Unit 3: Carry Forward and Set-off of Losses

I. Orientation: Statutory Framework

Under the Income-tax Act, 1961, a company’s taxable income is computed under separate heads of income. A loss is first adjusted, where permitted, against income of the same year; any eligible balance may then be carried forward and adjusted in later assessment years. The governing provisions include sections 32(2), 70–80, 115BAA, 115BAB and 115JB.

• Set-off: Adjustment of a loss against positive income, reducing the company’s total taxable income.
• Intra-head adjustment: Set-off of loss from one source against income from another source under the same head, principally governed by section 70.
• Inter-head adjustment: Set-off of loss under one head against income under another head, subject to section 71 and specific prohibitions.
• Carry forward: Transfer of an unadjusted loss to a later assessment year for set-off within the statutory time limit.
• Assessment year: The year in which income of the preceding financial year, called the previous year, is assessed.
• Business continuity: Except where a provision specifically requires otherwise, the business that generated an ordinary loss need not necessarily continue when the carried-forward loss is set off.
• Return requirement: Under section 80, specified losses can be carried forward only if the loss return is filed within the time prescribed under section 139(1), subject to statutory exceptions.
• Order of adjustment: Current-year depreciation and current-year business losses are generally absorbed before brought-forward business losses and unabsorbed depreciation.

II. Corporate Loss Adjustment

A. Provisions of carry forward and set-off of losses in the case of companies

The Act classifies each corporate loss because the permissible income for set-off, filing condition and carry-forward period differ by category.

• Current-year intra-head set-off: Under section 70, a loss from one source is generally adjustable against income from another source under the same head.
  • A loss from one manufacturing unit may ordinarily be set off against profit from another business unit.
  • Long-term capital loss cannot be adjusted against short-term capital gain because section 70 restricts it to long-term capital gain.
• Current-year inter-head set-off: Section 71 permits adjustment between heads unless expressly prohibited.
  • Business loss cannot be set off against salary income; this restriction has little practical effect on a company because a company does not earn salary.
  • Capital loss cannot be set off against business income, house-property income or income from other sources.
  • Speculation and specified-business losses remain confined to their respective categories.
• Carry-forward principle: A loss remaining after permitted current-year adjustments moves to a later year only under the provision governing that loss.
• Head-wise tracking: Companies must separately track ordinary business loss, speculation loss, specified-business loss, short-term capital loss, long-term capital loss and unabsorbed depreciation.
• Tax-regime effect: Companies opting for concessional taxation under sections 115BAA or 115BAB cannot use losses or depreciation attributable to deductions that those regimes disallow.
• Return compliance: A timely loss return is essential for carrying forward business, speculation, specified-business and capital losses; unabsorbed depreciation is governed separately by section 32(2).

B. Sequence of Set-off

Correct sequencing prevents a loss with a limited life from being displaced by an allowance that may be carried forward indefinitely.

• General sequence: The normal computational order is:
  1. current-year depreciation;
  2. current-year business and other eligible losses;
  3. brought-forward business loss under section 72;
  4. unabsorbed depreciation under section 32(2).
• Reason for priority: Brought-forward business loss normally expires after eight assessment years, whereas unabsorbed depreciation has no general time limit.
• Current-year stage: Intra-head set-off is considered before inter-head set-off, after which eligible balances are carried forward.
• No double deduction: The same loss cannot be used both against normal total income and again in a later year.

Carry-forward loss = Eligible current-year loss - Permitted current-year set-off

Here, “eligible current-year loss” is the loss recognized under the relevant head, and “permitted current-year set-off” is the amount legally adjustable in that assessment year.

III. Category-wise Carry Forward

A. Ordinary Business Loss

An ordinary non-speculative business loss is governed mainly by section 72 and can be carried forward for eight assessment years immediately following the year in which it arose.

• Permitted set-off: The carried-forward amount may be adjusted only against profits and gains of business or profession.
• Current-year flexibility: In the year of origin, an ordinary business loss may generally be adjusted against income under another head, except salary, subject to restrictions applying to particular income.
• Continuity rule: The loss-producing business need not be continued, but the company must have business or professional income in the year of set-off.
• Filing condition: Carry forward requires a return filed within the section 139(1) due date, read with sections 139(3) and 80.
• Period: If a ₹30 lakh loss arose in the previous year relevant to Assessment Year 2025–26, its final permissible set-off year would ordinarily be Assessment Year 2033–34.

B. Unabsorbed Depreciation

Unabsorbed depreciation under section 32(2) is an allowance treated as part of the following year’s depreciation rather than as an ordinary business loss.

• Origin: It arises when admissible depreciation exceeds the income available for absorbing that depreciation.
• Carry-forward period: It may generally be carried forward indefinitely.
• Scope of set-off: It can ordinarily be adjusted against income under any head except salary, subject to special-regime restrictions.
• Return distinction: The timely loss-return condition in section 80 does not apply to unabsorbed depreciation in the same manner as it applies to section 72 business loss.
• Priority: A company normally uses brought-forward business loss before unabsorbed depreciation because the former has an eight-year expiry.

C. Speculation Business Loss

A speculation loss under section 73 is ring-fenced and cannot reduce profit from an ordinary business.

• Permitted set-off: It may be adjusted only against profit of another speculation business.
• Carry-forward period: The unabsorbed amount may be carried forward for four assessment years immediately following the year of loss.
• Filing condition: Timely filing of the loss return is required.
• Eligible derivatives: Transactions in eligible derivatives carried out through a recognized stock exchange are excluded from speculative transactions when statutory conditions are met.
• Deemed speculation: The Explanation to section 73 may treat parts of a company’s business involving purchase and sale of shares as speculation business, subject to stated exceptions relating to the company’s income composition and principal business.

D. Specified-Business Loss

Section 73A governs loss from a business eligible for investment-linked deduction under section 35AD.

• Restricted set-off: The loss may be adjusted only against profits of another specified business.
• Carry-forward period: It may be carried forward without a fixed numerical limit while the statutory conditions remain satisfied.
• Filing condition: Carry forward requires compliance with the timely return provisions.
• Segregation: Profit from an ordinary manufacturing or trading activity cannot absorb a section 35AD specified-business loss merely because both activities belong to the same company.

E. Capital Losses

Section 74 separates capital losses according to whether the transferred capital asset generated a short-term or long-term result.

1. Short-term capital loss: It may be set off against either short-term or long-term capital gains.
2. Long-term capital loss: It may be set off only against long-term capital gains.

• No inter-head set-off: Neither category can be adjusted against business profits, interest income or house-property income.
• Carry-forward period: Both may be carried forward for eight assessment years immediately following the assessment year of origin.
• Filing condition: A return of loss must be filed within the prescribed due date.
• Corporate transactions: Capital gains arising from securities, land, buildings or other capital assets must be classified before the matching loss is applied.

F. House-Property Loss and Other Restricted Losses

Loss under the head “Income from house property” is governed by sections 71 and 71B, while certain specially regulated activities follow separate provisions.

• Current-year restriction: Inter-head set-off of house-property loss is limited to ₹2 lakh in an assessment year.
• Carry forward: The unabsorbed house-property loss may be carried forward for eight assessment years.
• Future set-off: A brought-forward house-property loss can be set off only against income from house property.
• Filing treatment: Section 71B is not included among the losses barred by section 80 merely because the return was late, although filing obligations still apply.
• Racehorse activity: Loss from owning and maintaining racehorses is governed by section 74A, is restricted to income from the same activity and may be carried forward for four assessment years.

IV. Company-Specific Limitations and Restructuring

A. Change in Shareholding under Section 79

Section 79 restricts carry forward of losses of a company in which the public are not substantially interested when ownership changes beyond the prescribed threshold.

• Basic test: The loss is generally unavailable unless persons beneficially holding at least 51% of voting power in the loss year continue to hold at least 51% in the year of set-off.
• Purpose: The rule discourages acquisition of closely held companies merely to purchase and exploit accumulated tax losses.
• Scope: The restriction concerns carried-forward losses; it does not bar carry forward of unabsorbed depreciation under section 32(2).
• Eligible start-ups: A qualifying eligible start-up may use an alternative continuity test based on continued holding by all original shareholders, provided the loss was incurred during the prescribed ten-year period beginning with incorporation.
• Statutory relaxations: Section 79 provides relief for specified changes, including changes caused by death, qualifying gifts to relatives, certain foreign-company reorganizations and approved insolvency-resolution situations.

B. Amalgamation, Demerger and Business Reorganization

Sections 72A and 72AA permit specified reorganizations to transfer accumulated loss or unabsorbed depreciation when detailed statutory conditions are satisfied.

• Eligible reorganizations: Relief may apply to qualifying amalgamations, demergers and specified banking reorganizations.
• Vesting effect: Once conditions are fulfilled, eligible accumulated loss and unabsorbed depreciation of the predecessor are treated as those of the successor company.
• Conditions: The provisions may require continuity of business, retention of assets, continuation of operations and achievement of prescribed production or capacity standards.
• Consequence of breach: If post-reorganization conditions are violated, a deduction already obtained may become taxable in the year of non-compliance.
• Policy basis: Relief preserves genuine commercial reorganizations while preventing transactions designed mainly to trade in tax losses.

C. Concessional Corporate Tax and Minimum Alternate Tax

Corporate tax options can alter the economic value and legal availability of carried-forward losses.

• Sections 115BAA and 115BAB: A company opting for these regimes must forgo specified deductions and cannot set off losses or unabsorbed depreciation attributable to those deductions.
• Adjustment before option: Prescribed depreciation adjustments may be required where the company enters the concessional regime.
• MAT interaction: Under section 115JB, tax may be payable on book profit even when normal taxable income is reduced by carried-forward tax losses.
• Book-profit deduction: The MAT computation permits deduction of the lower of brought-forward book loss or unabsorbed book depreciation, based on the books of account; if either figure is nil, the deduction is nil.
• Separate records: Tax losses under normal provisions, book losses for MAT and unabsorbed book depreciation are distinct figures and must not be combined.