Lossmaker's guide to tax savings

Income tax is a tax on income earned by a taxpayer in a given year. However, each and every activity of a taxpayer may not result in positive income.

It may cause losses too. It would be unfair to tax a person on his income, while ignoring the loss. In recognition of this principle, there are elaborate provisions permitting adjustment of loss, including the provisions for carrying forward unadjusted (unabsorbed) loss to future years.

Understandably, there are restrictions, which have been introduced to prevent misuse of artificial losses. Heads of income. Income of any assessee for the purpose of levy of income tax is computed under five heads-salary, house property, profits or gains of business or profession, capital gains and other sources.

There are specific rules provided for computation of income under each of these heads of income. Considering the computation rules, no loss can occur under the head 'salaries'.

Intra-head set off. Within each head of 'income', there could be more than one source of income. For example, a person may have two properties in different cities let out to different lessees.  Each property is a source of income covered by the same head of income. The law requires adjustment of loss falling within the same head of income in priority of adjustment of loss against profits under any other head of income.

Some Basic Rules. Adjustment or carry forward of loss is not an inherent right. One requires specific provision in the Act permitting such right. But, once such a right is available, an assessee cannot, by choice, forego it in one year and choose to exercise it in the second year, when he expects a much higher income.

House property loss. Loss under the head 'house property' may occur when, say, in respect of a self-occupied house or a rented house, interest expenditure is incurred on the loan borrowed for acquisition of property. In case of a self-occupied house, income is computed as nil and interest expenditure results in loss.

Any such loss can be set off against income from any other head, including salary income. If there is no sufficient income to absorb the loss, unabsorbed loss can be carried forward for eight years to be set off against house property income, if any, in the future year. It cannot be set off, in the future year, against any other income head like salary.

Business loss vs Salary income. Loss under the head 'profits and gains from business or profession' cannot be set off against salary income.

This restriction has been introduced very recently to plug the unhealthy practice of salaried employees claiming artificial business losses for the purpose of setting it off against salary income.

Business loss-Speculative vs normal. There is a distinction drawn between loss in speculative business and loss in any other business. Speculation loss can be set off only against speculation income. For example, loss from speculation in shares can be set off against income from speculation in commodities, but not against share brokerage income or salary income.

What is more, such speculation loss can be carried forward for a period of four years only. Even in those four years, it can be set off against income from speculation business only.

Business loss & unabsorbed depreciation. Business loss is divided into depreciation loss and operating business loss. Say, a person is engaged in the business of software development and training, which requires investment in computers eligible for depreciation at a higher rate of 60 per cent. He may become entitled to claim a large depreciation (Rs 10 lakh for example) while his profit before depreciation is low (Rs 2 lakh for instance). Such loss (Rs 8 lakh) is known as depreciation loss.

The rules for carry forward of depreciation are different from rules for carry forward of unabsorbed business loss (see: Uneven Rules).

Loss under Capital Gains. Capital loss assessed under the head 'capital gains' cannot be set off against income under any other head. Capital loss can be set off against capital gains income only.

Further, long-term capital loss cannot be set off against short-term capital gains. Unadjusted capital loss can be carried forward up to eight years. Long-term capital loss cannot be set off against short-term capital gains even during this period.

Loss under Other Sources. Loss under the head 'other sources' can be adjusted against income under any other head in the same year. But, there are no provisions for carry forward of unadjusted loss incurred under this head to subsequent years. Unabsorbed loss under this head will, therefore, lapse in the same year.

Submission of return within due date. One of the critical conditions for availing the benefit of carry forward of loss to future years is that the return of income for the year, in which loss has been incurred, should be furnished within the due date. This condition is applicable for carry forward of loss to next year and does not affect the right to adjust or set off loss in the same year. As a measure of relaxation, unadjusted depreciation can be carried forward even if there has been delay in furnishing the return.

Conclusion. Tax provisions about setting off losses are, indeed, a bit complex, but so is life. One needs to file income tax returns within the due date for availing the benefit of losses to reduce future tax liability.

Lossmaker's Guide to Tax Savings

The author is a member of the Bombay Chartered Accountants' Society.