A Step-by-Step Guide to Set-Off and Carry Forward of Losses Under Income Tax

The set-off and carry forward of losses are important provisions under the Income Tax Act, 1961, which allow taxpayers to reduce their taxable income by adjusting losses against income in the same or future years. These provisions are designed to provide tax relief to taxpayers who incur losses in certain heads of income. By understanding and utilizing these provisions correctly, taxpayers can optimize their tax liability and minimize the amount of tax they owe.

In this article, we will explain set-off and carry forward of losses in detail, with practical examples and illustrations to make these concepts clear.

What is Set-Off of Losses?

Set-off refers to the adjustment of losses against income within the same financial year (Assessment Year). When you incur a loss from one source of income, you can offset that loss against income from another source under the same head (category) of income, or even against income from a different head, depending on the type of loss.

There are two main types of set-off:

1. Intra-Head Set-Off: Offsetting losses within the same category of income.
2. Inter-Head Set-Off: Offsetting losses from one category of income against another category of income.

Types of Losses and Their Set-Off Rules

1. Intra-Head Set-Off

This occurs when a loss from one source of income under a specific head is adjusted against other income under the same head. For example, if a person has multiple properties and incurs a loss in one property but gains income from another, the loss can be offset against the gain from the other property.

Examples of intra-head set-off:

• Salary Income: If an employee has a salary income of ₹5,00,000 but incurs a loss of ₹20,000 (due to deductions, etc.), the loss can be adjusted against the salary income.
• Income from House Property: If a person earns ₹2,00,000 from one house property but incurs a loss of ₹50,000 on another, the loss can be set off against the gain.
• Business Income: If a business incurs a loss in one department, that loss can be adjusted against income from another department.

2. Inter-Head Set-Off

This is when a loss from one head (e.g., business income) is offset against income from another head (e.g., salary income or income from house property).

For example:

• Business Loss vs Salary Income: If a person incurs a business loss of ₹1,50,000 but has a salary income of ₹3,00,000, the loss can be offset against the salary income, reducing the taxable salary to ₹1,50,000.
• House Property Loss vs Other Income: If a person incurs a loss of ₹50,000 on house property but has salary income, the loss can be set off against the salary income.

Losses That Cannot Be Set-Off Against Other Income

Some losses are subject to specific rules and cannot be set off against income from other heads. These losses are treated separately under the Income Tax Act.

• Capital Losses:
  • Short-term capital losses (STCL) can only be set off against short-term capital gains (STCG).
  • Long-term capital losses (LTCL) can only be set off against long-term capital gains (LTCG).
  • Capital losses cannot be set off against salary, business income, or house property income.
• Speculative Business Losses: Losses arising from speculative business (e.g., intraday trading in stocks) can only be set off against speculative business income and cannot be adjusted against any other type of income.
• Casual Income Losses: Losses from sources like lotteries, gambling, etc., are not allowed to be set off against income from other heads.

What is Carry Forward of Losses?

If a taxpayer is unable to set off the loss in the same year, they can carry forward the loss to future years to offset income in those years. The carry forward of losses allows taxpayers to reduce their taxable income in future assessment years, thus lowering their tax liability.

Key Rules for Carrying Forward Losses:

• Time Limit: Losses can be carried forward for 8 years from the end of the assessment year in which the loss occurred. For example, if a loss occurs in FY 2023-24 (Assessment Year 2024-25), it can be carried forward and adjusted against income until FY 2031-32.
• Only Certain Losses Can Be Carried Forward: Not all losses can be carried forward. For example, losses from salary or house property can be carried forward, but speculative losses or capital losses have different rules.
• Filing of Return: To carry forward a loss, the taxpayer must file their income tax return on time. If the return is filed after the due date, losses cannot be carried forward, unless the loss pertains to capital gains.

Types of Losses and Their Carry Forward Rules

1. Business Losses

Business losses, including speculative business losses, can be carried forward for 8 years and set off against business income in subsequent years. However:

• Speculative losses can only be set off against speculative income in future years, not against regular business income.

2. Capital Losses

• Short-term capital losses (STCL) can be carried forward for 8 years and set off against short-term capital gains (STCG) in future years.
• Long-term capital losses (LTCL) can be carried forward for 8 years and set off against long-term capital gains (LTCG) in subsequent years.

3. House Property Losses

Losses from house property (such as loss from interest on home loan or depreciation) can be carried forward for 8 years and set off against future income from house property.

4. Losses from Other Sources

Losses that do not fall under capital gains, speculative business, or house property can also be carried forward, provided they meet the necessary conditions outlined in the Income Tax Act.

Illustrative Example of Set-Off and Carry Forward of Losses

Let’s take an example of Mr. A, who has the following income and losses in FY 2023-24:

• Salary Income: ₹5,00,000
• Business Loss: ₹3,00,000
• Short-Term Capital Gain: ₹1,00,000
• Long-Term Capital Loss: ₹1,50,000
• House Property Loss: ₹50,000

Step 1: Set-Off of Losses

1. Business Loss of ₹3,00,000: This can be set off against the Salary Income of ₹5,00,000, reducing the taxable salary to ₹2,00,000.
2. Short-Term Capital Gain of ₹1,00,000: This can be set off against the Long-Term Capital Loss of ₹1,50,000, leaving a net long-term capital loss of ₹50,000.
3. House Property Loss of ₹50,000: The house property loss can be set off against the remaining Salary Income (after adjusting the business loss), reducing the taxable salary income further to ₹1,50,000.

Now, the net taxable income becomes ₹1,50,000 after set-off.

Step 2: Carry Forward of Losses

• Remaining Long-Term Capital Loss of ₹50,000: This can be carried forward for 8 years to offset any future long-term capital gains.
• House Property Loss of ₹50,000: If the loss is not fully adjusted this year (e.g., if there were more property income next year), it can be carried forward for 8 years to be set off against income from house property in the future.

Conclusion

The provisions of set-off and carry forward of losses are valuable tools for taxpayers to optimize their tax liability. By setting off losses against income in the same year or carrying them forward to future years, taxpayers can reduce their taxable income and thus lower their tax burden.

Understanding which types of losses can be set off, which need to be carried forward, and the specific rules associated with each type of loss is crucial for effective tax planning. Always ensure to file your income tax returns on time, as this is a critical requirement to carry forward any losses. For complex tax situations, it’s advisable to consult a tax professional or financial advisor to ensure that you maximize the benefits of these provisions and comply with the relevant tax laws.