This article covers the provisions of The Income Tax Act, 1961 and rules made there under in regard to the Carry Forward and Set Off of Losses. The Income Tax Act has prescribed rules to set-off loss arising from one head against other heads of income. The process of setting off of losses and their carry forward can be divided in the following steps:

  • Inter source Adjusment under the same head of income
  • Inter head adjustment in the assessment year
  • Carry forward of a loss.

Inter source Adjusment under the same head of income

If in any year, the assessee has incurred loss from any source under a particular head of income, then he is allowed to adjust such loss against income from any other source falling under the same head. This may also be referred as Intra Head Adjustment.

Inter head adjustment in the assessment year

As explained above, any loss from one source of income is firstly set off against any gain from another source within the same head. Any remaining loss can then be set off against Income from any other Head. The process is to be done in the same previous year. This is known as Inter-Head Adjustment. Eg: Loss under the head house property to be adjusted against salary income.

Exceptions:

  • Losses from Speculative business will only be set off against the profit of speculative business only. One cannot adjust the losses of speculative business with the income from any other business or profession.
  • Long term capital loss can be set off against long term capital gain only. However, Short term capital loss can be set off against Short term capital gain and Long term capital gain.
  • Loss from owing & maintaining race horses can be set off against profit from owing & maintaining race horses.
  • Losses from a specified business will be set off only against profit of specified businesses. But the losses from any other businesses or profession can be set off against profits from the specified businesses.
  • Loss from business cannot be set off against salary income.
  • Loss from winning from lotteries, crosswords, puzzles, card games or other gambling can be set off against gains from winning from lotteries, crosswords, puzzles, card games or other gambling (section 58(4)

Carry Forward & Set-off of losses

If the losses could not be set off under the same head or under different heads of income in the same assessment year, such losses are allowed to be carried forward to be claimed as set off from the income of the subsequent assessment years.

 Nature of losses  Set off against which income Max. period loss can be carried forward Mandatory Filing of Return of Income u/s 139(1)
Loss from House Property Income from House Property* 8 Years No
Loss from normal business under the head Profits and Gains from business or profession Profit from any normal business 8 Years Yes
Loss from Speculation Business Profit from any speculation business 4 Years Yes
Loss from Specified Business u/s 35AD Profit from Specified Business No Limit Yes
Short Term Capital Loss Both Short Term and Long Term Capital Gain 8 Years Yes
Long Term Capital Loss Only Long Term Capital Gain 8 Years Yes
Loss from activity of owning and maintaining race horses Income from activity of owning and maintaining race horses 4 Years Yes

*In case in any Assessment Year, the assessee has house property loss, then he is entitled to set off such loss against income under other head upto a limit of Rs. 2 lakh per annum. The balance, if any, shall be carried forward.

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

1. unabsorbed depreciation;

2. unabsorbed capital expenditure incurred on scientific research;

3. unabsorbed expenditure on family planning. 

Other provisions related to carry forward and set off of losses

Some other provisions related to carry forward and set off of losses as provided by the Income Tax Act:

  • Change in constitution of business: Where there is a change in constitution of a partnership firm due to death or retirement of a partner (i.e. when a partner goes out of firm by retirement or death), the share of loss attributable to the outgoing partner cannot be carried forward by the firm. (Not applicable in respect of unabsorbed depreciation, unabsorbed capital expenditure on scientific research or family planning expenditure)
  • Change in shareholding of certain companies: Where a change in shareholding of a company has taken place in a previous year, not being a company in which the public are substantially interested, no loss incurred in any year prior to the previous year 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 per cent of the voting power were beneficially held by person who beneficially held shares of the company carrying not less than fifty-one per cent of the voting power on the last day of the year or years in which the loss was incurred.(Not applicable in respect of unabsorbed depreciation, unabsorbed capital expenditure on scientific research or family planning expenditure)

Loss from exempted source of income cannot be adjusted against taxable income

If income from a particular source is exempt from tax, then loss from such source cannot be set off against any other income which is chargeable to tax.

Order of set off of business losses from business income:

As we are aware, there are numerous type of losses which are required to be set-off. Hence, the effect of depreciation, business losses and investment allowance should be given in the following order:

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

2. current year capital expenditure on scientific research and current year expenditure on family planning to the extent allowed;

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

4. unabsorbed depreciation [Section 32(2)];

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

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

According to the provisions of the Act, the losses can be carried forward and set off only by the Assessee who has incurred Loss. However, there are certain exceptions to it:

  • Loss of business acquired by inheritance (excl. unabsorbed depreciation)
  • Accumulated business loss of Amalgamation/Demerger Company, fulfilling the conditions as laid down under section 72A/72AA of the Income-tax Act.
  • Accumulated loss of a Proprietary Concern or a Firm when its business is taken over by a Company by satisfying the conditions laid down in section 47(xiii)/47(xiv), as the case may be.
  • Accumulated loss of a Private Company or Unlisted Public Company when its business is taken over by a Limited Liability Partnership by fulfilling the conditions laid down in section 47(xiiib).

As we have seen different provisions relating to set off and carry forward of losses, we can say that loss should firstly be set off within the respective head in the same AY and if still there is a loss then only inter head set off is allowed. After completing first two steps, if any loss remains then it will be carry forward and will set off in next AY under the same head of income and not different head. But there still exception to it. Therefore, we should have a clear understanding of the provisions of the act while dealing with the business losses.

In case of any ideas, suggestions or queries, the author can be reached at shubhikhandelwal30@yahoo.com.

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