In investments, though you strive for profits, but in the process you may have to face losses too. Losses are painful but, Income tax law in India has provisions where you can set off losses with gains from other investments to reduce your overall tax liability. Moreover you may also carry forward your losses to subsequent years and set off with income of those years.
Isn’t it Interesting? Let’s go deep into it, and understand how you can reap benefits out of it.
For Income tax purposes, income is classified under 5 heads – Salaries, Income from House Property, Capital gains, Business Income and Income from other Sources. Income tax law allows you to set off losses from one category with the gain from the same or other category, with some conditions attached.
There may be different sources of income under a single head, for e.g you may be drawing salary from 2 companies, there may be 2 or more house properties, self-occupied and let out, there may be 2 or more businesses etc.
When you want to set off/adjust losses, then firstly you would have to set off losses against gain with in the same Income head ( Intra head set off), then if there’s still some loss left to be adjusted then go for Inter head set off i.e. from the gains from different Income heads. Let me explain in detail.
How to set off losses within the same head – Intra head adjustments
Intra head adjustments mean setting off losses from different income sources under the same head.
It is safe to assume that one cannot make losses in Salaries. So in this head, there’s nothing to be adjusted.
All houses including those which are not let out have Annual value, which is higher of actual rent received or fair market rent. To calculate income to be taxed, the rent figure got adjusted with municipal taxes and then reduced by 30% to account for repairs and maintenance. If there’s any loan running on that house then the interest paid on loan also gets deducted.
Even if house is self-occupied whose annual value is taken as nil, but to calculate the nett taxable annual value, interest on loan (if any) gets deducted. This turns the annual value into NEGATIVE or generates loss from house property.
Let’s assume you have 2 houses, one is self-occupied, but on which you are paying Housing loan EMIs and total interest paid in a single financial year is Rs 2 lakh and other one is let out where the Income after adjusting standard deduction comes out to be Rs 1.50 lakh.
So coming from the rules to set off losses, you can adjust the loss from one house with the income of other. In the case above you are making profit on house B for Rs 1.50 lakh and on House A you have loss of Rs 2 lakh. After setting out losses with gains there is no income left to be taxed. In fact there still remains some loss which needs to be further adjusted, which we’ll discuss later in the article.
Capital gains or losses can be short-term or long-term. In the case of Direct equity or equity-oriented instruments, if assets were sold within 1 year of holding, this would result in Short term capital gain or loss, otherwise, it would be long term; whereas in the case of Non- equity investments like debt mutual funds, gold or real estate, short term gain/loss arise if assets were sold within 3 years of holding, otherwise it would be long term.
Even tax rates vary in the short and long term. Like in Equity investments short term gains will be taxed @ 15%, and long term is tax-free. In the case of other assets, Short term gains would be added to the total income and long-term gains will be taxed @ 20% after Indexation.
As per set-off rules, capital losses can only be set off with capital gains. This means that there is no Inter head adjustment available to capital losses. There’s one more condition- Short term capital losses can be adjusted with both Short term capital gain and Long term capital gain, But Long term capital losses can only be adjusted with Long term capital gains.
Let’s say you have bought gold @ 30000 2 years back, and now if you sell it you will incur a loss of Rs 2 lakh. On the other side, you are seeing good short-term gains of Rs 1.50 lakh in your equity holdings. But if you book profits in equity this will result into paying 15% of short-term gain.
Now if you book the profits in equity and also sell out your gold and book losses then you need not pay tax on equity profit as it gets adjusted with the loss on gold.
Though as per the example, even after adjusting Rs 1.50 lakh of loss, there’s still Rs 50000 loss left to be set off. We’ll discuss this later in the article
Loss from one business can be set off with gains from another business. Here is one exception, losses of speculative business can be set off only with profits of the speculative business and not from non-speculative business.
For e.g, you run a bakery shop and also do Intra-day stock trading, where no delivery of shares takes place. Then the losses from intraday trading cannot be adjusted with profits of the bakery business. However, losses of bakery business can be set off with profits from intraday trading.
If intraday trading or trading in derivatives can be proved to be a normal business transaction, then it will not be taken as a speculative business.
In short Speculative losses can not be set off with nonspeculative profits, but NONspeculative losses can be set off with speculative gains.
This head covers income like Interest, dividends, casual income (like winning lotteries, TV shows, etc.), Business of owning and maintaining racehorses. Here also intra-head adjustments are allowed with few exceptions. Like No Losses can be adjusted with casual Income.
How to set off losses with income of different head – Inter head adjustments
Inter head adjustments mean setting off losses with income from different heads.
There cannot be any loss in salary income, however if you have incurred any loss in other heads and some portion is left after intra-head adjustments, then that loss can be set off with the salary income you earn and reduce your tax liability.
Business losses cannot be set off with salary income, also as per rules capital losses can only be adjusted with capital gains, so capital losses are also out of question.
Thus, technically Loss from house property and any loss from other sources can get adjusted with salary Income.
If there’s any loss from house property left after intra-head adjustments, then that loss is allowed to be set off with any other head of income. Like as per the example in the above section, where the loss of Rs 50000 was still left to be adjusted, this loss can now be adjusted with either salary income, Capital gains (LTCG or STCG) or even Business Income.
Capital Losses cannot be adjusted with any other income. This means that only Intra head adjustments are allowed in case of capital losses.
Business losses cannot be set off with salary income, but all other heads are open for it. So income from house property, capital gains can help in setting off business losses.
How to carry forward unadjusted losses
If your loss does not get set off at step 1 within same head, or at step 2 with other heads, then you have the third option too. You may carry forward the loss to subsequent years for adjustment with subsequent years’ income.
Unadjusted Loss from house property, Capital loss or business loss can be carried forward for 8 subsequent years. Unadjusted loss from speculative business can be carried forward for 4 subsequent years.
Carry forward and set off losses – Some important pointers
- Once you carry forward the loss then in subsequent years you can only do intra head adjustments i.e. within the same head and not inter head adjustments. Like unadjusted house property loss once carried forward will only be adjusted with income from house property, and not with income from any other head.
- Carry forward of losses are permissible only when you file Income tax returns in specified time. If delayed you can set off losses of that particular year but will not able to carry forward the losses.
- If it is business loss and the business has been discontinued, then also the losses can be carried forward and set off.
- If clubbing provisions apply, then the losses have to be clubbed in the same manner as income and carried forward and set off as per the income profile of the actual tax payer.
The knowledge of provisions of set off losses and carry forward is important from a tax planning point of view. Sometimes you stick on to bad investment just because it is running in losses and lose out on an opportunity that can get you good gains. If you know these tax provisions then you can comfortably make a smart move by switching on from bad to good investments and adjusting the losses with the gains incurred and managing your tax liability and gain in the process.
Moreover, knowledge of the law itself is very important, as many times laws are designed to work in our favor, but we could not take advantage, just because of ignorance.
Hope you find the article on “How to carry forward and set off losses” useful. Did you take benefit of these provisions before? Do share your experience.