Every businessman runs the business with the motivation to earn the profits out of it, but unfortunately there are possibilities of incurring the losses. As a businessman income tax expenses is an outflow from his earned income. Every businessman tries to minimize the tax expense to the extent possible.
Based on the natural justice, income tax department allows and provides the adjustments to utilize such losses with the income earned in future. However, there are some conditions which are defined under income tax laws to prevent the misuse of such adjustments.
In such situation it is always better to have awareness of the relevant provisions relating to set off and carry forward of losses in order to maximize tax benefits and minimize the tax expenses.
Set off of losses is to be done in the in the following ways:
Step 1: Inter source (intra-head) adjustment under the same head of income (section 70)
Step 2: Inter head adjustment in the same assessment year (section 71). This will be applicable only if the losses cannot be fully set off under step1.
Step 3: Carried forward of un-utilized losses
The relevant provisions related to set off and carried forward of losses have been summarized here:
A) Inter source (intra-head) adjustment or set off of losses under the same head of income
The process of adjusting the loss of one business against profit of other business is called inter source or intra head set off of losses. E.g.: Adjustment of loss from running manufacturing business setoff against profit from trading business.
If the net result from income from business is a loss, the tax payer is entitled to have the amount of such loss adjusted against any other source under the same head of income. In other words loss from business A can be set off against profits from business B. To the aforesaid rule, following exceptions should be kept in mind;
- Loss from speculation business: Any loss incurred from speculation business can only be set off against other speculation business.
- Loss from specified business: Any loss incurred from any specified business under section 35AD can only be set off against profit of any specified business.
- Loss under capital gains: Any loss in the nature of long term capital loss can only be set off against long term capital gains.
- Loss from owning and maintaining race horses: Any loss incurred in business of owning and maintaining race horses can only be set off against income from owning and maintaining race horses.
- Loss from winnings from lotteries, crosswords puzzles etc.: By virtue of section 58(4) a loss cannot be set off if incurred from winnings from lotteries, crosswords puzzles, house races, card games and any other game of any sort or from gambling or betting in any from or nature.
Subject to aforesaid five situations, any other losses can be set off against any other income within same head of income, in other words;
- Loss from house property can be set off against income from another house property.
- Loss from non-speculation business can be set off against income from speculative or non-speculative business
- Short term capital loss can be set off against short or long term capital gain
- Loss from an activity (other than owning and maintaining race horses) can be set off against any income except income from winnings from lotteries, crosswords puzzles.
B) Inter head adjustment or Set off of losses
Where the net result of computation of income for any assessment year in respect of any head of income is loss, the same can be set off against income from any other head of income subject to following conditions;
- Loss from speculative business cannot be adjusted against other head of income
- Loss from specified business cannot be adjusted against other head of income
- Loss from capital gains cannot be set off against other head of income
- Loss from business or profession cannot be set off against income from salaries
- By virtue of section 58(4) a loss cannot be set off if incurred from winnings from lotteries, crosswords puzzles, house races, card games and any other game of any sort or from gambling or betting in any from or nature.
- Where the particular source of income is exempt under the provisions of income tax laws then any losses incurred from such source cannot be set off against income chargeable to tax.
CARRIED FORWARD OF LOSS
Any un-utilized losses are allowed to be carried forward to subsequent years under the income tax laws subject to period of limitations. Carry forward of losses is tedious for taxpayers and mostly confusing but with the help of chart given below, it is very easy to understand.
1. 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.
2. Special provisions relating to carry forward and set off of loss in case of a company in which public are not substantially interested
As per section 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 per cent of the voting power were beneficially held by person who beneficially held shares of the company carrying not less than fifty-one per cent of the voting power on the last day of the year or years in which the loss was incurred.
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 pattern 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.
Hope this article have cleared lot of confusion about set off and carried forward of losses.