In the Indian Income Tax Act, dealing with income from multiple sources and managing losses across various types of income heads can be complex. Understanding how to aggregate income, set-off losses, and carry forward unabsorbed losses is crucial for tax planning and effective financial management. Let's dive deeper into each area with relevant details.
Download Source PDF1. Aggregation of Income
Aggregation refers to the process of combining income from different sources into a total, assessable income. Some amounts are deemed as income even if they aren’t typically categorized as such. This includes unexplained credits, investments, and expenses covered under sections like 68, 69, 69A, 69B, 69C, 69D <read here>. When a taxpayer fails to satisfactorily explain these amounts to the tax authorities, they are aggregated with the taxpayer’s other income for tax purposes.
2. What is Set-Off?
Set-off means using losses from one source of income to reduce taxable income from another. There are two types of set-off:
Inter-Source Set-Off: Allows losses from one source of income to be adjusted against income from another source within the same income head. For instance, a business loss from retail can offset profits from a consulting business.
Inter-Head Set-Off: Allows losses from one head of income to be offset against income from a different head, with specific restrictions.
3. What is Carry Forward of Losses?
When losses can’t be fully used in the current year due to a lack of profits, these losses are carried forward to the next years. In future years, these carried-forward losses can be offset against eligible profits. Each type of loss has specific rules on the duration for which it can be carried forward, typically ranging from 4 to 8 years, while some can even be carried indefinitely.
4. Types of Losses and Their Set-Off and Carry Forward Rules
Each type of loss has unique rules about when it can be set off, against which income it can be used, and how long it can be carried forward.
1. Business Losses (Non-Speculative):
Losses from general business activities can be set off against profits from any other business or professional activity within the same year. If there’s no sufficient profit to absorb the loss, it can be carried forward for up to 8 years. However, it can only be offset against business or professional profits in future years.
2. Speculative Business Losses:
Speculative business losses, like losses from day trading, can only be set off against profits from other speculative activities. Such losses cannot be offset against non-speculative business profits. If unused, they can be carried forward for up to 4 years.
3. Specified Business Losses under Section 35AD:
a. Under Section 35AD, certain businesses (e.g., infrastructure, hotels) are classified as specified businesses and qualify for deductions for capital expenditure.
b. If the taxpayer operates a specified business and opts out of the default tax regime (under Section 115BAC(1A)), they are eligible to claim a deduction under Section 35AD.
Important: Losses from specified businesses under Section 35AD can only be set off against profits from other specified businesses, even if the taxpayer exits the 115BAC tax regime. This restriction is vital for MCQ-type questions.
4. Capital Losses:
Short-Term Capital Losses (STCL) can be set off against both short-term and long-term capital gains in the same year. Unused losses can be carried forward for 8 years.
Long-Term Capital Losses (LTCL) can only be set off against long-term capital gains. If there are no gains to set it off against in the current year, the loss can be carried forward for up to 8 years but only for use against long-term capital gains in future years.
5. House Property Losses:
Losses from house property can be set off against income from any other head to a maximum of ₹2,00,000 in the same assessment year.
If a taxpayer opts for the concessional tax rate under Section 115BAC, the loss from house property cannot be set off against income from other heads, but it can be carried forward for 8 years.
If the taxpayer exits the 115BAC tax regime, up to ₹2,00,000 of house property losses can be set off against income from any other head in the future. The remaining losses can be carried forward only for use against income from house property.
6. Losses from Activities Like Gambling, Betting, Card Games:
Losses from gambling, betting, and similar activities cannot be set off against any other income and cannot be carried forward. This rule ensures that taxpayers can’t reduce their taxable income by losses from these activities.
7. Losses on Exempt Income Sources:
Losses from income sources that are exempt from tax, such as certain agricultural income, cannot be set off against any other taxable income. For example, losses in a partnership firm cannot offset other business income.
5. Restrictions on Set-Off and Carry Forward of Losses
The following restrictions apply to various types of losses:
Losses from Salary: Losses from business or professional income cannot be set off against salary income.
Capital Gains Losses: Losses under the head "Capital Gains" cannot be set off against income from any other head of income. Short-term losses can offset both short-term and long-term gains, while long-term losses can only offset long-term gains.
Speculation and Race Horse Business Losses: Losses from speculation businesses and activities like maintaining racehorses can only be offset against future profits from these specific activities. They cannot be offset against other sources of income.
Specified Business Losses (Section 35AD): Taxpayers who exercise the option of exiting the 115BAC default tax regime and claim a deduction under Section 35AD for specified businesses can only use losses from these businesses against profits from other specified businesses. They cannot offset these losses against income from other heads.
House Property Losses and Section 115BAC: If a taxpayer under Section 115BAC experiences a house property loss, it cannot be set off against income from any other head. However, upon exiting the 115BAC regime, they can offset house property losses up to ₹2,00,000 against other income, and any remaining losses can be carried forward for use only against house property income.
6. Order of Set-Off of Losses
The Income Tax Act specifies an order for setting off losses to ensure taxpayers maximize their tax benefits:
- Current year depreciation / Current year capital expenditure on scientific research and current year expenditure on family planning, to the extent allowed.
- Brought forward loss from business/profession [Section 72(1)]
- Unabsorbed depreciation [Section 32(2)]
- Unabsorbed capital expenditure on scientific research [Section 35(4)].
- Unabsorbed expenditure on family planning [Section 36(1)(ix)
7. Mandatory Timely Filing of Returns for Loss Carry Forward
To carry forward certain losses, the taxpayer must file their income return within the due date. Losses like business loss, speculation business loss, capital loss, and losses from specified businesses can only be carried forward if a timely return is filed. Exceptions include unabsorbed depreciation and losses from house property, which can still be carried forward even if the return is late.
8. Examples to Illustrate Set-Off and Carry Forward
Let’s look at examples to clarify these rules:
Example 1: If a taxpayer has a ₹30,000 business loss and ₹50,000 in profit from another business, they can set off the loss and only pay tax on the remaining ₹20,000 profit.
Example 2: A taxpayer with ₹40,000 long-term capital loss and ₹60,000 long-term capital gain can set off the loss against the gain and only pay tax on the remaining ₹20,000. However, this capital loss cannot offset short-term gains or income from any other head.
9. Quick Recap of Key Points
Aggregation of Income: Income from various sources must be combined to determine the taxpayer’s total income. Some amounts, such as unexplained income under sections 68, 69, etc., may also be added to the total income.
Set-Off of Losses:
- Inter-Source Set-Off: Losses within the same head of income can offset other sources of income within that head.
- Inter-Head Set-Off: Losses from one head can offset income under another head (with specific restrictions).
Carry Forward of Losses: Unabsorbed losses that can't be set off in the current year can be carried forward to future years to offset against eligible income.
Types of Losses and Their Treatment:
- Business Loss (Non-Speculative): Can be set off against any business income and carried forward for 8 years.
- Speculative Business Loss: Only set off against speculative gains; can be carried forward for 4 years.
- Specified Business Loss (Section 35AD): Can only offset specified business income; carried forward indefinitely if opted out of Section 115BAC regime.
- Capital Loss:
- Short-Term Capital Loss (STCL): Can be set off against short-term or long-term capital gains; carried forward for 8 years.
- Long-Term Capital Loss (LTCL): Only set off against long-term gains; carried forward for 8 years.
- House Property Loss: Can offset other income up to ₹2,00,000, with remaining loss carried forward for 8 years (special limits under Section 115BAC).
- Losses from Gambling, Betting, etc.: Not eligible for set-off or carry-forward.
Order of Set-Off:
- Current year depreciation / Current year capital expenditure on scientific research and current year expenditure on family planning, to the extent allowed.
- Brought forward loss from business/profession [Section 72(1)]
- Unabsorbed depreciation [Section 32(2)]
- Unabsorbed capital expenditure on scientific research [Section 35(4)].
- Unabsorbed expenditure on family planning [Section 36(1)(ix)