Carry Forward and Set-Off of Losses in Certain Companies [Section 79]

Section 79 of the Income Tax Act, 1961, imposes strict restrictions on the carry-forward and set-off of losses in closely-held companies (private companies) when there is a change in shareholding. Here’s a detailed breakdown:

1. Applicability of Section 79

• Applies only to closely-held companies(private limited companies).
• Does not apply to:
  • Public limited companies listed on a recognized stock exchange.
  • Government-owned companies.
  • Startups (subject to conditions under Section 80-IAC).

2. Key Restriction: Change in Shareholding

• If 51% or more of the voting powershifts from the original shareholders to new shareholders, the company loses the right to carry forward and set off losses incurred before the change.
• Exception: If the same business continuesand the change is due to death, gift, or inheritance, losses can still be carried forward.

Example:

• Company Xhas accumulated losses of ₹50 lakh.
• If 60% sharesare sold to new investors, the losses cannot be carried forward.
• If only 40% shareschange hands, losses remain eligible for set-off.

3. Conditions for Loss Carry Forward

To retain the benefit of carried-forward losses, the company must ensure:

1. Same Business Continuity: The company must continue the same businessin which the loss was incurred.
2. 51% Shareholding Test: The majority of voting power must remain with the same shareholders(directly or indirectly).
3. No Tax Avoidance Motive: The change in ownership should not be primarily for tax benefit purposes.

4. Exceptions Where Losses Can Still Be Carried Forward

• Death of a shareholder(inheritance by legal heirs).
• Gift to relatives(as defined under Section 56(2)).
• Amalgamation/demerger(covered under Section 72A instead).
• Subsidiary-to-holding company transfers(if ownership remains within the group).

5. Judicial Interpretations

• CIT vs. Concord Pharmaceuticals Ltd. (2009): Losses allowed despite share transfer, as the same business continued.
• Bombay High Court Ruling: If commercial purpose(not just tax benefit) drives share transfers, Section 79 restrictions may not apply.

6. Practical Implications

• Mergers & Acquisitions: Companies must structure deals carefullyto avoid triggering Section 79.
• Startups & Investors: If a startup raises funding and crosses the 51% shareholding change, past losses may lapse.
• Tax Planning: Companies should document business continuityto defend against IT scrutiny.

7. Comparison with Public Companies