SKP Tax Alert
18 December 2014 | Volume 7 Issue 15
Denial of set-off of losses incurred in earlier years due to change in the immediate shareholding of the company

Background
Recently, the Delhi Bench of the Income Tax Appellate Tribunal (Tribunal), in the case of Yum Restaurants (India) Pvt Ltd [TS-755-ITAT-2014(DEL)] (Taxpayer) held that the benefit of set-off of unabsorbed business loss would not be available to the taxpayer, if there is a change in the immediate shareholding of the taxpayer company by more than 49% as compared to shareholding of the year in which loss was incurred. This is despite the fact that the ultimate holding company of the new shareholder and the erstwhile shareholder remained the same.

Facts of the case
  • The taxpayer had claimed set-off of brought forward business loss against the business income of the current year.
  • During the year under consideration, 100% shareholding of the taxpayer company underwent a change from Yum Restaurant Asia Pte Ltd (YRAPL) to Yum Asia Franchisees Pte Ltd. (YAFPL)
  • YRAPL and YAFPL were the two fellow subsidiary companies of the same holding company based in the US.
  • The Assessing Officer (AO) refused to allow set-off of brought forward losses of past years against income of the current year pursuant to a change in shareholding by more than 49%.
  • The AO adopted this position based on the provisions of Section 79 of the Income Tax Act, 1961 (IT Act) which provides that in case of a company which lacks substantial public interest, the benefit of carry forward and set-off of unabsorbed business loss would not be available against the income of the year if there is a change in the beneficial voting power by more than 49% as compared to the beneficial voting power of the previous year in which the loss was incurred. 
  • Aggrieved by this, the taxpayer appealed to the Tribunal.
Key issue before the Tribunal
Whether provisions of section 79 of the IT Act will be triggered if there is a change in immediate shareholding by more than 49% even though the predecessor and the successor shareholders are subsidiaries of the same holding company (i.e. ultimate beneficial ownership remains unchanged)?

Taxpayer’s contention
  • The reference to 'shareholders' in Section 79 of the IT Act relates to the 'beneficial shareholding', where it states that if the shares carrying 51% of the voting power continues to be held by the same group i.e. the same ultimate holding company, then the beneficial holding does not change;
  • It was contended by the taxpayer that there is no change of the beneficial ownership of shares because both the predecessor and successor companies are fellow subsidiaries of the same holding company.
Revenue’s contention
  • There is a change of the beneficial ownership of shares because the predecessor and successor companies are distinct from each other; and
  • The fact that they are subsidiaries of the same ultimate holding company does not mean that there is no change in the beneficial interest.
Tribunal’s observations and ruling
  • It is an undisputed fact that 100% shareholding of the taxpayer company underwent a change due to which another company came to hold 100% shares of the taxpayer company.
  • A company is a distinct legal entity; its identity is separate from the identity of its shareholders and therefore the beneficial interest has to be considered of the immediate shareholders of the company and not the ultimate holding company.
  • Holding and subsidiary companies, though bound by their legal relationship, do not lose their individual existence in the commercial world. Both are separately liable for tax with respect to the respective transactions undertaken by them.
  • The contention of the taxpayer, if taken to a logical conclusion, would obliterate the separate legal existence of subsidiary and require the assessment of its income in the hands of holding company alone, which is patently incorrect.
Based on the above observations, the Tribunal  denied the carrying forward of loss, maintaining that the provisions of Section 79 of the IT Act regarding  the change in beneficial shareholding would be triggered even if ultimate beneficial ownership remains unchanged.
SKP's Comments
This ruling is important for taxpayers contemplating group re-organisation by transferring shares from one subsidiary to another, under the impression that the business loss would not lapse if the ultimate holding remains the same. However, in view of this decision, it is necessary to check whether such re-organisation results in change of immediate ownership by over 49% of a closely held company which has unabsorbed losses.
 
If a corollary is drawn from the above observations and ruling of the Tribunal, it is possible to argue that in case of change in shareholding at the ultimate holding company level without change in the immediate shareholding, the provisions of section 79 of the IT Act cannot be invoked.


It is, however, important to note that the taxpayer in this case did not cite the earlier ruling of the same High Court in the case of Select Holiday Resorts Private Limited [(2013) 35 Taxmann.com 368], in which the High Court considering the peculiar fact of merger, has taken cognizance of the fact that the management and the control of the company continues to be with same persons and hence, allow the carry forward and set-off of losses.

SKP
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