Carry Forward and Set Off of Losses with FAQs- Income Tax

While one endeavors to derive income, the possibility of incurring losses cannot be ruled out. Based on the principles of natural justice, a set-off should be available for loss incurred. The income tax laws in India recognise this and provide for adjustment and utilisation of the losses. However, there are conditions which have been introduced to prevent misuse of such provisions. 

To the common taxpayer, income tax is a crunch into the income earned. Accordingly, awareness of the relevant provisions pertaining to set off and carry forward of losses is essential in order to maximize tax benefits. The relevant provisions have been summarised here:

A) Set off of loss under the same head of income.(section 70) (Intra-head set off)

Income of a person is computed under five heads. ‘Sources’ of income derived by an individual may be many but yet they could be classified under the same head. For instance, an individual may have a dual employment, yet the income would be classified under the head ‘Salaries’. However, given the mechanism of computing taxable salary income, it would be safe to say that an individual cannot incur losses under this head of income.

Consider a situation where Harsh has two properties – one, occupied by him and the other, let out. Harsh pays interest on loan of Rs 1.50 lakh on the property occupied and derives net rental income of Rs 1.50 lakh from the let-out property. In case of a self-occupied property, income is computed as nil and interest expenditure results in loss. The loss of Rs 1.50 lakh can be set off against rent income of Rs 1.50 lakh; the income chargeable under the head ‘House property’ will be ‘Nil’.

An exception to intra head set off is loss under the head ‘Capital gains’, which may arise from transfer of any capital asset. 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. Long-term capital loss cannot be set off against short-term capital gains.

Further, loss incurred from speculation loss (eg. from shares or commodities) cannot be set off against any other income.

Also, it is unlikely that the benefit of set off of loss under an activity or source will be available, where the income from an activity or source is exempt from taxation.

Summary of exceptions to Intra-head set off:

1.    Loss from speculation business cannot be set of against profit from an non speculation business

(Interpretation: Loss from non speculative business can be set-off against speculation income)

2.    LTCL can only be set off against LTCG and cannot be set off against STCG

(Interpretation: STCL can be set off against LTCG)

3.    No loss can be set-off against casual income i.e. Income from lotteries, cross word puzzles, betting gambling and other similar games.

4.    No expenses can be claimed against casual income

5.    Loss from the activity of owning and maintaining race horses cannot be set off against other incomes

6.    Loss from an exempted source cannot be set off

(e.g. Share of loss of firm, agricultural losses, cultivation expenses)

B) Set off Loss from one head against Income from another Head (Inter head set off) 

A person may have various sources of income computed under different heads of income. Loss under one head of income is generally allowed to be set off against income under another head.

For instance, X has only one property, which is occupied by him and the loss is Rs 1.50 lakh. He derives salary of Rs 10 lakh during the year. Here, he can set off the loss of Rs 1.50 lakh against his salary income by making appropriate declarations to his employer, thereby making his net taxable income Rs 8.50 lakh.

Certain exceptions to the provisions are that the loss from business or profession cannot be set off against salary 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 can be carried forward and set off against income, in the future years as explained here.

Summary of exceptions to Inter-head set off:

1.    Loss from speculation cannot be set of against any other head.

(Interpretation: Loss from other heads can be set-off against business income.)

For Example: House property loss can be set-off against Speculative Incomes but speculation loss cannot be set off against House property)

2.    Business loss cannot be set-off against salary income. (It can be set-off against other incomes)

1. Loss under the head Capital Gains (LTCL or STCL) cannot be set-off against any other head.

(Interpretation: Loss from other heads can be set-off against Capital Gains)

For Example: HP loss can be set-off against CG but LTCL or STCL cannot be set off against HP

4.    No loss can be set-off against casual income

5.    No expenses can be claimed against casual income

6.    Loss from the activity of owning and maintaining race horses cannot be set off

7.    Loss from an exempted source cannot be set off (e.g. Share of loss of firm, agricultural income, cultivation expenses)

C) Carry forward and set off of losses

Unabsorbed loss under house property, capital loss and business loss can be carried forward for 8 years. Unabsorbed speculation business loss can be carried forward only for a period of 4 years.

Loss can be carried forward and set off even if the business in respect of which it was incurred has been discontinued. However, such loss cannot be set off against income under any other head. An exception exists in respect of unabsorbed depreciation from business which can be set off against any other source of income in the absence of business income and can be carried forward indefinitely, even if the business through which depreciation was incurred has ceased to exist.

Carry forward of losses (other than loss from house property and unabsorbed depreciation) is permissible if the return of income for the year, in which loss is incurred, is filed in time. The late filing of return should not impact the status of carry forward of loss of previous years.

When clubbing provisions apply, loss is required to be clubbed in the same manner as income. Such clubbed loss can be set off and carried forward, as if it is loss determined in the taxpayer’s own case. The successor of business can carry forward and set off the loss of his predecessor, if such succession is by way of inheritance.

In light of the above, taxpayers are advised to be mindful of the relevant provisions and seek guidance, where required, to effectively utilise their losses and achieve optimum tax results.

Conditions in brief related to carry forward and set-off of losses :-

1. Past year losses can be set-off against income from that respective head of income (Inter head adjustment is not possible)

(e. g. Unadjusted loss of HP for the year 2004-05 c/f Rs. 20,000. This loss can be set-off only against HP income of the year 2007-08 and not under any other head)

1. The above rule (1) is not applicable to unabsorbed depreciation, which can be set-off against any other head
2. All losses (Except loss due to owning and maintaining of race horses) can be carried forward and set-off for 8 subsequent financial years following the Previous Year in which such loss arose.
3. Unadjusted loss due to owning and maintaining of race horses can be carried forward and set-off for 4 subsequent financial years following the Previous Year in which such loss arose.
4. Unabsorbed depreciation can be carried forward for an unlimited period.

D) Order of Set-off of losses

In case where profits are insufficient to absorb brought forward losses, current depreciation and current business losses, the same should be deducted in the following order

• Current scientific research expenditure [Sec. 35(1)].
• Current depreciation [Sec. 32(1)].
• Brought forward business losses [Sec. 72(1)].
• Unabsorbed family planning promotion expenditure [Sec. 36(1)(ix)].
• Unabsorbed depreciation [Sec. 32(2)].
• Unabsorbed scientific research capital expenditure [Sec. 35(4)].
• Unabsorbed development allowance [Sec. 33A(2)(ii)].
• Unabsorbed investment allowance [Sec. 32A(3)(ii)].

E) FAQs on Set Off and Carry Forward of Losses

​If income from any source is exempt, then can loss from such source be adjusted against any other 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.

E.g., Agricultural income is exempt from tax, hence, if the taxpayer incurs loss from agricultural activity, then such loss cannot be adjusted against any other taxable income.​

​What is the meaning of inter-source adjustment?

​ If in any year the taxpayer 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.

The process of adjustment of loss from a source under a particular head of income against income from other source under the same head of income is called inter-source adjustment, e.g.., Adjustment of loss from business A adjusted against profit from business B.

​What are the restrictions to be kept in mind while making inter-source adjustment of loss?​

Following restrictions should be kept in mind before making inter-source adjustment of loss:

• 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.
• 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.
• 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.
• 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.
• Loss from business specified under section 35AD cannot be set off against any other income except income from specified businesses ( section 35AD​ is applicable in respect of certain specified businesses like setting up a cold chain facility, setting up and operating warehousing facility for storage of agricultural produce, developing and building a housing projects, etc.).

​What is the meaning of inter-head adjustment?​

After making inter-source adjustment (if any) the next step is to make inter-head adjustment. If in any year, the taxpayer has incurred loss under one head of income and is having income under other head of income, then he can adjust the loss from one head against income from other head, E.g., Loss under the head of house property to be adjusted against salary income. Following restrictions should be kept in mind before making inter-head adjustment:

Restrictions to be kept in mind while making inter-head adjustment of loss

Following restrictions shouldto be kept in mind before making inter-head adjustment:

• Before making inter-head adjustment, the taxpayer has to first make inter-source adjustment.
• Loss from speculative business cannot be set off against any other income. other than income from speculative business. However, non-speculative business loss can be set off against income from speculative business.
• Losses under head “”Capital gains” cannot be set off against income under other heads of income.
• 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.
• Loss from the business of owning and maintaining race horses cannot be set off against any other income.
• Loss from business specified under section 35AD cannot be set off against any other income ( section 35AD​ is applicable in respect of certain specified businesses like setting up a cold chain facility, setting up and operating warehousing facility for storage of agricultural produce, developing and building housing projects, etc.)
• Loss from business and profession (including unabsorbed depreciation) cannot be set off against income chargeable to tax under the head “Salaries”.

​ If the income of the year in which loss is incurred falls short, and taxpayer is unable to adjust entire loss, then can the taxpayer carry forward the unadjusted loss for adjustment in next year?

​ Many times it may happen that after making inter-source and inter-head adjustments, still the loss remains unadjusted. Such unadjusted loss can be carried forward to next year for adjustment against subsequent year(s)’ income. Separate provisions have been framed under the Income-tax Law for carry forward of loss under different heads of income (refer next FAQ for more provisions in this regard).​

​ What are the provisions framed under the Income-tax law in relation to carry forward and set off of business loss other than loss from speculative business?​

If loss of any business/profession (other than speculative business) 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 charged to tax under the head “Profits and gains of business or profession”.

Loss under the head “Profits and gains of business or profession” can be carried forward only if the return of income/loss of the year in which 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.

Above provisions are not applicable in case of unabsorbed depreciation (provisions relating to unabsorbed depreciation are discussed later).

Loss from business specified under section 35AD cannot be set off against any other income except income from specified businesses ( section 35AD is applicable in respect of certain specified businesses like setting up a cold chain facility, setting up and operating warehousing facility for storage of agricultural produce, developing and building a housing projects, etc.). Such loss can be carried forward to befor adjustedment against income from specified business for any number of years.

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.​

​ What are the provisions framed under the Income-tax law in relation to carry forward and set off of loss from speculative business?

​ ​If loss of any speculative business 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).

Loss from speculative business can be carried forward only if the return of income/loss of the year in which 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.

Above provisions are not applicable in case of unabsorbed depreciation of speculative business (provisions relating to unabsorbed depreciation are discussed later).

​What are the provisions framed under the Income-tax Law in relation to carry forward and set off of house property loss?​​

If loss under the head “Income from house property” cannot be fully adjusted in the year in which such loss is incurred, then unadjusted loss can be carried forward to next year.

In the subsequent years(s) such loss can be adjusted only against income chargeable to tax under the head “Income from house property”.

Such loss can be carried forward for eight years immediately succeeding the year in which the loss is incurred.

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

​What are the provisions framed under the Income-tax law in relation to carry forward and set off of capital loss?​

If loss under the head “Capital gains” incurred during a year cannot be adjusted in the sameat year, then unadjusted capital loss can be carried forward to next year.

In the subsequent year(s), such loss can be adjusted only against income chargeable to tax under the head “Capital gGains”, 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.

Such loss can be carried forward for eight years immediately succeeding the year in which the loss is incurred.

Such loss can be can carried forward only if the return of income/loss of the year in which loss is incurred is furnished on or before the due date of furnishing the return, as prescribed under section 139(1)​.​

​ What is the meaning of unabsorbed depreciation, unabsorbed capital expenditure on scientific research and unabsorbed capital expenditure on promoting family planning amongst the employees?​

Apart from several other deductions, while computing income chargeable to tax under the head “Profits and gains of business or profession” a person is allowed to claim deduction on account for depreciation, capital expenditure incurred by him 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 next year in the form of unabsorbed depreciation or unabsorbed capital expenditure on scientific research or unabsorbed capital expenditure on for promoting family planning amongst the employees. Consider the following illustration for better understanding.

Illustration

Business income (computed as per the provisions of Income-tax Law) of Mr. Kiran before allowing deduction on account of depreciation amounted to Rs,. 84,000. Depreciation as per the provisions of section 32 amounted to Rs. 1,00,000. What will be the amount of unabsorbed depreciation in this case?

**

It can be observed that business income before claiming deduction under section 32 on account of depreciation is Rs. 84,000 and depreciation allowable as per section 32​ is Rs. 1,00,000, hence, after claiming deduction on account of depreciation of Rs. 1,00,000, there will be a loss of Rs. 16,000. This loss is on account of depreciation and, hence, loss of Rs 16,000 will be termed as unabsorbed depreciation.​

​ What are the provisions framed 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 amongst the employees?

In the first year (i.e., the year in which these expenses are incurred), allowance for these expenses are first deductedible from the income chargeable to tax under the head “Profits and gains of business or profession”. If such expenses are not fully deductedible from business/profession income, then these items are deductedible from income chargeable to tax under other heads (except “Salaries”) for the same year. If still these allowances remain unabsorbed, then they can be carried forward to the subsequent year(s).

These allowances which remained unabsorbed can be carried forward for any number of years and in subsequent year(s) they can be set off against income chargeable to tax under any head (except “Salaries”). However, in the case of set off, following order of priority is to be followed:

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

​In case of change in the constitution of business, can the loss be carried forward by the reconstituted entity?

​ 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  predecessor entity (provided that conditions specified in this regard are satisfied).​

​ Are there any special provisions in case of carry forward of loss in case of a partnership firm if any partner of the firm retires?​

Section 78 contains provisions relating to carry forward and set off of loss in case of 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). In such a case, the share of loss attributable to the outgoing partner cannot be carried forward by the firm.

Restriction of section 78​ is applicable only in case of loss and is not applicable in case of adjustment of unabsorbed depreciation, unabsorbed capital expenditure on scientific research or family planning expenditure.​

​ Are there any special provisions in case of carry forward and set off of loss in case of a company in which public are not substantially interested?​

In case of a company in which public are not substantially interested, if the person beneficially holding 51% of the voting power as on the last day (i.e. 31^st March) of the year in which the loss was incurred and on the last day (i.e. 31^st March) of the year in which the company wants to set off the brought forward loss are different, then the company cannot set off such brought forward loss.

Restriction of section 79 is applicable only in case of loss and is not applicable in case of adjustment of unabsorbed depreciation, unabsorbed capital expenditure on scientific research or family planning expenditure.

Further, the provisions of section 79​ are not applicable in case of change in share holding on account of death of shareholder or on account of transfer of shares by way of gift to any relative of the shareholder or change in shareholding in case of an Indian company which is a subsidiaryy of foreign company, when such foreign company is amalgamated/demerged with another foreign company and 51% or more shareholders in amalgamating/resulting demerged foreign company and amalgamated/demerged resulting foreign company are same.