India: Adjustment And Carry Forward Of Losses

According to the Indian Income Tax law, the Income Tax is leviable on 'Total Income' of assessees. The Total income is arrived at by aggregating income under all the 'heads of income' during the year and allowing certain deductions that the assessee is eligible to claim in accordance with the Income Tax Act. Further, there are certain defined nature of income which are specifically 'exempt' from tax and thus they do not form part of the total income for the year.

In case an assessee has incurred loss in any year, it is only fair that such loss be allowed to be carried forward and set-off against the income of the subsequent year. The Income Tax Law does recognise this need to set off loss incurred in a particular year against the income of the subsequent year before arriving at the 'total income' on which tax becomes payable by the assessee. However, such loss is allowed to be carried forward and set off subject to satisfying of certain conditions and restrictions as specified under the Act. Contrary to the common belief that all the losses are allowed to be set against any income in the same year or carried forward and set off against any income in the subsequent year, it is extremely important to be aware about the conditions and restrictions so as not to lose out on the benefit of this provision and optimise the tax liability.

Section 70: Inter source (under the same head of income) adjustment:

The question arises whether loss incurred from a source of income under the same head of income is allowed to be set off against income earned from another source taxable under the same head of income in the same year?

The answer is a yes in most cases. However, there are exceptions to this rule, which are enumerated below:

• Speculation loss which is taxable under the head "Business Income" cannot be set-off against income earned under any other business income.
• Loss incurred under the head 'Long-term capital Gain' can only be allowed to be adjusted against income earned under the source 'Long-term capital Gain'. It cannot be set-off against Short Term Capital Gain. However, a short-term capital loss can be set off against both long-term capital gains as well as short-term capital gain.

It was held in the case of. Kishorebhai Bhikhabhai Virani that Loss arising on sale of Long-Term capital asset (which are essentially the securities sold on the stock market) covered under section 10(38) was not available for set off. However, with effect from Assessment Year 2019-20, Long term capital gains from the transfer of equity shares listed on recognised stock exchange are now taxable @10% and therefore, in our opinion, such loss shall now be allowed to be set off from other long-term capital gain.

• Short-term capital loss determined as per section 111A (essentially the transaction on recognised stock exchange) is allowed to be set off from other short-term capital gain, although the former is taxed at concessional rate of tax of 15% and the later may be taxable at higher rate of tax. [Fidelity Investment Trust, Fidelity Overseas Fund - Mumbai Tribunal)
• Further, there was an interesting observation by Mumbai Tribunal in the case of Vipul Shah that Long Term Capital Loss worked out by assesse with indexation can also be set off against Long Term Capital Gains computed without indexation.

Section 71: Inter head adjustments:

After the inter source adjustments, the taxpayers can set off remaining losses against income from other heads of income. For example: Loss under the head "Business Income" can be set off against income under Capital Gains etc.

Loss from house property can be set off against other heads of income subject to a maximum amount of Rs. 200,000/-.

Exceptions:

• Speculation Loss on trading under securities and mutual funds cannot be set off against any other head of income. It can only be set off against Speculation Profit. However, normal business loss can be set-off against speculation business profits.
• Loss under Capital gains (both short term and long term) cannot be set-off against any other head of income.
• Business Loss cannot be set off against income from salary.
• Loss from an activity of owning and maintaining race-horses can be set off only against the profit from an activity of owning and maintaining race-horses.

Carry forward of losses and set off of loss:

The tax payer can first adjust the loss under one source/head of income against income from another source/head of income in the same assessment year in accordance with the provisions of Section 70 and Section 71 as stated above. The remaining amount of loss, if any, after the adjustment as stated above can be carried forward to the next assessment year and allowed to be set off against income of the next year subject to the conditions as restrictions as stated below:

Section 71B: Income from House Property:

Loss under the head "Income from house property" can be carried forward and set-off only against "Income from House Property" in the subsequent years. Such loss can be carried forward for a maximum period of 8 years only.

Section 72: Business Loss:

Loss incurred under the head "Business Income" other than from speculation business, to the extent it is not adjusted in the year of loss with any other income, can be carried forward and set off against income under the head "Business Income" only. Such loss is allowed to be carried forward for 8 years only.

Section 73: Speculation Loss:

Speculation loss can be carried forward and set off against Speculation income only. Such loss is allowed to be carried forward for 4 years only.

Section 73A: Loss from 'Specified Business':

Loss incurred from 'Specified Business' as mentioned under section 35AD can only be allowed to be set off from income from any other 'Specified Business' as mentioned in that section. Interestingly, there is no restriction in terms of number of years that such loss is allowed to be carried forward.

Section 35AD lists various businesses that are regarded as 'Specified Businesses". Few of these businesses are:

• Setting up and operating a cold chain facility;
• Setting up and operating a warehouse facility for storage of agricultural produce or sugar;
• Build and operate a 2 Star and above category hotel;
• Build and operate a hospital with at least 100 beds;
• Develop and build a housing project under affordable housing scheme;
• Production of fertiliser in India

Section 74: Capital Loss:

Loss under the head "Capital Gains" can be carried forward and set off as follows:

• Loss from short term capital asset can be set-off both against Long Term Capital Gain and Short-Term Capital Gain;
• Loss from long term capital asset can be set off only against income from long term capital asset.

Loss under the head 'Capital Gains' can be carried forward for 8 years only.

Section 78: Change in constitution of firm or on succession:

• In the case of change in constitution of a firm, the continuing firm shall not be entitled to carry forward and set off so much of the loss proportionate to the share of the retired or deceased partner in respect of previous year.

The provision of this section does not apply in the case of adjustment of unabsorbed depreciation.

• Where any business or profession is succeeded by another person otherwise than by inheritance, it is only the person incurring the loss who will be entitled to carry forward and set off such loss against their income.

Section 79: Change in shareholding in certain companies:

• In the case of change in shareholding of a Private company, loss incurred shall be allowed to be carried forward and set off only if 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 persons 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 in which the loss was incurred.

This essentially mean that benefit of carry forward and set off of the loss incurred will be available only if 51% or more of voting power is common in the year in which loss was incurred and the year in which set off is sought.

• In case of change in shareholding of a start-up company u/s. 80-IAC, the loss incurred in any year shall also be allowed to be carried forward and set off against the income of the previous year if all the shareholders of such company who held shares carrying voting power on the last day of the year in which the loss was incurred, continue to hold those shares on the last day of such previous year and such loss has been incurred during the period of seven years beginning from the year in which such company was incorporated.

The provision of section 79 also does not apply in the case of adjustment of unabsorbed depreciation.

The provisions are also 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 Insolvency and Bankruptcy Code, 2016.

Further, there are also substantial relaxation on the companies that are governed by the National Company Law Tribunal (NCLT).

Case Study - Set off against gain from sale of depreciable asset:

Where the assessee set off the brought forward long-term capital loss against capital gain on sale of depreciable asset and the Assessing Officer did not allow the set off of long-term capital loss from capital gain on sale of depreciable asset by holding it to be short-term capital gain as per section 50, it was held that prescription of section 50 are to be extended only up to the stage of computation of capital gains. Therefore, capital gain resulting from transfer of depreciable assets which were held for a period more than 3 years would retain the character of long-term capital gain for all other provisions except section 50. Consequently, such capital gain shall qualify for set off against brought forward loss from long-term capital assets. [Manali Investments - Mumbai Tribunal and also upheld by Bombay High Court and referred in Pursarth Trading Co. (P) Ltd.]

Section 74A: Loss from activity of owning and maintaining race horses allowed to carry forward for 4 years to adjust against income from the same activity only.

Section 80: Filing of Tax Return within prescribed time:

It is mandatory on the part of the tax payer to file the tax return within the time specified under section 139(1) to be able to carry forward loss under any head of income to the subsequent assessment years except in the case loss from 'Income from House Property' and 'Unabsorbed depreciation'.

Other Noteworthy Points:

• A taxpayer incurring loss from a source, income from which is otherwise exempt from tax, cannot set off these losses against profit from any taxable source of Income. For ex: loss from agricultural activity cannot be set off against income from normal business income.
• Losses cannot be set off against any casual income i.e. crossword puzzles, winning from lotteries, races, card games, betting etc.
• Unabsorbed depreciation can be carried forward and set off against any other income in the subsequent assessment years. Where after set off of business loss against current year business income, the assessee was entitled to set off unabsorbed depreciation against income from other sources. The Madras High court in the case of SPEL Semi-Conductor Ltd. held that section 72(2) does not control operation of section 32(2) to have set off of unabsorbed depreciation against income from other sources.

Example:

From the below information, compute the total income of 'A' for Assessment Year 2020-21;

Solution

Note: Business loss should first be set off from long-term capital gain as it is taxable @ 20% whereas the income from house property is taxable at much lower rate, in this case, @ 5%.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.