What are Set-Off Losses and Carry Forward Losses?

Economics' public finance sector is concerned with the principles/canons of taxes. There are several taxation schemes, but in growing economies, progressive taxation schemes have been applied, which indicates that those with a higher annual income should join hands more to the public welfare than those with a lower income.

While discussing this matter, it had been proposed that if a citizen/employee/buisness man earns profits or has a high income, he should pay taxes on that income. If he makes profits and losses concurrently, he is bound to pay tax on the net profit/income after deducting the losses suffered in business or job; and if he earns a loss, the person does not need to pay taxes. 

However, measures about set-off of losses and carry forward of losses have been considered due to the complications and need. Due to the lawmakers' and tax administrators' arguments, further complexities were created, and losses have been limited from being set off.

Did you know?

A deduction for a loss from an exempt source of income cannot be made against taxable income. If income from a particular source is tax-free, any loss cannot be offset against any other taxable income. When a member's total pension inputs for a tax year exceed their yearly allowance limit, carryforward rules are applied.

For example, agricultural income is tax-free. Hence, if the taxpayer incurs a loss from agricultural activities, the loss cannot be offset against other taxable income.

Also Read: How To File ITR (Income Tax Returns) Online – Income Tax E-filing Guide For FY 2020-21

What Are Set-Off and Carry-Forward Losses?

As the name implies, set-off of losses entails balancing a person's losses against his profit or income in a given assessment year. Suppose it is not feasible to offset the losses in the same assessment year, either because the assessee did not earn the requisite profit or because the revenue earned is less than the amount carried forward. In that case, the losses are carried over to the next year. The procedure for offsetting losses and then carrying them forward is outlined in the following steps:

1. An adjustment is made between sources of revenue from the same source of income.

2. Inter-head adjustment in the same year's evaluation. (This is only applicable if a loss cannot be set off by step-1).

3. Continuation of a loss. (This is true only if 1 and 2 are not true.).

 Also Read: How Do You Calculate Taxes on Income Generated From Share Sales?

What is the Intra Head and Inter Head Set Off?

Inter head set off indicates that a loss under one head of income can be offset against revenue under another head of income in the preceding year. Intra head set-off means that losses by one source of income are offset against gains from any other source of revenue that falls under the income of the same head.

Following intra-head adjustments, taxpayers may offset any leftover losses against other sources of income.

For instance, a loss on real estate might be offset against pay income.

Points That Come Under Set Off and Carry Forward of Loss

1. Set-Off and Carryforward of Loss in House Property

• If a loss falls under the head 'Revenue from home property' in any assessment year, the loss will first be set off against income by the other head in the same year.
• If such loss cannot be set off entirely or partially, it will be carried over to the coming assessment year to set off income under the heading 'Income from home property'.
• The loss under this heading may be carried forward for up to eight assessment years following the year loss was originally computed.

2. Business Loss Set-Off and Carryforward

• Business losses are deferred and carried forward.
• The loss must have occurred in the course of profession and buisness.
• The loss should not be of the type that occurs in the speculative sector.
• The loss can be carried forward and set off against business or professional income, but not necessarily against earnings and gains from the same business or profession the loss was incurred.
• The loss can be carried forward and set off only against the assessee's earnings. Only the party that sustains the loss has the right to carry forward or set-off of losses. As a result, even in the case of succession by inheritance, the successor of a firm cannot carry forward or offset his predecessor's losses.

3. Set-Off and Carryforward of Losses in Speculation Business

• The definition of speculative transaction' in section 43(5) and the handling of revenue from speculation businesses were previously considered under the topic "Profits and profits of profession and buisness."
• Therefore, if an assessee's losses in a speculation business cannot be offset against any other profit of speculation in the same year, they may be carried over to later years and business loss set off solely against revenue from the assessee's speculation business.
• If you have lost money while trading, you can carry it forward with a maximum of four years from the ending term of the AY in which you lost money to the next year in which you lose money again.

4. Specified Business Loss Set-Off and Carryforward

• Any loss incurred in connection with the defined business described in section 35AD will be set off against the profits and gains incurred in connection with any other business.
• If any unabsorbed losses will be carried forward and offset against earnings and gains from any designated business in the subsequent assessment year.
• Because carry forward and set-off are not time-limited, such loss may be carried forward indefinitely for set-off against income from a defined company.

5. Capital Gains

Section 74 specifies that if the net result under the heading 'Capital gains' for any assessment year is a short term loss of capital or a long term loss of capital, the loss should be carried over to the coming assessment year and set off as follows:

• If the carried forward loss is a short term loss of capital, and the short term capital loss is set off against any short or long term profit of capital realised in that year.
• Where the loss is a long-term loss of capital, it may be offset only against the long-term capital gain realised in that year.
• Capital gains losses cannot be offset against other types of income.
• A loss left unabsorbed should be carried over to the coming assessment year, up to a maximum of eight assessment years after the year for which the loss was initially estimated.

Conclusion

As we have seen many heads of income and their provisions for set off and carry forward losses, we can conclude that losses should be set off inter source in the same assessment year and that only inter head set-off is permitted if there is still a loss. If any loss remains after completing the first two phases, it will be carried forward and will begin in the following assessment year under the income of the same head, not a separate head. Furthermore, this rule has some exceptions as well. For example, losses in the speculation business can be set off against the same head for the assessment year in question.
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