Carry Forward and Set Off of Losses – Income Tax

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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 summarized 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 rentincome 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-termcapital 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
offagainst 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
offagainst salary income. Capital loss, whether long term or
short term, can be set off only againstcapital 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)
3. 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)
2. The above rule (1) is not
applicable to unabsorbed depreciation, which can be set-off against any other
head
3. 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.
4. 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.
5. 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
o   
Current scientific research expenditure [Sec. 35(1)].
o   
Current
depreciation [Sec. 32(1)].
o   
Brought
forward business losses [Sec. 72(1)].
o   
Unabsorbed
family planning promotion expenditure [Sec. 36(1)(ix)].
o   
Unabsorbed
depreciation [Sec. 32(2)].
o   
Unabsorbed
scientific research capital expenditure [Sec. 35(4)].
o   
Unabsorbed
development allowance [Sec. 33A(2)(ii)].
o   
Unabsorbed
investment allowance [Sec. 32A(3)(ii)].

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