Set-off and Carry Forward Provision of Losses Under Income Tax

The Income Tax Act provides for provisions to carry forward and set off losses incurred by taxpayers. These provisions are applicable to var...

The Income Tax Act provides for provisions to carry forward and set off losses incurred by taxpayers. These provisions are applicable to various types of losses, including business losses, capital losses, and losses from the sale of house property. The primary objective of these provisions is to ensure that taxpayers can use their losses to reduce their taxable income in subsequent years, thereby providing them with some relief in the event of a loss-making year.

Carry forward and set off of losses are important provisions that help taxpayers manage their tax liabilities efficiently. By utilizing these provisions, taxpayers can reduce their tax liability and save money. However, it is crucial to understand the rules and regulations surrounding these provisions to ensure that taxpayers can take maximum advantage of them. In general, losses can be carried forward for a specified number of years and set off against profits in subsequent years. Different types of losses have different carry forward periods, and there are also restrictions on the amount of loss that can be set off in a given year.

Set off Provision

Loss from an exempted source of income is not uncommon. Many taxpayers may incur losses from activities that fall under exempted sources of income, such as agricultural income, winnings from the lottery or gambling, and owning and maintaining racehorses. However, the Income Tax Act restricts the adjustment of such losses against taxable income.

The reason for this restriction is that exempted sources of income are exempted precisely because they are meant to provide a benefit or relief to taxpayers. If the losses from such sources were allowed to be adjusted against taxable income, it would defeat the purpose of the exemption. Hence, the law provides for separate treatment of such losses.

Intra-Head Adjustment

Intra-head adjustment is the first step in adjusting losses from any source of income. If a taxpayer incurs a loss from any source under a particular head of income, they are allowed to adjust such loss against income from any other source falling under the same head. For example, if a taxpayer has a loss from business A, they can adjust it against profits from business B.

However, there are certain restrictions on intra-head adjustment. For instance, loss from speculative business cannot be set off against any income other than income from speculative business. Similarly, long-term capital loss cannot be set off against any income other than income from long-term capital gain.

Restrictions for Intra-head adjustment of loss:

1. Loss from speculative business cannot be set off against any income other than income from speculative business. However, non-speculative business loss can be set off against income from speculative business.
2. Long-term capital loss cannot be set off against any income other than income from long-term capital gain. However, short-term capital loss can be set off against long-term or short-term capital gain.
3. No loss can be set off against income from winnings from lotteries, crossword puzzles, race including horse race, card game, and any other game of any sort or from gambling or betting of any form or nature.
4. Loss from the business of owning and maintaining race horses cannot be set off against any income other than income from the business of owning and maintaining race horses.
5. Loss from business specified under section 35AD cannot be set off against any other income except income from specified business.

Inter-Head Adjustment

The next step is inter-head adjustment. If a taxpayer incurs a loss under one head of income and has income under another head of income, they can adjust the loss from one head against income from the other head. For example, loss under the head of house property can be adjusted against salary income.

Again, there are restrictions on inter-head adjustment. Loss from speculative business cannot be set off against any other income. Loss under the head of capital gains cannot be set off against income under other heads of income. Loss from business and profession cannot be set off against income chargeable to tax under the head "Salaries."

Furthermore, the law provides for a cap on the amount of loss that can be set off against income from other heads. For instance, loss under the head of house property can be set off against any other head of income only to the extent of Rs. 2,00,000 for any assessment year. Any unabsorbed loss can be carried forward for set-off in subsequent years as per the existing provisions of section 71B.

Restrictions for Inter-head adjustment of loss:

1. Before making inter-head adjustment, the taxpayer has to first make intra-head adjustment.
2. Loss from speculative business cannot be set off against any other income. However, non-speculative business loss can be set off against income from speculative business.
3. Loss under the head “Capital gains” cannot be set off against income under other heads of income.
4. No loss can be set off against income from winnings from lotteries, crossword puzzles, race including horse race, card game, and any other game of any sort or from gambling or betting of any form or nature.
5. Loss from the business of owning and maintaining race horses cannot be set off against any other income.
6. Loss from business specified under section 35AD cannot be set off against any other income.
7. Loss from business and profession cannot be set off against income chargeable to tax under the head “Salaries”.
8. Loss under the head “house property” shall be allowed to be set-off against any other head of income only to the extent of Rs. 2,00,000 for any assessment year.
9. However, unabsorbed loss shall be allowed to be carried forward for set-off in subsequent years as per the existing provisions of section 71B.

In conclusion, loss from an exempted source of income cannot be adjusted against taxable income. However, losses from sources falling under the same head of income and losses from one head of income can be adjusted against income from another head of income subject to certain restrictions. It is important for taxpayers to be aware of these restrictions to avoid any unintended violations of the Income Tax Act.

Carry Forward Provisions

Carry forward of unadjusted loss is a provision under the Income-tax Law that allows individuals and businesses to offset their losses against subsequent years' income. The Income-tax Law has separate provisions for carry forward of loss under different heads of income.

Summary of Provisons:

The number of years allowed for carry forward of loss varies depending on the category of loss. Here are the details:

1. Business Loss: Business loss can be carried forward for up to 8 years immediately succeeding the year in which the loss was incurred. However, for certain specified businesses, such as those engaged in the generation or distribution of power, the time limit for carry forward of loss is 12 years.
2. Speculation Loss: Speculation loss can be carried forward for up to 4 years immediately succeeding the year in which the loss was incurred. However, it can only be set off against speculation gains in those years.
3. Short-Term Capital Loss: Short-term capital loss can be carried forward for up to 8 years immediately succeeding the year in which the loss was incurred. It can be set off against both short-term and long-term capital gains.
4. Long-Term Capital Loss: Long-term capital loss can be carried forward for up to 8 years immediately succeeding the year in which the loss was incurred. It can be set off only against long-term capital gains.
5. House Property Loss: House property loss can be carried forward for up to 8 years immediately succeeding the year in which the loss was incurred. It can be set off against income from house property in those years.

It is important to note that the loss can only be carried forward if the tax return for the year in which the loss was incurred is filed within the due date. Additionally, the loss can be carried forward only if the taxpayer continues to hold the asset from which the loss was incurred.

Carry forward and set off of Business loss 

In case of business loss (other than loss from speculative business), if the loss incurred in a year cannot be fully adjusted after intra-head and inter-head adjustments, then the unadjusted loss can be carried forward for making adjustment in the next year. In the subsequent year(s), such loss can be adjusted only against income charged to tax under the head “Profits and gains of business or profession”. However, it is important to note that the loss can be carried forward only if the return of income/loss of the year in which the loss is incurred is furnished on or before the due date of furnishing the return, as prescribed under section 139(1). Such loss can be carried forward for eight years immediately succeeding the year in which the loss is incurred.

However, in the case of loss from business specified under section 35AD, such loss cannot be set off against any other income except income from specified business. Loss from business specified under section 35AD can be carried forward for adjustment against income from specified business for any number of years. But it is important to note that such loss can be carried forward only if the return of income/loss of the year in which the loss is incurred is furnished on or before the due date of furnishing the return as prescribed under section 139(1).

Loss from the business of owning and maintaining race horses cannot be set off against any income other than income from the business of owning and maintaining race horses. Such loss can be carried forward only for a period of 4 years.

In the case of speculative business, if the loss cannot be fully adjusted in the year in which it is incurred, then the unadjusted loss can be carried forward for making adjustment in the next year. In the subsequent year(s), such loss can be adjusted only against income from speculative business (may be same or any other speculative business). But it is important to note that such loss can be carried forward only if the return of income/loss of the year in which the loss is incurred is furnished on or before the due date of furnishing the return, as prescribed under section 139(1). Such loss can be carried forward for four years immediately succeeding the year in which the loss is incurred.

It is important to note that above provisions are not applicable in case of unabsorbed depreciation (provisions relating to unabsorbed depreciation are discussed later).

Carry forward and set off of House Property Loss

Under the Income-tax Law, if an individual incurs a loss under the head “Income from house property” and cannot adjust the loss in the same year, then the unadjusted loss can be carried forward to the next year. However, such loss can only be adjusted against income chargeable to tax under the head “Income from house property” in the subsequent year(s). The loss can be carried forward for eight years immediately succeeding the year in which the loss is incurred. This provision was amended by the Finance Act, 2022.

Moreover, it is noteworthy that the loss under the head “Income from house property” can be carried forward even if the return of income/loss of the year in which the loss is incurred is not furnished on or before the due date of furnishing the return, as prescribed under section 139(1).

Carry forward and set off of Capital Loss

Under the Income-tax Law, if an individual incurs a loss under the head “Capital gains” and cannot adjust the loss in the same year, then the unadjusted capital loss can be carried forward to the next year. In the subsequent year(s), such loss can be adjusted only against income chargeable to tax under the head “Capital gains.” However, long-term capital loss can be adjusted only against long-term capital gains. Short-term capital loss can be adjusted against long-term capital gains as well as short-term capital gains. This loss can also be carried forward for eight years immediately succeeding the year in which the loss is incurred. Additionally, the loss can be carried forward only if the return of income/loss of the year in which the loss is incurred is furnished on or before the due date of furnishing the return, as prescribed under section 139(1).

Set Off Carry Forward of Losses on Shares

In India, gains arising from the sale of shares are classified as capital gains and are taxed accordingly. Capital gains can be either short-term or long-term, depending on the period of holding of the shares. The Income Tax Act, 1961 provides for the set-off and carry forward provisions of both short-term capital gains (STCG) and long-term capital gains (LTCG) on shares.

Set-off and Carry Forward of STCG on Shares:

STCG on shares is the profit made by selling shares held for a period of up to 1 year. The set-off of STCG on shares can be done only against any long-term capital gains (LTCG) on shares. If there is no LTCG, then the STCG can be set off against any other capital gains.

However, if the STCG on shares cannot be set off fully in the same year, the remaining loss can be carried forward for up to 8 assessment years. The STCG loss can be set off against any LTCG on shares in the future.

For example, let's say Mr. A sold shares of XYZ Ltd. on 1st January 2022 after holding them for 6 months and made a short-term capital gain of Rs. 50,000. In the same year, he also sold shares of ABC Ltd. and made a long-term capital gain of Rs. 1,00,000. Mr. A can set off his STCG of Rs. 50,000 against the LTCG of Rs. 1,00,000, thereby reducing his tax liability.

If Mr. A could not set off his entire STCG loss of Rs. 50,000 in FY 2022-23, he can carry forward the remaining loss of Rs. 50,000 to the next year (FY 2023-24) and set it off against any future LTCG on shares.

Set-off and Carry Forward of LTCG on Shares:

LTCG on shares is the profit made by selling shares held for more than 1 year. LTCG on shares up to Rs. 1 lakh in a financial year is exempt from tax. Any LTCG on shares above Rs. 1 lakh is taxed at a rate of 10%.

If an individual has made an LTCG on shares and is unable to set off the entire gain in the same year, the remaining gain can be carried forward for up to 8 assessment years. This gain can only be set off against any future LTCG on shares.

For example, let's say Mr. B sold shares of PQR Ltd. on 1st April 2022 after holding them for 2 years and made a long-term capital gain of Rs. 5,00,000. In the same year, he also sold shares of MNO Ltd. and made a short-term capital gain of Rs. 1,00,000. Mr. B can set off his LTCG of Rs. 1,00,000 against the STCG of Rs. 1,00,000, thereby reducing his tax liability. He can also avail the exemption of Rs. 1 lakh on his LTCG on shares.

If Mr. B could not set off his entire LTCG of Rs. 4,00,000 in FY 2022-23, he can carry forward the remaining gain of Rs. 4,00,000 to the next year (FY 2023-24) and set it off against any future LTCG on shares.

Unabsorbed Depreciation

Meaning of Unabsorbed Depreciation, Unabsorbed Capital Expenditure on Scientific Research, and Unabsorbed Capital Expenditure on Promoting Family Planning Amongst the Employees

While computing income chargeable to tax under the head “Profits and gains of business or profession,” an individual is allowed to claim deduction on account of depreciation, capital expenditure incurred on scientific research, and capital expenditure incurred by a company for promoting family planning amongst its employees. If the income of the year in which these expenses are incurred falls short of these expenses, then the unabsorbed expenses can be carried forward to the next year in the form of unabsorbed depreciation or unabsorbed capital expenditure on scientific research or unabsorbed capital expenditure on promoting family planning amongst the employees.

Illustration for Better Understanding

For instance, let's say Mr. Kiran's business income (computed as per the provisions of Income-tax Law) before allowing deduction on account of depreciation amounted to Rs. 84,000. The depreciation as per the provisions of section 32 amounted to Rs. 1,00,000. In this case, the amount of unabsorbed depreciation would be Rs. 16,000. This is because, after claiming the deduction on account of depreciation of Rs. 1,00,000, there will be a loss of Rs. 16,000, which will be termed as unabsorbed depreciation.

Provisions under the Income-tax Law relating to set off of unabsorbed depreciation, unabsorbed capital expenditure on scientific research, and unabsorbed capital expenditure on promoting family planning among employees are as follows:

Set off of Unabsorbed Depreciation:

Depreciation is first deducted from the income chargeable to tax under the head "Profits and gains of business or profession." If such depreciation could not be fully adjusted against such income chargeable to tax in that previous year, the unabsorbed portion shall be added to the amount of depreciation for the following year and shall be deemed to be the part of depreciation for that year(similar treatment would be given to other allowances as mentioned above). However, in the case of set off, the following order of priority is to be followed:

• i. First adjustments are to be made for current scientific research expenditure, family planning expenditure, and current depreciation.
• ii. Second adjustment is to be made for brought forward business loss.
• iii. Third adjustments are to be made for unabsorbed depreciation, unabsorbed capital expenditure on scientific research or on family planning.

Set off of Unabsorbed Capital Expenditure on Scientific Research:

Unabsorbed capital expenditure on scientific research can be carried forward and set off against the profits and gains of any business or profession for an unlimited period.

Set off of Unabsorbed Capital Expenditure on Promoting Family Planning Among Employees:

Unabsorbed capital expenditure on promoting family planning among employees can be carried forward and set off against the profits and gains of any business or profession for an unlimited period.

Carry forward of loss in case of change in the constitution of business:

Generally, the person incurring the loss is only entitled to carry forward the loss to be adjusted in subsequent year(s). However, in certain cases of reconstitution of the business like amalgamation, demerger, conversion of proprietary firm into company or conversion of partnership firm into company, etc., the reconstituted entity is entitled to carry forward the unadjusted loss of the predecessor entity (provided that conditions specified in this regard are satisfied).

Provisions relating to carry forward of loss in case of retirement of a partner from a partnership firm:

Section 78 contains provisions relating to carry forward and set off of loss in case of a change in the constitution of a partnership firm due to death or retirement of a partner (i.e. when a partner goes out of the firm by retirement or death). In such a case, the share of loss attributable to the outgoing partner cannot be carried forward by the firm. However, the restriction of section 78 is applicable only in the case of loss and is not applicable in the case of the adjustment of unabsorbed depreciation, unabsorbed capital expenditure on scientific research, or family planning expenditure.

Special provisions relating to carry forward and set-off of losses in the case of a change in shareholding of certain companies:

Section 79 of the Income-tax Act, 1961 provides for carry forward and set-off of losses where a change in shareholding has taken place in a previous year in case of following companies:-

In case of a company, being a company in which the public are not substantially interested but not being an eligible start-up as referred to in section 80-IAC, no loss incurred in any year prior to the previous year in which change in shareholding has taken place 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 51% of the voting power were beneficially held by persons who beneficially held shares of the company carrying not less than 51% of the voting power .Provided that the company does not carry on any business or has not incurred any expenditure other than the statutory fees required to be paid to the Registrar of Companies.

It is important to note that these provisions relating to set off of unabsorbed depreciation, unabsorbed capital expenditure on scientific research, and unabsorbed capital expenditure on promoting family planning amongst the employees are subject to certain conditions and limitations. It is advisable to consult a tax expert or refer to the Income-tax Act, 1961 for detailed provisions and their applicability in specific cases.

No set-off of loss against undisclosed income discovered during search

The Income-tax Act has been amended by the Finance Act, 2022 to insert a new section 79A which aims to restrict the set-off of losses consequent to search, requisition, and survey. The provision applies if an assessee's total income for a previous year includes any undisclosed income detected as a result of search, requisition, or survey conducted by the tax authorities.

The new section 79A provides that no set-off of any loss, whether brought forward or otherwise, or unabsorbed depreciation shall be allowed against such undisclosed income while computing the total income of the assessee for such previous year. This means that if an assessee has undisclosed income detected as a result of search, requisition or survey, then they cannot use any of their losses, either brought forward or otherwise, to reduce the tax liability arising from such undisclosed income.

For the purpose of this provision, 'undisclosed income' means any income of the previous year represented, either wholly or partly, by any money, bullion, jewellery, or other valuable article or thing, or any entry in the books of account or other documents or transactions found during a search under section 132, requisition under section 132A or survey under section 133A (other than under section 133A(2A)), which has not been recorded on or before the date of search or requisition or survey in the books of account or other documents maintained in the normal course relating to such previous year or not been disclosed to the Commissioner before the date of search or requisition or survey.

Additionally, any income of the previous year represented, either wholly or partly, by any entry in respect of an expense recorded in the books of account or other documents maintained in the ordinary course relating to the previous year, which is found to be false and which would not have been found to be so had the search not been initiated or the survey not been conducted or the requisition not been made, would also be considered as undisclosed income for the purpose of this provision.

It is important to note that these provisions are effective from the Assessment Year 2022-23. Hence, taxpayers need to ensure that they comply with the provisions to avoid any legal consequences.