Set Off Carry Forward of Losses

Published On - June 9, 2024

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Set Off and Carry Forward of Losses

Introduction

Profits and losses are integral parts of any business. Set off and carry forward of losses is a way provided under income tax which taxpayers can use to reduce their taxable income. As the Assessment year 2024-25 approaches, understanding the regulations of set-off and carry forward of losses can help make well-informed financial decisions. Delve into the intricacies of set-off and carry-forward losses in India for the FY 2023-24.

What is Set Off of Losses?

Set-off loss means deducting the losses against any other profits of the same financial year. In other words, reducing the taxable Income against such losses saves taxes. Even If losses are not set off against income or profits in the same year in which losses were incurred, they can be carried forward to the future assessment years (with some limitation and set off against income of subsequent years).A set-off could be an intra-head set-off or an inter-head set-off.

  • Intra-head set off
  • Inter-head set off

Carry forward of losses

After making the appropriate and permissible intra-head and inter-head adjustments, there could still be unadjusted losses. These unadjusted losses can be carried forward to future years for adjustments against income of these years. The rules as regards carry forward differ slightly for different heads of income.

Types of Losses

Capital Loss:

  • Can be carry forward up to next 8 assessment years from the assessment year in which the loss was incurred
  • Long-term capital losses can be adjusted only against long-term capital gains
  • Short-term capital losses can be set off against long-term capital gains as well as shortterm capital gains
  • Cannot be carried forward if the return is not filed within the original due date

Losses from owning and maintaining race-horses :

  • Can be carry forward up to next 4 assessment years from the assessment year in which the loss was incurred
  • Cannot be carried forward if the return is not filed within the original due date
  • Can only be set off against income from owning and maintaining race-horses only

Specified Business Loss under 35AD :

  • No time limit to carry forward the losses from the specified business under 35AD
  • Not necessary to continue the business at the time of set off in future years
  • Cannot be carried forward if the return is not filed within the original due date
  • Can be adjusted only against Income from specified business under 35AD

Speculative Business 

Speculative business income refers to profits or gains derived from speculative transactions in certain commodities, including shares, securities, and derivatives. Speculative transactions are characterized by a high degree of risk, uncertainty, and the intention to make a quick profit by taking advantage of price fluctuations.

Speculative Business Loss :

  • Can be carry forward up to next 4 assessment years from the assessment year in which the loss was incurred.
  • Can be adjusted only against Income from speculative business.
  • Cannot be carried forward if the return is not filed within the original due date.
  • Not necessary to continue the business at the time of set off in future years.

Non-speculative business

Non-speculative business refers to the profits or gains derived from regular business activities that involve the purchase and sale of goods or assets in the ordinary course of business. Non-speculative business activities are characterized by a more stable and predictable nature, as opposed to speculative transactions.

Income from non-speculative business activities is generally categorized under the head of “Profits and Gains of Business or Profession” for tax purposes. It includes income generated from various business sources, such as manufacturing, trading, services, consultancy, and professional practices.

Losses from Non-speculative Business (regular business) loss :

  • Can be carry forward up to next 8 assessment years from the assessment year in which the loss was incurred.
  • Can be adjusted only against Income from business or profession.
  • Not necessary to continue the business at the time of set off in future years.
  • Cannot be carried forward if the return is not filed within the original due date.

Losses from House Property :

  • Can be carry forward up to next 8 assessment years from the assessment year in which the loss was incurred
  • Can be adjusted only against Income from house property.
  • Can be carried forward even if the return of income for the loss year is belatedly filed.
  • If individuals, HUF,AOP, BOI, opting to pay taxes under old tax regime, loss under the head income from house property firstly setoff against income from any other head to the extent of Rs 2,00,000 during the same year, unobserved loss will be carried forward to the following assessment year to be set off against income under the head income from house property of future years. If individuals, HUF,AOP, BOI, opting to pay taxes under old tax regime, loss under the head income from house property firstly setoff against income from any other head to the extent of Rs 2,00,000 during the same year, unobserved loss will be carried forward to the following assessment year to be set off against income under the head income from house property of future years.
  • Under the new tax regime, loss under the head income from house property would not be allowed to be set off against income under any other head, additionally losses of the earlier years will not be allowed to the future years.

Unabsorbed capital expenditure on scientific research and unabsorbed capital expenditure on promoting family planning amongst the employees

Depreciation is first deducted from the income chargeable to tax under the head Profits and gains of business or profession’. If such depreciation could not be fully adjusted against such income chargeable to tax in that previous year, the unabsorbed portion shall be added to the amount of depreciation for the following year and shall be deemed to be the part of depreciation for that year (similar treatment would be given to other allowances as mentioned above) However, in the case of set off, following order of priority is to be followed:

  • First adjustments are to be made for current scientific research expenditure, family planning expenditure and current depreciation.
  • Second adjustment is to be made for brought forward business loss.
  • Third adjustments are to be made for unabsorbed depreciation, an absorbed capital expenditure on scientific research or on family planning.

Set Off and Carry Forward of Losses: Special Considerations

The provisions for set off and carry forward of losses in special cases are as follows:

Losses in Case of Company Mergers

When companies undergo mergers or acquisitions, handling accumulated losses is a crucial aspect of the transaction. Under Indian tax law, losses can be carried forward by the amalgamated company if the business is continued for at least 5 years post-merger. This provision ensures that mergers are undertaken for genuine business purposes and not merely for tax evasion. Strategic planning and legal compliance are critical to utilizing these benefits effectively.

Loss in case of retirement of a partner from a partnership firm

If a partner’s death or retirement results in a change in the partnership firm’s structure, Section 78 contains provisions relating to the carry forward and set off of losses (i.e., when a partner goes out of the firm by retirement or death). In this scenario, the firm is unable to carry forward the portion of the loss that is attributable to the departing partner. Section 78’s restriction only applies to losses; it does not apply to adjustments of unabsorbed depreciation, unabsorbed capital expenditures for scientific research, or unabsorbed family planning expenditures.

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. However, the above condition is not applicable in case of an eligible start up referred under section 80-IAC​ in case of such start up, loss can be carried forward and set off against the income of the previous year, if all shareholders of such company (who held shares carrying voting power on the last day of the year or years in which loss was incurred) continue to hold the shares on last day of such previous year.

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 share holding 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 IBC.

Strategic Tax Planning with Losses

An effective strategic tax planning with losses will help save income tax of the taxpayer. Here is how a taxpayer can plan for set off and carry forward of losses:

Planning for Set Off and Carry Forward Effective tax planning can maximize the benefits of setting off and carrying forward losses. Here are some strategies:

  • Timely Compliance: Ensure tax returns are filed on time as late filings can prevent carrying forward losses to subsequent years.
  • Documentation and Tracking: Keep detailed records of all incurred losses, noting the nature and relevant financial details for audits and future set offs.
  • Understand the Rules: Familiarize yourself with the different rules applicable to various types of losses, such as business, capital, and speculative losses, to avoid losing tax benefits.
  • Professional Assistance: Given the complexities involved, consulting with tax professionals can provide tailored strategies that optimize the use of losses.

Common Mistakes to Avoid

The taxpayer should avoid following common mistakes to effectively set off and carry forward the losses:

  • Ignoring Time Limits: Failing to carry forward losses within the stipulated time frame (4 to 8 years, depending on the type of loss) can lead to lost benefits.
  • Failing to Track Ownership Changes: Neglecting to monitor shareholding changes can result in disqualification from carrying forward losses.
  • Improper Documentation: Inadequate documentation of transactions that led to losses can result in disallowances during tax assessments.
  • Neglecting Legal Structures in Mergers: Overlooking the legal structures governing mergers can result in losing the ability to carry forward losses.

Documentation and Compliance

Proper documentation is vital for claiming set-off and carrying forward losses:

  • Return Filing: Losses can be carried forward only if the tax return is filed within the due date.
  • Audit Requirements: A business person whose gross receipts/turnover/sales for the previous financial year is more than Rs. 1 crore, other than a person who opts for a presumptive taxation scheme under section 44AD ​who’s general income or turnover would not exceed the amount of Rs.2 crores. A professional whose gross receipts for the previous financial year are more than Rs. 50 lakhs are required to do a tax audit, and losses can only be carried forward if the audit is completed within the stipulated time.

Conclusion

The set-off and carry-forward provisions offer avenues to reduce tax liability and thus are integral elements of effective financial planning. While intra-headset-offs work within specific income categories, inter-headset-offs offer broader avenues but come with their own set of rules. Given the complexities and potential impact on tax liability, it’s advisable to consult with a qualified tax professional to make the most of these provisions. Properly managing losses not only reduces the tax liability for the current year but also provides relief in subsequent years through carry-forward provisions.