In a progressive taxation system, income is not always steady. Businesses may incur losses in some years and make profits in others. The Income Tax Act, 1961 acknowledges this economic reality by allowing taxpayers to set off losses against income and carry them forward to future assessment years. This provision is a significant relief for taxpayers and encourages entrepreneurial risk-taking while ensuring the integrity of taxable income over time.
Meaning and Concept
- Set-Off refers to adjusting a loss against taxable income in the same or another head of income in the same assessment year.
- Carry Forward means transferring unadjusted losses to subsequent assessment years to be set off against future income.
The governing provisions are primarily found in Sections 70 to 80 of the Income Tax Act, 1961.
Set-Off of Losses
The set-off of losses is of two types:
1. Intra-Head Adjustment (Section 70)
This allows losses from one source of income to be adjusted against income from another source under the same head.
Example: A loss in business A can be set off against profits from business B, both being under the head “Profits and Gains of Business or Profession.”
Exceptions [Section 70(3) & 70(4)]:
- Loss from a speculative business can only be set off against speculative profits.
- Long-term capital losses can be adjusted only against long-term capital gains.
2. Inter-Head Adjustment (Section 71)
When a loss under one head cannot be completely set off against the income from the same head, it can be set off against income from other heads.
Example: Business loss can be adjusted against salary or house property income.
Exceptions (Section 71(2A)):
- Loss under the head “Business or Profession” cannot be set off against income under the head “Salaries”.
- Capital losses cannot be set off against income under any other head.
Carry Forward of Losses
If losses cannot be set off entirely in the same assessment year, they can be carried forward to be set off in subsequent years, subject to conditions.
1. Carry Forward of House Property Loss (Section 71B)
- Loss from house property can be carried forward for 8 assessment years.
- Can be set off only against income from house property.
2. Carry Forward of Business Losses (Section 72)
- Can be carried forward for 8 assessment years.
- Must be set off against business income only.
- The business in which the loss was incurred need not be continued.
- Loss can only be carried forward if a return is filed within the time limit under Section 139(1).
3. Speculative Business Loss (Section 73)
- Can be carried forward for 4 assessment years.
- Set-off allowed only against speculative gains.
4. Capital Losses (Section 74)
- Short-term capital losses (STCL) can be set off against any capital gain.
- Long-term capital losses (LTCL) can be set off only against LTCG.
- Carry forward allowed for 8 assessment years.
5. Loss from Owning and Maintaining Race Horses (Section 74A)
- Can be carried forward for 4 assessment years.
- Can be set off only against income from the same activity.
6. Loss from Specified Business (Section 73A)
- Applicable to businesses under Section 35AD.
- Carried forward indefinitely.
- Can be set off only against income from the same specified business.
Conditions for Carry Forward of Losses
Timely Filing of Return: As per Section 80, losses (other than house property loss) can be carried forward only if the return is filed within the due date u/s 139(1).
Same Assessee: Losses can be carried forward only by the assessee who incurred the loss.
Continuity in Business: Not required except in some cases (e.g., unabsorbed depreciation, amalgamations).
Unabsorbed Depreciation [Section 32(2)]
Though not a ‘loss’ technically, unabsorbed depreciation is allowed to be carried forward indefinitely.
- Can be set off against any income (except salary).
- Does not require a timely return under Section 139(1).
- No restriction on the number of years.
Order of Set-Off
When multiple losses are to be adjusted, the following order is generally followed:
- Current year depreciation (Section 32)
- Current year business loss (Section 72)
- Unabsorbed depreciation (Section 32(2))
- Brought forward business losses
- Capital losses
Judicial Interpretation
Commissioner of Income Tax v. Mahendra Mills (2000):
In Commissioner of Income Tax v. Mahendra Mills, the Supreme Court held that depreciation under Section 32 of the Income-tax Act, 1961, is a benefit available to the assessee, which must be expressly claimed with the prescribed particulars under Section 34; it cannot be thrust upon the assessee by the Income Tax Officer if the assessee chooses not to claim it.
The Court emphasised that furnishing the prescribed particulars is a condition precedent for allowing depreciation and clarified that a privilege like depreciation cannot become a compulsory burden. Upholding the Gujarat High Court’s view, the Court ruled that if an assessee deliberately does not claim depreciation, it cannot be forced by the Revenue, and accordingly dismissed the appeal of the Revenue.
Losses in Case of Amalgamation or Demerger (Sections 72A, 72AA, 72AB)
Losses can be carried forward by the amalgamated or merged entity, subject to:
- Continuity of business for at least 5 years.
- Retention of assets for at least 5 years.
- Approval by the Central Government in specified cases.
Restrictions on Set-Off for Companies (Section 79)
- Closely held companies (not widely held) cannot carry forward losses unless:
- There is continuity in shareholding (at least 51% of voting power remains with the same shareholders).
- Exceptions apply to startups (eligible under DPIIT).
Finance Act 2025: Carry Forward of Losses in Amalgamations Now Capped
Sections 14 and 15 of the Finance Act, 2025, have amended Sections 72A and 72AA of the Income Tax Act, 1961, to impose a time limit on the carry forward and set-off of accumulated losses and unabsorbed depreciation in cases of amalgamation or business reorganisation.
Key Changes:
1) Eight-Year Cap Introduced:
Carry forward of accumulated losses by successor entities is now restricted to eight assessment years from the year the losses were first computed by the original predecessor entity. This cap applies even in cases of successive amalgamations.
2) Scope of Application:
The amendment will come into force from April 1, 2026.
3) Definition Introduced:
The term “original predecessor entity” now refers to the entity in the first instance of amalgamation or reorganisation. This ensures that losses are not indefinitely carried forward through multiple restructurings.
4) Affected Sections:
Section 72A: Relates to general business reorganisations involving companies, LLPs, firms, etc.
Section 72AA: Covers specific cases like amalgamations of banks and government companies.
5) Purpose:
- Aligns with Section 72, which already limits carry forward of losses to eight years.
- Prevents tax abuse through the evergreening of losses.
- Enhances clarity and tax efficiency in corporate restructurings
Conclusion
The provisions for set-off and carry forward of losses under the Income Tax Act, 1961, strike a critical balance between equitable taxation and entrepreneurial encouragement. However, these benefits come with conditions, timelines, and specific compliance mandates. Taxpayers, especially businesses and professionals, must understand and plan for these provisions to maximise tax efficiency.
Proper loss management not only reduces tax burdens but also improves cash flows, aiding in sustainable business growth.
References
[1] Income Tax Act, 1961
[2] Commissioner of Income Tax v. Mahendra Mills, AIR 2000 SC 1960
[3] Section 72 of Income Tax Act: Everything You Need to Know About Carry Forward and Set Off of Losses, Available Here
[4] Unabsorbed Depreciation: Section 32(2) of the Income Tax Act, Available Here
[5] Finance Act 2025
