Set-off and Carry forward of Loss | Commerce & Accountancy Optional Notes for UPSC PDF Download

Introduction

When there is a net loss for any assessment year in a particular source of income under a certain head, the taxpayer can offset this loss against the income from another source within the same head. This process is known as Inter-Source Adjustment. For example, if a taxpayer has four house properties and three of them generate taxable income while the fourth incurs a loss, the taxpayer can use the loss from the fourth property to reduce the taxable income from the other three properties. Similarly, if a taxpayer has four businesses of different natures in a year, and two businesses generate taxable profit while the other two incur losses, the taxpayer can offset the losses from the two businesses against the profits from the other two businesses.

Exceptions:

• Speculation losses can only be offset against profits from another speculation business carried out by the taxpayer.
• Losses from tax-free sources of income cannot be offset against profits from other sources. For example, agricultural losses cannot be used to offset income from other sources.
• Losses from owning and maintaining race horses cannot be offset against income from other sources except within the same head.
• Losses from other businesses cannot be offset against winnings from races, lotteries, etc.
• Long-term capital losses can only be offset against long-term capital gains, not short-term capital gains.
• Short-term capital losses can be offset against gains from any capital asset.
• Losses from lotteries, betting, crossword puzzles, gambling, etc., cannot be offset against winnings from similar activities.
• Losses from specified businesses referred to in Section 35AD can only be offset against income from other specified businesses.

Inter Head Adjustment (Set off) (Section 71)

When there is a net loss for any assessment year in a particular head of income, the taxpayer can offset this loss against income assessable under any other head of income. However, there are exceptions to this general rule:

• Losses from speculation businesses cannot be offset against any other income.
• Losses from specified businesses referred to in Section 35AD can only be offset against income from other specified businesses.
• Income from other heads cannot be used to offset losses under the capital gains head.
• Losses from owning and maintaining race horses cannot be offset against any other income.
• Losses from business or profession cannot be offset against salaries.
• In any assessment year, losses from income from house property can be offset against income from any other head of income, subject to a restriction of Rs. 2 lakhs.
• Losses from an exempted source of income cannot be offset against any taxable income.
• Losses from lotteries, betting, crossword puzzles, gambling, etc., cannot be offset against income from other heads or sources under the same head.
• Losses from any source cannot be offset against winnings from races, card games, lotteries, bets, etc.

Set-off of Losses of General Business or Non-Speculation Business

1. General Business includes any non-speculation business. Any loss from a business (except speculation business) or profession can be offset against any other income under the same head or any other head, including income from speculation business but excluding salaries. 
2. Losses from illegal businesses cannot be offset against profits from legal businesses, but they can be offset against profits from other illegal businesses. Losses from discontinued businesses can also be offset.

Set-off of Losses of Speculation Business [Section 73(1)]

Losses from speculation businesses can only be offset against profits and gains (if any) from another similar business (i.e., speculation business) carried out by the taxpayer, not against income from any other head.

Set-off of Losses of Specified Business [Section 73A] (w.e.f. AY 2010-11)

• Any loss from a specified business referred to in Section 35AD cannot be offset against the income from any other business, but it can be offset against profits and gains from any other specified business.

Set off of Losses under the Head Capital Gains

Capital losses can be short-term or long-term.

• Short-term capital losses can be offset against any capital gain, i.e., short-term gain or long-term gain.
• Long-term capital losses can only be offset against long-term capital gains.

Set-off of Losses from Owning and Maintaining Race Horses [Section 74A (3)]

• Losses from owning and maintaining race horses can only be offset against income from the same activity (i.e., owning and maintaining race horses), not against income from any other source.

Set off of Losses of Lottery, Betting, Gambling, Crossword Puzzles or Card Games, etc.

• These losses cannot be offset against any income, including winnings from lotteries, crossword puzzles, races, card games, etc.

Set off of Losses of Partnership Firm

• Losses of a partnership firm can be offset against its own (firm's) income. The rules for offsetting losses are the same as those for non-firm taxpayers, as explained earlier. Partners cannot offset their share of losses in the firm against their personal income.

Set off of Losses of Association of Persons (AOP) or Body of Individuals (BOI)

• Losses of an AOP or BOI can be offset against their own income. The rules for offsetting losses are the same as those for general taxpayers. 
• Members of an AOP or BOI cannot offset their share of losses in the AOP or BOI against their personal income.

Carry Forward and Set Off of Losses

As previously discussed, setting off losses refers to using them to reduce the taxable income of the same year. However, when the losses exceed the incomes for the year, the entirety of the loss cannot be set off against the income of the same assessment year. In such cases, the losses that cannot be set off (i.e., the excess of losses over incomes) are carried forward to be set off against the income of subsequent years. This process is known as carry forward and set off of losses. Losses from house property can be carried forward even if the return is not filed within the due time limit under Section 139(1).

Provisions Regarding Carry Forward and Set Off of Losses

Not all losses can be carried forward for setting off in succeeding years. Only specified losses can be carried forward and set off in succeeding assessment years. These include:

Loss from House Property [Section 71(B)]

• Losses under the head 'Income from House Property' can be set off against any other head of income, subject to a maximum of Rs. 2 Lakhs for any assessment year. 
• Any unabsorbed portion of such loss can be carried forward to be set off against income under the 'Income from House Property' for a maximum of eight subsequent assessment years.

Losses of General Business [Section 72]

It is not possible to set off the full amount of losses of a general business in the same previous year. Any 'Not Set Off Losses' can be carried forward and set off against the profits of subsequent years. However, there are specific provisions:

• These losses can only be carried forward and set off against profits under the head 'Profits and Gains of Business or Profession'.
• If carried forward and set off in subsequent years, such losses cannot be set off against any other head of income except business or profession income.
• These losses can also be set off against incomes (not falling under the head ‘Profits and Gains of Business or Profession’) arising due to a Business Activity.
• Such losses shall be carried forward for a maximum of eight assessment years immediately succeeding the assessment year for which the loss was first computed.
• The assessee who owns the business at the time when it suffers losses is entitled to carry forward such losses. If the business is transferred to a new owner, the new owner cannot carry forward 'Not Set Off Losses.'
• Not Set Off Losses can be carried forward and set off against profits or gains of business or profession even if the business in which the loss was incurred has been discontinued.
• Brought forward losses of a specified business (referred to in Section 35AD) can be set off in subsequent years against the income of any specified business.
• If a business undertaking is discontinued due to losses from natural calamities like floods or cyclones but later revived within three years, the unabsorbed losses of such undertaking shall be carried forward and set off against the profits of the revived business or any other business for a maximum of eight years from the year in which the business is restarted.
• These losses cannot be carried forward and set off unless the details of such losses are furnished in the income tax return filed by the assessee under the provisions of Section 139. However, a delay in the submission of the return may be condoned if certain new conditions are satisfied.

Accumulated Losses and Unabsorbed Depreciation

In addition to business losses, (a) unabsorbed depreciation, (b) unabsorbed capital expenditure on scientific research, and (c) unabsorbed expenditure on family planning can also be carried forward indefinitely. These losses can be set off against income under any head except salaries in the following order:

Current year's depreciation [Section 21(1)]

• Current year capital expenditure on scientific research and current year expenditure on family planning to the extent allowed.
• Brought forward business or profession losses [Section 71(1)]
• Unabsorbed depreciation [Section 32(2)]
• Unabsorbed capital expenditure on scientific research [Section 35(4)]
• Unabsorbed expenditure on family planning [Section 21(1) (9)]

It is necessary that the details of all such losses must be given in the return of income, and the return must be filed before the due date under Section 139(1) for the loss to be carried forward. The rules for carry forward and set off of unabsorbed depreciation and accumulated losses in different situations are as follows:

In certain cases of Amalgamation [Section 72A]

• According to Section 72A(1), when a company (i) owning an industrial undertaking or a ship or a hotel amalgamates with another company or (ii) a banking company amalgamates with a specific bank or (iii) one or more public sector companies engaged in the business of the operation of aircraft amalgamate with one or more public sector companies engaged in similar business, the accumulated loss and the unabsorbed depreciation of the amalgamating company for the previous year in which the amalgamation was effected can be carried forward. 
• Thus, subject to certain conditions for set off, the amalgamated company shall be eligible to carry forward and set off the loss and unabsorbed depreciation of the amalgamating company. If the prescribed conditions under Section 72(i) are not complied with, the set off and carry forward shall not be allowed to the company eligible for doing so.

In certain cases of Demerger [Section 72A]

• Under Section 72A(4), in the case of a demerger of an undertaking, the accumulated loss and the allowance for unabsorbed depreciation of the demerged company shall be allowed to be carried forward and set off in the hands of the resulting company. 
• Such accumulated losses and unabsorbed depreciation transferred by the demerged company to the resulting company can be carried forward and set off by the resulting company.

In cases of succession of a firm or a proprietary concern by a company:

• According to the provisions of Section 72A(6), where a firm or a proprietary concern is succeeded by a company that fulfills the prescribed conditions, the accumulated loss and the unabsorbed depreciation of the predecessor firm or proprietary concern shall be deemed to be the loss or allowance for depreciation of the successor company for the previous year in which the business reorganization was effected. Other provisions of set off and carry forward of loss and unabsorbed depreciation shall apply accordingly.

In cases of succession of a private company or an unlisted public company by a Limited Liability Partnership (LPP):

Under the provisions of Section 72A(6A), due to the reorganization of business, a private company or unlisted public company is succeeded by a Limited Liability Partnership fulfilling the conditions laid down in Section 47 (xiii)(b), the accumulated loss and the unabsorbed depreciation of the predecessor company shall be deemed to be the loss and the unabsorbed depreciation of the predecessor company, shall be deemed to be the loss or allowance for depreciation of the successor Limited Liability Partnership of the previous year in which such succession has taken place. Other provisions of set off and carry forward of loss and depreciation shall apply accordingly.

In cases of a scheme of amalgamation of Banking Company in certain cases [Section 72AA]

Under Section 72AA, if there has been an amalgamation of a Banking Company with any other Banking Institution, under a sanctioned and brought into force scheme, other provisions of this Act relating to set off and carry forward of loss and allowance for depreciation shall apply accordingly.

In cases of Business Reorganization of Co-operative Banks [Section 72AB]

• Under Section 72AB, if two cooperative Banks have an amalgamation, then, the accumulated loss and unabsorbed depreciation of the predecessor Co-operative Bank can be set off and carried forward by the successor co-operative Bank. 
• All other provisions of the Act relating to set-off and carry forward of the losses and unabsorbed depreciation shall apply accordingly.

Loss of Speculation Business [Section 73]

When it is not feasible to fully set off speculation business losses against the profits of another speculation business in the same year, the "Not Set Off Losses" can be carried forward to set off such losses from the profits of speculation business in subsequent years. However, this carry forward of "Not Set Off Losses" can only be done for a maximum period of four assessment years immediately following the assessment year for which the loss was first calculated.

Losses of Specified Business [Section 73A]

• As per Section 73 A, if any loss computed for a specified business in any assessment year has not been entirely set off against any other specified business in the same assessment year, then the "Not Set Off" losses can be carried forward to the following assessment year. The following rules apply:
• It shall be set off against the profits and gains, if any, of any specified business carried on by the assessee assessable for the assessment year.
• If the loss cannot be entirely set off, the amount of loss "not so set off" shall be carried forward to the subsequent assessment year and so on until it is fully set off from the profits of any specified business.

Capital Losses [Section 74]

• Any "Not Set Off" Short-Term Capital Loss of a previous year can be carried forward to be set off against the Capital Gains (whether Long-term or Short-term) arising in the eight subsequent years immediately following the assessment year for which the loss was first calculated.
• Any "Not Set Off" Long-Term Capital Loss of a previous year can be carried forward to be set off against the Long-Term Capital Gains arising in the subsequent eight years immediately following the assessment year for which the loss was first calculated.

Losses on Account of Owning and Maintaining Race Horses [Section 74A]

• Any "Not Set Off" Losses from the activity of Owning and Maintaining Race Horses can be carried forward for a maximum of four assessment years immediately succeeding the assessment year in which such loss was first calculated. 
• Such "Not Set Off Losses" can be carried forward but are allowed to be set off from the profits of Owning and Maintaining Race Horses only if such activities have been continued until the losses are carried forward. If such activities related to race horses are discontinued, the losses of such discontinued business cannot be carried forward.

Losses of Firms

The partners of a firm share the profits of the firm, which is exempt in their hands, but the losses of the firm are not shared among the partners. The laws related to set off and carry forward of losses of firms are broadly the same as already discussed in the previous pages. However, some key points are as follows:

• The firm can only set off and carry forward and set off its own losses and not those of the partners.
• The firm's "Not Set Off" business losses can be carried forward for eight assessment years and set off against business income of subsequent years.
• Unabsorbed Depreciation, Capital Expenditure on Scientific Research, and Family Planning are allowed to be carried forward for being set off in the subsequent assessment years, and there is no time limit prescribed for such carry forward.

Losses of Firm in Case of Change in Constitution [Section 78 (1)]

• If there is a change in the constitution of the firm due to retirement or death of a partner, insolvency of one or more partners, admission of one or more partners in the firm, or change in the profit-sharing ratio of the partners, then under any of these situations and if there is any loss to a deceased partner, it cannot be carried forward.

Losses in Case of Change in Succession of Firm [Section 78 (2)]

• Losses of a firm related to the pre-succession period cannot be carried forward and set off by the successor in the post-succession period.

Losses in Case of Change in Succession in Business by Inheritance

• If the succession has occurred due to inheritance, losses of a firm related to the pre-succession period can be carried forward and set off by the successor against the profits of the post-succession period.

Losses in Case of Certain Companies [Section 79]

• If there is a change in the shareholders of a company (in which there is no substantial interest of the public in general) in the previous year, then losses incurred in any year prior to the previous year shall be carried forward and set off against the income of the previous year provided that shareholders having 51% voting rights should be old shareholders on the last day of the year or years in which the loss was incurred and the change should be in minority shareholding only.
• In the case of a company, not being a company in which the public are substantially interested but being an eligible start-up as referred to in Section 80-IAC, the loss incurred in any year prior to the previous year shall be carried forward and set off against the income for the previous year, if all the shareholders of such company who held shares carrying voting power on the last day of the year or years in which the loss was incurred:
  • Continue to hold those shares on the last day of such previous year; and
  • Such loss has been incurred during the period of seven years beginning from the year in which such company is incorporated. This provision shall not apply in the following cases:
  • The death of a shareholder.
  • On account of the transfer of shares by way of a gift to any relative of the shareholders making such a gift.

Losses of Lottery, Crossword Puzzles, Gambling, Betting, etc.

• These losses cannot be carried forward; however, they can be set off in the same year in which they occur against the incomes of similar sources.
• Losses in the Case of Association of Persons (AOP) or Body of Individuals (BOI)
• Losses of AOP or BOI shall be set off and carried forward by the AOP or BOI itself. It will not be apportioned among members. In other words, rules regarding set off and carry forward of losses of AOP or BOI are the same as are applicable in the case of a firm assessee.

Loss Arising in Case of Bonus Stripping [Section 94 (8)]

• Bonus stripping is a situation when the purchase or sale of units of a listed company is transacted in a manner that would result in a short-term capital loss that can be adjusted against any other capital gains.
• In Bonus Stripping, shareholders acquire units before the company makes any bonus issue. Once the company issues bonus units, the investors sell the original units which they had held earlier. This can result in a short-term capital loss. Later, after one year they dispose of the bonus units. This situation enables the shareholders to enjoy two-fold benefits:
  • Short-term capital loss for the sale of original units can be set off against any capital gains.
  • Benefit of a concessional rate of tax at the rate of 10% can be availed on the long-term gains made on the sale of the bonus unit.
• To prevent the practice of Bonus Stripping, Section 94 (8) has been inserted. According to the said Section [94 (8)], if an investor sells or transfers all or any of the original units within a period of 9 months after the record date (date on which bonus units are allotted), while continuing to hold all or any of the bonus units, then the loss, if any arising from such transfer shall be ignored for the purpose of calculating income chargeable to tax, and the amount of the loss so ignored shall be deemed to be the cost of purchase or acquisition of additional units (bonus units). Thus, the shareholders will not be allowed to book the above-mentioned loss on original units against other capital gains.

Loss Return (Section 74)

• A loss cannot be carried forward and set off unless it is determined as per the provisions of Section 139(3) and filed before the Assessing Officer within the prescribed or extended time limits. If the loss return is filed after the allowed time limit or prescribed time limit, the delay may be excused, subject to certain conditions.

Order of Set Off

If the assessee is eligible to claim depreciation, capital expenditure, etc., and carried forward business losses, the order of set off will be as follows:

• Current year depreciation [Section 32 (1)]
• Current year capital expenditure on scientific research and family planning to the extent allowed.
• Brought forward business or profession losses [Section 72(1)]
• Unabsorbed Depreciation [Section 32 (2)]
• Unabsorbed Capital expenditure on scientific research [Section 35 (4)]
• Unabsorbed expenditure on family planning [Section 36 (i) (ix)]