Business Loss set off under Sec.72: Widened scope

The judiciary does play a vital role in the economy by discerning the real intentions of the law. In this regard, the recent rulings with respect to carry forward and set off of losses in the tax law are indeed testimonial of the value addition by our judiciary. At present, the set off and carry forward of Business losses are governed by Sec.71 and Sec.72 of the Income Tax Act 1961. Sec.71 is intended to deal with the set off of a loss computed under a particular head of Income against Income computed under any other Head subject to certain disallowances. This is to facilitate a set off only during the first assessment year when loss is computed under a particular source and invariably no gains will be available within the same head to offset the loss. But Sec.72 is meant to allow carry forward of Business losses which could not be set off even after applying Sec.71 in the assessment year when the Business loss first arose. It goes further and talks about set off of the carried forward Business loss in the subsequent assessment years as well.

What does Sec.72 say?

Where for any assessment year, the net result of the computation under the head "Profits and gains of business or profession" is a loss to the assessee, not being a loss sustained in a speculation business, and such loss cannot be or is not wholly set off against income under any head of income in accordance with the provisions of section 71, so much of the loss as has not been so set off or, where he has no income under any other head, the whole loss shall, subject to the other provisions of this Chapter, be carried forward to the following assessment year, and (i) it shall be set off against the profits and gains, if any, of any business or profession carried on by him and assessable for that assessment year and (ii) if the loss cannot be wholly so set off, the amount of loss not so set off shall be carried forward to the following assessment year and so on

On a plain reading, a layman is bound to conclude that losses computed under the head ‘Profits and Gains of Business or Profession’ which were not successfully set off in the first year, is carried forward to next assessment year, only to be set off against profits and gains of same or any other business or profession which are in turn assessable ONLY under the head ‘Profits and Gains of Business or Profession’ in the next assessment year. To mean more technically, the profits or gains used for the set off should also be one of those items mentioned in Sec.28 of the Income Tax Act which are assessable only under the head Profits and Gains of Business or Profession’

But here are couple of court decisions which have drawn different interpretations and ultimately brought cheers to the assessees.

A look at relevant judgments:

The Madras High Court opened the doors for the assessee in the case of Ramnath Goenka vs. CIT way back in 2002 where the assessee claimed that the carried forward losses of the earlier years from his business should be set off against his dividend income during the assessment year as the dividends were derived from the shares which were held as stock in trade. The Assessing Officer rejected the claim of the assessee. The Tribunal allowed the assessee's claim. On further appeal by the Revenue, the High Court concluded as following, in favour of the assessee,

“As held by the Apex Court in the case of Western States Trading Co. (P.) Ltd. v. CIT [1970],  the amount of dividend would form part of the income from the business of the assessee if the shares were a part of the assessee trading asset even when the dividend received on those shares had been computed as being part of the assessee's income under the head ‘Other sources’. The Apex Court in very clear terms approved the view that had been taken by the High Courts consistently that "business loss carried forward from earlier years can be set off against the dividend income derived from the shares held as stock-in-trade. Therefore, the Tribunal was correct in law in holding that the business loss brought forward from earlier years should be set off towards the dividend income”.

No more clarity is needed on the above. It was very lucidly explained that as long as the Profits and Gains arose from a business or profession, they should be allowed to be set off against carried forward Business losses irrespective of the fact that they may be assessable under any other Head of Income other than ‘Profits and Gains of Business or Profession’.

Ten years down the line, the Delhi High Court has dealt the same issue in the case of Lavish Apartments P Ltd vs. CIT to assessee’s favour. It held that in the subsequent year in which the assessee claims set off of the brought forward business loss, there is no condition that the business income against which the brought forward loss is claimed to be sought for should have been computed under the head "profits and gains of business". The income against which the loss brought forward is claimed to be set-off should represent business income judged by the application of commercial principles, and not on an application of the provisions of the Act.

An element of surprise is the ITAT Mumbai Bench decision in the case of Digital Electronics Ltd vs. ACIT (2010). The assessee claimed set off of brought forward business losses against short-term capital gains on sale of factory building and plant and machinery. The Tribunal allowed the set off citing the same grounds. However it may be noted a different bench of ITAT at Bangalore had already disallowed the set off of Business loss against gains from sale of business assets citing that sale of capital asset does not form part of Business income of any person (Nandi Steels Ltd case – 2011). Under this scenario the recent Delhi HC judgment should bring a lot of respite since obviously Tribunals are expected to toe the line of Court decisions in future, especially if it is in their respective states.

The words used in Sec.72 are ‘profits’ and ‘gains’ of any business or profession of the assessee. At the hindsight, whether the words ‘Profits’, ‘Gains’ are synonymous with the term ‘Income’ such that other incidental incomes assessable under ‘Income from Other Source’ can be equated to either of the words ‘Profit’ or ‘Gain’? All these words have distinctions at subtle level. This is for judiciary to decide whether to give weight age to the literary meanings. But at the moment there is a good leeway to the assessee.

Conclusion:

The position as it stands now seems as below in the light of these opinions,

Sec.72 seems to be gaining ground with these Court judgments starting to allow offsets against income from other heads similar to Sec.71 which deals with the set off of business loss only for the year when loss is first computed. It would be highly helpful if CBDT comes out with a circular regulating the revenue officers to allow such offsets as discussed above, so that such rows do not keep on continuing only to create wastage of time and funds. As time progresses it also looks like the scope of Sec.28 needs to be widened once the judiciary starts opining that additionally so many items including gain on sale of capital assets are in fact business income. This will simplify the things.