Section 70 becomes applicable only when capital gains have been computed by the provisions contained in sections 45 to 55A. We allow for the set-off of a loss from one source against income from another source under the same head of income.
In a case where an assessee, a non-resident Indian, sold a property and earned a capital gain, he also reported a long-term capital loss on the sale of certain equity shares in a company. The Assessing Officer took the view that the long-term capital loss appeared fictitious and was not entitled to be adjusted against taxable income. However, the transaction involving the shares was complete — the ownership was transferred, consideration was paid, and there was no legal basis to treat the loss as fictitious. The tribunal held that the benefit of this long-term capital loss set-off could not be denied. It was a legitimate transaction, and tax-saving strategies, if backed by real and completed transactions, are permissible under the law.
In another decision, it was clarified that Section 70 would apply only when capital gains are taxable under the Act. Where, after applying a deduction under section 54F, the net capital gain became non-taxable, any loss on the sale of other assets could not be set off against such exempt gains.
Case Reference for Section 70
In the case of Naresh Jain v. Assistant Commissioner of Income Tax, it was held that the set-off of loss can only be claimed when the capital gain is chargeable to tax. If the gain is exempt due to deductions like under section 54F, then the corresponding loss cannot be adjusted.
In the matter of Michael E Desa v. Income Tax Officer, the assessee, a non-resident Indian, had reported both long-term capital gains from the sale of property and long-term capital losses from the sale of shares. The Assessing Officer rejected the loss, claiming it was fictitious. However, the tribunal found that the transaction was real and supported by valid documentation. The ownership was transferred, payment was made, and there was no evidence to doubt the authenticity of the loss. Hence, the long-term capital loss was allowed to be set off against the capital gains.
Carry Forward and Set Off of Business Losses under Section 72
Section 72 allows business losses to be carried forward and set off against future business income. It is not necessary that the assessee must have claimed such losses in the original return of income. Even if omitted, the assessing authorities are mandated to consider such losses, provided they were declared earlier and not disturbed in earlier assessments.
When the books of accounts were rejected by the Assessing Officer and additions were made to the income, but the matter was remanded by the tribunal, it was held that the set-off of returned loss in subsequent assessment years could not be disallowed merely because the earlier assessment was pending.
Another important ruling emphasized that once a loss has been disclosed in the return of income and not disturbed in a scrutiny assessment, it must be treated as accepted. Later, the quantification or eligibility of the loss cannot be questioned.
If the assessee has failed to furnish the returns of the earlier years from which such business loss and depreciation were brought forward, the matter should be remanded rather than rejecting the claim altogether.
Case Reference for Section 72
In Shelf Drilling Ron Tappmeyer Ltd. v. Deputy Commissioner of Income Tax, the tribunal held that even if the original assessment year is under scrutiny or remanded, losses declared therein could still be set off in subsequent years unless specifically disallowed.
In Mistral Solutions (P.) Ltd. v. Deputy Commissioner of Income Tax, the assessee filed a rectification request to claim a set-off of unabsorbed business losses that were missed in the return. The Assessing Officer rejected the request,, citing that the claim was not made in the original return. The tribunal held that under section 72(1)(i), even if not claimed, the assessing authority is bound to allow such losses.
In ACIT v. Parag Fans & Cooling System (P.) Ltd., the assessee claimed a set-off of brought-forward business losses and depreciation, but failed to provide returns forr earlier years. The tribunal directed that the matter be remanded for proper verification.
In Cargo Service Centre India (P.) Ltd. v. Deputy Commissioner of Income Tax, the company declared a loss in its return, which was accepted under scrutiny assessment. The Commissioner later attempted to revise the rectification order under section 263 because the loss carry-forward claim was not properly examined. The tribunal quashed the revision, stating that the loss, once accepted in scrutiny, cannot be revisited unless disturbed originally.
In Sarovar Hotels (P.) Ltd. v. Deputy Commissioner of Income Tax, it was held that a loss incurred by one business unit claiming deduction under section 35AD can be set off against profits of another unit not eligible under the same section. There is no legal bar against intra-business unit set-off, even if one of the units enjoys a specific deduction benefit.
Speculation Losses under Section 73
Section 73 deals with losses arising from speculative business. As per the Explanation to this section, certain types of share trading losses are deemed to be speculative. However, courts have interpreted that not all losses from share-related activities fall under speculative losses.
In cases where losses occurred due to erroneous trades in client dealings in share trading, the courts have ruled that such losses, being part of the broking business and not the assessee’s transactions, are not speculative. These are incidental to the business and should be allowed as normal business losses.
In another case, where transactions were done on behalf of clients and not reflected in the financial accounts of the assessee, it was held that such losses do not belong to the assessee and are not speculative.
Case Reference for Section 73
In Dy. Commissioner of Income Tax v. UBS Securities India (P.) Ltd., the tribunal held that the error trades that led to losses were not speculative since they were done in the course of client dealings, not on the assessee’s account. No expenditure was incurred directly, and the transactions were part of accepted market practice.
In Dy. Commissioner of Income Tax v. Edelweiss Financial Advisors Ltd., the tribunal found that the losses incurred due to errors in executing client orders were not speculative since they were not reflected in the company’s accounts. The provisions of the Explanation to section 73 did not apply, and the losses could not be treated as speculative.
Losses Under the Head Capital Gains under Section 74
Section 74 governs the carry forward and set-off of capital losses. According to this provision, short-term capital losses can be set off against both short-term and long-term capital gains, but long-term capital losses can only be set off against long-term capital gains. Any unabsorbed loss under this section can be carried forward for a maximum of eight assessment years.
A significant issue arises when dealing with exempt income under section 10(38). The law exempts income arising from the transfer of a long-term capital asset where securities transaction tax has been paid. The controversy is whether the loss arising from such a transaction, which gives rise to exempt income, can be carried forward and set off in subsequent years.
Judicial pronouncements have consistently held that if a transaction results in a long-term capital loss and securities transaction tax has been paid, the loss should be allowed to be carried forward even though the gain from such a transaction would have been exempt. The rationale is that only income is exempt under section 10(38), and not the transaction itself. Therefore, a loss is still a loss and must be recognized.
Further, courts have emphasized that the computation of loss has to follow the same mechanism as that of gain. Therefore, if the cost inflation index is to be applied for gains, it should be similarly allowed for computing losses. Even if gains are exempt, the mechanics of computing loss cannot be disturbed.
Case Reference for Section 74
In Shiv Kumar Jatia v. Income Tax Officer, the assessee claimed a loss from the sale of long-term capital shares on which securities transaction tax was duly paid. The income from such a transfer was exempt under section 10(38), but the assessee claimed that the loss should still be allowed to be carried forward. The tribunal agreed, ruling that although the gain from such a transaction is exempt, the loss arising from it does not become non-existent. It is to be computed and allowed under section 74.
In Peerless General Finance & Investment Company Ltd. v. Deputy Commissioner of Income Tax, the issue involved the application of the cost inflation index to determine the amount of capital loss on the sale of government securities. The Commissioner (Appeals) allowed the loss claim after applying indexation. Later, the Principal Commissioner tried to revise the order under section 263 on the ground that it was erroneous. However, it was held that once the issue had been decided by the Commissioner (Appeals), it became part of the appellate order and could not be reopened under section 263.
Conditions for Carry Forward and Set Off of Losses
Apart from specific sections governing each type of loss, the Income Tax Act imposes certain conditions for losses to be carried forward and set off. One essential condition is that losses must be declared in the return of income filed within the due date prescribed under section 139(1). If the return is filed after the due date, the loss will not be eligible for carry forward, even if it is otherwise genuine.
The exceptions to this rule are losses under the head “Income from house property” and “unabsorbed depreciation,” which can be carried forward even if the return is filed late.
Losses must also be carried forward in the same capacity in which they were incurred. For example, if the loss was incurred in a proprietary concern, it cannot be carried forward after the concern is converted into a company or LLP. Similarly, in the case of firms, the set-off of carried forward losses can only be claimed by the firm and not by the partners individually.
Set-Off Not Allowed in Certain Cases
There are specific restrictions imposed by the Act under section 79 in the case of closely held companies. If there is a change in the shareholding of more than fifty percent of the company, then business losses cannot be carried forward, except where the company is a start-up recognized under the relevant laws. This restriction is intended to prevent tax evasion through the purchase of loss-making companies to claim the benefit of losses.
Also, under section 78, a legal heir or successor cannot carry forward the loss of a deceased person unless it is due to inheritance. The logic is that losses are personal to the assessee and do not transfer unless explicitly allowed under the provisions of the Act.
Furthermore, set-off is not allowed in respect of losses that are speculative, or losses disallowed by specific provisions such as section 14A (expenditure incurred to earn exempt income), or disallowed under sections relating to tax evasion or misreporting of income.
Procedural Aspects and Legal Finality
Another crucial element in the set-off and carry forward of losses is the procedural discipline. Once a loss has been determined and accepted in a completed assessment, it attains finality. In subsequent years, the revenue authorities cannot challenge the authenticity or computation of such a loss unless there is a clear case of fraud or misrepresentation. This principle upholds the sanctity of completed assessments and brings certainty to tax administration.
Where an assessee has disclosed losses in its return and such losses are accepted during scrutiny, the Assessing Officer cannot later reopen the matter and disturb the quantum or the carry forward status unless new tangible material is available on record.
There have also been cases where claims for set-off were denied on technicalities like the omission to file a revised return or to furnish specific details in the return. The judiciary has generally taken a liberal view where the omission was procedural and not indicative of any mala fide intention. However, where there is a complete absence of filing or reporting, the courts have upheld the denial of benefits.
Relevance of Judicial Interpretation in Tax Planning
Understanding the nuances of set-off and carry-forward provisions is critical not only for compliance but also for legitimate tax planning. Many transactions are structured in a way that they result in permissible losses to be set off against income. While aggressive tax planning may face resistance from the department, courts have reiterated that as long as the transaction is real and not fictitious, the resultant tax advantage cannot be denied.
Taxpayers must ensure that documentary evidence is maintained for all loss transactions, including contracts, consideration paid or received, accounting entries, and disclosures in the return of income. If the transaction is genuine, courts have provided strong protection against the arbitrary denial of the set-off benefit.
Losses, especially capital losses and business losses, play a critical role in reducing tax liability. The key is to ensure that the losses are declared in time, supported by evidence, and carried forward correctly across years. Errors or omissions in any of these aspects may result in permanent disallowance, leading to higher tax costs.
Set Off and Carry Forward of Losses in the Case of Firms under Section 75
Section 75 of the Income Tax Act governs the treatment of losses in the case of partnership firms. It provides that any loss incurred by a firm before the assessment year in which it became liable to be assessed as a firm shall be dealt with as if it were a loss incurred by the partners. In such cases, the partners are entitled to set off the loss individually in their returns. However, for losses incurred after the firm becomes liable to be assessed as a separate entity, the set-off and carry forward are allowed only in the hands of the firm and not the partners.
This distinction is crucial in cases where a firm transitions from being a mere association to a registered taxable entity. Any carry forward of loss is permissible only to the same assessee, and once the entity changes, the loss cannot be claimed by another person or entity unless expressly permitted under the Act. Courts have affirmed that the benefit of carried-forward losses is not a transferable right unless specified.
The loss of a firm can be carried forward and set off in subsequent years only by the firm itself. If the constitution of the firm changes, for example, if a new partner joins or an old one retires, the firm may continue to be entitled to carry forward the losses. However, if the firm is dissolved and a new firm is constituted with different partners, the new firm cannot claim the set-off of the old firm’s losses.
Restrictions on Carry Forward of Losses under Section 78
Section 78 of the Act introduces further limitations on the carry forward of losses. According to subsection (1), where there has been a change in the constitution of a firm owing to the death or retirement of a partner, the firm is not entitled to carry forward and set off so much of the loss proportionate to the share of the retired or deceased partner that cannot be set off against his share of profit in the firm for that year.
This ensures that the benefit of a loss does not continue indefinitely where there has been a structural change in the ownership of a firm. The logic is that the partner whose share of loss cannot be absorbed within his share of profit in the relevant year loses the benefit permanently. The balance of the loss can be carried forward only to the extent it is attributable to the continuing partners.
Subsection (2) of Section 78 deals with individual taxpayers. It provides that a loss cannot be carried forward and set off by a successor unless the succession is by way of inheritance. This prevents losses from being carried forward in cases of transfers, sales, or gifts of business. Only in the event of inheritance can the legal heir continue to claim the losses of the deceased assessee.
Judicial decisions have clarified that succession due to inheritance allows the heir to enjoy all tax benefits, including the carry forward and set-off of unabsorbed business losses. However, such benefits are not available where the business is transferred through a will to a third party not classified as a legal heir. The courts have consistently upheld that such benefits are a personal right and cannot be transferred unless specifically permitted by law.
Provisions Relating to Filing Return in Time under Section 80
Section 80 lays down the fundamental condition that any loss which is to be carried forward under the head profits and gains of business or profession, capital gains, or speculation business must be declared in the return of income filed within the time allowed under section 139(1). If the return is filed late, such losses cannot be carried forward.
This provision has been strictly enforced by courts. They have ruled that while other deductions or benefits may be allowed even when the return is filed late, the benefit of carrying forward losses is not permitted if the return is belated. The rationale is that the carry forward of loss is a concession and not a right, and the condition for claiming this concession must be fulfilled strictly.
The exceptions are for unabsorbed depreciation under section 32(2) and loss from house property under section 71B. These can be carried forward even if the return is filed after the due date. The difference lies in the fact that depreciation is a statutory allowance and not a business loss, and house property losses are treated more leniently due to their nature.
In many cases, taxpayers have sought condonation of delay and requested the department to allow carry forward of losses despite late filing. While the Act does not provide for any condonation in this context, in a few rare cases, courts have allowed relief based on equity where the delay was due to factors beyond the assessee’s control. However, such cases are exceptions and not the norm.
Judicial Interpretation and Practical Relevance
In applying section 80, it is critical to establish that the return of income was filed within the prescribed due date. If the return was revised or rectified later, it does not affect the validity of the original timely filing to carry forward losses. Therefore, even if the original return did not reflect a claim, but was filed on time and later revised correctly, the losses could still be carried forward.
Taxpayers should also maintain proof of timely filing, such as acknowledgment receipts,, and ensure the loss figures are properly reported in the income computation statements. Errors in mentioning the correct head under which the loss is claimed may result in the loss being disallowed, as set-off and carry-forward provisions are strictly interpreted.
Professionals and tax preparers must exercise caution in filing returns for clients who have incurred losses. The consequences of missing the due date are severe, as the right to carry forward a loss gets completely extinguished. No remedy is available under any other provision unless the taxpayer is eligible for condonation under some administrative relief.
Carry Forward of Unabsorbed Depreciation
Though not directly under sections 70 to 80, unabsorbed depreciation under section 32(2) holds a special place. Unlike business losses, it can be carried forward for an indefinite period and can be set off against any head of income except salary. It is not subject to the limitation of filing returns within time under section 80.
This makes unabsorbed depreciation a highly beneficial allowance for businesses with capital-intensive operations. Even if business income ceases to exist, depreciation can still be adjusted against income from other sources, subject to the provisions of the Act.
There have been several rulings confirming that even after amendments in law, the unabsorbed depreciation prior to assessment year 2002-03 continues to be available for set-off without time restriction. The benefit continues to be one of the most useful tools for tax planning in manufacturing and service businesses alike.
However, to avail the benefit, proper records of depreciation schedules, opening written down values, and utilization in earlier years must be maintained. In case of mergers, demergers, or business reorganization, the treatment of unabsorbed depreciation becomes complicated, and professional advice must be taken to ensure compliance.
Applicability of Section 78: Succession and Losses
When a business undergoes succession due to reasons other than inheritance, the carry forward of losses is not allowed in the hands of the successor. Section 78 of the Income Tax Act addresses this. According to this section, where there has been a change in the constitution of a firm or a business succession, losses incurred before the change cannot be carried forward by the successor, except in the case of inheritance. This provision applies to both business and speculation losses. The rationale behind this is that tax benefits should not be transferable unless it is a case of inheritance, which is not considered a business transaction. However, an exception exists in cases of amalgamations and demergers, where Section 72A provides specific conditions under which loss carry forward is allowed.
Applicability of Section 79: Closely Held Companies
Section 79 places restrictions on the carry forward and set off of losses in the case of companies in which the public isnot substantially interested, commonly referred to as closely held companies. According to this section, a company cannot carry forward and set off its losses unless 51 percent of the shareholders who held shares in the year the loss was incurred continue to hold those shares in the year the loss is set off. This restriction is primarily to prevent the practice of acquiring companies with accumulated losses to set off against profits and evade tax. However, Section 79 contains exceptions for companies undergoing insolvency proceedings under the Insolvency and Bankruptcy Code and eligible start-ups satisfying specific conditions.
Losses and the Minimum Alternate Tax (MAT) Credit
The MAT regime under Section 115JB requires companies to pay a minimum tax based on book profits. Under this regime, if tax payable under regular provisions is less than 15 percent of the book profit, the company must pay MAT. However, a credit is allowed under Section 115JAA for the MAT paid over and above the regular tax liability. This MAT credit can be carried forward for 15 assessment years. Although not a loss in the conventional sense, it operates similarly by allowing companies to reduce future tax liabilities. It should be noted that MAT credit is different from loss carry forward and has its own set of rules and restrictions.
Interplay Between Business Losses and Deductions under Chapter VI-A
Losses that are carried forward and set off must be accounted for before claiming deductions under Chapter VI-A, such as Section 80C to 80U. This sequencing ensures that taxpayers do not get undue tax benefits by first claiming deductions and then carrying forward losses. This order of adjustments is relevant in determining the taxable income correctly. The logic is to absorb the losses first so that only the genuine residual income is eligible for deductions.
Clubbing of Income and Impact on Losses
When the income of another person is included in the hands of the assessee due to provisions like clubbing of income, the question arises whether the losses of the clubbed person can also be set off. The law is clear that only income is clubbed, not the losses. For example, if a spouse has incurred a loss in a proprietary business and that business is subject to clubbing in the hands of the other spouse, the income (if any) will be clubbed, but the loss will not be available for set-off. This distinction ensures that tax avoidance is minimized while genuine cases are treated fairly.
Treatment of Depreciation Losses
Unabsorbed depreciation is treated differently compared to other business losses. As per Section 32(2), unabsorbed depreciation can be carried forward indefinitely and set off against any income except salary income. It is not subject to the eight-year limit applicable to business losses. Moreover, it can be carried forward even if the business is discontinued. This makes unabsorbed depreciation a valuable tax asset. In cases of amalgamation or demerger, subject to fulfillment of conditions under Section 72A, the benefit of unabsorbed depreciation may also be transferred to the amalgamated or resulting company. However, continuity of business and assets is essential for such transfers to be valid.
Losses in Case of Demerger or Amalgamation
Section 72A provides for the carry forward and set-off of accumulated losses and unabsorbed depreciation in the case of amalgamation or demerger of companies. The section lays down strict conditions, such as continuation of business by the amalgamated company, holding of assets for a prescribed period, and fulfillment of prescribed production levels. If these conditions are met, the losses and depreciation of the amalgamating company can be carried forward and set off in the hands of the amalgamated company. This provision encourages corporate restructuring and ensures tax neutrality in genuine business consolidations. Similarly, in the case of demerger, the losses and unabsorbed depreciation directly relatable to the undertaking being transferred can be carried forward by the resulting company.
Return Filing and Losses: Section 139(3)
For a loss to be carried forward under the Income Tax Act, the return must be filed within the due date prescribed under Section 139(1). This is provided under Section 139(3), which states that if a return showing a loss is not filed on time, the right to carry forward the loss is forfeited, except for unabsorbed depreciation and capital losses under Section 74. The logic behind this provision is to encourage timely compliance and allow tax authorities to scrutinize returns within the prescribed timelines. Failure to file returns on time results in a permanent loss of the tax benefit.
Speculative Business Loss and Non-Speculative Gains
Speculative losses are treated strictly and cannot be set off against normal business income. However, income from speculative transactions can absorb these losses. This ensures that speculative transactions do not provide an undue advantage in reducing taxable income from stable and recurring business activities. Judicial precedents have consistently upheld the strict interpretation of speculative transactions. In the case of CIT v. Mohanlal Kedarnath, it was held that a loss from a speculative business cannot be set off against profits from any other business. This promotes tax discipline and discourages high-risk speculative behavior from distorting tax liabilities.
Priority of Set-Off: Order of Adjustment
The Income Tax Act prescribes a logical order in which losses and allowances are to be set off. Firstly, the current year’s depreciation is set off against income. Next comes the current year’s business loss. Thereafter, unabsorbed depreciation, unabsorbed business loss, and finally, unabsorbed capital expenditure on scientific research are allowed to be set off. This order ensures that perishable tax benefits (like current year’s depreciation) are utilized first, followed by those that have longer carry forward periods. This sequencing avoids a situation where short-term tax benefits lapse unused.
Restrictions on Set-Off of Losses Against Lottery and Casual Income
Income from winnings such as lotteries, races, gambling, and other casual income is taxed at special rates under Section 115BB and isnot eligible for any deduction or set-off of losses. This ensures that such windfall gains are fully taxed and not diluted by artificial set-offs. For example, if an assessee wins a lottery and has a business loss in the same year, the business loss cannot be set off against the lottery income. This provision aims to keep casual income taxation straightforward and free from complex adjustments.
Filing of Revised Returns and Loss Adjustments
If a loss return is revised within the time allowed under Section 139(5), and the original return was filed within the time under Section 139(1), the revised return will also be valid for carry forward of losses. However, if the original return was belated, a revised return will not cure the defect. This aspect is important for taxpayers who discover errors after filing. Judicial rulings,, like in the case of Kulu Valley Transport Co. Pvt. Ltd.,, have held that loss returns filed within time are valid for carry forward even if not processed immediately by the department.
Inter-Firm and Inter-Entity Set-Off Limitations
Losses of one firm or business entity cannot be set off against the income of another. For example, a partnership firm’s loss cannot be set off against the income of its partners or vice versa. Similarly, losses of a proprietary business cannot be set off against the income of a company, even if both are owned by the same person. This maintains the sanctity of separate legal entities under the tax law and prevents misuse through artificial cross-entity set-offs.
Tax Planning and Artificial Loss Arrangements
The Income Tax Department closely scrutinizes artificial arrangements intended solely to generate losses. In such cases, the General Anti-Avoidance Rules (GAAR) can be invoked to deny the benefit. For example, circular trading or creating fictitious loss-generating businesses may not be accepted. Courts have held in various cases that the substance of a transaction prevails over form, and tax benefits will be denied where there is no commercial rationale. Therefore, legitimate loss planning is acceptable, but tax evasion through artificial means is not.
Case Law: CIT v. Manmohan Das
In the case of CIT v. Manmohan Das (1966), the Supreme Court held that if a loss has been determined and accepted in an assessment, it can be carried forward even if the income is not assessable in the following year. This ruling affirms the principle that carry forward is a statutory right once properly established. It also emphasizes that the Income Tax Officer does not have the discretion to refuse to carry forward once legal requirements are met.
Case Law: CIT v. Mother India Refrigeration
In the case of CIT v. Mother India Refrigeration Industries Pvt. Ltd., the Supreme Court ruled on the priority of set-off and confirmed that current year depreciation should be adjusted first before setting off carried forward losses. This case clarified the precedence of adjustments and ensured consistency in tax computations. It also highlighted that the legislative intent was to ensure that more time-sensitive allowances are used before older accumulated losses.
Conclusion
The provisions of set-off and carry forward of losses under Sections 70 to 80 are essential tools for ensuring fair and equitable taxation. They provide relief to genuine businesses and taxpayers while setting boundaries to prevent misuse. The judicial interpretations further reinforce the principles of clarity, equity, and administrative efficiency. Understanding the nuances of these provisions, including their limitations and judicial context, is crucial for effective tax planning and compliance. These rules strike a balance between providing tax relief and maintaining the integrity of the tax system. Proper recordkeeping, timely return filing, and a clear understanding of applicable rules are essential to ensure that the benefits are not lost due to procedural lapses or misinterpretation of law.