De-Tax: Know your set offs and carry forwards

The taxman, contrary to general perception, has a considerate side too. One that lets you adjust (set off) losses against income earned, thus reducing your tax outgo. Not just that. If you can’t adjust the losses fully in a year, the taxman gives you more time. So, you can carry forward the loss to future years for set off. But like most good things in life, the largesse — contained in Sections 70 to 74 of the Income Tax Act — comes with ifs and buts.

First, some basics. The tax law categorises income into five heads — salary, house property, business or profession, capital gains and other sources. It’s not really possible for you to make a loss on salary, but there sure can be losses on the other heads. Also, within the same head, it’s possible that you make income from one source and a loss from another. For example, you can make capital gain on selling shares of company A but suffer loss on selling shares of company B.

Here’s how you can set off and carry forward your losses. Not all losses qualify for this benefit. If a source of income is exempt from tax, then the loss from such source cannot be set off or carried forward. For instance, capital gains on sale of shares held for more than a year is exempt from tax. So, if you incur a loss on sale of shares held for more than a year, you cannot adjust it against any income, now or in the future.

For losses that qualify for set off and carry forward, there’s a hierarchy to be followed. First, inter-source (also known as intra-head) adjustment needs to be done — that is, the loss from a source under a particular head (say business A) should be first set off against income from a source under the same head (say business B).

Next, the remaining loss can be set-off against income under other heads — this is called inter-head adjustment. For instance, loss from house property adjusted against income from salary. Finally, if the loss is still not fully adjusted, it can be carried forward to future years for set-off.

Besides the hierarchy for claiming the benefit, there are other restrictions too. For instance, capital losses can be set off only against capital gains and not against any other income head. Also, while a short-term capital loss can be set off against both short-term and long-term capital gains, a long-term capital loss can be set off only against a long-term capital gain.

Here’s an example. Say, you incurred long-term capital loss on gold sold after three years of purchase and short-term capital loss on share X sold within a year of purchase.

You also made long-term capital gains on a painting sold after three years of purchase, and short-term gains on share Y sold within a year of buying it. The loss on gold can be set off only against the gain on the painting while the loss on share X can be set off against the gains of both the painting and share Y.

Similarly, losses from owning and maintaining race horses can be set off only against gain arising from such activity, and not against any other income. So also in the case of loss from card games, lotteries, etc which can be set off only against income from such activity. Likewise, speculative business loss can be set off only against gains from speculative business.

Besides, loss on other business or profession cannot be set off against salary income. Finally, winnings from lottery, card games, etc cannot be used to set off any other loss.

By far, loss on house property has the most leeway for set-off. Such loss is incurred due to the interest cost on the housing loan. It can be set off first against any income from house property and then against all other incomes except those from lotteries, cards, etc.

Unadjusted losses of a financial year can be carried forward and set-off in future years. But there are two key restrictions in such cases.

One, carry forward losses can be set-off only against income under the same head. For instance, if you carry forward loss from house property, it can be set off only against income from house property and not against income of any other head. Besides, losses can be carried forward for a maximum of 8 years in the case of loss from house property, capital loss and non-speculative business loss. Loss from owning and maintaining race horses and from speculative business can be carried forward only for four years.

To carry forward your capital loss or loss on business or profession, be sure to file your tax return by the due dates. Else, the benefit will be denied.

The taxman though is lenient when it comes to loss from house property — this can be carried forward even if you delayed filing of the tax return.

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