Changing business dynamics requires corporates to review their investment and business structures. Often, corporate restructuring is undertaken to align the business with the current economic reality, wherein besides commercial reasons, other considerations such as legal, tax and regulatory implications also play a pivotal role.
As per Section 79 of the Income Tax Act, 1961 (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. It is pertinent to note that this provision was introduced pursuant to the recommendations of the Report of the Taxation Enquiry Commission – Mathai Commission. The moot point was to restrict any attempt to transfer losses incurred by a company by means of a transfer of shareholding, except in a situation where a majority of the shareholders’ continues to remain the same.
Section 79 of the Act as it reads today operates as a Special Anti-Abuse Rule (SAAR); however, it also becomes an impediment in case of bona fide commercial transactions. As a result, in case of a closely held company, losses incurred in any year prior to the previous year are not eligible to be carried forward and set-off against the subsequent years’ income, if the change in beneficial ownership is more than 49% in any previous year.
Though few exceptions to the above provisions have been provided to cover certain scenarios such as the death of a shareholder or on account of transfer of shares by way of a gift to any relative of the shareholder making the gift. Similarly, an exception has been carved out in case of global mergers and demergers, where there is a change in the shareholding of an Indian company which is a subsidiary of a foreign company, as a result of amalgamation or demerger of a foreign company, provided 51% of the shareholders of the amalgamating or demerged foreign company continue to be shareholders of the amalgamated or the resulting foreign company. Still, there are situations where exceptions need to be carved out to cover genuine business cases.
The underlying issue is whether the provisions are to be read in the context of the immediate holding company i.e. the registered or legal shareholder or are they to be read in reference with the parent holding company i.e. the ultimate beneficial shareholder which has the voting power, directly or indirectly, in the company whose shares are the subject matter of transfer.
Extant provisions of the Act neither define the term ‘beneficial ownership’ nor contain any guidelines or rules that lay down the criteria to determine as to what would qualify as a change in beneficial ownership. Interpretation of this phrase has been the subject matter of litigation and divergent rulings have only added to the complexity.
In the case of Yum Restaurants, the Delhi High Court held that in the absence of any specific agreement/arrangement, the ultimate holding company cannot be considered as the beneficial owner, since beneficial ownership stays with the immediate holding company – there arises no need to pierce the corporate veil. A similar view was taken by the Mumbai Tribunal in the cases of Just Lifestyle Pvt. Ltd. and Tainwala Trading and Investments Company Ltd.
In contrast, the Karnataka High Court in the case of Amco Power Systems, took a view that beneficial ownership would be said to be held by the ultimate parent company. This view was taken by drawing reference to the Supreme Court ruling dealing with the issue of control, basis which, it was held that Section 79 of the Act should be applicable only when a change in shareholding results in a change in the control of a company – every change in a registered shareholding need not trigger the provisions of this section.
In the case of Select Holiday Resorts Private Limited (SHRPL), where the Holding Company (H Co.) of SHRPL merged with it under a High Court Scheme and consequently, 98 per cent of the stake in SHRPL was transferred to promoters of the H Co. which was earlier held by the H Co., the Delhi High Court allowed to carry forward the tax losses of SHRPL and treated the liquidation of the H Co. equivalent to the death of a shareholder.
As is evident from the above examples, the interpretation of the term beneficial ownership could lead to very different results and in the absence of clarity, a lot of uncertainty prevails vis-à-vis Indian corporate group restructuring.
Globally, many tax jurisdictions allow for the carry forward of losses in case of group restructurings, subject to certain conditions. Hence, it is time that the necessary clarity is provided on these provisions and specific exemptions are brought in for domestic group restructuring.
Vasal is partner, tax at KPMG India.
The views and opinions expressed herein are those of the authors and do not necessarily represent the views and opinions of KPMG in India.
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