Treatment of deduction in change of entity control

Treatment of deduction in change of entity control

Treatment of deduction in change of entity control has been explained under Section 98 of the Income Tax Ordinance, 2001 as it plays a significant role in addressing changes in ownership and business continuity, ensuring that the tax implications are appropriately managed.

This section contains provisions related to changes in control of an entity, the constitution of associations of persons, discontinuance of businesses, and succession to businesses.

Change in Control of an Entity (Section 98):

Section 98(1) states that when there is a change of fifty percent or more in the underlying ownership of an entity, any losses incurred in a tax year before the change cannot be deducted in a tax year after the change. However, there are exceptions. The entity may still be allowed to use the losses if it continues to conduct the same business as before the change until the losses are fully offset. Additionally, the entity must refrain from engaging in any new business or investment if the primary purpose is to utilize the losses to reduce the income tax payable on the income arising from the new business or investment.

Definitions (Section 98):

This section provides key definitions that are crucial to understanding its application. An “entity” is defined as a company or association of persons to which Section 92(1) applies. “Ownership interest” refers to a share in a company or the interest of a member in an association of persons. “Underlying ownership” in relation to an entity means ownership interests held directly or indirectly through interposed entities by an individual or a person not ultimately owned by individuals.

Change in the Constitution of an Association of Persons (Section 98A):

Section 98A addresses situations where there is a change in the constitution of an association of persons during a tax year. It stipulates that the association of persons as constituted at the time of filing the tax return is liable for filing and any associated taxes. The income of the association of persons is apportioned among its members entitled to receive it. If a member’s assessed tax cannot be collected from them, it will be recovered from the association of persons as constituted at the time of filing the return.

Discontinuance of Business or Dissolution of an Association of Persons (Section 98B):

Section 98B outlines the implications of business discontinuance or the dissolution of an association of persons. It states that, subject to the provisions of Section 117, when a business or profession carried out by an association of persons is discontinued or the association is dissolved, the provisions of the Income Tax Ordinance will apply as if no such discontinuance or dissolution had occurred. Every person who was a member of the association at the time of discontinuance or dissolution, as well as the legal representative of a deceased member, will be jointly and severally liable for the tax amount payable by the association of persons.

Succession to Business, Otherwise than on Death (Section 98C):

Section 98C addresses cases where one person succeeds another in carrying on a business or profession, except in cases of death. It establishes that the predecessor is liable for tax related to the income earned up to the date of succession. The successor is liable for tax related to income earned after the succession. If the predecessor cannot be found, the tax liability for the relevant years will fall on the successor. The successor, in such a case, is entitled to recover this amount from the predecessor.

In summary, Section 98 of the Income Tax Ordinance, 2001, is a crucial component in ensuring that changes in ownership and business continuity are appropriately managed and taxed in accordance with the law. These provisions are designed to maintain the integrity of the tax system while accommodating the evolving business landscape.