Provision for set off & carry forward of Losses & Tax Planning

Income tax law provides for computation of income independently under five heads of income, as under:

1. Income from Salary
2. Income from House Property
3. Income from Business & Profession
4. Income from Capital Gain
5. Income from Other Source.

Every income of the taxpayers has to be categorized in any one of the first four heads of income. If income cannot be categorized under any one heads of income as mentioned above, it will be considered as “Income from Other Heads”.  There are specific rules and regulations for each head of income & the income has to be computed in accordance with the specific computation mechanisms provided therein.

Taxpayers must note that income tax liability doesn’t always arise on “Net Income” during the year. It is subject to provision related to intra-head and inter-head adjustment of the losses. Let us understand this with following two examples:

1. Mrs. Smart has earned Rs. 12 Lakh from Business whereas he has incurred a loss of Rs. 29 Lakh on sale of capital assets. Even though there is a net loss of Rs. 17 Lakh still she would be liable to pay the tax on Rs. 12 Lakh. Income tax law doesn’t permit the set off of loss from sale of capital assets against income from business.
2. Mr. Smart has earned Rs. 18 Lakh from Business “A” whereas he has incurred a loss of Rs. 20 Lakh in business “B”. Effectively, there is a net loss of Rs. 2 Lakh. Mrs. Smart won’t be liable to pay any tax as loss from one business is allowed to be set off against profit of another business.

Income Tax Act contains specific provision for set off & adjustments of losses which is subject to various terms & conditions. Let us have a look at the broader provision of such adjustment for tax optimization:

1. Intra Head Adjustment:
   Intra Head Source adjustment means set off loss under the same head of income. Normally, the losses from one source of income can be set off against income from another source under the same head of income. For example, Loss in Business “A” can be set off against income of another Business “B”. Here, Business A is one source and Business B is another source and the common head is “Income from Business”. However, there are few riders attached to an intra-head adjustment:
   i. Losses from speculative business can be set off against profit of speculative business only.
   ii. Loss from an activity of owning and maintaining race-horses is allowed to be set off only against the profit from such activity.
   iii. Long-term capital loss (LTCL) is allowed to be adjusted against Long Term Capital Gain (LTCG) only. Interestingly, a short-term capital loss (STCL) can be set off against both, LTCG or STCG.
   iv. Losses from a few specified businesses are allowed to be set off only against profit of such specified businesses only. Specified business means business of cold storage, hotel, infrastructural facility which has claimed deduction u/s 35AD.
2. Inter-head Set Off:
   After the intra-head adjustments, the taxpayers can set off remaining losses against income of other heads. For example, Loss under the head “Income from House Property” can be set off against “Income from Salary”. The rule of inter head set off is subject to the following exceptions:
   i. There is a cap of Rs. 2 Lakh for adjustment of loss under the head “Income from House Property”. Loss from House property can be set off against income under any other head subject to a max of Rs. 2 Lakh. Loss over & above Rs. 2 Lakh can be carried forward for set off in subsequent 8 Assessment Years.
   ii. Regular Business loss (other than speculative business) can be set off against any head of income except salary income i.e., Salary income is not allowed to be set off against Business Loss.
   iii. Following losses can’t be set off against any other heads of income:
   a. Speculative Business loss
   b. Capital Losses
   c. Specified business loss
   d. Losses from an activity of owning and maintaining race-horses

Provision for Carry Forward (C/F) of Loss:
After making above permissible intra-head and inter-head adjustments if there remains losses then such unadjusted losses can be c/f for set off against income of subsequent years. Of-course, it is also subject some riders which are as under:

1. Losses from House Property can be C/F up to next 8 assessment years & can be adjusted only against “Income from House property”.
2. Losses from Regular Business (non-speculative Business) can be C/F for 8 years & can be adjusted only against regular business income.

iii.   Speculative Business Loss can be C/F for 4 years for adjustment against Income from speculative business only.

1. Specified Business Loss u/s 35AD loss as mentioned above can be adjusted only against Income from specified business u/s 35AD. However, there is no time limit to C/F such losses.
2. Loss under the head “Income from Capital Gain” can be C/F up to next 8 years & is allowed to be adjusted only against long-term capital gains. Short-term capital losses can be set off against long-term capital gains as well as short-term capital gains.
3. Losses from owning and maintaining race-horses can be C/F up to next 4 years & is allowed to be set off against income from such activity only.

Special Provision:

1. If income of any particular source or nature is exempt from tax then loss from such source or nature cannot be set off against any other source of Income.
2. Casual Income (i.e. crossword puzzles, winning from lotteries, races, card games, betting etc) is not allowed to be set off against any other income of the taxpayer.

III. Business loss, capital gain loss, horse race loss can be c/f forward only if the income tax return is filed within the due date.

1. No loss or set off is permissible for income chargeable to tax as unexplained cash credit, unexplained money/investment etc u/s 68 & 69A/B/C/D.

Tax Planning Tips & Caution:

1. The benefit of carry forward of loss is there only if the income tax return is filed within the due date of filing ITR.
2. Adjustment of loss against income in the same head of income or other head of income is not optional but mandatory.
3. There is no specific set of rules for adjustment of losses against income except discussed above. Accordingly, taxpayers may adjust the loss against various incomes as per their convenience and keeping the tax planning aspects in Mind. For example, Mr. Smart is having Business Income of Rs. 2 Lakh, LTCG income taxable @ 20% of Rs. 3 Lakh, Other source income of Rs. 1 Lakh and Loss under the head Income from House Property of Rs. 2 Lakh. In such a case, Mr. Smart can set off the House Property Loss of Rs. 2 Lakh against LTCG of Rs. 3 Lakh thereby reducing the taxable income in the bracket of 20% special rate. This freedom of set off can enable the taxpayer to optimize the tax liability.
4. Business loss is allowed to be set off against Capital Gain/House property income in the same year but not in the subsequent years.

 

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