Proposed Amendment  

Pursuant to the Finance Bill, 2023, the Central Government proposes to amend section 79 of the Income Tax Act, 1961 (“IT Act”) as follows:

“In section 79 of the Income-tax Act, in sub-section (1), in the proviso, for the word “seven”, the word “ten” shall be substituted.”

Overview

This amendment is advantageous for startups because it offers them relief from financial difficulties typically experienced in the early stages of operation, giving them a longer time frame to recover and utilize their losses. It also results in a lower taxable income and tax liability, freeing up more capital for reinvestment and better financial planning. Furthermore, the amendment leads to better cash flow management and financial stability, boosting the startups' creditworthiness and increasing the chances of securing loans and investments.

Current Scenario 

At present, section 79 (1) of the IT Act in relation carry forward and set off of losses in case of certain companies specifies the conditions under which a company can carry forward and set off losses incurred in previous years. If there has been a change in shareholding during the previous year and the company is not one in which the public are substantially interested, the loss cannot be carried forward. However, this does not apply if more than 51% of the voting power is held by the same shareholders as on the last day of the year in which the loss was incurred.

Further, in the case of an eligible start-up as referred to in section 80-IAC of the IT Act, the loss can be carried forward if (i) all the shareholders who held voting power in the year the loss was incurred still hold those shares on the last day of the previous year, and (ii) the loss was incurred within 7 years of the company's incorporation.

Please find the relevant extract below: 

“(1) Notwithstanding anything contained in this Chapter, where a change in shareholding has taken place during the previous year in the case of a company, not being a company in which the public are substantially interested, no loss incurred in any year prior to the previous year shall be carried forward and set off against the income of the previous year, unless on the last day of the previous year, the shares of the company carrying not less than fifty-one per cent of the voting power were beneficially held by persons who beneficially held shares of the company carrying not less than fifty-one per cent of the voting power on the last day of the year or years in which the loss was incurred:

Provided that even if the said condition is not satisfied in case of an eligible start-up as referred to in section 80-IAC, the loss incurred in any year prior to the previous year shall be allowed to be carried forward and set off against the income of the previous year if all the shareholders of such company who held shares carrying voting power on the last day of the year or years in which the loss was incurred, continue to hold those shares on the last day of such previous year and such loss has been incurred during the period of seven years beginning from the year in which such company is incorporated.”
 

However, section 80-IAC (2), currently provides a timeline of 10 years from the company’s incorporation in this regard. Please find the relevant extract below:

“(2) The deduction specified in sub-section (1) may, at the option of the assessee, be claimed by him for any three consecutive assessment years out of ten years beginning from the year in which the eligible start-up is incorporated.” 

Conclusion

The proposed extension of the time of seven years to ten years will align the aforementioned provisions of the IT Act. This amendment is beneficial for start-ups as it (i) is a much-needed respite for startups who often face financial challenges in their initial years of operation; (ii) provides startups with a longer runway to recover and utilize their losses; (iii) will allow startups to reduce their taxable income and reduce their tax liability, providing them with more capital to reinvest in their business and plan their finances more effectively; (iv) will lead to improved cash flow management and financial planning; and (v) will enable startups to become more financially stable, increasing their creditworthiness, and making them more likely to secure loans and investments due to reduced tax liability.

 

This update has been contributed by Namitha Mathews (Partner) and Anukriti Goswami (Associate).

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