In business and personal finance, profits and losses go together. Sometimes, we gain profit and sometimes we lose. To protect the taxpayers against unprecedented loss, the Income Tax Act, 1961, provides relief when a taxpayer faces losses. Section 32(2) of the Income Tax Act, 1961, provides for set off and carry forward losses. It helps taxpayers reduce their tax burden by adjusting losses against income.
If a business makes a profit in one year and a loss in another, the Income Tax Act, 1961 allows an adjustment so that the taxpayer pays tax only on the actual net income. In this blog, we will understand in very simple words what set-off and carry forward of losses mean, their types, conditions, and rules under the Income Tax Act, 1961.
What is Set-off of Losses?
The word set-off means adjusting a loss against income. If you have income from one source and a loss from another, you can adjust them according to the rules. This way, your taxable income reduces.
There are two types of set-off:
- Intra-head set-off – adjusting loss from one source of income against another source under the same head.
- Inter-head set-off – adjusting loss from one head of income against income from another head.
1. Intra-head set-off
Here, the loss from one source can be adjusted against income from another source under the same head of income.
Examples:
- Loss from one business can be set off against profit from another business.
- Loss from one house property can be set off against income from another house property.
Exceptions (where intra-head set-off is not allowed):
- Loss from speculation business cannot be set off against non-speculative business income.
- Loss from owning and maintaining racehorses can only be set off against income from the same activity.
- Long-term capital loss can only be set off against long-term capital gains (not short-term).
2. Inter-head Set-off
If, after intra-head adjustment, there is still some loss left, it can be adjusted against income from another head of income.
Examples:
- Loss from house property can be set off against salary income.
- Loss from business can be set off against income from house property.
Restrictions (important to note):
- Business loss cannot be set off against salary income.
- Loss from speculative business cannot be set off against any other income.
- Loss under capital gains cannot be set off against income under any other head.
What is the Carry Forward of Losses?
Sometimes, even after set-off, losses may remain. In such cases, the law allows taxpayers to carry forward these losses to future years. Then, they can be set off against future income according to rules.
This provision is very useful because many businesses take time to become profitable. Carry forward ensures that when profits do come, earlier losses are considered, and tax is charged only on net gains.
Types of Losses and Their Rules
- Loss from house property: Loss from the house property in India can be set off against any other income in the same year (including salary). You can earn a maximum of ₹2,00,000 in a year. If still unadjusted, it can be carried forward for 8 assessment years. In future years, it can be set off only against income from house property.
- Business Loss (Non-speculative): Losses from the loss of the business can be set off against any income except salary. If not fully adjusted, it can be carried forward for 8 assessment years. In later years, it can be set off only against business income. The business in which the loss was incurred does not need to continue in future years.
- Speculative Business Loss: Speculative business means transactions where there is no actual delivery of goods or shares (like share trading without delivery). Loss from speculation can be set off only against speculative business income. If not adjusted, it can be carried forward for 4 assessment years.
- Loss from Specified Businesses under Section 35AD of the Income Tax Act, 1961: These are special businesses, like setting up cold storage, hotels, or hospitals, where heavy investments are made. Loss from such businesses can be set off only against income from the same specified business. It can be carried forward for an unlimited number of years.
- Capital Losses: The capital losses is divided into two types:
| Type of capital loss | Meaning | Can be set off against | Carry forward allowed | Period of carry forward |
| Short-term Capital Loss (STCL) | Loss from selling assets held for a short duration (shares held for less than 12 months, property held for less than 36 months, etc.) | Can be set off against both short-term and long-term capital gains | Yes | Up to 8 assessment years |
| Long-term Capital Loss (LTCL) | Loss from selling assets held for a long duration (shares held for more than 12 months, property held for more than 36 months, etc.) | Can be set off only against long-term capital gains | Yes | Up to 8 assessment years |
- Loss from owning and maintaining racehorses: It can be set off only against income from the same activity. It can be carried forward for 4 assessment years.
- Loss from lottery, crossword puzzle, or other casual income: Such losses cannot be set off against any income, nor can they be carried forward.
Conditions for Carry Forward of Losses
The Income Tax Act, 1961, has laid down specific conditions to carry forward the losses:
- File the Income Tax Return: Losses can be carried forward only if you file the Income Tax Return. Loss from house property can be carried forward even if the return is filed late.
- Same Assessee: Loss can be carried forward only by the person who has incurred it, not their representative, not their heir, or successor.
- Set-off Priority: Current year losses must be adjusted first. Only then can carried forward losses be used.
Importance of Set-off and Carry Forward of Losses
- Tax is charged only on real net income. Losses reduce taxable income, so taxpayers do not pay more than what they actually earn.
- Losses in one year are not wasted; they can be used to reduce tax in the same year or future years.
- Startups and small businesses often face losses in the early years. These provisions give them time to recover and still benefit later.
- Investors are more confident to invest when they know losses can be adjusted in the future.
- People are more willing to file ITR honestly if they know losses can help them save tax later.
