A specific ‘anti-avoidance’ provision under the Income Tax Act is a stumbling block for Indian corporate groups who wish to restructure their internal operations and shareholdings. This affects only the Indian subsidiaries of Indian parent companies while granting a safe harbour to similar subsidiaries of foreign parent companies. The Act, since its inception in 1961, contains a stipulation (Section 79) which prohibits the carry forward of losses of a closely-held Indian company if its majority shareholding is passed on to new shareholders. This section was introduced in the Act based on the recommendations of the Report of the Taxation Enquiry Commission (Mathai Commission) of 1953-54. The Commission apprehended that it would be possible for a few persons to acquire the shares of companies which had sustained losses in earlier years, commence to carry on profitable business through these companies and, in this way, be able to reduce their tax liability by setting off losses of earlier years when the shares in the company were held by different shareholders. It therefore recommended that a closely-held company should be allowed to set off losses against profits of subsequent years only if its shareholders in the profit-earning year remain substantially the same as those in the year when the losses occur. The provision was incorporated in the Bill introducing the new income tax legislation of 1961. The redoubtable Minoo Masani of the Swatantra Party was a member of the Select Committee of Parliament which examined the Bill. He opposed the provision on the ground that whereas other countries were amending their income-tax laws to provide for carrying back business losses, the provision tried to abridge even the limited right of carrying forward business losses.
The Select Committee chose to retain the provision with a safeguard that it would apply only if the change in shareholding was made for the purpose of getting the benefit of the company’s losses for avoiding tax liability. Over the years, Indian Revenue found it extremely difficult to discharge this onus of proof. This safeguard in the provisions of Section 79 was dropped by the legislature in 1989. Therefore, as soon as the objective test of substantial shareholding is violated, a company is not allowed to carry forward its losses, irrespective of the purpose of the transaction. Some minor exceptions like change in shareholding owing to death or gift of shares to relatives are allowed.
A major change in outlook came in the NDA government’s 1999 budget which took a number of proactive measures to facilitate corporate restructuring, mergers and acquisitions. Policy makers recognised that in a globalised business environment, reorganisations of companies in foreign multinational groups were common and could trigger corresponding changes in the shareholding of the Indian subsidiary of the group leaving the ultimate control still in the hands of the foreign parent. A carve-out in the provisions of Section 79 was therefore introduced to safe-guard the carry forward of losses of the Indian company as long as the majority shareholding of the company remained with the ultimate foreign parent company of the multinational group.
It is logical that a similar carve-out should also be provided for reorganisations by Indian multi-national groups but none exists even 15 years after the facility was extended to foreign multi-nationals. The saga of tax litigation on this issue therefore continues with contradictory rulings from the high courts. The Karnataka High Court (in the case of Amco Power Systems Ltd.) has recently allowed the carry forward of losses in an Indian company (despite a substantial change in the shareholding) on the ground that the intention of the legislation is not violated since it was an internal restructuring within the Indian group’s subsidiary companies with the ultimate majority shareholding being retained by the parent company. The Delhi High Court (in the case of Yum Restaurants Pvt. Ltd.), has held otherwise.
Facilitating internal restructurings within Indian corporate groups is just as important as it is for foreign ones. This should not be left to long drawn litigation regarding the scope, interpretation and intention behind the provisions. The carve-out from the rigours of Section 79 needs to be quickly provided for internal restructurings among subsidiary companies of Indian corporate groups as has already been done for Indian subsidiaries of multi-nationals a decade and a half ago.
The author is of-counsel, BMR & Associates LLP, and formerly, joint secretary, ministry of finance, Government of India