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Set Off and Carry Forward of Losses – Rules & Restrictions

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This is part of a new series on taxation for investors in India by Sandeep Koonaparaju. Sandeep is a practicing Chartered Accountant based out of Bangalore. His area of expertise and interest is Taxation. He can be reached at sandeep.vvc98 [at] gmail.com.


The Good News: Indian Income tax law allows you – a taxpayer – to offset losses from one source of income against gains from other sources to reduce the total tax payable. 

The Bad News: There’s a lot of fine print and restrictions. In this article, we explore the terms ‘set off’ and ‘carry forward’ and the related rules to keep in mind as you plan or file your taxes.

Setting off losses

As we are aware, the Income Tax Act classifies your income into five heads – Salaries, House Property income, Income from Business or Profession, Capital Gains and Income from other Sources.

Set off is the process of setting off losses against gains, which can be intra head or inter head adjustments (explained in the next paragraph). Carry forward is the process of carrying forward excess losses (losses that could not be completely set off against gains in a year) to subsequent years.

Intra-head and Inter-head Adjustments

Intra-head

The term intra-head adjustment refers to setting off of losses from one source of income against another source of income under the same ‘head’. Such as – losses from trading in shares (when not considered as business) being offset against gains from sale of property. Here income from both the ‘sources’ is classified under the same ‘head of income’ i.e. income from capital gains. Similarly, gains from F&O trading could be used to offset losses from any other business as both the sources are classified under the head ‘Income from Business or Profession’.

Inter-head

This refers to offsetting losses from one head of income against gains from another head of income. Such as, losses from business being offset against income from capital gains etc. Sequentially – Intra head is the first step in setting off losses, inter head comes next. 

Carrying Forward of Losses

If there is not enough income in a year to offset the losses incurred, such excess losses can be carried forward to next assessment years. The following points are worth noting:

  • Carried forward losses do not qualify for inter-head adjustments. They can only be adjusted against income from the same head.
  • There are restrictions on the number of years for which losses can be carried forward. Losses that could not be set off within the said time period expire and cannot be carried forward further.
  • A majority of the losses can be carried forward only if they are declared in the income tax return filed within the due date.

Now that we are done understanding the terms set off and carry forward, let’s go through the table below that summarizes the rules and restrictions in place. 

Set Off and Carry Forward of Losses - Rules & Restrictions

It’s important to note that loss from house property can be carried forward even when the return of income is filed after the due date. Also the condition of filing return within the due date is relevant only for carry forward and not setting off of losses incurred in the same year. 

Illustrative Example:

For a particular financial year Mr X incurred a loss of INR 5,00,000 in his business, earned INR 1,00,000 from house property and has capital gains of INR 3,00,000. Let’s assume the due date for filing return of income is 31st July. Mr X, missed the deadline and filed return on 10th of August. In this case Mr X will be permitted to set off INR 3,00,000 of business loss against capital gains but he cannot carry forward the excess loss (INR 2,00,000) to subsequent years as the return is filed after the due date. He may however, carry forward the loss from house property without any restrictions.

Interesting Facts about Set Off Rules

Is Setting off of losses optional or mandatory? 

There is no straight answer to this question and we have to rely on case law before deciding. There is case law where it was decided that it’s mandatory to set off losses before claiming section 80 deductions (80C etc..).

Example:

Mr. X has business loss of INR 2,00,000 and interest on FD of INR 3,00,000. Mr. X has eligible section 80 deductions worth 2,00,000 and he wants to claim the entire deduction from interest income without offsetting the business loss first. 

This sequence would definitely benefit Mr. X but unfortunately it’s not permitted, courts have ruled against this practice. The loss should be first set off against interest income leaving only INR 1,00,000 for claiming section 80 deductions.

Contrary to this, in the case of Sh. Ajay Kumar Singhania Vs DCIT Bangalore (2018), it was held that it is not mandatory to set off business losses against capital gains. A plain reading of the relevant section gives a similar impression. Does this mean that you can choose to carry forward your derivative losses without offsetting against capital gains? We simply can’t say for sure, since each case is different from another and the tax officials might challenge your stand. 

What about Choosing the order of inter-head set off ?

In the case of Coated Fabrics (p) Ltd Vs JCIT (2006) it was held that assessee can choose the sequence for setting off losses where he has gains under multiple heads of income. Also, there is a very old circular issued by the department in 1955 which explains the process for Set Off where total income includes exempt income. 

Let’s understand these with an example.

Ex: Mr. X, a taxpayer, has business loss of INR 1,50,000, interest from FD of INR 60,000, long term capital gain of INR 1,00,000 and exempt income of INR 3,00,000. In this case Mr. X can choose to offset the business loss against interest income first (as it is taxed at higher slab) the balance loss against capital gains and do nothing against exempt income.

Setting off losses and threshold for long term gains on equity.

A question that’s often asked by many taxpayers is, if I have a business loss of 1,00,000 and   long term equity gain of 90,000, can I choose not to set off the loss against capital gain, as I don’t pay any tax on capital gain upto 1 lakh, and carry forward the entire loss?   

Unfortunately this is not permitted as long term equity gain is not ‘exempt’ income though you don’t pay tax on the first 1 lakh. Confused? The explanation can get a little technical, but will try to keep it simple. 

Under the Income Tax Act, no income is considered exempt unless the Act specifically says so. For long term gains on equity the Act just says if the total income of an assessee includes income from long term gains on equity, tax should be paid at 10% on such gains exceeding 1 lakh. The word exempt is not used anywhere. Sounds unfair, well, we are discussing taxes.

You may, however, work with your CA to explore the possibility of applying the judgement in  Sh. Ajay Kumar Singhania Vs DCIT Bangalore (2018), for your case. 

Losses from exempted source of income.

Loss from any source of income that is exempted from tax, cannot be offset against taxable income.

Setting off losses against salary income.

Only Loss from house property (restricted to 2 lacs per year) can be offset against salary income.

Other Popular Taxation Articles:

How taxation works for AIF and PMS Investors

The Basics of Capital Gains Taxes


If you’re a Capitalmind Premium member you can continue the conversation and ask more specific questions on the #taxation channel in Slack.

You can also reach me on my email sandeep.vvc98 [at] gmail.com

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