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Income tax is a tax on income earned by a taxpayer in a given year. However, activity of a taxpayer may not always result in income. Certain activities may cause losses too. It would be unfair to tax a person on his income, while ignoring the loss.

In recognition of this principle, there are elaborate provisions in Income Tax Law. These provisions, not just permit adjustment of losses, but also give provisions for carrying forward unadjusted (unabsorbed) loss to future years to be set off against future income. Understandably, there are restrictions, which have been introduced to prevent misuse of this provision by means of artificial losses.

Income of a person for the purpose of levy of income tax is computed under five heads, namely salary, house property, profits or gains of business or profession, capital gains and other sources. There are specific rules provided for computation of income under each of these heads of income. Considering the computation rules, no loss can occur under the head ‘salaries’.

Intra-head set off

Within each head of ‘income’, there could be more than one source of income. For example, a person may have two properties in different cities let out to different lessees. Each property is a source of income and is covered under the head of income ‘House Property’. The law requires adjustment of loss falling within the same head of income, in priority of adjustment of loss against income under any other head.

To illustrate: Consider case of Mr Amit who has inherited property at Delhi from which he derives rent income of Rs. 1.50 lacs. Mr Amit is residing in a flat at Mumbai which he had purchased against loan from Bank. The aggregate interest payment on this loan is Rs. 1.20 Lacs. In case of a self-occupied house, income is computed as nil and interest expenditure results in loss. The loss of Rs. 1.20 Lacs can be set off against rent income of Rs. 1.50 lacs and the income chargeable under the head ‘house property’ will be Rs. 30,000 only.

However, there are certain exceptions to intra head set off and the significant being loss under the head capital gains. Capital loss arises from transfer of any capital asset. Long-term capital loss cannot be set off against short-term capital gains. Long term capital loss arises from transfer of shares or units where holding period is more than 12 months and in respect of other assets holding period is more than 36 months prior to sale. Transfer of assets held for less than prescribed period results in short term capital loss.

In case, where the income from an activity or source is exempt from taxation, it is unlikely that the benefit of set off of loss under the same activity or source will be available; for eg. the sale of listed shares and equity oriented mutual funds, which are held for more than 12 months and on which Securities Transaction Tax (STT) paid are fully exempt from taxation, any loss from sale cannot be set off against any other long term capital gain.

Inter head set off

A person may also have more than one source of income computed under different heads of income mentioned above. Loss under one head of income is generally allowed to be set off against income under another head. For instance consider the case mentioned above of Amit who has loss under the head ‘house property’ of Rs. 1.20 lacs being interest payment on loan in respect of flat occupied by him.

Assume, he had no other income under the head ‘house property’ and he derives salary of Rs. 10 lacs during the year. In this instance, he can set off the loss of Rs. 1.20 lacs against his salary income by informing his employer and reduce the tax being withheld by the employer. Thus, his net taxable income will be Rs. 8.80 lacs.

Consider another example of Lata who has incurred a loss of Rs. 1.50 lacs from her small business as a beautician, which is chargeable under the head ‘Business and Profession’. During the same period, she has earned interest income of Rs. 1 lac on Bank fixed deposits chargeable under the head ‘Other Sources’. In this instance, the loss incurred by her in business can be set off against interest income resulting in net chargeable income to tax of Rs. 50,000.

However, there are certain exceptions to inter head set off. Loss from business or profession cannot be set off against salary income. Similarly, loss incurred from speculation loss cannot be set off against other income. For instance, loss from speculation in shares can be set off against income from speculation in shares or commodities, but not against any other income. Capital loss, whether long term or short term, can be set off only against capital gains income.

Where during a given year, there is no sufficient income to absorb the loss, unabsorbed loss under each of the head mentioned above can be carried forward to future and can be set off against income under the same head if any, in the future year.

Unabsorbed loss under house property, capital loss, and business loss can be carried forward for about 8 years for further set off. It needs to be noted that set off, in the future year, against any other income head is not possible. Timely filling return of income on or before due date is imperative for claiming carry forward of any unabsorbed loss.

Hence, taxpayers are advised to effectively utilize their losses and achieve the best tax results.

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May 2024