The Income-tax Act, 1961 provides for two ways by which the losses incurred by an individual can reduce the overall taxable income – set-off where the loss can be adjusted against income in the year of occurrence and carry forward where the loss can be adjusted against income in succeeding tax years.
Set-off can be done against income within the same source (inter-source adjustment) or income earned from another head of income (inter-head adjustment). Losses that cannot be set off in the same year, can be carried forward and then set off in the subsequent years under relevant heads of income.
Inter-source adjustment of losses with income earned: As the name suggests, this is adjustment of loss in one source against income from the same source. Lucky are the salaried people as there cannot be losses from salaries even by mere definition. However, with respect to other heads of income, inter source adjustments operates as under:
An individual having two house properties can set off loss incurred in one against income earned from the other. Similar is the case of an individual having two businesses as the loss from one can be set off against the profit earned from the other.
A person investing in capital assets needs to be aware that long-term capital loss from transfer of such assets can be adjusted only against long-term gains whereas this restriction does not apply for short-term loss.
Further, if the income from a particular source is tax exempt, loss from such source cannot be set off against income from the same source or otherwise. This is pertinent in the case of long-term loss on sale of shares or equity-oriented mutual funds as the corresponding gains are tax-free.
Inter-head adjustment: The principal is that loss under one head of income has to be first adjusted against any income from the same head, the remaining flows to the other heads of income. This is the most sought after provision by salaried individuals who, typically, would have loss from house property owing to the loan taken for acquisition of the property. Such losses can be set off against the salary income and the resultant income alone needs to be offered for tax. However, one must bear in mind that loss from business or profession cannot be set off against salary income. The capital loss incurred on capital assets cannot, however, be adjusted unless there is a capital income as stated previously. This means long-term capital loss can be set off only against long-term capital gains, whereas short-term capital loss can be set off against long-term/ short-term capital gains and not against any other heads of income.
Carry forward of losses: Losses that cannot be set off during a year, can be carried forward to subsequent years. The carry-forward loss can be set off only against a similar source of income as that of the loss and not against other heads of income.
If an individual has suffered a loss that cannot be fully adjusted in the current year, it can be carried forward to the next year for adjustment against income of similar nature. More so, it can be carried forward to specified number of years following the year in which the loss was incurred. For example, business/capital loss can be carried forward for eight succeeding years following the year of incurrence. In order to carry forward the remaining loss under these two heads, a person should have furnished the return of income/ loss of the year in which loss is incurred on or before the due date for furnishing the return, as prescribed under section 139(1) of the Act.
The writer is partner with Deloitte Haskins & Sells. With inputs from Padmapriya Ravichandran, deputy manager, Deloitte Haskins & Sells