SET-OFF AND CARRY FORWARD OF LOSSES UNDER INDIAN INCOME TAX LAW

Introduction 

The concept of set-off and carry forward of losses is a critical feature of the Indian income tax framework, ensuring a fair and equitable system of taxation. Under the provisions of the Income-tax Act, 1961, particularly Sections 70 to 74A, an assessee is taxed on their total income computed after adjusting permissible losses from one source or head of income against income from another. This mechanism recognizes the practical reality that not all income sources yield profits in the same financial year. It prevents undue hardship to taxpayers by allowing them to adjust losses either within the same assessment year or carry them forward to future years, subject to specific conditions and limitations.

The computation of Gross Total Income (GTI) involves the aggregation of income under five heads: salaries, house property, profits and gains of business or profession, capital gains, and income from other sources. If income under each head is positive, computing GTI is straightforward. However, in practical scenarios, losses often occur in one or more sources or heads. In such cases, the tax laws permit intra-head (inter-source) and inter-head adjustments, with certain restrictions.

The legal framework distinguishes between: Intra-head (Inter-source) set-off under Section 70, Inter-head set-off under Section 71, Carry forward and set-off in subsequent years under Sections 72 to 74A.

Each provision comes with exceptions—speculation losses, capital losses, losses from specified businesses under Section 35AD, race horse activities, and unexplained incomes under Sections 68 to 69D. Such specific treatments are designed to curb tax avoidance and abuse of deductions while maintaining equitable taxation principles.

Judicial pronouncements have reinforced these statutory interpretations. For example, in CIT v. Harprasad & Co. Pvt. Ltd. [(1975) 99 ITR 118 (SC)], the Supreme Court held that losses under exempted heads cannot be set off against taxable heads. The interplay between statutory provisions and judicial clarity forms the bedrock of loss adjustment principles.

This legal infrastructure balances taxpayer relief with revenue integrity, ensuring that genuine losses are accounted for, while disallowing adjustments from tax-free or speculative avenues. The following section elaborates each type of adjustment, Inter-source and inter-head, along with exceptions, formulas, and landmark judicial guidance, culminating in a complete perspective on this vital area of income tax law.

1. Inter-Source Adjustment (Intra-Head Adjustment) – Section 70

Section 70 of the Income-tax Act, 1961 allows the assessee to set off a loss from one source of income against income from another source within the same head of income in the same assessment year. This is known as intra-head or inter-source adjustment. However, there are notable exceptions.

General Rule:

If there are multiple sources of income under a particular head, and any one of them results in a loss, such a loss can be adjusted against income from another source under the same head.

Exceptions to Inter-Source Adjustment under Section 70:

(a) Capital Gains [Section 70(2) and 70(3)]

• Short-Term Capital Loss (STCL): Can be adjusted against both Short-Term Capital Gains (STCG) and Long-Term Capital Gains (LTCG).
• Long-Term Capital Loss (LTCL): Can be adjusted only against LTCG.

Statutory Reference:

• Section 70(2): STCL can be adjusted against STCG and LTCG.
• Section 70(3): LTCL can only be adjusted against LTCG.

Judicial Reference:
CIT v. Kantilal Nathuchand Sampat– Held that long-term capital loss cannot be set off against short-term capital gain.

(b) Speculation Business Loss [Section 73(1)]

• Loss from a speculation business can only be adjusted against profits from another speculation business.
• Loss from a non-speculative business can be adjusted against speculation business income.

(c) Specified Business under Section 35AD

• Loss from a specified business (such as cold chain facility, warehousing for agricultural produce, etc.) can only be adjusted against income from another specified business.
• Income from other businesses cannot be used to set off such losses.

(d) Activity of Owning and Maintaining Race Horses [Section 74A]

• Loss from this activity can only be set off against income from the same activity.
• Loss cannot be adjusted against income from any other source.

Example:

Case Law:
CIT v. Dr. M.A.M. Ramaswamy (2000) 243 ITR 65 (Mad)– Loss from horse races cannot be adjusted against income from other sources.

(e) Loss from an Exempt Source

• Loss from a source whose income is exempt under Section 10 (e.g., agricultural income, dividend income under certain conditions) cannot be adjusted against any taxable income.

Judicial Precedent:
Harprasad & Co. Pvt. Ltd. v. CIT – Loss from exempt income cannot be set off.

(f) Winnings from Lotteries, Crossword Puzzles, Gambling, etc. [Sections 58(4) and 115BB]

• No loss can be set off against income from such winnings.
• Similarly, losses cannot be set off against unexplained income under Sections 68 to 69D.

Inter-Head Adjustment – Section 71

Section 71 deals with the set-off of losses from one head of income against another head (e.g., set-off of business loss against house property income). However, this is also subject to specified exceptions.

General Rule:

If the net result under any head (except capital gains) is a loss, it can be set off against income under other heads in the same year.

Exceptions to Inter-Head Adjustment under Section 71:

     (a) Capital Gains

• Loss under the head “Capital Gains” cannot be set off against income under any other head.
• However, losses under other heads can be set off against capital gains.

(b) Speculation Business Loss

• Cannot be set off against any head other than profits from speculation business.
• Loss from house property, however, can be set off against speculation profits.

      (c) Specified Business Loss (Section 35AD)

• Cannot be set off against any other income, even under the same head, unless it’s from another specified business.

(d) Race Horse Losses [Section 74A]

• Cannot be set off against any other income.
• However, other head losses (e.g., business loss) can be set off against income from horse racing.

(e) House Property Loss [Section 71(3A)]

• Loss up to ₹2,00,000 can be set off against other heads.
• Excess loss must be carried forward for 8 assessment years.

Case Law:
CIT v. Shantilal Pvt. Ltd. – Validated legislative limitation on house property loss set-off.

(f) Business Loss Against Salary

• Business loss cannot be set off against salary income.

(g) Loss from an Exempt Source

• Cannot be adjusted against any taxable income.

(h) Winnings from Lotteries/Gambling/Betting

• No loss can be adjusted against such income.
• No carry forward of loss against such winnings is allowed.

Conclusion 

The law on set-off and carry forward of losses under the Indian Income-tax Act is a robust mechanism that attempts to bring fairness and rationality into the process of computing taxable income. Sections 70 and 71 provide a structured framework that distinguishes between intra-head and inter-head adjustments, while simultaneously imposing necessary restrictions to prevent misuse and protect the integrity of the tax system.

The underlying philosophy of these provisions is to allow genuine economic losses to be recognized while simultaneously curbing the misuse of artificial or contrived losses for tax avoidance. For instance, losses from speculation businesses, racehorse activities, and capital gains have been ring-fenced, meaning they can only be adjusted against income of a similar nature. This avoids misuse where speculative or artificial losses are set off against real income from salaries or regular business.

Further, the bar on setting off against lottery winnings, income from betting and gambling, and unexplained incomes ensures that windfall gains and undisclosed incomes remain fully taxable. Similarly, restricting house property loss adjustment to ₹2,00,000 ensures that the benefit does not disproportionately benefit those with large real estate holdings.

The courts have supported this framework with clarity and consistency. The Supreme Court’s decision in Harprasad & Co. and various High Court rulings have emphasized the principle that tax benefits such as loss adjustments must be governed strictly within the statutory framework, not as a matter of right.

In practice, this makes accurate record-keeping, proper head-wise computation, and strategic tax planning essential. For professionals and taxpayers alike, it becomes crucial to understand how loss from one source or head can or cannot be adjusted with another and when losses must be carried forward instead.

In essence, the set-off and carry forward provisions reflect a fine balance between taxpayer relief and revenue protection. They serve as an instrument for economic fairness, supporting enterprises through their lean phases—while upholding the sanctity of tax administration. The onus remains on taxpayers and advisors to interpret and apply these rules judiciously, ensuring compliance while leveraging lawful tax benefits. Mastery of this area is indispensable for anyone engaged in taxation, business advisory, or financial planning.