Direct & Indirect Taxes, Tax Ready Reckoner, Tax Management, Tax Act. & Rules, Tax Planning & Tax Savings.

Direct & Indirect Taxes, Tax Ready Reckoner, Tax Management, Tax Act. & Rules, Tax Planning & Tax Savings.

Set Off or Carry Forward and Set Off Of Losses under Income Tax Act

Income-tax is a composite tax on the total income of a person earned during a period of one previous year.  There might be cases where an assessee has different sources of income under the same head of income.  Similarly, he may have income under different heads of income. It might also happen that the net result from a  particular source/head may be a loss. This loss can be set off against other sources/head in a particular manner.

For example, where a person carries on two business and one business gives him a loss and the other a profit, then  the income under the head ‘Profits and gains of business or profession’ will be the net income i.e. after an  adjustment of the loss.

Similarly, if there is a loss under one head of income, it should normally be adjusted  against the income from another head of income while computing the Gross Total Income.

The provisions for set off or carry forward and set off of losses are contained in sections 70 to 80 of Income tax Act and it involves the following three steps.

Step 1:  Inter source adjustments under the same head of income also known as intra head adjustment.

Step 2: Inter-head adjustment in the same assessment year at the time of aggregation of income of various heads.

Step 3: Carry forward of loss to the subsequent assessment years to claim it as set off if it could not be set off  under Step 1 and Step 2.

Set Off or Carry Forward and Set Off Of Losses under Income Tax Act
Set Off or Carry Forward and Set Off Of Losses under Income Tax Act

Table of Contents

1.   [Section 70]- Set Off of Loss from one source against income from another source under the Same Head of Income (Intra-Head Adjustment)

Where the net result for any assessment year in respect of any source, falling under any head of income other than “capital gains”, is a loss, the Assessee shall be entitled to have the amount of such loss set off’ against his income from any other source under the same head. This may also be referred to as intra-head adjustment.

Example:

If the Assessee has two houses and the net income from one house is Rs. 4,80,000 while from the other house there is a loss of Rs. 3,00,000, the loss shall be adjusted against the income (as both fall under the same head i.e., ‘Income from house property’) and after set off, the income under the head ‘income from house property’ shall be Rs. 1,80,000.

Exceptions to Section 70 (Intra-Head Adjustment not permitted)

However, there are certain exceptions to this rule. In the following cases loss from one source cannot be adjusted against income from another source of income although it falls under the same head:

(a)    Loss from a Speculation Business:

As per section 73, any loss, in respect of a speculation business carried on by an Assessee, shall be set off only against income of another speculation business. It cannot be set off from non-speculative business income, although speculation business also falls under the head ‘profits and gains of business or profession’.

However, a business loss can be set off against income from speculation business but vice versa is not possible.

Note:

What is a speculation business?

According to section 43(5) “Speculative transaction” means a transaction in which a contract for the purchase or sale of any commodity including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips.

 (b)    Loss of a Specified Business referred to in section 3SAD:

As per section 73A, any loss computed in respect of any specified business referred to in section 35AD (e.g., business of cold chain facility, business of building and operating hotel, business of warehouse for storage of agricultural produce, etc.) shall not be set off except against profit or gains, if any, of any other specified business. It cannot be set off from any other business income.

(c)     Loss from the Activity of Owning and Maintaining Race Horses:

As per section 74A, the loss incurred by the Assessee, in the activity of owning and maintaining race horses, shall only be set off against the income of such activity. It cannot be set off against the income from any other source.

(d)    Loss an account of Lottery, etc.

This Loss cannot be set off against winnings from lotteries, crossword puzzles, card games., etc.: No expenditure or allowance is allowed from winnings from lotteries or crossword puzzle, etc. Similarly, no loss from any lottery, card games, races, etc. is allowed to be set off from the income of the winnings of lotteries, crossword puzzles, card games, races, etc.

(e)    Loss from a Source which is Exempt:

Loss incurred by an Assessee from a source, income from which is exempt, cannot be set off against income from a taxable source.

(J)     Long-Term Capital Losses:

Short-term capital loss can be set off from any capital gain (long-term or short-term) but long-term capital loss can now be set off only against long-term capital gain.

W.e.f. A.Y. 2019-20 long-term capital gain for a transfer of equity shares listed or recognized stock exchange is now taxable @ 10% and hence if there is any long-term capital loss from these equity shares, such loss shall now be allowed to be set off from other long-term capital gain.

2.   [Section 71]- Set Off of Loss from one head against income from another head (Inter-head adjustment)

As per section 71(1), where in respect of any assessment year, if after setting off losses against income under the same head, the net result of the computation under any head of income, other than “Capital Gains” is a Loss, the Assessee shall be entitled to have the amount of such a loss set off against his income, if any, assessable for that assessment year under any other head.

For instance, loss from business can be set off from income under the head house property and loss under the head income from other sources may be set off against profits of business. etc.

Further, as per section 71(2), where in respect of any assessment year, the net result of the computation under any head of income, other than “Capital gains”, is a loss and the Assessee has income assessable under the head “Capital Gains”, such loss may be set off against his income, if any, assessable for that assessment year under any head of income including the head “Capital gains” (whether relating to short-term capital assets or any other capital assets).

Losses under the head ‘House Property’, ‘Capital gains’ and ‘Business or Profession’ shall be treated as under:

(1)    [Section 71(2A)]- Loss under the head Business or Profession:

Where in respect of any assessment year, the net result of the computation under the head “profits and gains of business or profession” is a loss and the Assessee has income assessable under the head “Salaries”, the Assessee shall not be entitled to have such loss set off against such income. However, it shall be allowed to set off from income under any other head.

(2)    [Section 71(3)]- Loss under the head ‘Capital Gains’:

Such capital loss, whether short-term or long-term, shall not be allowed to be set off against income under any other head. It shall however be allowed to be carried forward.

(3)    [Section 71(3A)]- Loss under the head Income from House Property allowed to be set off from any other head upto Rs. 2,00,000:

Notwithstanding anything contained in section 71(1) or section 71(2), where in respect of any assessment year, the net result of the computation under the head “Income from house property” is a loss and the Assessee has income assessable under any other head of income, the Assessee shall be entitled to set off such loss, to the maximum extent of Rs. 2,00,000, against income under the other head. The balance loss of income from house property in excess of Rs. 2,00.000 shall be carried forward to be set-off only under the head income from house property.

Example:

Suppose, in the previous year 2019-20, income from property ‘A’ is Rs. 1,40,000 and from property ‘B’ there is a loss of Rs. 4,80,000. Besides this, there is an income under the head salary amounting to Rs. 6,00,000.

In this case, loss of 4,80,000 of property B will first be set off from income from property A to the extent of Rs. 1,40,000 as per section 70. The net loss of Rs. 3,40,000 under the head income from house property will be allowed to be set off from income under the head salary to the extent of Rs. 2,00,000 as per section 71(3A) and the balance of Rs. 1,40,000 shall be carried forward to claim it as set off from income under the head house property of the subsequent assessment year.

As already discussed, in the following cases as intra-head adjustment was not permitted, hence. inter-head adjustment will also be not permitted:

(a)           Loss from a speculation business;

(b)          Loss from a specified business referred to in section 35AD;

(c)           Loss from the activity of owning and maintaining race horses;

(d)          Loss of lottery, etc. cannot be set off against winnings from lotteries, crossword puzzles, card games, etc.;

(e)           Loss from a source which is exempt.

3.   [Section 72]- Carry Forward and Set Off of Business Losses

Where the loss under the head ‘profits and gains of business or profession’ other than loss from speculation business and loss from specified business, could not be set off in the same assessment year because either the Assessee had no income under any other head or the income was less than the loss. such loss which could not be set off in the same assessment year, can be carried forward to the following assessment years and it shall be set off against the profit and gains of business or profession subject to the following conditions:

(1).  Business Losses can be adjusted only against Business Income:

The loss can be carry forward to the subsequent assessment year and set off only against business income of the subsequent year. It may be observed that in the same assessment year, loss from a business can be adjusted against income from any other head of income except salary.

However, when the loss is to be carried forward to the subsequent year, it can be adjusted only against business income. Business income may be from the same business in which the loss was incurred, or may be any other business.

(2).  Business in respect of which a Loss is incurred may or may not be continued:

The business loss can be carried forward and set off in the subsequent assessment year(s) even if the business in respect of which the loss was originally computed is not carried on by him in the previous year in which such loss is sought to be carried forward and set off.

(3).  [Section 78(2)]- Losses can be Set Off only by the Assessee who has incurred Loss:

Where any person carrying on any business or profession has been succeeded in such capacity by another person otherwise than by inheritance, nothing in this Chapter (relating to set off and carry forward of loss) shall entitle any person other than the person incurring the loss to have it carried forward and set off against his income.

In other words, the brought forward business losses can be set off only by the same Assessee. The Assessee, who has suffered the loss and in whose hands the loss has been assessed, is the person who can carry forward the loss and set off the same against his business income of the subsequent year.

The following are the exceptions:

(a) Inheritance:

Where a business carried on by one person, is acquired by another person through inheritance.

However, such loss can be carried forward by the son for the balance number of Years for which the father could have carried forward the loss.

However, the unabsorbed depreciation cannot be carried forward by the legal heir as inheritance is not covered under section 32(2).

(b) Amalgamation:

Business losses and unabsorbed depreciation of an amalgamating company can be set off against the income of the amalgamated company if the amalgamation is within the meaning of section 72A/72AA of the Income-Tax Act.

Similarly, business losses and unabsorbed depreciation of an amalgamating co-operative bank can be set off against the income of successor co-operative Bank.

(c)     Succession of Proprietary Concern or a Firm by a Company:

Where there has been reorganisation of business whereby a proprietary concern or a firm is succeeded by a company and certain conditions mentioned in section 47(xiii) or (xiv) are fulfilled, the accumulated business loss and the unabsorbed depreciation of the predecessor proprietary concern / firm shall be deemed to be the loss or allowance for depreciation of the successor company for the previous year in which business reorganisation was effected and carry forward provisions shall be applicable to the successor company.

(d)    Succession of a Private Company or Unlisted Public Company by a Limited Liability Partnership (LLP):

Where there has been reorganization of business whereby a private company or unlisted public company is succeeded by a limited liability partnership (LLP) and certain conditions mentioned in section 47(xiiib) are fulfilled, the accumulated business loss and unabsorbed depreciation of the predecessor company for the previous year shall be deemed to be loss or allowance for depreciation of the LLP for the previous year in which business reorganization was effected and carry forward provision shall be applicable to successor LLP.

(e)    Demerger:

Loss of the demerged company can be carried forward by the resulting company subject to fulfilment of certain conditions which the Central Government may for this purpose notify, to ensure that the demerger is for genuine business purposes.

Similarly, certain losses of the demerged co-operative bank can be carried forward by the resulting cooperative bank in certain cases.

(4).  Period of Carry Forward:

Each year’s loss is a separate loss and no loss shall be carried forward for more than 8 assessment years immediately succeeding the assessment year for which the loss was first computed.

Therefore, a loss of previous year 2019-20 i.e., assessment year 2020-21 can be carried forward till assessment year 2028-29.

Besides the above, the following can also be carried forward indefinitely although these are not business losses as per Income-tax law:

(i)            unabsorbed depreciation;

(ii)           unabsorbed capital expenditure on scientific research;

(iii)          unabsorbed expenditure on family planning.

(5).  Order of Set Off:

Unabsorbed depreciation, unabsorbed capital expenditure on scientific research and unabsorbed expenditure on family planning are not pans of business losses and they can also be carried forward.

However, as per section 72(2), the business loss should be set off before selling off unabsorbed depreciation, etc. Such carried forward business loss will be set off against business head only after the current year’s depreciation, current capital expenditure on scientific research and expenditure on family planning have been claimed.

Therefore, the order of set off will be as under:

(i)            current year depreciation [Section 32(1)];

(ii)           current year capital expenditure on scientific research and current year expenditure on family planning to the extent allowed:

(iii)          brought forward business or profession losses [Section 72(1)];

(iv)          unabsorbed depreciation [Section 32(2)];

(v)           unabsorbed capital expenditure on scientific research [Section 35(4)];

(vi)         unabsorbed expenditure on family planning [Section 36(1)(ix)].

(6).  [Section 80]- Compulsory Filing of Loss Returns:

Although the above losses are allowed to be carried forward, but the carry forward is allowed only when such loss has been determined in pursuance of a return of loss submitted by the Assessee on or before the due date for filing of the returns prescribed under section 139(1).

However, loss under the head Income from house property can be carried forward even if the return is not filed within the due date mentioned under section 139(1).

See also  [Section 89/Rule 21A]- Relief when ‘Salary is paid in Arrears or in Advance’, etc. - for Computing Salary Income
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