Finance & Accounting

Set Off and Carry Forward of Losses

Profit and loss are two sides of a coin. However, incurring losses can be demoralizing for the business, but the Indian Income-tax law does provide taxpayers with some benefits from incurring losses too. The provisions regarding set off and carry forward of Losses, along with the exemptions pertaining to the adjustments, are provided in the income tax Act 1961^[1], which are discussed in detail in this article.

Set off and Carry Forward of Loss: Definition 

The definition of both the terms is provided herein under –

Set off of Losses

Set off of losses can be defined as the adjustment of the losses against the profit or income of that particular year. The losses that aren’t set off against the said income in the same year can be carried forward to the next years for set off against the income of those years. A set can be further classified into intra-head and inter-head setoff.

Meaning of Intra-Head Adjustment

The intra-head adjustment refers to the process of adjusting the loss from a source in a particular head of income against income from any other source in the same head of income. If the loss has been incurred by the assessee in any year from any source under a particular head of income, the assessee is allowed to adjust such a loss for income from any other sources under the same head.

Meaning Of Inter-Head Adjustment

Subsequent to making the intra-head adjustment (if any), the  further step is making an inter-head adjustment which means that if the taxpayer has incurred a loss under one income head and is having income under other head of income in any year, the loss can be adjusted from one head against income from other head.

Carry Forward Losses

Even after making the appropriate and permissible intra-head and inter-head adjustments, there can still be unadjusted losses, which can be carried forward to future years for adjustments against the income of these years. The rules regarding carry forward differ slightly for different heads of income.

Restrictions to Be Considered During Intra-Head Adjustment of Loss

The following restrictions should be kept in mind before making intra-head adjustments of loss:

1. Loss from speculative business can only be set off against income from speculative business and not against any income. However, if the business loss is non-speculative in nature, it can be set off against income from speculative business.
2. The setoff in respect of Long-term capital loss can be made against income long-term capital gain only. However, a STCL can be set off against long-term or short-term capital gain.
3. The loss can’t be set off against income from winnings availed from lotteries, races including horse races, crossword puzzles, card games, and any other game of any type or from betting, gambling or of any nature or form.
4. Loss from the business of ownership or maintenance of racehorses can only be set off against income from the business pertaining to the same and no income other than the same.
5. Loss from business specified u/s 35AD can’t be set off against any other income from specified businesses.  

Restrictions Regarding Inter-Head Adjustment of Loss

The below-mentioned restrictions must be kept in mind before making inter-head adjustment:

• It is important for the assessee to make the intra-head adjustments before initiating inter-head adjustments and the 5 restrictions mentioned in the intra- head adjustments applies here as well. Other restrictions regarding inter-head adjustments are discussed below –
• Loss from business and profession can’t be set off against Salaries” income head. 
• Loss under “house property” shall be permitted to be set off for any other head of income only upto Rs. 2, 00,000 for any AY. 
• However, the unabsorbed loss shall be permitted to be carried forward for set-off in the years according to the existing provisions of section 71B.
• C/D of unadjusted loss for adjustment in the next year.
• Despite making intra-head and inter-head adjustments, the certain loss remains unadjusted, which can be carried forward to next year for adjusting the same against subsequent year(s)’ income. Separate provisions have been framed under the IT Act for the carry forward of loss under different heads of income.

Provisions Regarding Carry Forward and Set Off Of Business Loss Other Than the Loss from Speculative Business

• In the event of a loss of any business/profession (other than speculative business) not being adjusted in the yr of incurrence, it can be carried forward to make adjustments in the next year wherein such loss can be adjusted only under the head of “Profits and gains of profession or business. 
• Loss incurred under the head “Profits and gains of business or profession” can be carry forward only in cases where the return of income/loss of the year of the incurrence of loss is furnished on or prior to the due date of filing the return, as prescribed under section 139(1).
• The loss can be c/d for a span of 8 years immediately succeeding the year of the incurrence of the loss Above provisions won’t apply for unabsorbed depreciation.
• Loss from business specified u/s 35AD can’t be set off for any other income except income from the specified business, which can be c/d for adjustment against income from specified businesses for any number of years.
• Loss from business specified u/s 35AD won’t be carried forward if the ITR /loss of the year of incurrence incurred is not filed on or prior to the due date of filing the return as prescribed under section 139(1).
• If the loss has been incurred from the business of ownership or maintenance of racehorses, the same won’t be eligible for set off for any income except income from the business of maintaining and owning racehorses, which can be carried forward only for a span of 4 years.

• If the loss of any speculative business is unable to be fully adjusted in the year of incurrence, then the unadjusted loss can be carried forward for the purpose of making adjustments in the next year, wherein such loss can be adjusted only for the speculative business’s income.
• Such can be carried forward only if the ITR /loss of the year of incurrence is filed on or prior to the due date of filing the return, as prescribed under section 139(1).
• Such loss will be carried forward for a span of 4 years immediately after the year in which the loss is incurred. The above provisions won’t apply in case of unabsorbed depreciation of speculative business.
• If in any Assessment Year, the assessee suffered a loss from house property, he shall be entitled to set off.
• Such loss against income for other heads upto a limit of Rs. 2 lahks p. The balance, if any, would be carried forward.

Apart from this, the following can also be carried forward indefinitely despite not being business losses as per Income-Tax Act:

• Unabsorbed capital expenditure incurred on scientific research;
• Unabsorbed depreciation;
• Unabsorbed expenditure incurred on family planning. 
• Other provisions with regard to carry forward and set off losses.

Change in the Constitution of Business:

In the event of a change in the constitution of a partnership firm owing to the death or retirement of a partner, the share of loss attributable to the outgoing partner can’t be carried forward by the firm. However, this does not apply in regard to unabsorbed depreciation, family planning expenditure or unabsorbed capital expenditure on scientific research.

Change in Shareholding of Certain Companies

• When the shareholding of a company changes in a previous year, not a company wherein the public has a substantial interest, the loss incurred in any year prior to the PY cannot be set off and carried forward against the income of the PY unless-
• On the final day of the PY, the company’s shares having a minimum of 51% of the voting power were beneficially held by a person beneficially holding the shares of the co. for a minimum of 51% of voting power on the final day of the yr /yrs of incurrence of loss (N/A for unabsorbed capital expenditure on scientific research, unabsorbed depreciation, or family planning expenditure)
• No loss from an exempted source of income can be adjusted against the income that shall be taxed – If income from a particular source is exempted from tax, then loss arising from such source can’t be set off against any other income which is taxable.

Order of Set-Off Of Business Losses from Business Income:

The effect of depreciation, business loss and investment allowance must be provided in the below-mentioned order:

1. Depreciation of current yr. [Sec- 32(1)];
2. Current yr capital expenditure on scientific research and current yr expenditure on family planning to the extent allowed;
3. B/d loss from business or profession [Section 72(1)];
4. Unabsorbed depreciation [Section 32(2)];
5. Unabsorbed capital expenditure incurred on scientific research [Section 35(4)];
6. Unabsorbed expenditure with respect to family planning [Section 36(1)(ix)].

As per the provisions of the Act, Only, the assessee incurring the loss, is entitled to carry forward or set off the loss. However, there are certain exceptions to it:

• Loss of business acquired by inheritance (excluding unabsorbed depreciation) Accumulated business loss of Demerger Company/ Amalgamation/, satisfying the conditions as provided u/s 72A/72AA of the Income-tax Act.
• Accumulated loss of a Firm or Proprietary Concern at the time of its business being taken over by a Company by fulfilling the conditions prescribed in section 47(xiii)/47(xiv), depending upon the case
• Accumulated loss of a Pvt. Company or Unlisted Public Company in the event of its business being taken over by an LLP upon the fulfilment of the conditions provided u/s 47(xiiib).

Conclusion

There are different provisions with regard to set off and carry forward of losses, wherein the loss must be the first set off within the respective head in the same AY, followed by inter head set off if the loss exists even after the previous adjustment. Upon the completion of the steps mentioned above, if any loss subsists, it should be carried forward, making it eligible for set off in the next AY under the same income head only, not before considering the prescribed exemptions. Therefore, a clear understanding of the act’s provisions is necessary while dealing with business losses.

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