[Megha Porwal and Manav Pamnani are 3rd year B.A., LL.B. (Hons.) students at the NALSAR University of Law, Hyderabad]
The Union Budget presented on 1 February 2025 marks a significant development in the jurisprudence pertaining to direct taxes in India. This is because it introduces a substantial amendment to sections 72a and 72AA of the Income Tax Act, 1961 (IT Act). The Bill proposes the insertion of sub-sections 72A(6B) and proviso to 72AA, aimed at preventing tax avoidance through the indefinite carry forward of losses by the predecessor entity via amalgamation or business reorganisation. The amendment posits itself as a positive step towards stricter tax compliance but this post argues that it risks adversely affecting the landscape of mergers and acquisitions (M&A) in India.
Detailed Exploration of the Amendment and its Background
Section 72(3) of the IT Act provides that profits and gains from business or profession (other than from speculative business) can be carried forward for eight assessment years immediately succeeding the assessment years for which the loss was first computed. To ensure that the benefit of this provision does not get denied in amalgamation, section 72A was introduced. Sections 72A and 72AA of the IT Act allow companies undergoing amalgamation, demerger, or business reorganisation to carry forward and set off accumulated losses and unabsorbed depreciation. The period of application for section 72A has been set as eight years from the year of amalgamation. Theoretically, this means that accumulated losses can be perpetually rolled over to reduce the taxable income through periodic amalgamation or reorganisation.
In order to bring parity with section 72(3) and to plug this loophole, the 2025 Finance Bill has inserted sub-section (6B) in section 72A, which states that accumulated losses of the predecessor entity in amalgamations or reorganisations can only be carried forward by the successor entity for the remaining period within the original eight-year window. A corresponding amendment has been introduced to section 72AA, which governs the amalgamation of banking or government companies.
Navigating the Amendment: An Obscure Change or a Move Towards Clarity?
The key rationale behind introducing section 72A, as explained in Commissioner of Income Tax Bombay v. Mahindra and Mahindra Limited, was to minimise social costs in terms of loss of production and employment and to relieve the government of the uneconomical burden of taking over and running sick industrial units. The conscious extension of support by the Government under this provision would incentivise acquirers by offering tax benefits, thus supporting the Government in reviving the sick industry.
The amendment through its new timeline ensures that loss carry-forward provisions remain true to their original intent, thus providing relief to genuine business losses rather than facilitating tax avoidance. This intention was explained in IEL Limited v. Union of India, wherein the Delhi High Court reiterated that the conditions stipulated under section 72A have to be strictly followed to prevent deceitful amalgamation. The amendment also reinforces the legislative intent of “amalgamation” mentioned in Section 2(1B) of the IT Act, which is to ensure that all liabilities of the amalgamating company are transferred to the amalgamated entity. This simplification of the tax regime further ensures speedy approval of M&A by the National Company Law Tribunal (NCLT). This is because the NCLT will no longer have to conduct a deep scrutiny to confirm that the scheme is not intended to evade tax, since the amendment serves as an effective check on the same.
This amendment is set to have come into effect from 1 April 2025. However, there is no mention in the amendment whether this date refers to the appointment date or the effective date. In any scheme of amalgamation, there are two essential dates: the appointed date and the effective date. The appointed date is the date from which the business of the amalgamating entity gets transferred to the amalgamated company. On the other hand, the effective date is when the amalgamation is legally recognised after fulfilling the requisite pre-conditions. The appointed date is generally decided by the parties but the scheme attains legal sanctity only on the effective date, after all the formalities are fulfilled. However, the scheme is deemed to have become effective from the appointed date itself. This is evident from a reading of section 232(6) of the Companies Act, 2013 and the clarification released by the Ministry of Corporate Affairs (MCA) in 2019.
A reading of sections 72A and 72AA suggests that the amendment applies to amalgamating entities as of the appointed date. While section 72A does not explicitly specify whether the amendment is effective from the appointed date, section 72AA clarifies this by using the phrase “brought into force” for certain banking companies. Legally, this phrase impliesthat any amendment under section 72AA takes effect from the appointed date of the scheme, not the effective date. Applying this interpretation to section 72A, it is reasonable to conclude that any amendments related to section 72A also apply from the appointed date.
Analysing the Amendment and its Practical Implications: A Double-Edged Sword?
This amendment has significant consequences for the M&A landscape and its several stakeholders. Sections 72A and 72AA were always regarded as policy-level tax reliefs extended by the Government. However, the proposed amendment does not seem to take into consideration the genesis of the said provision and the socio-economic impact that the withdrawal of such a provision could create. Profit-making companies are often incentivised to acquire loss-making enterprises, as it allows them to absorb accumulated losses, reduce taxable income, and fuel business growth. Such transactions help improve efficiency, preserve jobs, and minimise non-performing assets (NPAs), contributing positively to the economy. By restricting the carry-forward of losses, the amendment may reduce the attractiveness of loss-making firms, thereby weakening the economy and increasing job insecurity.
Additionally, a sudden overhaul of the legal regime could severely prejudice corporates who structure financial projections relying on tax benefits. A potential counter-argument to this is that these tax-planning strategies are anyway illegal as per the General Anti-Avoidance Rules (GAAR) and thus, they should not affect the implementation of the amendment. This can be refuted by noting that GAAR only gets attracted if the ‘purpose test’ of obtaining tax benefits and the ‘tainted element test’ mentioned in clauses (a) to (d) of section 96 of the IT Act are fulfilled. The purpose test requires that the main purpose or one of the main purposes behind entering into the scheme is to obtain tax benefits. The mere consideration of tax implications in an amalgamation does not automatically classify the transaction as a tax avoidance strategy. To maintain tax certainty and stability, GAAR should only be applied in cases where the transaction lacks a clear commercial rationale and, therefore, the threshold for its invocation is high. Thus, it cannot be said that since amalgamation includes offsetting of loses, it automatically becomes a tax evasion scheme that attracts GAAR because offsetting of losses can very well be an ancillary benefit to a commercially viable scheme.
Potential Non-Alignment With Global Norms
This amendment results in a significant departure from international taxation practices by mandating that the loss carry-forward period be calculated from the first computation by the original predecessor entity. This diverges from the global approach, with most jurisdictions providing greater flexibility.
In the United States (U.S.), companies can carry forward losses up to an annual limit calculated using the federal long-term tax-exempt interest rate, with a maximum carry-forward period of five years. Unlike India’s new amendment, the U.S. does not refer to the “original entity,” allowing for a reset of losses upon each merger. Similarly, Hong Kong does not impose any timeline or amount restrictions on the carry-forward of losses. This means that losses can be carried forward indefinitely, provided the amalgamating and amalgamated entities have entered into a qualifying relationship and the amalgamated company continues the same business. Moreover, even the European Union (EU) does not have any restriction or limitation with respect to carrying forward of losses. Countries within the EU such as France and Belgium create their own restrictions and taxation statues per se have no limitation of timeline in carrying forward losses of the original predecessor entity.
It can be argued that such provisions do not truly allow the indefinite carry-forward of losses, as the GAAR regulates the same. However, this argument is flawed as general principles of GAAR are triggered when amalgamation is undertaken when the main purpose is resetting the losses and not when loss reset is merely an incidental benefit alongside genuine commercial objectives. This is because the objective of GAAR is to prevent tax evasion and not tax mitigation. These provisions, therefore, strike a balance between preventing tax avoidance and facilitating M&A growth through added tax benefits.
By contrast, India’s amendment, by permanently linking losses to the original predecessor entity, may overreach and deter strategic M&A transactions aimed at reviving distressed companies. This might adversely affect financial development and India’s objective to become a five trillion-dollar economy by the end of 2025.
Striking a Balance: Tax Compliance versus M&A Growth
The global trend, explored above, indicates that while restrictions exist to prevent tax evasion, jurisdictions balance these measures with incentives to promote economic growth. This amendment aims to prevent tax evasion by restricting the perpetual carry-forward of losses. However, this objective can be achieved without explicitly prohibiting the resetting of losses under section 72A.
In fact, the existing legal framework already provides sufficient safeguards. Notably, GAAR provides the relevant protection against amalgamations undertaken for tax evasion. The assessing officer has the authority to apply the principles of GAAR during the assessment of schemes as per the procedure stipulated under section 144ba of the IT Act. This has also been reiterated In re Panasonic India (P.) Ltd, wherein the NCLT approved the scheme recognising that the invocation of GAAR exists for the revenue department to dispute the validity of the scheme.
Section 72 has been recognized as sufficient to protect the interest of revenue in any case of amalgamation or demerger. Additionally, section 72A(2)(b)(iii) mandates that an amalgamation must either aid in the revival of the amalgamating company’s business or serve a legitimate business purpose. To reinforce this, rule 9C of the Income Tax Rules, 1962 was introduced as a condition under section 72A(2)(b)(iii), requiring the amalgamated company to achieve at least 50% of its manufacturing capacity within four years to ensure business revival. Moreover, section 72A(3) provides an enforcement mechanism, stating that if the conditions of section 72A(2) are violated, any previously permitted set-off of losses or depreciation will be deemed taxable income for the amalgamated company in the year of non-compliance.
If additional safeguards were necessary, the legislature could have adopted less disruptive measures that balance tax enforcement with M&A growth. Instead of permanently tying losses to the original entity, a time-bound and capped approach, like in the U.S. and Belgium, could limit loss set-offs while ensuring some tax revenue is collected. This would prevent indiscriminate carry-forward of losses while keeping loss-making companies attractive for mergers. Without such flexibility, profitable companies may hesitate to merge, fearing that they cannot restructure after the eight-year window to optimise losses. As a result, only companies certain of full loss adjustment and revival would desire amalgamation.
Conclusion
The introduction of section 72A(6B) and proviso to 72AA is aimed at strengthening India’s tax laws, but possesses its fair share of drawbacks and criticisms. By permanently linking loss carry-forwards to the original predecessor entity, the amendment creates significant hurdles for M&A, potentially discouraging investments in distressed businesses. Although the legislature had its intent in the correct direction, an alternative model of preventing tax evasion under these sections should be explored. It will however be interesting to observe how this amendment plays out in the actual scheme of things which will largely depend on effective implementation and efficient monitoring.
– Megha Porwal & Manav Pamnani
