What is Section 79 of the Income Tax Act? Section 79 restricts a closely held company from carrying forward and setting off accumulated business losses if more than 49% of its voting power changes hands. For example, if a private limited company had a Rs 50 lakh business loss in FY 2023-24 and then 60% of its shares were acquired by new investors in FY 2024-25, the entire Rs 50 lakh loss lapses and cannot be set off against future profits. The rule exists to prevent shell companies with accumulated losses from being acquired purely for tax benefit.
Closely held companies in India routinely face this trap during funding rounds, promoter exits, and M&A transactions. A single share transfer can extinguish years of accumulated losses, turning what appeared to be a tax asset into nothing.
This guide covers the mechanics of Section 79, the startup exception, the unabsorbed depreciation carve-out, and the practical scenarios where founders and CFOs need to plan ahead.
Who Does Section 79 Apply To?
Section 79 applies exclusively to closely held companies, which the Income Tax Act defines as companies "in which the public are not substantially interested." In practice, this covers:
- Private limited companies (the default structure for most Indian startups and SMEs)
- Unlisted public companies, unless shares carrying at least 50% of the voting power were held throughout the year by the Government, a statutory corporation, a widely held company or its wholly owned subsidiary (Section 2(18)(b)(B))
Section 79 does not apply to a company in which the public are substantially interested under Section 2(18), which includes:
- Listed companies (shares listed on a recognised stock exchange in India on the last day of the previous year)
- Section 8 companies (non-profit companies, described in Section 2(18)(aa) by reference to Section 25 of the Companies Act, 1956)
- Companies owned by the Government or the Reserve Bank of India, or in which at least 40% of the shares are held by the Government, the RBI or a corporation owned by the RBI
- Companies in which shares carrying at least 50% of the voting power are held by one or more co-operative societies, and Nidhi or mutual benefit finance companies
If your company is a private limited company with accumulated losses, Section 79 is relevant every time a share changes hands.
The 51% Voting Power Test
The core rule is straightforward:
A closely held company can carry forward and set off a loss only if, on the last day of the previous year in which the loss is to be set off, shares carrying at least 51% of the voting power are beneficially held by persons who beneficially held shares carrying at least 51% of the voting power on the last day of the previous year in which the loss was incurred.
The test compares two dates only: the last day of the loss year and the last day of the set-off year. It is applied separately for each loss year being carried forward.
How the Test Works: An Example
Consider a private limited company, Alpha Pvt Ltd, which incurred a loss in FY 2023-24. On 31 March 2024 its shareholders were Founder A (40%), Founder B (35%) and Founder D (25%).
Case 1: In FY 2025-26, Founder B sells the entire 35% to Investor C. On 31 March 2026, the continuing shareholders are Founder A (40%) and Founder D (25%) = 65%. This is above 51%, so the FY 2023-24 loss can be set off in FY 2025-26.
Case 2: In the same year, Founder A also sells 20% to a second new investor. The continuing shareholders now hold Founder A (20%) + Founder D (25%) = 45%. This is below 51%, so the FY 2023-24 loss cannot be set off against the income of FY 2025-26.
Exceptions Under Section 79(2)
The 51% test does not apply to a change in shareholding caused by:
- the death of a shareholder, or a gift of shares to a relative of the shareholder;
- the amalgamation or demerger of a foreign parent company, where at least 51% of the shareholders of the amalgamating or demerged foreign company remain shareholders of the amalgamated or resulting foreign company;
- a resolution plan approved under the Insolvency and Bankruptcy Code, 2016, after the jurisdictional Principal Commissioner or Commissioner has been heard;
- a few other specified cases (companies whose boards were replaced by the Central Government under Sections 241 and 242 of the Companies Act, relocation of an offshore fund to an IFSC, and erstwhile public sector companies after strategic disinvestment).
Under the Income Tax Act, 2025, from tax year 2026-27, the same rules sit in Section 119(3) and (4), with the eligible start-up defined in Section 140 of that Act.
Eligible Start-up Exception
Section 79 contains a separate relaxation for an eligible start-up as referred to in Section 80-IAC. DPIIT recognition alone is not enough: the company must be an eligible start-up under Section 80-IAC, which means a company or LLP incorporated on or after 1 April 2016 and before 1 April 2030 (the Finance Act 2025 extended the window from 1 April 2025), with turnover not exceeding Rs 100 crore in the relevant previous year, holding a certificate of eligible business from the Inter-Ministerial Board of Certification. For such a company, a loss is allowed to be carried forward and set off regardless of the change in percentage of shareholding, if both of these conditions are met:
- All the shareholders who held shares carrying voting power on the last day of the loss year continue to hold those shares on the last day of the set-off year; and
- The loss was incurred during the period of ten years beginning from the year of incorporation (the Finance Act 2023 extended this from seven to ten years).
How the Start-up Exception Differs from the General Rule
The general rule looks at a percentage: 51% of voting power must stay with the loss-year shareholders. The start-up exception ignores the percentage but looks at people: every loss-year shareholder must still hold the shares held on the last day of the loss year. A company can use whichever of the two it satisfies.
Practical implication: An eligible start-up raising Series A or Series B funding through a fresh issue of shares can dilute its loss-year shareholders below 51% without losing the loss, as long as every loss-year shareholder (including seed-round angel investors) still holds those shares. If any loss-year shareholder sells, the start-up exception is lost and the company must pass the 51% test instead.
What Losses Are Covered by Section 79?
Section 79 applies to any loss incurred in an earlier year that the company wants to carry forward and set off. That includes:
- Business losses (non-speculative) under Section 72
- Speculation business losses under Section 73
- Capital losses (short-term or long-term) under Section 74
- House property losses carried forward under Section 71B
Section 79 does not apply to unabsorbed depreciation under Section 32(2). Section 79 opens with "notwithstanding anything contained in this Chapter" and restricts the carry forward of a "loss" under Chapter VI, whereas unabsorbed depreciation is an allowance carried forward under Section 32(2) in Chapter IV, outside the reach of Section 79.
This distinction is important. If a closely held company has both business losses and unabsorbed depreciation on its books, a shareholding change above 49% will block the business losses but leave the unabsorbed depreciation intact. See our detailed guide on set-off and carry forward of losses for the complete framework.
Unabsorbed Depreciation Carve-Out
Unabsorbed depreciation under Section 32(2) is outside the scope of Section 79.
Key points about unabsorbed depreciation:
- Can be carried forward indefinitely (no 8-year limit like business losses)
- Can be set off against income under other heads, not just business income
- Not affected by any change in shareholding, however large
- Survives even a 100% change in ownership
Practical Scenarios
Scenario 1: VC Funding Round (Series A)
A startup with Rs 2 crore accumulated business loss raises Series A funding. The VC fund acquires 40% of the post-money equity through fresh issuance.
General rule analysis: The original founders held 100% in the loss year. After Series A, they hold 60%. Since 60% exceeds 51%, the loss survives under the general rule.
But watch for the next round. If Series B dilutes founders further to 45%, the 51% test fails for all losses of years before the dilution.
Start-up exception: If the company is an eligible start-up under Section 80-IAC, the losses were incurred within ten years of incorporation, and every loss-year shareholder (including any angel investors) still holds the same shares, the loss survives regardless of the dilution percentage.
Scenario 2: Promoter Exit in M&A
A closely held company with Rs 5 crore accumulated business loss undergoes a partial acquisition. The acquirer buys 55% of shares from existing promoters.
Result under general rule: Only 45% of voting power remains with original shareholders. The Rs 5 crore business loss cannot be set off.
Planning opportunity: If the acquirer had purchased only 49%, the remaining 51% with original shareholders would have preserved the loss. Deal structuring around the 51% threshold is common in M&A transactions involving companies with significant loss carry-forward positions.
Scenario 3: ESOP Exercise and Dilution
A private limited company grants ESOPs to employees. When employees exercise their options, new shares are issued, diluting existing shareholders.
Impact: If ESOP exercises reduce original shareholders' combined voting power below 51%, Section 79 is triggered. However, since ESOPs typically involve fresh issuance (not transfer from promoters), the dilution is usually gradual and manageable.
Risk factor: Large ESOP pools (15-20% of equity) combined with VC dilution can collectively push original shareholders below the 51% mark.
Worked Example: Startup Series A Funding
Facts:
- Beta Pvt Ltd, incorporated April 2022, an eligible start-up under Section 80-IAC
- Shareholders in FY 2023-24 (loss year): Founder X (60%), Founder Y (25%), Angel Investor Z (15%)
- Business loss in FY 2023-24: Rs 80 lakh
- Series A in FY 2025-26: VC fund acquires 35% through fresh issue
- Post-Series A: Founder X (39%), Founder Y (16.25%), Angel Z (9.75%), VC Fund (35%)
General rule test: Continuing shareholders: Founder X (39%) + Founder Y (16.25%) + Angel Z (9.75%) = 65% of post-money voting power held by persons who held shares in the loss year. 51% test: PASSED.
Start-up exception test: All three loss-year shareholders (X, Y, Z) still hold the shares they held on 31 March 2024, and the loss arose within ten years of incorporation. Exception condition: SATISFIED.
Result: Rs 80 lakh business loss can be carried forward and set off against future profits. Both the general rule and the start-up exception are satisfied.
What if, along with the fresh issue, Angel Z also sold its entire 9.75% to the VC fund?
- General rule: Founder X (39%) + Founder Y (16.25%) = 55.25%. Still above 51%. PASSED.
- Start-up exception: Angel Z no longer holds its shares. FAILED.
- The company must rely on the general rule alone. Future dilution that pushes the loss-year shareholders below 51% will block the loss.
How to Check Section 79 Compliance
- List every loss year still being carried forward, with the shareholding on the last day of each loss year.
- Compare it with the shareholding on the last day of the year in which you want to set off the loss.
- Check the 51% test and, for an eligible start-up, the all-shareholders test, separately for each loss year.
- Check whether any change falls within the Section 79(2) exceptions (death, gift to a relative, IBC resolution plan and the others listed above).
Common Mistakes
1. Ignoring indirect transfers. Section 79 looks at beneficial ownership. A transfer through a nominee arrangement can still matter if the beneficial owner changes.
2. Forgetting angel investors. Start-ups relying on the Section 80-IAC relaxation often forget that the seed-round angel investor is also a loss-year shareholder. If that angel sells, the start-up exception breaks.
3. Confusing unabsorbed depreciation with losses. Companies sometimes treat the entire carry-forward balance as extinct after a shareholding change. Carried-forward losses are affected; unabsorbed depreciation survives.
4. Not testing each loss year separately. If a company has losses from FY 2021-22, FY 2022-23, and FY 2023-24, the Section 79 test must be applied to each year independently. The shareholder composition in each loss year may be different.
5. Assuming DPIIT recognition is enough. The start-up relaxation needs eligible start-up status under Section 80-IAC, including the Inter-Ministerial Board certificate.
6. Overlooking ESOP dilution. Fresh share issuance under ESOP schemes dilutes all existing shareholders proportionally. Combined with VC funding rounds, this can push original shareholders below the 51% threshold unexpectedly.
How Tax Garden Helps
Tax Garden works with closely held companies and funded startups on loss carry-forward reporting during ownership transitions. Founders comparing options can also read how to pick a chartered accountant for startups in Hyderabad. Our support covers:
- Start-up exception records: We keep the shareholding and Section 80-IAC documentation needed for the start-up exception for each year.
- ITR filing with Schedule CFL: We file the company ITR (ITR 6) with correct loss carry-forward schedules, ensuring each loss year is tracked and disclosed.
- Tax audit support: For companies under tax audit, we include Section 79 compliance details in Form 3CD.
- Shareholding records: We keep a record of share transfers alongside your loss carry-forward schedule for ITR reporting.
Reach out to get your company ITR filed.
Sources: Section 79 and Section 2(18), Income Tax Act 1961 (Section 79 as amended by the Finance Act 2023, seven to ten years); Section 119, Income Tax Act 2025; Section 80-IAC, Income Tax Act 1961 (as amended by the Finance Act 2025); Section 32(2), Income Tax Act 1961.
