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Introduction :-

The public finance domain of Economics deals with principles/cannons of taxations. There are various models of Taxation but in the developing economies progressive system of taxation has been advocated which means a person having larger income should contribute more to the public exchequer in comparison to the person having lesser income.

While dealing with the subject, it has been envisaged that if a person has profits/income he should pay taxes if he has profit and losses simultaneously he should pay tax on net profit after deducting the losses and if he has resultant loss or only loss he is not required to pay taxes. However, due to the complexity and need it has been thought of to incorporate the provisions relating to set off and carry forward of losses. Additional complexity has been created and the losses have been restricted to be set off due to greediness of the legislators and tax administrators.

The set off and carry forward of losses can be sub divided into two broad categories:-

1. Set off of losses.
2. Carry forward and Set off of losses.

Specific provision have been made in the income tax act, 1961 for the set-off and carry forward of losses.

The term "Set-off" and "Carry forward of losses" in simple words,

"Set-off" means adjustments of losses against the profit from another source/head of income in the same assessment year.

If losses cannot be set-off in the same year due to inadequacy of edible profit, then such losses are carry forward to next assessment year for adjustment against the eligible profit of that year.
The maximum period for which different losses can be carried forward for set-off has been provided in the Act.




Procedure for setting off losses:

The process of setting off of losses and their carry forward may be covered in the following Steps:

Step 1.

Set-off loss from same head of income – “Inter-source” adjustment.

Step 2.

If the loss is still existing after Step 1, loss can be set-off from other heads of income (subject to certain restrictions) – “Inter head” adjustments.

Step 3.

If loss still persists after Step 1 & Step 2, the same can be carried forward to the subsequent assessment years – Carry forward of losses.

I am trying to re-produce the same in tabular form herein below along with FAQ issued by income tax department and some important case laws and respective notes.

Inter-source and inter-head Set-off [Section 70 & 71]

Section
Provision
Exception
70
Set off of loss from one source against income from another source under the same head of income/
inter- source set-off under the same head of income

Any loss in respect of one source shall be set-off against income from other source under the same head of income. But, there are some exception to this.
i) Loss from Speculative business
ii) Loss from specified business under section 35 AD
iii) Long term capital loss
iv) Loss from the activity of owning and maintaining race horses
v) No loss can be set- off against casual income i.e. Income from lotteries, cross word puzzles, betting gambling and other similar games
vi) Loss from an exempted source cannot be set off against from a taxable source of income.
(e.g. Share of loss of firm, agricultural losses, cultivation expenses)



Section
Provision
Exception
71
Set Off of Loss from one head against income from another/ Inter head adjustment

Loss under one head of income can be set-off against income assessable under any other head of income.
i) Loss under the head Profits and gains of business or profession" cannot be set off against income under the head "Salaries"
ii) No expenses can be claimed against casual income
iii) Loss under the head "Capital gains" cannot be set off against income under any other head.
iv) Speculation loss and loss from the activity of owing and maintaining race horses cannot be set-off against income under any other head.


Tabular Summary for adjustments of loss

Incomes
Salary
House Property
Non Speculative Business
Speculative Business
LTCG
STCG
Owning and
maintenance
of race
horses
Others
Loss under
the head
House
Property
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Speculative
business loss
No
No
No
Yes
No
No
No
No
Other
business or
professional
loss
No
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Long term
capital loss
No
No
No
No
Yes
No
No
No
Short term
capital loss
No
No
No
No
Yes
Yes
No
No
Loss from
owning and
maintenance
of race horses
No
No
No
No
No
No
Yes
No

Remarks:-
"Yes" denotes loss can be adjusted with respective income.
"No" denotes loss cannot be adjusted with respective income.
Carry forward and Set-off of brought forward losses

If a loss cannot be set off either under the same head or under the different heads because of absence or inadequacy of the income of the same year, it may be carried forward and set off against the income of the subsequent year.

However, the loss so carried forward can be set-off only against same head of income, i.e. the benefit of “inter-source’ adjustment is lost.


Section
Nature of loss to be carried forward
Income against which the brought forward loss can be set off in subsequent years.
Maximum permissible period [from the end of the relevant assessment year] for carry forward of losses
71B
Unabsorbed loss from house property
Income from House Property
8 assessment years
72
Unabsorbed business loss (non- speculative)
Profit and gains from business or profession (non- speculative)
8 assessment years
73
Loss from speculation business
Income from speculation business
4 assessment years
73A
Loss from specified business under section 35AD
Profit from specified business under section 35AD
Indefinite period
74
Long-term capital loss
Long-term capital gains
8 assessment years
74
Short-term capital loss
Short/Long-term capital gains
8 assessment years
74A
Loss from the activity of owning and maintaining race horses
Income from the activity of owing and maintaining race horses.
4 assessment years

Remarks:

Past year losses can be set-off against income from that respective head of income (Inter head
adjustment is not possible)



Important Note:-

a)  Mandatory Filing of IT return in order to carry forward and set-off of a loss in stipulated time

ü  As per section 80, the assesses must have filed a return of loss under section 139(3) in order to carry forward and set off a loss. In other words, the non-filing of a return of loss disentitles the assesses from carrying forward the loss sustained by him. Such a return should filed within the time allowed under section 139(1).

ü  However, this conditions does not apply to a loss from house property carry forward under section 71B and unabsorbed depreciation carry forward under section 32(2).

However in case return is filed late CBDT has a power to condone delay – Circular No. 8/2001 dt 16-05-2001

ü  If return of the current year is not submitted in time, losses of the past years are not affected.

ü  Return of loss in the case of a sick company

If a sick company fails to file the return of loss within the stipulated time specified in section 139(3), and a scheme made pursuant to an order under section 17(3) of the Sick Industrial Companies (Special Provisions) Act, 1985 is sanctioned by the Board for Industrial and Financial Reconstruction under section 18 of that Act, specifying a particular tax treatment for the carry forward and set off of loss incurred by the sick company, the said scheme will have overriding effect over the provisions of section 80 of the Income-tax Act. In such a situation the Assessing Officer will have to take cognisance of the scheme and give effect to the carry forward and set off of loss provided for under the scheme—Circular No. 576, dated August 31, 1990.

Earlier the Board had issued Circular No. 523, dated October 5, 1988 in connection with the procedure to be followed in respect of grant of “consent” by the Central Government in cases involving financial assistance to be given under direct tax laws for rehabilitating sick industries under Sick Industrial Companies (Special Provisions) Act, 1985 (SICA).

Withdrawal of circulars - The Board had withdrawn with immediate effect the above Circular Nos. 523 and 576 vide its letter of even number dated December 30, 1993. The said letter to AAIFR and BIFR clarified that each case of fiscal concession of “financial assistance” under direct tax laws will now be considered in each individual case on merits. The model agency for coordination between the Board for Industrial and Financial Reconstruction (BIFR) and Central Board of Direct Taxes and Appellate Authority for Industrial and Financial Reconstruction (AAIFR) and Central Board of Direct Taxes will be the Director General of Income-tax (Admn.), 7th Floor, Mayur Bhawan, New Delhi-110001. Cases already decided in accordance with Circular Nos. 523 and 576 were, however, not required to be reopened— Circular No. 683, dated June 8, 1994.




b) What is Speculation business ?

ü  Defined u/s 43(5) as transaction in which a contract for purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by actual delivery or transfer of the commodity or scrips.

ü  The explanation to this section provides that where any part of business of a company consists in the purchase and sale of the shares of other companies, such a company shall be deemed to be carrying on speculation business to the extent to which the business consists of the purchase and sales of shares.

However, this deeming provision does not apply to the following companies -

1) A company whose gross total income consists of mainly income chargeable under the heads "Interest on securities", "Income from house property", "Capital gains" and "Income from other sources".

2) A company, principle business in which is -
         
          i) the business of trading in shares; or

          ii) the business of banking; or

          iii) the grating of loans and advances.

Thus, these companies would be exempted from the operation of this explanation. Accordingly, if these companies carry on the business of purchase and sales of shares of other companies, they would not be deemed to be carrying on speculation business.

ü  Transactions of trading in derivatives entered into on recognized stock exchange through a broker, or SEBI recognized intermediary and supported by a time stamped contract note is excluded from the definition of speculative transaction u/s. 43(5)(d). Thus, loss from such transactions can be set off against any other income.

In simple words, Trading in derivatives shall not to be treated as speculation business.

It may be noted that the losses on derivatives trading were treated as speculation losses upto a/y 2005-06. The profit/losses on derivative trading are treated as normal business income/losses from a/y 2006-07. Therefore the losses on derivative incurred upto a/y 2005-06 can not be setoff against the profit form derivative trading in a/y 2006-07 and future assessment years speculation losses can’t be set=off against non speculative income.
ü  Trading in commodity derivatives carried out in a recognized association and chargeable to commodities transaction tax under Chapter VII of the Finance Act, 2013 shall not be considered to be a speculative transaction

c) Order of set-off of losses

ü  As per provisions of section 72(2), brought forward business loss is to be set-off before setting off unabsorbed deprecation. In case where profits are insufficient to absorb brought forward losses, current depreciation and current business losses, the same should be deducted in the following order :

          i) Current year depreciation/ current year capital expenditure on scientific                     research and current year expenditure on family planning, to the extent allowed.
                        ii) Brought forward loss from business/profession.
                        iii) Unabsorbed expenditure on family planning
                        iv) Unabsorbed depreciation
                        v) Unabsorbed capital expenditure on scientific research
                                               
d) Important notes on capital gains

ü  Capital gain resulted from the transfer of an depreciable asset held for a period of more than three years, can be set off against the brought forward loss from the long term capital assets.

ü  Losses of the taxable long term capital gains to be set off only taxable long term capital gains and not against exempt long term capital gains. However set-off of indexed long term capital loss can be set off against long term capital gain without indexation.

ü  Long-term Capital Gains in respect of equity shares sold in recognized stock exchange and units of equity oriented mutual fund which has suffered Securities Transaction Tax (STT) are exempt u/s. 10(38) with effect from 1/10/2004.

However long term gains is not exempt in case where STT is not paid on sale e.g. off market transactions, off market buyback, etc.

e) Loss when clubbing provision apply

ü  When clubbing provisions apply, loss is required to be clubbed in the same manner as income. Such clubbed loss can be set off and carried forward, as if it is loss determined in the taxpayer’s own case. The successor of business can carry forward and set off the loss of his predecessor, if such succession is by way of inheritance.

ü  Business income of wife or minor child, clubbed under provision of section 64, with the income of assessee can be set off against any loss brought forward by assessee in respect of a business carried on by him—CIT v. J.H. Gotla [1985] 156 ITR 323 (SC).



e) Other Issue

ü  Loss can be carried forward by the assesses who incurs the loss

Exceptions

·         Accumulated business loss of an amalgamating company/demerged (section 72A).

·         Accumulated loss of a proprietary concern or a firm when its business is taken over by a company by satisfying conditions of section 47(xiii)/(xiv) (section 72A).

·         Accumulated business loss of a demerged company

·         Loss of business acquired by inheritance (section 78).CIT v. Bai Maniben [1960] 38 ITR 80 (Bom.).

ü  Loss cannot be carried forward for more than eight assessment years

Exceptions

·         Unabsorbed business loss in respect of rehabilitated business referred to in section 33B (such loss can be carried forward for eight assessment years after the business is revived including the year of revival).

·         Unabsorbed business loss in respect of non-speculation business discontinued and after discontinuation there is receipt deemed as business income u/s 41(1), (3),(4) or (4A) [(section 41(5)].




Important Case laws:-

·         Losses in illegal business must be taken into account for computation of real profits of the illegal business.
However loss for illegal business cannot be set off against profits of legal business – CIT v/s Kurji Jinabhai Kotecha (1977) 107 ITR 101 (SC).

·         Losses in one business can be set off from profits in another business – CIT v/s Muthuram Chettiar (1962) 44 ITR 710(SC).

·         Loss of dead business cannot be set off against the gains of a going concern
B.C.G.A (Punjab) Ltd. v/s CIT (1937) 5 ITR 279 (Lahore) & South Indian Industrials Ltd. (1935) 3 ITR 11(Mad) (applicable upto A.Y.1999-2000).

·         Loss from exempt source of income cannot be set off against income from a different source or income under a different head
CIT v/s Thiagarajan (1981) 129 ITR 115 (Mad)

·         Partial set off and partial carry forward is not permissible
G.Atherton & Company v/s CIT (1989) Tax LR 13 (Cal.).

·         Unabsorbed loss to be carried forward without interruption – Hiralal Jeramdas v/s CIT (1965) 58 ITR 1 (Bom.)

·         No option given to assessee to show profit as income from one source and carry forward the loss from another source of income to the next year  - CIT v/s Milling Trading Company. (P) Ltd. (1994) 76 Taxman 389 (Guj.)

·         Loss from exempt source of income cannot be carried forward (CIT v/s Harprasad & Co. (P) Ltd. (1975) 99 ITR 118 (SC).

·         Current depreciation must be deducted first before deducting the unabsorbed carried forward business losses of earlier years – CIT v/s Mother India Refrigeration Industries (P) Ltd. 155 ITR 711 (SC)

·         Whether losses may be carried forward and set off in the following year u/s 72 to be determined by the assessing officer dealing with the assessment in the subsequent year (CIT v/s Manmohan Das (1966) 59 ITR 699 (SC)

·         Carry forward of losses returns allowable even if return of losses is filed within extended period prescribed u/s 139(3) of the Act (I.e within one year from the end of the assessment year) [CIT v/s Glucose Products Ltd. (2001) 250 ITR 512(AP)]



·         The term “inheritance” means only a transmission of the assets and liabilities of one person to another by the personal law applicable to them and not by any other mode of transfer known to law—Hindustan Aeronautics Ltd. v. CIT [1983] 15 Taxman 265 (Kar.).

·         Where legal heirs of a deceased-proprietor enters into partnership and carries on the same business in the same premises under the same trade name, there is succession by inheritance as contemplated in section 78(2) and assessee-firm is entitled to carry-forward and set-off of the deceased’s business loss against its income for subsequent years—CIT v. Madhukant M. Mehta [2002] 124 Taxman 130 (SC).

·         Loss incurred in speculative business in banned items cannot be carried forward to the next year—CIT v. Kurji Jinabhai Kotecha [1977] 107 ITR 101 (SC).


·         A transaction cannot be described as a “speculative transaction” where there is a breach of contract and on a dispute between the parties damages are awarded as compensation by an arbitration award—CIT v. Shantilal (P.) Ltd. [1983] 14 Taxman 1 (SC).

[Author can be reached at caagrawalpankaj@gmail.com]


Disclaimer:

This article contains interpretation of the Act and personal views of the author are based on such interpretation. Readers are advised either to cross check the views of the author with the Act or seek the expert’s views if they want to rely on contents of this article and Information in this publication is intended to provide only a general outline of the subjects covered. It should neither be regarded as comprehensive nor sufficient for making decisions, nor should it be used in place of professional advice. Pankaj Kumar Agrawal accepts no responsibility for loss arising from any action taken or not taken by anyone using this publication.

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