The Income Tax Act, 1961 (“IT Act”), allows certain taxpayers to carry forward and set off the losses incurred in a financial year (“FY”)against the income of subsequent FYs, on satisfaction of prescribed conditions. However, to ensure taxpayers do not use such beneficial provisions to escape their tax liabilities, the IT Act also includes anti-abuse provisions, which disallow carry forward or set off of such losses under specified circumstances. In this respect, section 79 of the IT Act disallows a closely held company from carrying forward and setting off its tax losses if there is a change in the beneficial ownership of shares carrying more than 49% of the voting power of the company as compared to the year in which the loss was incurred (subject to certain exceptions). This provision was introduced with the intent to curb the practice of profitable enterprises acquiring loss making undertakings for the sole reason of utilising tax losses accumulated by such undertakings to reduce their taxable business profits.
A question that often comes up before courts and tribunals is whether beneficial ownership can be said to have remained unchanged if the registered owner of shares, holding more than 49% of the voting power, has changed. Recently, the Hon’ble Mumbai Income Tax Appellate Tribunal (“ITAT”) had an occasion to opine on this, in the case of Sodexo India Services Private Limited.
Ruling in Sodexo India Services Private Limited
In the said case, Sodexo India Services Private Limited (“Taxpayer”) had declared certain tax losses in its tax returns (“Accumulated Losses”). However, the Taxpayer’s case was later selected for revisionary proceedings, where it was noticed that there was a substantial change in the shareholding (i.e., more than 51%) of the Taxpayer during the relevant FY, as follows:
Accordingly, the tax authorities invoked section 79 of the IT Act and passed an order, disallowing the Taxpayer from setting off or carrying forward the Accumulated Losses.
Aggrieved, the Taxpayer appealed before the ITAT. The Taxpayer contended that the factum of change in shareholding had been duly disclosed by it in its tax audit reports and the ultimate power for voting remained with the same beneficial shareholder as in the earlier years. Further, the Taxpayer had not claimed any set off against the Accumulated Losses in the relevant FY. Thus, section 79 could not have been invoked and the revisionary order was erroneously passed by the tax authorities.
The ITAT noted that it was an undisputed fact that no set off had been claimed by the Taxpayer. Thus, it agreed that the invocation of section 79 of the IT Act was unwarranted, and hence, unsustainable. Further, the ultimate beneficial ownership of the Taxpayer remained with the same ultimate holding company (i.e., F Co 1). Accordingly, even if the Taxpayer had claimed a set off, section 79 still would not have been attracted. Thus, the ITAT quashed the revisionary order.
Section 79 of IT Act does not get attracted unless there is a change in persons beneficially holding shares, carrying at least 51% of the voting power of the company on the last day of the FY in which a set off is claimed, as compared to the last day of the FY in which the loss was incurred.
While in Sodexo India Services Private Limited, the Mumbai ITAT did not do a deep dive into whether the Taxpayer was required to present evidence to substantiate that beneficial ownership of its shares was always with its ultimate holding company (i.e., F Co 1), the courts and tribunals, in the past, have adopted contrary positions on this issue. For instance, the Hon’ble Karnataka High Court in the case of Commissioner of Income-tax v. AMCO Power Systems Ltd., held that a holding company would naturally exercise control over its wholly-owned subsidiary and thus, it would also be considered to have voting power over the shares of its step-down subsidiary. However, the Hon’ble Delhi High Court in Yum Restaurants (India) (P.) Ltd. v. Income-tax Officer, held that simply because the ultimate holding company remained unchanged, this would not automatically imply that the beneficial ownership also remained unchanged. The onus was on the taxpayer to show that there was a separate beneficial shareholder, distinct from the registered shareholder, who was entitled to the benefits flowing from the shares (i.e., voting rights, dividend, etc.). Similarly, the Hon’ble Delhi ITAT in ACIT v. WSP Consultants India (P.) Ltd., noted there was nothing on record to show that the ultimate holding company was the beneficial owner of shares of the company having 51% or more voting right. In the absence of such evidence, the registered shareholder would be presumed to be the beneficial shareholder.
Basis these decisions, the tax authorities may require taxpayers to present evidence to substantiate the fact that in a given case, the beneficial owner is distinct from the registered owner. Thus, it may be advisable for taxpayers to get their transaction documents adequately vetted and have sufficient material which records such an understanding.
Additionally, the Mumbai ITAT, in Sodexo India Services Private Limited, also clarified that section 79 of the IT Act gets attracted in the year in which set off is claimed and not in the year when the shareholding of the company changes. Since, there might be a considerable gap between incurring a loss and claiming set-off, it is also critical to undertake an analysis on the applicability of section 79 vis-à-vis the changing circumstances in the intervening period. For instance, section 79 of the IT Act may not be attracted if the taxpayer is no longer considered to be a closely held company at the time of claiming the set off. Such an analysis would need to be undertaken on a case-to-case basis.
 TS-79-ITAT-2023 (Mum).
  62 taxmann.com 350 (Karnataka).
  66 taxmann.com 47 (Delhi).
  140 taxmann.com 65 (Delhi – Trib.).