Sometime, it comes as a surprise for my NRI clients when their huge income of current year gets adjusted(set off) from past year carry forward losses which reduce their tax liability drastically.
Or Short-term capital Loss they incurred by selling the Mutual funds get adjusted (set off) from their long-term gain from sale of equity shares or from long term gain from sale of their residential property.
Or Loss under head house property gets setoff from income from salary which reduce total income and hence overall tax liability.
It means there is a scope of doing tax planning around setoff and carry forward of losses.
But it is not that we can set off any income with any Loss or we can carryforward the loss under any head for indefinite period. There are few rules which needs to be follow to get benefit of it. Let’s discuss them in detail through FAQs:
1. What are various income heads in Income Tax Act?
There are five heads in which income is divided under income tax act:
- Income from Salary – Covers income from salary, gratuity, EPF etc and its related deductions
- Income from House property – Covers rental income and deduction related to payment of interest on home loan etc
- Income from profit and gains from Business/Profession- Covers income from any business or profession and expenses related to it.
- Income from Capital gain – Covers Long term or Short capital gain on sale of immovable property like land, building, plot etc and sale of movable property like shares, mutual funds, gold etc.
- Income from other sources- Interest, Dividend, commission or any other income not covered in any other head.
2. What is Set off?
Set off is a process of adjustment of loss from a source under a particular head of income against income from other source under the same head of income or from other head of income.
3. How can we Setoff income?
Intra head adjustment – When a Loss from any source under a particular head of income, is allowed to adjust from the loss against income from any other source falling under the same head then it is called Intra head adjustment. For example: A person carrying two business activity then loss of one business can be set of from loss of any other business. Or Loss from one house property can be adjusted from Gain from second house property.
Inter head adjustment – When a Loss under one head of income is adjusted from the income under other head of income then it is called Inter head adjustment. For example: Loss under the head of house property can be set off from income from salary.
4. What are restrictions in Intra had adjustments?
Following are the restrictions which should be kept in mind before making intra-head adjustment of loss:
- Long-term capital loss can be set off only from income from Long-term capital gain. However, Short-term capital loss can be set off against Long-term or Short-term capital gain.
- Loss from speculative business* canbe set off only from income from speculative business. However, non-speculative business loss can be set off against income from speculative business.
- Loss from the business of owning and maintaining race horses canbe set off only against income from the business of owning and maintaining race horses.
- No loss can be set off against income from winnings from lotteries, crossword puzzles, race including horse race, card game, and any other game of any sort or from gambling or betting of any form or nature.
- Loss from business specified under section 35AD**canbe set off only againstincome from specified business.
- Loss on investments in virtual digital assets (Crypto, NFT etc) cannot be set off from any income, not even from any income from other virtual digital assets.
* Speculative business -Intraday trading of shares
**35AD – specified businesses like setting up a cold chain facility, setting up and operating warehousing facility for storage of agricultural produce, developing and building a housing project, etc
5. What are restrictions in Inter had adjustments?
Following are the restrictions which should be kept in mind before making inter-head adjustment of loss:
- Loss from Capital gainscannot be set off against income under other heads of income.
- Loss from business and profession cannot be set off against income chargeable to tax under the head “Salaries”. However, unabsorbed business loss shall be allowed to be carried forward for set off in subsequent years.
- Loss under the head “house property” shall be allowed to be set-off against any other head of income only to the extent of Rs. 2,00,000 for any assessment year. However, unabsorbed loss shall be allowed to be carried forward for set-off in subsequent years.
- Loss on investments in virtual digital assets(Crypto, NFT etc) cannot be set off against incomeunder other heads of income.
Other than above, all restrictions applicable in case of intra head adjustment is applicable in inter head adjustment also. For example:
- Loss from speculative business cannot be set off against any other income.
- Loss from the business of owning and maintaining race horses cannot be set off against any other income.
- No loss can be set off against income from winnings from lotteries, crossword puzzles, race including horse race, card game, and any other game of any sort or from gambling or betting of any form or nature.
- Loss from business specified under section 35AD cannot be set off against any other income.
Please note: Inter-head adjustment can be done only after making intra-head adjustments.
6. What is Carry forward of unadjusted Loss?
If making intra-head and inter-head adjustments still the loss remains unadjusted then unadjusted loss can be carried forward to next year for adjustment against subsequent year income.
7. What are the rules applicable in case of Carry forward of Loss?
Following are the rules which should be kept in mind while Carry forward of Loss:
- Loss of business/profession (other than speculative business) can be carried forwardfor subsequent eight years and can be adjusted only against income under the headbusiness or profession.
- Loss from business specified under section 35AD can be carried forward for adjustment only against income from specified business for any number of years.
- Loss from the business of owning and maintaining race horses can be carry forward for subsequent four years and canbe set off only against income from business of owning and maintaining race horses.
- Loss from the speculative business can be carry forward for subsequent four years and can be set off only against income from speculative business.
- Loss under the head house property can be carry forward for subsequent eight years and can be adjusted only against income under head house property.
- Loss under the head Capital gains can be carry forward for subsequent eight years and can be adjusted only against income under the head capital gain. However, long-term capital loss can be adjusted onlyagainst long-term capital gains. Short-term capital loss can be adjusted against long-termcapitalgainsaswellasshort-termcapitalgains.
- Loss from virtual digital asset (Crypto, NFT etc) cannot be carry forward in future years.
8. What are the important points which should be considered while taking benefit of carry forward of losses?
- Carry forward is allowed if income tax return of the year in which loss is incurred is furnished on or before the due date of furnishing the return, as prescribed under section 139(1). Only exception is income from house property, it means Loss under the head “Income from house property” can be carried forward even if the income tax return of the year in which loss is incurred is not furnished on or before the due date of furnishing the return, as prescribed under section 139(1).
- To take benefit of carry forward of losses then return shall be filed every year.
9. What is the hierarchy of setting off Losses?
It is not defined anywhere but as a general practice below hierarchy is followed:
- First set off Intra head adjustments.
- Then set off Inter head adjustments.
- Then brought forward losses should be set off
- If there is still any unabsorbed Losses that can be carried forward which will be treated as brought forward Losses as next year.
10. What are interesting points to know about setoff and carry forward?
- Virtual digital asset can not be setoff at all i.e Neither from intra head nor from inter head. Also, even carry forward of Loss on Virtual digital Asset is not allowed.
- Long term Capital Loss can be setoff only from Long term Capital gain.
- Long term capital Loss from sale of securities can be set off from Long term capital gain from sale of immovable property and vice versa.
- Short term Capital Loss can be set off from Long term orShort term capital gain. And Loss from sale of securities can be set off from Gain from sale of immovable property or Loss from sale of immovable property can be set off from Gain from sale of securities.
Disclaimer: This article is just to make you understand about very basics of the concepts. Please take Professional advice in case you have any doubts.
Or You can write to me at ushma@nricaservices.com or call/whatsapp me at +91 9910075924.