by the status of the subsidiaries for taxation of the dividend or other income. It would well be perfectly harmonious to hold the immediate holding company liable for taxation and, at the same time, to look through it for the purposes of section 79, right up to the ultimate holding company. Such an approach would not defeat the purposes of the Act but would serve the cause of the scheme of taxation.
