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Budget 2022 may be an opportunity to provide clarity on certain provisions and also extend the ambit of the existing provisions to cater to the needs of the current times. Budget 2022 is gaining much attention among the public. Even as the COVID cases go through a see-saw, the expectations on this year’s Budget shows a sharp upward curve as each day passes by.
Considering the limited resources in midst of the pandemic, this year's Budget is not expected to bring in fresh deductions/exemptions. Hence, this budget may be an opportunity to provide clarity on certain provisions and also extend the ambit of the existing provisions to cater to the needs of the current times.
One of the key aspects which generally go unnoticed is appropriately rewarding the assessee on accumulated tax losses, whereby such losses can be carried forward and set off against the income in subsequent years.
This topic is much more relevant considering the last two years have been challenging for most of the business staring at significant losses. Accordingly, in this article, we have discussed the key provisions on the carryforward of losses and our suggestions to ensure to maximise the benefits of the assessee while truly retaining the intent of the provision.
We are in the “startup era”, with start unicorns expected to cross 100 in 2022. With respect to startups, tax provisions allow the carry forward of losses irrespective of change in voting power beyond 51% with the condition that all the shareholders hold shares subscribed by them in order to enable carry forward of losses.
Though the reason behind the same is to promote the investment in startups, whether the proviso addressed the objective in full is a question to be addressed.
When one thinks of a startup, there are several rounds of fundraise with different sets of investors which will exit at different point in times. As a general practice, each set of investors agrees to sign in only after addressing the exit option.
Considering this background, expecting all shareholders to hold on to the shares for a longer duration of seven years to enable them to carry forward the losses may lead to reluctance in investments in start-ups.
It is therefore suggested to provide relaxation and only the founder or co-founder is required to hold all of their shares, in order for the startup to continue to carry forward losses and set-off with the income in future.
This will help the startup significantly and truly reward them, without worrying about the exit of the investor which will make them lose their benefit to carry forward losses.
Under tax provision, the benefit of the carry forward of losses and unabsorbed depreciation pursuant to amalgamation is not provided to all entities but to only “industrial undertaking” and certain specified classes of companies.
The tax provisions define the term “industrial undertaking” which predominantly covers undertakings engaged in the manufacturing sector. This eventually negates the service sector to carry forward the business losses and unabsorbed depreciation by the surviving entity pursuant to amalgamation.
Needless to say, in current times the economy is surviving with the service industry contributing a lion’s share to the GDP. Also, it can be noted that the service and real estate sectors have been severely hit by the pandemic.
Last budget, the scope has been enhanced to include public sector companies to be eligible to carry forward business losses and unabsorbed depreciation on account of amalgamation.
On the same lines, considering the drive towards the digital economy, it is recommended to widen the ambit of the term “industrial undertaking” to include real estate and service industries including hospitality, tourism and IT/ITES companies.
To claim the benefit of carry forward of losses as per income tax provision, it is necessary that the amalgamating company has to be engaged in the business, in which accumulated loss occurred or depreciation remains unabsorbed, for three or more years.
There could be two possible views to interpret the section – the amalgamating company should be in existence for three or more years or the second view can be that the business of the amalgamating company in which the losses were incurred should be in existence for three or more years.
Though there are judicial precedents to confirm that the condition of three years is in respect to the amalgamating company and not a particular division/unit, the perspective is still a litigative issue to tackle. To add on, the memorandum is silent which further restricts us in understanding the intent of the tax department in bringing up such a condition.
Considering that for many businesses only hope is to amalgamate with profitable entities to survive this pandemic, it is recommended to provide a suitable amendment to the aforesaid condition to provide clarification that the only condition to satisfy that such amalgamating company should be in existence for more than three years and thereby providing tax certainty on this matter.
The benefit of carry forward of losses is possible only when shares of the company carrying not less than 51% of the voting power were beneficially held by persons who beneficially held shares of the company carrying not less than 51% of the voting power on the last day of the year or years in which the loss was incurred.
However, it is pertinent to note that the term “beneficially held” has not been defined in the Income-tax Act. Consequently, the scope of beneficial holding may refer to direct as well indirect holdings.
Though there are judicial precedents which provide that beneficial holding shall refer to indirect holding as well, currently the Income-tax Act is silent on whether the direct or indirect holding is to be considered. It is therefore recommended to provide clarity on the beneficial holding by suitably defining the same in the said section itself to avoid tax litigations.
The current times have been challenging for industries across the globe. A supporting hand by the government is the major expectation from this Budget. With this objective in mind, we hope that Budget 2022 is going pave way for a stronger and stable economy.
This article was originally published on Business Today.