The Hindu Business Line : Facets of losses

THE concept of `loss' under the Income-tax Act, 1961, has several connotations. From the assessee's perspective any loss arising out of a particular year can be put to productive use in future years through the mechanism of carry forward and set off.

The Department always views losses with suspicion. This is more so because a `loss' which arises today can result in reduced revenue in future through the mechanism of set off.

Hence, protracted legal battle between the assessee and the Department on the manner and quantum of carry forward and set off.

The issue gets more complicated since `loss' under the Companies Act has a slightly different connotation. Controversies have surfaced in various contexts, particularly the one relating to book profits tax as to whether `loss' includes `depreciation'. In other words, whether depreciation loss is part of business loss for the purpose of book profits tax and normal computation has been a matter of debate for several years. The Supreme Court had to step in to resolve this issue. The Kelkar Task Force has rationalised and simplified the concept as also carry forward of corporate tax losses.

Existing law

Various sections deal with losses under various heads of income and they are as follows:

Section 32(2) — carry forward and set off of depreciation losses;

Section 70 — inter source adjustment under the same head;

Section 71 — inter head adjustment of losses;

Section 71B — carry forward of losses under property income;

Section 72 — carry forward and set off of business losses;

Section 72A — carry forward and set off of accumulated losses and unabsorbed depreciation in the case of amalgamation, and so on;

Section 73 — losses in speculation business;

Section 74 — losses under the head capital gains; and

Section 75 — losses of partnership firms.

A look at the aforesaid provisions and the types of losses clearly demonstrates that the law applicable to the treatment of losses is not only complicated but also difficult to administer. On the question of business losses they can be quantified and carried forward for a maximum period of eight assessment years and can be set off only against business income in the future years.

Losses arising on account of depreciation can be carried forward and set off for an unlimited period and unabsorbed depreciation is treated as part of depreciation for the succeeding years.

While both business losses and depreciation losses are the result of the performance or non-performance of the business, there appears to be no rationale or logic for the eight-year rule for business losses and unlimited time span for depreciation losses.

The report

The Kelkar Report deals with corporate losses as follows: "... The carry back and carry-forward provisions are typically limited (example, a three-year carry-back and a seven-year carry-forward).

"These provisions are provided in recognition of the arbitrary choice of a fixed period (example, 12 months) for which to assess tax. The practice recognises that many companies/firms encounter negative cash flows during their initial phases, despite being profitable over the longer term or on a present value basis. Moreover, in certain high-risk industries, even very efficient and profitable firms may experience wide fluctuations in their earnings over both negative and positive ranges. Disallowing loss transfers over time would be inconsistent with a proper matching of revenues and expenses, would impose a higher tax burden on firm with unstable profit profiles, and would discourage risk-taking... "

The report makes out a strong case to merge depreciation and business losses for the sake of simplicity.

A large number of audit objections relate to the accuracy and manner of carry forward and set off of business losses. This, coupled with depreciation calculations, has only forced tax officials, apart from grappling with the provisions of the law, to busy themselves with their calculators.

The suggestion of merger of a different sort will certainly help matters and reduce litigation on this score.

(The author is Chennai-based chartered accountant.)