The govt should reconsider the provisions of Section 79 of the I-T Act to help make doing business in India easier
Today, large corporates have complex group-holding structures because of their diversified operations and other commercial or legal considerations. For instance, the companies operating in the infrastructure sector are typically required to take up separate projects in separate companies, which are usually set up as wholly-owned subsidiaries.
However, over a period of time, due to various commercial objectives (synergies, investor-entry, relaxations in laws), companies consider reorganising their group structures. Such reorganisation includes intra-group share transfers and mergers, often resulting in change in the legal shareholding of a company with the ultimate shareholder remaining the same.
Business reorganisation within a group usually leads to tax implications for the companies, including potential impact on their tax losses. Generally, a corporate entity that has incurred losses is permitted to carry forward and set off such losses in the subsequent years. However, Section 79 of the I-T Act restricts carry-forward and set-off of losses for a company whose beneficial shareholding changes by more than 49% from the last day of the year in which the loss was incurred.
Interpretation of the term ‘beneficial shareholding’ in the case of intra-group transfers for the purposes of Section 79 has been a subject matter of judicial debate for some time now, and the recent judgment in the matter involving Yum Restaurants (2016) has reignited the debate of legal ownership over beneficial ownership. Legal ownership refers to the registered ownership of an asset whereas beneficial ownership refers to the owner enjoying the economic benefits from such asset.
In the past, courts have tried to ascertain the meaning of the term ‘beneficially-held’ and have had divergent views in this regard. The general principle laid down by these judgments is that the term ‘beneficial owner’ should be construed to be the ‘legal’ or ‘registered’ owner of the shares.
The rationale of legal ownership being equivalent to beneficial ownership was laid down by apex court in the case of Howrah Trading Co Ltd (1968), holding that the beneficial owner of a share could only be the person who has the share certificate in his/her name.
Ever since, the courts have constantly opined that companies are separate legal entities, having the ability to take their own decisions, even if they are wholly-owned by other companies and, hence, if they hold investments, it can’t be said to be beneficially-held by the ultimate holding company.
However, in a recent judgment in the matter involving Amco Power Systems Ltd (2015), the Karnataka High Court ruled otherwise. The court considered ‘complete control’, even after change in shareholding, to be the prime basis for administering the provisions of Section 79. A similar rationale was laid down by the Delhi High Court in the matter inviolving Select Holiday Resorts Pvt. Ltd (2011), wherein it held that where a parent company is merged with its subsidiary, the benefit of losses claimed by the subsidiary company cannot be disallowed as there was no change in control of amalgamated company pre- and post-merger.
It also construed the amalgamation akin to the death of a shareholder and provided the benefit of carry-forward of losses to the taxpayer. Subsequently, the Supreme Court had dismissed the taxman’s special leave petition against the Delhi HC ruling.
In the case of Yum Restaurants, the court has upheld the traditional interpretation of the term ‘beneficial ownership’. It denied set-off and carry-forward of business losses under Section 79, owing to 100% change in shareholding of the taxpayer. It dismissed the taxpayer’s contention that despite change in shareholding, the ultimate holding company remained unchanged and hence Section 79 was not triggered.
Though the court, in the case of Yum Restaurants, has reaffirmed the interpretation of the section, this matter has not attained finality due to other contrary high court judgments. In our view, ‘beneficial ownership’ should be construed to be equivalent to ‘legal ownership’. Accordingly, if there is a change in the immediate shareholding of the company by more than 49%, it should lead to lapse of its losses.
However, if it is able to substantiate that its beneficial shareholding remains the same pre- and post-reorganisation, then an alternate view may be explored. Though this would need to be tested in light of the proposed General Anti Avoidance Rules.
Further, since Section 79 was introduced way back in 1961, there is a need for the government to reconsider the provisions in light of the recent developments and business dynamics. Proposals like exemptions for start-ups (which require regular fund infusion in the initial years) and group reorganisations (where ultimate beneficial ownership is not changing), which have been an outstanding demand of the industry, should be addressed to facilitate ease of doing business in India.
Written By: Nitin Savara. The author is partner (Tax), EY India. Views are personal