Set Off and Carry Forward of Losses : An analysis

Key Points To Remember

If there is any loss under any head of income, the assessee can set off losses against income. There are two ways to set off of losses against income.

1. Intra-head adjustments
2. Inter-head adjustments

Intra-head Adjustments

If in any year, the taxpayer incurs any loss from any source of income, then such loss can be adjusted against any source of income falling under the same head of income. The process of adjusting the loss against any income under the same head of income is known as Intra-head Adjustments.

However, there are certain restrictions for Intra-head adjustments. The same has been noted below-

• Speculative business loss cannot be set off against any income other than Speculative Income. But, Non-speculative business loss can be set off against Income from Speculative Business.
• Long Term Capital Losses cannot be set off against Short Term Capital Gain. However, Short Term Capital Loss can be set off against Long 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 business of owning and maintaining race horses cannot be set off against any income other than income from business of owning and maintaining race horses
• Loss from specified business under section 35AD cannot be set off against income from any other income except income from specified business

Inter-head Adjustments

If in any year, the taxpayer incurs any loss from one head of income, then such loss can be adjusted against any income falling under any head. The process of adjusting the loss against any head of income is known as Inter-head Adjustments.

Below are the restrictions/conditions for Inter-head Adjustments-

• Before making inter-head adjustment, the taxpayer has to first make intra-head adjustment.
• Loss from speculative business cannot be set off against any other income. However, non-speculative business loss can be set off against income from speculative business.
• Loss 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, races 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
• Loss from business and profession cannot be set off against income chargeable to tax under the head 'Salaries'.

Losses which cannot be Set-Off

Though most of the losses are set off through intra- head and inter-head adjustments, there are few losses which cannot be set off. Loss from an exempted source of income is one such loss which cannot be adjusted against a taxable source of income. For Example, loss from agricultural activities. Because agricultural income is an exempted income.

Carry forward of Losses

Though there are provisions for set off of losses through intra-head and inter-head adjustments, there are chances that the losses remain unabsorbed. Such unabsorbed losses can be carried forward.

Below is the table which provides the period for which the unabsorbed losses can be carried forward-

However, in certain cases, to carry forward the losses the assessee must have filed the return within the due date under section 139(1).

Provisions under the Income-tax Act 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.
• The set-off of loss from house property against 'income from any other source' is restricted to Rs. 2 lakh per annum.
• 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).

Provisions 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

Depreciation is first deducted from the income chargeable to tax under the head 'Profits and gains of business or profession'. If such depreciation could not be fully adjusted against such income chargeable to tax in that previous year, the unabsorbed portion shall be added to the amount of depreciation for the following year and shall be deemed to be the part of depreciation for that year (similar treatment would be given to other allowances as mentioned above).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.

Carry forward of loss in case of change in the constitution of business

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 the predecessor entity (provided that conditions specified in this regard are satisfied) for the remaining unexhausted carry forward period.

Provisions relating to carry forward of loss in case of retirement of a partner from a partnership firm

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.

Special provisions relating to carry forward and set-off of losses in case of change in shareholding of certain companies

As per Secti​on 79 of the Income-tax Act, where a change in shareholding has taken place in a previous year in the case of a company, not being a company in which the public are substantially interested, no loss incurred in any year prior to the previous year shall be carried forward and set off against the income of the previous year unless, on the last day of the previous year the shares of the company carrying not less than fifty-one percent of the voting power were beneficially held by person who beneficially held shares of the company carrying not less than fifty-one percent of the voting power on the last day of the year or years in which the loss was incurred.

However, the above condition is not applicable in case of an eligible start up referred under section 80-IAC​ in case of such start up, loss can be carried forward and set off against the income of the previous year, if all shareholders of such company (who held shares carrying voting power on the last day of the year or years in which loss was incurred) continue to hold the shares on last day of such previous year. [Inserted by the Finance Act, 2017]

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 shareholding 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 subsidiary of foreign company, when such foreign company is amalgamated/demerged with another foreign company and 51% or more shareholders of the amalgamating/demerged foreign company continues to be the shareholders of the amalgamated/resulting foreign company and where any change in shareholding in the company takes place pursuant to a resolution plan approved under the IBC.

With an objective to facilitate resolution of distressed companies, the Finance (No. 2) Act, 2019 extend the benefit of secti​on 79​ to the following companies, and their subsidiary and the subsidiary of such subsidiary, where:

(a) ​When NCLT, on a petition moved by the Central Govt., has suspended the board of directors and has appointed new directors.

(b) When change in shareholding has taken place in a previous year pursuant to a resolution plan approved by the Tribunal.​

Note:

W.e.f., Assessment Year 2022-23, the Finance Act, 2021 provides that section 79 not applicable in case there change in the shareholding has taken place during the previous year on account of relocation referred to in the Explanation to clauses (viiac) and (viiad) of section 47.