Set off of losses under the income tax laws

Though business aims to make income, there is always a possibility of incurring loss. On the basis of the principles of natural justice, a set-off is allowed under the income tax laws for the loss incurred by an individual or a firm. The Income Tax Act, 1961 provides for adjustment of such losses. However, there are some essentials that have been incorporated to avail such provisions.
To the common taxpayers in India, income tax is levied on the income earned. As such, knowledge regarding the relevant provisions dealing with set off and carry forward of losses is required for the purpose of utilizing income tax benefits.

Provisions dealing with set off and carry forward of losses can be summarized as follows:

A. Intra-head set off – Section 70 of the Income Tax Act, 1961 deals with the process of adjustment of loss under a particular head of income against income from the other sources which is commonly known as “intra-head adjustment”. It refers to the adjustment of business loss against business profit.
According to the Income Tax Act, 196, income of a person is calculated under five different heads. “Sources” of income derived by a person may be more than one, but might be classified under a single head. For example, an individual may have two sources of income; still it might be classified under the head “Salaries”. However, for computing tax on salary income, it might be said that an assessee cannot incur losses under the head “Salaries”.
Illustration: An individual has two properties of which one is occupied by him and the other one has been let out by him. The individual pays an interest towards loan of Rs 2.50 lakh on the property occupied by him and he earns a rental income of Rs 2.50 lakh from the property which is let-out. In case of a self-occupied property, there is no income and the interest paid results in loss. The loss of Rs 2.50 lakh can be set off against the income from rent of Rs 2.50 lakh. As a result, there is no income chargeable under the head ‘House property’.

Exceptions:

1. An exception to “intra-head set off” is loss under “Capital gains” which arises from transfer of a capital asset. A long-term capital loss arises from transfer of shares held for more than 12 months and for other assets held for more than 36 months before sale. Transfer of assets held for a period less than the prescribed one results in short-term capital loss. As a general rule, under the Income Tax Act, 1961, a long-term capital loss cannot be set off against short-term capital gains.
2. Loss incurred from speculation loss cannot also be set off against profit from a non-speculation business or any other income. The benefit of set off of loss under a source is available where the income from such source is exempt from income tax.
3. Loss cannot be set-off against income from lotteries, puzzles, horse race, gambling, betting, etc.
4. Loss from a source of income which is exempt from tax cannot be set off against any other income that is chargeable to tax. Example – agricultural income is exempt from tax. For the said reason, if a person incurs loss from agriculture, such loss cannot be adjusted against any other income that is taxable.
5. Loss from business stated in section 35AD of the Income Tax Act, 1961 such as setting up an operating warehouse for storage of agricultural products, developing a housing project, etc cannot be set off against an income other income other than income from specified business.

B. “Inter-head set off”: After availing intra-head adjustment, a tax payer can avail inter-head adjustment. If in an assessment year, a taxpayer incurs loss under a head of income but has an income under another head, then he can adjust the loss from one head against the income from the other one. For example, a loss under the head “house property” can be adjusted against the head “salary income”.
A person may have many sources of income under separate heads of income. He may be allowed to set off loss under one head of income against income under the other head.

Exceptions:

There are some exceptions to the aforesaid provisions.
1. The loss from business is not to be allowed to be set off against salary income. However it can be set off against other incomes.
2. Long term capital loss or short term capital loss, can be set off only against capital gains.
3. Set off cannot be allowed against casual income derived from winnings of lotteries, puzzles, any other game of gambling or betting, etc.
4. Set off cannot be allowed in case of loss from the business of owning race horses against any other head of income.
5. Set off cannot be allowed in case of loss from an exempted source such as agricultural income, etc.
6. Set off cannot be allowed in case of loss from business stated in section 35AD of the Act.

Carry forward of losses:

Often it happens that even after making intra-head and inter-head adjustments, loss remains which are not adjusted. Such unadjusted loss is allowed to be carried forward to the following year for adjustment. Separate provisions have been provided under the Income Tax Act for carry forward such loss under different heads of income.
Provisions relating to carrying forward of losses:
Unabsorbed loss under house property, business loss, etc. can be carried forward for the next eight years. However unabsorbed speculation business loss can be carried forward for four years.
Loss can be carried forward even if the business for which it was incurred is not been continued. But such loss cannot be allowed to be set off against income under another head.

Exception:

An exception lies in case of unabsorbed depreciation arising out of business that can be set off against any other source of income when there is no business income and can be carried forward even if the said business does not exist.
Carry forward of losses is allowed only if the return of income in the year when loss is incurred, is filed within due time. Late filing of return does not permit carry forward of loss incurred in the previous years.

Carrying forward of clubbed losses:

When clubbing provisions apply, loss should be clubbed in the same fashion as income. Clubbed loss is allowed to be set off and carried forward. The successor of business who has acquired the same by way of inheritance can carry forward the loss.

Conditions to carry forward of losses:

1. Previous years’ losses can be set off against income from the concerned head of income.
2. Inter head carrying forward is not allowed.
3. Unadjusted loss for owning or maintaining of race horses can be carried forward for four years following the Previous Year in which it actually arose.
4. Unabsorbed depreciation is allowed to be carried forward for any period.

Conclusion:

In view of the above, taxpayers are advised to be cautious about the relevant provisions to properly utilize their losses and get best tax results.