Set-off and Carry Forward of Losses

Set-off and Carry Forward of Losses

According to the Income Tax Act, 1961, the income of an assessee is generally put to tax in his own hands and not in the hands of any other person. With a view to reduce tax burden, sometimes assessees with huge taxable income tend to shift their burden of tax by deliberately transferring their portion of income to other assessees who do not have taxable income or are taxed at lower rates of taxes. For example, this can be achieved by increasing revenue generating capacity or gifting income generating assets to immediate family members.

In order to curb these practices adopted by assessees, the Income Tax Department has imposed restrictions by virtue of Sections 60 to 64. As per these provisions, although the income may be earned by one person, it is sought to be clubbed and taxed in the hands of another person so as to protect the revenue interests of the government. In certain cases, the assessee has to pay tax in respect of the income derived by another person. These sections counteract the tendency of the taxpayers to transfer their income or dispose of their property with a view to avoid or reduce their tax liability.

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Income of Other Persons Included in Assessee’s Total Income

Under the provisions of clubbing, the income derived by one person shall be includible in the total income of the assessee and charged to tax in his hands.

These provisions are explained in Table below:

Section	Nature of Income to be Clubbed	Taxability
Section 60	There is a transfer by a person of income accruing to an asset without the transfer of the asset itself giving rise to such income.	Such income shall be included in the total income of the transferor. It is immaterial whether such transfer is revocable or irrevocable.
Section 61	There is a revocable transfer of assets and income arises to any person on assets obtained by virtue of revocable transfer of assets.	Such income shall be included in the total income of the transferor.
Section 62	Section 61 does not apply where the asset is transferred by way of trust and is not revocable during the lifetime of the beneficiary or where the asset is transferred otherwise, and is not revocable during the lifetime of the transferee.	Such income shall be included in the total income of the transferee.
Section 64(1)(ii)	Remuneration is received by an individual’s spouse from a concern where the individual holds a substantial interest. However, if the remuneration received by spouse is solely attributable to her technical or professional knowledge and experience, then such income shall not be clubbed. According to Explanation to Section 64(1)(ii), in case where both individual and the spouse have substantial interest in a concern and both receive remuneration from such concern, then such income shall be clubbed in the hands of that spouse whose total income excluding such income is higher.	Such income arising to spouse shall be included in the total income of the individual.
Section 64(1)(iv)	Income arises to spouse of an individual from assets transferred (other than house property) to spouse without adequate consideration or under an agreement to live apart. This section does not apply where house property is transferred to spouse, because in that case, the transferor shall be deemed to be the owner of such house property under Section 27 and his income shall be computed under the head ‘Income from House Property’.	Such income arising from assets transferred to spouse shall be included in the total income of the transferor (i.e., individual).
Section 64(1)(vi)	Income arises to son’s wife from assets transferred by the individual to the son’s wife without adequate consideration.	Such income arising from assets transferred to son’s wife shall be included in the total income of the transferor (i.e., individual).
Section 64(1)(vii) and Section 64(1) (viii)	Income arises to any person or AOP from assets transferred otherwise than for adequate consideration by an individual; where such assets are transferred for the immediate or deferred benefit of the individual’s spouse or son’s wife.	Such income shall be included in the total income of the transferor.
Section 64(1A)	Income arises or accrues to a minor child (including minor married daughter). The clubbing provisions, however, will not be attracted in case the income of the minor child accrues on account of his manual work, application of skills, knowledge, experience, etc. or where the minor child is suffering from disability as specified under Section 80U.	Such income of the minor child shall be included in the total income of his or her parent. Such income of the minor child shall be clubbed with the income of that parent whose total income excluding minor’s income is higher, where the marriage of parents subsists. Where the marriage of parents does not subsist, the income of the minor child shall be clubbed with the income of the parent who maintains the minor child. The parent in whose total income the minor child’s income is clubbed, shall be entitled to an exemption of maximum ₹1,500 per child in respect of such income under Section 10(32).

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Concept of Set-off and Carry Forward of Losses

Set-off of loss means that a particular amount of loss is equated and negated by an equal amount of profit. Carry forward of loss means that if instead of profit an assessee incurs losses and they are not being set-off by profits, they can be carried forward to the next assessment year where they can be set-off against the allowable profits.

Set-off of losses refers to the adjustment of losses incurred by an assessee against the profit of that financial year. Losses can be carried forward to subsequent assessment years in case there are no adequate profits in the given financial year.

Regarding the set-off and carry forward of loss, the following points must be remembered:

• Loss from a source of income that is exempted from tax cannot be set-off against any other income which is taxable. For example, loss on the grounds of agricultural activity (which is exempted from tax) cannot be adjusted against profit or income from any other taxable source of income.
  
  
• In any year, if a taxpayer has incurred loss from any source under a particular head of income, then, the taxpayer may adjust such loss against income from any other source falling under the same head of income. This process of adjustment of a loss from a source under a particular head of income against income from some other source under the same head of income is called intra-head adjustment. For example, if an assessee runs two businesses X and Y, then loss from business X can be set-off against profits from business Y.
  
  
• After making intra-head adjustments (if any); the next step is to make inter-head adjustments. If, in any year, the taxpayer has incurred loss under one head of income and is having income under other heads of income, then he can adjust the loss from one head against income from other head. For example, loss under the head of house property can be adjusted against salary income.
  
  
• At times, some part of the loss may still remain even after making intra-head and inter-head adjustments. In such cases, the unadjusted loss can be carried forward to the next year for adjustment against subsequent years’ income. This is called carry forward of loss. Different heads of income have different provisions for carry forward of loss.

Provisions under the income tax law in relation to carry forward and set-off of loss from house property:

If the loss from house property is not fully adjusted in the same year in which the loss incurred, then such loss can be carried forward to the next year. However, such loss can only be adjusted against the head of income from house property in the subsequent years. It means that in the subsequent years, inter-head adjustment would not be allowed.

Such amount of loss can be carried forward for eight years succeeding the year in which the loss occurred. According to the Income Tax Act, 1961, an individual taxpayer may set-off and carry forward the income losses incurred by him/her to the coming years. The provisions of set-off and carry forward of income losses has been made so as to divide the tax burden of assessee in the case of losses.

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Inter-Source Adjustment of Losses

As per Section 70 of Income Tax Act, 1961, if the assessee has incurred losses under a certain income head, then he/she is permitted to adjust these losses from any other income source under the same head. This is referred to as intra-head adjustment.

A taxpayer is not allowed to carry out intra-head/inter-source adjustment of loss in the following cases:

• Speculative business losses: Speculative business losses are not allowed to be set-off against any income other than income from the speculative business. However, non-speculative business loss can be set-off against income from the speculative business.
  
  
• Long-term capital loss: Such losses cannot be set-off against any income other than income from long-term capital gain. However, short-term capital loss can be set-off against long-term or shortterm capital gain.
  
  
• Losses from owning and maintaining race horses: Loss incurred from the business of owning and maintaining race horses is not allowed to be set-off against any income other than income from the business of owning and maintaining race horses.
  
  
• Losses of specified business: Section 35 AD specifies that income losses of specified business are not permissible to be set-off against any other income except income from the specified business. However, loss from other business can be set-off against the profit of the specified business in a given financial year.

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Inter-Head Adjustment of Losses and Setoff of Brought Forward Losses

The other method of carrying forward or set-off of losses is through inter-head adjustment. As per Section 71 of Income Tax Act, 1961, if an assessee incurs loss under one head of income and has earned any income under other heads of income, he/she is allowed to adjust the loss from one head against income from other heads.

Some examples are as follows:

• House property income losses: House property income losses can be set-off against profits from other heads. Such loss can be adjusted against salary income, business income, income from capital gain, and income from other sources except for casual income.
  
  
• Non-speculative business losses: Non-speculative business losses can be set-off under any other head except income from salary.

The losses incurred in the following cases cannot be set-off under inter-head adjustments:

• Speculative business loss
• Specified business loss
• Capital gain income loss
• Loss from owning and maintaining race horses

Even after the taxpayer has made intra-head or inter-head adjustments, it may be the case that the losses continue to remain unadjusted. Such unadjusted loss can be carried forward to the subsequent year for adjustment against the income from that subsequent year.

The Act lays down different provisions for carrying forward of losses under different heads of income, which are as follows:

• House property income losses: As per Section 71(B) of Income Tax Act, 1961, an assessee can carry forward losses incurred under the head house property up to a period of eight years immediately succeeding the assessment year in which the loss has been incurred. It can be adjusted only against house property income loss. In this case, the assessee can file the deferred return.
  
  
• Non-speculative business losses: As per Section 72 of Income Tax Act, 1961, an assessee can carry forward non-speculative business loss up to a period of eight years immediately succeeding the assessment year in which the loss has been incurred. He/she must file Income Tax Return (ITR) within the due date prescribed under Section 139 (1) of Income Tax Act, 1961. The loss can be set-off only against business income.
  
  
• Speculative business losses: Section 73 of the Act specifies that losses in speculative businesses can be carried forward up to a period of four years immediately succeeding the assessment year in which the loss has been incurred. An assessee must file the ITR within due date prescribed to carry forward the losses from speculative business. Such loss can be adjusted only against income from speculation business.
  
  
• Specified business loss: According to Section 73A of Income Tax Act, 1961, losses in specified business can be carried forward subject to the following conditions:
  
  
  • Loss in respect of any specified business referred to in section 35AD shall not be set-off except against profits and gains, if any, of any other specified business.
    
    
  • If the loss in specified business has not been wholly set-off, so much of the loss as is not so set-off or the whole loss where the assessee has no income from any other specified business, shall be carried forward to the next assessment year. It shall be set-off against profits and gains, if any, of any specified business, carried on by him assessable for that assessment year.
    
    
• Capital gain losses: If a taxpayer is unable to set-off the capital loss in the given financial year, both long-term loss and short term loss can be carried forward immediately for eight assessment years.
  
  
• Brought forward losses or unabsorbed depreciation: In case where a company suffers a loss before claiming depreciation, then the entire amount of depreciation is unabsorbed depreciation. However, if the company suffers a loss as a result of depreciation amount, then the business loss would be considered as nil and the balance of depreciation amount will be unabsorbed depreciation.

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Summarised Provisions of Set-off and Carry Forward of Losses

Now let us summarise the provisions of set-off and carry forward of losses in Table below:

Section	Nature of Loss	Inter-Source/Inter-Head Set-off of Losses	Maximum no. of Years for Carry Forward and Set-off of Losses
Section 71B	Loss from house property	Inter-source: Can be setoff against income from another house property Inter-head: Can be setoff against income under any other head, but restricted to the extent of ₹2 lakhs	Brought forward loss of one assessment year can be carried forward to the following eight assessment years to be set-off against income under the head ‘Income from House Property’
Section 72	Loss from business or Profession	Inter-source: Can be set-off against income from another business or profession Inter-head: Can be setoff against income under any other head, but not against income under the head ‘Salaries’	Brought forward loss of one assessment year can be carried forward to the following eight assessment years to be set-off against income under the head ‘Profits and Gains of Business or Profession’
Section 73	Loss from speculation business	Inter-source: Can be setoff only against income from any other speculation business Inter-head: Cannot be set-off against income under any other head	Brought forward loss of one assessment year can be carried forward to the following four assessment years to be set-off against income from any speculation business
Section 73A	Loss from specified business under Section 35AD	Inter-source: Can be setoff only against income from any other specified business under Section 35AD Inter-head: Cannot be set-off against income under any other head	Brought forward loss of one assessment year can be carried forward to the following any no. of assessment years to be setoff against income from any specified business
Section 74	Longterm capital loss	Inter-source: Can be setoff only against long-term capital gain Inter-head: Cannot be set-off against income under any other head	Brought forward loss of one assessment year can be carried forward to the following eight assessment years to be set-off against long-term capital gain
Section 74	Shortterm capital loss	Inter-source: Can be set-off against both shortterm capital gain or longterm capital gain Inter-head: Cannot be set-off against income under any other head	Brought forward loss of one assessment year can be carried forward to the following eight assessment years to be set-off against long-term capital gain or short-term capital gain
Section 74A	Loss from the activity of owning and maintaining race horses	Inter-source: Can be setoff only against income from such activity Inter-head: Cannot be set-off against income under any other head	Brought forward loss of one assessment year can be carried forward to the following four assessment years to be set-off against income from the activity of owing and maintaining race horses
Section 32(2)	Unabsorbed depreciation	Inter-source: Can be setoff against income from any business Inter-head: Can be setoff against income under any other head except salary	Brought forward loss of one assessment year can be carried forward to the following any no. of assessment years to be set-off against income from any head other than salaries

Mandatory Filing of Return of Income (Section 80)

According to Section 80, in order to be eligible to carry forward and set-off a loss suffered in a particular assessment year, the assessee must have filed the return of income within the time limit as prescribed under Section 139(1). However, this condition is not applicable of loss from house property income (Section 71B) and unabsorbed depreciation (Section 32(2)).

Order for Set-off of Losses

The order in which set-off of losses shall be given effect is as follows:

• Depreciation of current year or capital expenditure of current year on scientific research and current year expenditure on family planning, to the extent allowed.
  
  
• Brought forward losses of business or profession
  
  
• Unabsorbed depreciation
  
  
• Unabsorbed capital expenditure on scientific research
  
  
• Unabsorbed expenditure on family planning

Let us discuss some illustrations to understand the concept of set-off and carry forward.

Illustration 1: Mr Mukherjee submits the following particulars of his income for the A.Y. 2021-2022. Find his gross total income setting off and carrying forward losses.

Particulars	Amount (in ₹)
Income from the let out house (Computed)	15,000
Loss from self occupied house	14,000
Profit of business of publication of books	45,600
Speculation income	8,000
Short-term capital gains	26,000
Long-term capital gains	4,000
Winnings in card game	8,000
The items brought forward for set-off:
Loss from Sugar Mill of A.Y. 2013-2014 which is discontinued	13,000
Loss from publication business of A.Y. 2013-2014	9,000
Loss in card game of A.Y. 2014-2015	4,000
Speculation loss of A.Y. 2012-2013	24,000
Short-term capital loss of A.Y. 2016-2017	12,000
Long-term capital loss of A.Y. 2006-2007	14,000

Solution: Computation of gross total income of Mr Mukherjee:

Income from House Property (15,000 – 14,000, being loss from self-occupied house)	1,000
Income from Business and Profession: (i) General Business (Publication business profit ₹45,600 – B/F Loss of sugar mill ₹13,000 – B/F Loss of publication business ₹9,000) (ii) Speculation business (Profit ₹8,000 – B/F ₹24,000). (Balance Loss of ₹16,000 shall be carried forward)	23,600 NIL
Capital gains (STCG ₹26,000 + LTCG ₹4,000 – B/F short term capital loss ₹12,000) (B/F long-term capital loss cannot be setoff, on account of expiry of time limit of 8 years)	18,000
Income from other sources (winnings in card game, B/F loss cannot be set-off)	8,000
Gross Total Income	50,600

Illustration 2: From the following particulars regarding income, compute the total income of Ms. Mehak for the A.Y. 2021-2022:

• Salary ₹9,000 p.m.
  
  
• House A (let out) ₹40,000; House B (let out) ₹(20,000); House C (Self-occupied) ₹(50,000)
  
  
• Business A ₹2,00,000; Business B ₹(2,50,000), Business C (shares speculation) ₹30,000; Business D (commodity speculation) ₹(40,000)
  
  
• STCG ₹30,000; short-term capital loss ₹40,000
  
  
• LTCG ₹1,00,000
  
  
• Profits from card games (gross) ₹50,000; Loss from horse races ₹30,000
  
  
• Winnings from lottery ₹70,000

Solution: Computation of gross total income of Ms. Mehak for A.Y. 2021-2022:

Particulars	Amount (in ₹)
Salary	1,08,000
Income from house property (₹40,000 – ₹20,000 – ₹50,000)*	(30,000)
Profits and gains of Business or profession : (i) General Business (₹2,00,000 – ₹2,50,000)* (ii) Speculation Business (₹30,000 – ₹40,000) – Balance loss of ₹10,000 to be carried forward to A.Y. 2022-2023	(50,000)
Capital gains : (i) Short-term capital gains (₹30,000 – ₹40,000) (10,000) (ii) Long-term capital gains 1,00,000	90,000
Income from other sources : [₹50,000 + ₹70,000] (Loss from horse races of ₹30,000 to be carried forward to next A.Y. 2022-2023)	1,20,000
Total income	2,38,000

Loss from house property can be set-off against salary income and loss from general business can be set-off against income from other sources.

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Computation of Total Income

As we know, the income tax is levied on the total income of an assessee. Such total income is computed in accordance with the provisions laid down under the Income Tax Act, 1961. After making deductions under Chapter VI-A from the Gross Total Income for a previous year, the total income of an individual is arrived at. Gross Total Income (GTI) is computed by the summation of the net income calculated under the different heads of income, after giving consideration to the provisions of clubbing of income and set-off and carry forward of losses.

For the purpose of levy of income tax, the procedure for computation of total income of an assessee is discussed in Table below:

Step	Treatment under the Income Tax Act
Step 1 – Determination of residential status	The determination of residential status forms the foundation for computation of assessable income of an assessee. It is determined in order to ascertain as to which income shall be subject to tax and included while computing the taxable income of an assessee. The number of days of stay of an individual in India determine his/her residential status, which in turn, determines the scope of total income. Similarly, for a company assessee, the place of effective management and control of affairs of the company determine its residential status. The provisions of residential status are discussed earlier in Chapter 2 of the book. The categories of residential status of an assessee are: Resident Resident and ordinarily resident Resident but not ordinarily resident Non-resident
Step 2 – Classification of income under different heads	The income of an assessee is identified, classified and grouped under different heads of income as prescribed under the Income Tax Act. The incomes are classified based on the charging section of each head which defines the incomes chargeable to tax under the relevant heads (for example, Section 15 is the charging section for taxability of salaries). The charging section and other deeming sections of a particular head of income determine the scope of income to be taxed under such head. The five heads of income are: Salaries Income from House Property Profits and Gains of Business or Profession Capital Gains Income from Other Sources
Step 3 – Computation of income under each head, respectively	The provisions governing a specific head of income are applied to compute the income chargeable to tax under each head. The taxable income under each head is calculated after allowing or disallowing for exemptions and permissible deductions contained in the provisions of each head, and also accounting for certain exemptions contained in Section 10 of the Act.
Step 4 – Clubbing of income of spouse, minor child, etc.	Individuals falling within higher tax brackets generally have a tendency to divert their income to some other person (e.g., family members) who falls within a lower tax bracket or is not subject to tax. With a view to prevent tax evasion by such means, clubbing provisions are incorporated under the Act. Under these provisions, income arising to certain persons (e.g., family members) have to be aggregated with the income of the person who has diverted his revenue/income to such persons.
Step 5 – Set-off of losses and carry forward and set-off of losses	An assessee can have different sources of income and may have profit from one source and loss from another. The provisions of Income Tax Act allow an assessee to adjust loss from one head or source of income with profits earned under another head or source of income under the same head. There are different provisions for inter-source set-off of losses (setoff of loss of one source from profits of another source of the same head), inter-head set-off of losses (set-off of loss of one head from profits of another head) and carry forward, and set-off of brought forward losses.
Step 6 – Computation of Gross Total Income	The total income under each head is aggregated and, thereafter, clubbing and set-off/carry forward provisions are given effect to arrive are at the Gross Total Income. Gross Total Income = Submission of income calculated under each head + Application of clubbing provisions + Application of provisions of set-off and carry forward of losses
Step 7 – Deduction under Chapter VI-A	Certain deductions are allowed to assessees under Chapter VI-A of the Income Tax Act. These deductions from Gross Total Income are categorised into: Deductions in respect of certain payments Deductions in respect of certain incomes Deduction in respect of other incomes Other deductions The provisions of residential status are discussed earlier in Chapter 8 of the book.
Step 8 – Computation of Total Income	The Gross Total Income as reduced by the above deductions is referred to as Total Income. Total Income = Gross Total Income – Deductions under Chapter VI-A The total income should be rounded off to the nearest multiple of ₹10.
Step 9 – Applicability of rates of income tax on the total income of an assessee	Tax is computed on the Total Income of an assessee. Slab rates as prescribed by the Finance Act, 2018 are to be applied on the total income to compute the tax liability of an assessee. These rates are discussed in Chapter 1 of the book. Also, there are some specific tax rates on some special types of income prescribed under relevant sections of the Act itself such as tax rates on long-term capital gains under Section 112 or 112A.
Step 10 – Computation of Surcharge and Rebate	Surcharge is an additional tax levied in income tax as calculated above. After adding surcharge to income tax calculated at the normal rates, the total income tax is arrived at. Under Section 87A, a tax rebate is also allowed to resident individuals whose total income does not exceed ` 3,50,000 during the previous year. The rebate is deducted from total income tax before calculating the health and education cess. The concept and rates of surcharge and rebate are discussed earlier in Chapter 1 of the book.
Step 11 – Computation of Health and Education Cess	Health and Education Cess is computed on income tax as increased by surcharge and as reduced by rebate, if any. After the tax is increased by Health and Education Cess, net income tax payable is arrived at. Heath and Education Cess is payable by all assesses who are liable to pay tax regardless of their level of income. Health and Education Cess on income tax = 4% of income tax and surcharge, if applicable. The concept and rates of Health and Education Cess are discussed earlier in Chapter 1 of the book.
Step 12 – Computation of Total Tax Liability	The total tax liability is computed as follows: Total Tax Liability = Tax on Total Income at applicable rates + Surcharge – Rebate + Health and Education Cess
Step 13 – Credit for Advance tax, TDS and TCS	From the total tax due, the advance tax paid, TDS and TCS for the relevant assessment year has to be deducted to arrive at the net tax liability. Net Tax Liability = Total Tax Liability – Tax Deducted at source (TDS) – Tax Collected at source (TCS) – Advance Tax paid Net Tax Payable or Net Tax Refundable is rounded off to the nearest multiple of ₹10.