35 INCOME TAX: SET OFF AND CARRY FORWARD OF LOSSES CHAPTER We have studied so far that income tax is to be computed under five different heads, salary, income from house property, income from business and profession, capital gains and income from other sources. Each of these heads may have different sources. For example, a firm may have different production units, in different locations. Each of these would be a source for business income of the firm. Having got the income arising from different sources, how do we total these to get the total income? Chapter 4 of the income tax Act, Aggregation of Income and Set off and Carry forward of loss requires us to total the income from different sources under a head. It calls this aggregation of income under heads. Thereafter, it provides for totalling of income across the five heads. At the outset, let us take note of the key concerns of the State. If a person is reporting a gain, the state is happy to total it all up and charge income tax. The state s worry, however, is in the cases where a person has a loss from a source or a head. If allowed to total up losses and gains, persons would create means of showing loss to off set income on which they would have paid tax. The State wants to limit this possibility. Towards this, the first activity it identifies is losses arising from speculative business. It considers losses from speculative business separately. The second prominent source it finds is in the general category of capital gains. Capital gains are one of transaction of the sale of a capital assets. A person can always report a loss through many means and mechanisms. With this general thrust, let us first take the computation of total income under the five heads. The Act deals with losses arising from speculative business in a special manner. We would take up this case later. Aggregation of Income under Heads So long as the income from different sources is positive, the Act requires them to be totalled up to compute the total income under a head. It has reservations when there are losses. Towards setting off of losses, Section 70 makes a distinction between the head of capital gains and the other four heads. It provides: Section 70(1): where the net reisult for any assessment year in respect of any source falling under any head of income, other than Capital gains, is a loss set off against this income from any other source under the same head.
Income Tax: Set Off and Carry Forward of Losses 443 Thus, in relation to the heads of salary, house property, business and profession, and other sources, we simply have to add up all the figures from different sources to get a consolidated value for the head. In relation to the head of capital gains, the Section makes a further distinction between long term capital gain and short term capital gain. In relation to short-term capital loss, Section 70(2) provides: 70(2) Where the result of the computation in respect of any short-term capital asset is a loss set off against the income, if any, in respect of any other capital asset. Thus, short-term capital loss is to be set off against short term capital gain and long term capital gain. This is no different from the treatment given to the other four heads under Section 70(1). Now, a different treatment would be given to long term capital loss. Section 70(3) provides: 70(3) Where the result of the computation in respect of any capital asset (other than a short-term capital asset) is a loss set off against the income, if any in respect of any other capital asset not being a short-term capital asset. The reference to other than short-term capital asset to long-term capital asset. Thus, a long term capital loss can be set off against a long term capital gain only. Let us take up a case to explore the application of Section 70. Case Abhijit changed his job during the previous year. Thus, he got salary from two employers. Both his employers had allowed him to do private consulting after office hours. In addition, as the only son of his father, he had inherited a bakery shop. The shop had a manager. The shop was not doing well, as Abhijit could not give much time to it. Abhijit sold off shares of different companies in four rounds during the previous year. As the shares were bought during different times, some two were long term assets and the other two short-term assets. In addition, Abhijit sold off a flat which he had rented out towards the end of the year. The income of Abhijit during the previous year after, allowing deductions is as follows: Salary First employer Second Employer House Property Rental of flat Business and Profession Consulting Practic Bakery shop Capital Gain Short Term Capital Gain Sale of shares (Third Round) Sale of shares (Fourth Round) Long-term Capital Gain Sale of Flat Sale of shares (First Round) Sale of shares (Fourth round) Other Sources Rs. 2 Lakhs Rs. 0.5 Lakhs Rs. 1.2 Lakhs Rs. 0.5 Lakhs Rs. 2.2 Lakhs (Loss) Rs. 0.5 Lakhs Rs. 0.2 Lakhs (loss) Rs. 1 Lakhs Rs. 0.7 Lakhs (loss) Rs. 0.4 Lakhs (loss) Nil
444 Legal Aspects of Business We begin our discussion with income from salary. Salary income is a consideration for employment. It can never be negative. The lowest it can be is nil in the case of an employee who has gone on long special leave, say, for further studies. We, thus, need to total up income from different sources to compute the total salary income. Income from house property can also never be negative. The provisions attribute a minimum of expected annual rental as annual value. Further, a deduction of only 30% of this value is allowed. Thus, the least income from house property can be nil. We, thus, need to total income from all house property. There can be loss in exceptional case of individual house owners who have taken loan for the property. We would not be getting into this. Under the head of business and profession, we need to separate out speculative business from other business and deal with losses arising from speculative business separately. In this case, there is no speculative business. From other sources of business, as provided by Section 70(1), we can total up loss and profit together to get a consolidated value. In the case of capital gain, we could separate out Long Term Capital Gain and Short Term Capital Gain. Short-term loss can aggregated in the sub-category of short-term capital gain to arrive at an aggregated figure. This is a positive value of Rs. 0.3 Lakhs. Similarly, different sources under long term capital gain can be totalled to get a consolidated figure. This comes to a loss of Rs. 0.10 Lakhs. Now, under Section 70(3), a long-term loss cannot be set off against shortterm capital gain. Thus, the figures would stay the way they are for further treatment. Income from Other Sources can be totalled up. We would consolidate the table as follows: Salary House Property Business and Profession Capital Gain Long-term Capital Gain Short Term Capital Gain Other Sources Rs. 2.5 Lakhs Rs. 1.2 Lakhs Rs. 1.7 Lakhs (loss) Rs. 0.1 Lakhs (loss) Rs. 0.3 Lakhs Nil We could explore the working of provision on short term and long term capital loss by exploring the following situation. Different persons had the following long term capital gain and short term capital gain. In Rs. thousands A B C D E LTCG: 8 (loss) LTCG: 8 LTCG: 6 LTCG: (3 loss) LTCG: 4 STCG: 9 STCG: 6 (loss) STCG: 8 (loss) STCG: (2 loss) STCG: 3 The setting off of losses would be as follows: A B C D E LTCG: 8 (loss) LTCG: 2 LTCG: 0 LTCG: (3 loss) LTCG: 4 STCG: 9 STCG: 0 STCG: 2 (loss) STCG: (2 loss) STCG: 3
Income Tax: Set Off and Carry Forward of Losses 445 We would need to keep the aggregated figures of long term and short term capital gains separate as they are subject to different treatment. In fact, we may even need to differentiate the sources. Once we do this, we would get the total income for each of the five heads. We would need to total across the heads to get the net taxable income. The aggregated figure for a head can be a loss. The Act is concerned about the losses. Section 71 provides the set off of losses across heads. We could summarise the provision by considering the treatment of loss under each of the heads. 1. Salary: There can be no loss under this head. 2. House Property: There can be loss in exception cases of individual house owners who have taken loan for the property. We would ignore this special case. 3. Business and Profession: A loss again this can be set off against gain under other heads other than salary. In other words, business loss can be set off against income from house property, capital gains and other sources. 4. Capital Gain: A loss under the head of capital gain cannot be set off against any other head. Thus, the case above would get worked out as follows: Salary House Property Business and Profession Capital Gain Long-term Capital Gain Short Term Capital Gain Other Sources Rs. 2.5 Lakhs nil Rs. 0.2 Lakhs (loss) Rs. 0.1 Lakhs (loss) nil Nil Having made all the inter-head adjustments, we still have loss under different heads. The Act provides for carry forward of such loss to subsequent years. Section 72 provides for carry forward of loss arising from business or profession. Section 72. Carry forward and set off of business losses. (1) Where for any assessment year, the net result of the computation under the head Profits and gains of business or profession is a loss to the assessee, not being a loss sustained in a speculation business, and such loss cannot be or is not wholly set off against income under any head of income in accordance with the provisions of Section 71, so much of the loss as has not been so set off or, where he has no income under any other head, the whole loss shall, subject to the other provisions of this Chapter, be carried forward to the following assessment year, and- (i) it shall be set off against the profits and gains, if any, of any business or profession carried on by him and assessable for that assessment year: (ii) if the loss cannot be wholly so set off, the amount of loss not so set off shall be carried forward to the following assessment year and so on: (2) Where any allowance or part thereof is, under sub-section (2) of section 32 carried forward, effect shall first be given to the provisions of this section. (3) No loss (other than the loss referred to in the proviso to sub-section (1) of this section) shall be carried forward under this section for more than eight assessment years immediately succeeding the assessment year for which the loss was first computed.
446 Legal Aspects of Business Thus, in the year a business loss has arisen, it would be set off across other heads, as discussed earlier. The remainder loss, however, can be carried forward and set off only against gains from business and profession in the subsequent years. The loss can be carried forward for eight years from the year in which the loss arose. Further, section 72(2) refers to depreciation allowance and stipulates that losses carried forward would be set off first. It should be noted here that Section 32, which provides for depreciation allowance on written down value of block of assets, also provides for carrying forward of unadjusted depreciation allowance. Section 32(2) provides: Section 32: Depreciation Section 32 (2): Where, in the assessment of the assessee, full effect cannot be given to any allowance under sub-section (1) in any previous year, owing to there being no profits or gains chargeable for that previous year, or owing to the profits or gains chargeable being less than the allowance, then, subject to the provisions of sub-section (2) of Section 72 and sub-section (3) of Section 73, the allowance or the part of the allowance to which effect has not been given, as the case may be, shall be added to the amount of the allowance for depreciation for the following previous year and deemed to be part of that allowance, or if there is no such allowance for that previous year, be deemed to be the allowance for that previous year, and so on for the succeeding previous years. Section 73 provides for losses in speculation business. The section is structured just like Section 72 on losses arising from business. In other words, speculative business forms a category of its own for setting off and carrying forward losses. Section 74 deals with losses arising from capital gains. Section 74. Losses under the head Capital gains. (1) Where in respect of any assessment year, the net result of the computation under the head Capital gains is a loss to the assessee, the whole loss shall, subject to the other provisions of this Chapter, be carried forward to the following assessment year, and- (a) in so far as such loss relates to a short-term capital asset, it shall be set off against income, if any, under the head Capital gains assessable for that assessment year in respect of any other capital asset; (b) in so far as such loss relates to a long-term capital asset, it shall be set off against income, if any, under the head Capital gains assessable for that assessment year in respect of any other capital asset not being a short-term capital asset; (c) if the loss cannot be wholly so set off, the amount of loss not so set off shall be carried forward to the following assessment year and so on. (2) No loss shall be carried forward under this section for more than eight assessment years immediately succeeding the assessment year for which the loss was first computed. *** Thus, short-term capital loss can be adjusted in the subsequent years against both kinds of capital gains. However, long term capital loss can be adjusted against only long term capital gain. It is clear that capital gains have been subject of special provision. In this context, we should note that income tax is charged on capital gain at different rates. Let us become familiar with special provisions on capital gains.
A Note on Capital Gain Income Tax: Set Off and Carry Forward of Losses 447 For understanding the rate for calculation of income tax on capital gains, we would need to divide capital assets into two separate categories. The first category is equity shares listed on the recognised stock exchange and units of equity oriented mutual funds. The Finance Act, 2004 has introduced a Securities Transaction Tax on transfer of such shares through the stock exchange. The following is the provision on capital gain on transfer of such assets. Equity Shares and Units of Mutual Funds Long Term Capital Gain The Finance Act, 2004 has exempted long term capital gain arising from transfer of such equity shares and units of equity oriented funds, on whose transfer securities transaction tax was charged, from income tax. This has been done by including such long term gain as exempted income under Section 10. Short Term Capital Gain The Finance Act 2004, also gave benefit to the short term capital gain of the above mentioned equities, that is, equities charged to securities transaction tax. It reduced income tax on such gain and made it payable at the rate of 10%. In has been done by introducing a Section 111 A in the Act. Other Capital Assets Other capital assets would include building, land, jewellery and equity shares not listed on the stock exchange or not being traded through the stock exchange. If these assets are held for longer than 36 months, these would be long term assets. If held for a lesser period, these would be short term capital assets. Capital gains arising from sale of depreciable assets would be short term assets. Chapter XII of the Income Tax Act is titled Determination of tax in Certain Special Cases. This chapter provides a separate and special rate for calculation of income tax for some kinds on income. Section 112, under the chapter, provides for charging of long term capital gain at the rate of 20%, while, there is no separate provision for a special rate for short-term capital gains on these assets. Thus, the usual rate of taxation, applicable in the previous year, would apply to short term capital gain. Case A recently formed computer software company bought 100 computers at the rate of Rs. 30,000 per computer on September 6, 2001 and put these to immediate use. Soon thereafter, a new generation of computers got introduced in the market. The newer computers were far more useful for the kind of work the software company was doing. The company decided to move to a use of the new generation computers. Towards this, it sold off 70 of its computers at the rate of Rs. 20,000 a computer in February, 2003. It took on hire 70 of the new generation computers for the months of February and March at the rate of Rs. 500 per computer per month. The reported income of the company for the previous year 2002-03 is as follows. Calculate the aggregate income for taxation for the previous year 2002-03 and mention losses, if any, to be carried forward next year.
448 Legal Aspects of Business S.No. Income for the previous year 2002-03 Amount 1. Income from business (After deducting all expenses other than depreciation allowance) Rs. 50,000 2. Short-term capital loss from sale of shares Rs. 5,000 Long-term capital loss Rs. 20,000 3. Income from other sources Rs. 10,000 Total Taxable amount Answer: Rate of depreciation: 60% WDV on March 31, 2002 before depreciation: 30,000 100 = Rs.30,00,000 WDV on March 31, 2002 after depreciation = Rs.30,00,000 0.4 = Rs.12,00,000 WDV on March 31, 2002 before depreciation: 12,00,000 14,00,000 = Rs.2,00,000 Since the WDV is negative, it is a case of shot term capital gain of Rs.2,00,000 We take this figure below. S. No. Income for the previous year 2002-03 Amount Inter-head total 1. Income from business (After deducting all Rs. 50,000 Rs. 50,000 expenses 1 other than depreciation allowance) 2. Short-term capital loss from sale of shares Rs. 5,000 Short term gain from sale of computers Rs. 2,00,000 Total short-term gain 2,00,000-5,000 = 1,95,000 Long-term capital loss Rs. 20,000 (Carry forward) 3. Income from other sources Rs. 10,000 Rs. 10,000 Total Taxable amount Rs. 2,55,000 Case A recently formed computer software company bought 100 computers at the rate of Rs. 30,000 per computer on September 6, 2001 and put these to immediate use. Soon thereafter, a new generation of computers got introduced in the market. The newer computers were far more useful for the kind of work the software company was doing. The company decided to move to a use of the new generation computers. Towards this, it sold off 50 of its computers at the rate of Rs. 20,000 a computer in February, 2003. It took on hire 50 of the new generation computers for the months of February and March at the rate of Rs.500 per computer per month. The reported income of the company for the previous year 2002-03 is as follows. Calculate the aggregate income for taxation for the previous year 2002-03 and mention losses, if any, to be carried forward next year. S. No. Income for the previous year 2002-03 Amount 1. Income from business (After deducting all expenses other than depreciation allowance) Rs. 50,000 2. Short-term capital loss from sale of shares Rs. 5,000 Long-term capital loss Rs. 20,000 3. Income from other sources Rs. 10,000 Total Taxable amount 1 Since all expenses are taken into account, the cost of hiring computers should not be deducted.
Income Tax: Set Off and Carry Forward of Losses 449 Answer: Rate of depreciation: 60% WDV on March 31, 2002 before depreciation: 30,000 100 = Rs.30,00,000 WDV on March 31, 2002 after depreciation = Rs.30,00,000 0.4 = Rs.12,00,000 WDV on March 31, 2002 before depreciation: 12,00,000 10,00,000 = Rs.2,00,000 Depreciation Allowance for year 2002-03 = 2,00,000 0.6 = 1,20,000 We take this figure below and deduct from the business income. S. No. Income for the previous year 2002-03 Amount Inter-head total 1. Income from business(after deducting all Rs. 50,000 Rs. 50,000 expenses 2 other than depreciation allowance) Deduct depreciation allowance Rs. 1,20,000 Total income from business 2. Short-term capital loss from sale of shares Rs. 5,000 (carry forward) Long-term capital loss Rs. 20,000 (Carry forward) 3. Income from other sources Rs. 10,000 Rs. 10,000 Total income amount Rs. 50,000 + 10,000 = 60,000 Deduct Depreciation Allowance =Unabsorbed depreciationtaxable income 60,000 1,20,000 60,000 Rs. 0 Case X Ltd. was a newly formed computer software development company. It bought a building for Rs. 30 lakhs. However, even before it could get possession of the building, it realised that the locality in which the building was situated was not to its advantage. It thus, instead of using it as its office, it rented it out to a school. Statement of its accounts and transaction for the next two years were as follows. April 1, 2001 to March 31, 2002 It rented out the building it had bought for Rs. one lakh per year to the school with effect from April 1, 2001. The fair rent of the building was Rs. 90,000 per year. It spent Rs. 20,000 in May 2001 in repairs and maintenance of the building. X rented a building in a location convenient to its office in May, 2001. In May 2001 itself, it bought 50 computers for Rs. 40,000 a computer. It also bought furniture for Rs. 1 lakh in May, 2001. During April 1, 2001 to March 31, 2002, X Ltd. received Rs.17,15,000 from sale of software. It had incurred a total revenue expenditure towards salary, travels, electricity, maintenance etc. of Rs. 4 lakhs. April 1, 2002 to March 31, 2003 X Ltd. sold all its furniture in March 2003 for Rs. 35,000. X was going to buy ergonomically designed furniture in the coming months. It also sold 40 of its computers for Rs. 20,500 a computer in the month of March, 2003. It, thus, received Rs. 8,20,000 from sale of computers. It received Rs. 1 lakh from the building it had rented out. The Company received Rs. 7 lakhs from sale of software. It had incurred a total revenue expenditure towards salary, travels, electricity, maintenance etc. of Rs. 8 lakhs. A consulting company was doing a study on human resources in newly formed companies. The consulting company paid X Ltd. Rs. 20,000 for participating in the study. List the income for X Ltd. Under different heads, and total taxable income for the financial years 2001-02 and 2002-03. 2 Since all expenses are taken into account, the cost of hiring computers should not be deducted.
450 Legal Aspects of Business Answer: Year: 2001-02 S. No. Income Receipt (in Rs) Deduction (in Rs) Amount (in Rs) 1. House Property 1 lakh 30% of 1 lakh 70,000 2. Business Income 17,15,000 Depreciation:(12,00,000 + 15,000) = 12,15,000 + Expenditure: 4,00,000 = 16,15,000 1,00,000 Total 1,70,000 Year: 2002-03 WDV of Furniture on 1 April 2002: Rs 85,000 Furniture sold for Rs. 35,000 Capital loss= Rs 85,000 35,000 = Rs 50,000 WDV of computers on 1 April 2002: Rs 8 lakhs 40 computers sold for Rs.20,500 a piece = Rs 8,20,000 Capital gain = Rs 8,20,000 8,00,000 = Rs 20,000 S. No. Income Receipt Deduction Amount Inter-head Inter-head adjustment (in Rs) (in Rs) (in Rs) adjustment (in Rs) (in Rs) 1. House Property 1 lakh 30% of 1 lakh 70,000 0 2. Business Income 7 lakhs Expenditure: Loss = 10,000 Carry forward loss of 8 lakhs 1,00,000 10,000 to be adjusted against business gain 3 Short-term From sale of Short term 30,000 carried forward to be capital gain Furniture (loss) loss = 30,000 adjusted against capital = 50,000 gains Total (loss) = 30,000 4 Other Income 20,000 20,000 0 Total 00 Case A consulting company bought 4 laptop computers at the rate of Rs. 50,000 per computer on July 6, 2001 and put it to immediate use. The laptops were for the use of its professional employees. Later, the company realised that there were problems in sharing, maintenance and security of the laptops among its employees. It proposed that it would be much better if its professional employees purchased their own laptops. The company could help/compensate them towards this. On this suggestion, two of the employees bought laptop for themselves. Following this, the company sold off two laptops for a total value of Rs. 90, 000 on March 5, 2003. The company also bought its only car for Rs. 5 lakhs to be used by the professional employees in November, 2001. The car was underutilised as all the professional employees had their own cars and preferred using their own vehicles. The company sold off the car on March 12, 2003 for Rs. 4,10,000. The reported income of the company for the previous year 2002-03 is as follows.
Income Tax: Set Off and Carry Forward of Losses 451 S. No. Income for the previous year 2002-03 Amount 1. Income from business (After deducting all expenses other than depreciation allowance) Rs. 1,00,000 2. Short-term capital loss from sale of land Rs. 5,000 Long-term capital gain from sale of land Rs. 20,000 3. Income from other sources Rs. 10,000 Questions The following questions are with reference to the previous year 2002-03. 1. Calculate the income under each of the income heads. 2. Calculate the aggregate income for the year. 3. Mention carry forward, if any, and principles for their settlement in the previous year 2003-04. Answer: Calculation of Depreciation for laptops Rate of depreciation: 60% WDV on March 31, 2002 before depreciation: Rs. 50,000 4 = Rs. 2,00,000 Depreciation allowance for 2001-02: Rs. 2,00,000 0.6 = Rs. 1,20,000 WDV on March 31, 2002 after depreciation: Rs. 2,00,000 1,20,000 = Rs 80,000 WDV on March 31, 2003 before depreciation: Rs. 80,000 90,000 = Rs. 10,000 Since the WDV is negative, it is a case of shot term capital gain of Rs. 10,000 Calculation of Depreciation for the car Rate of depreciation: 20% WDV on March 31, 2002 before depreciation: Rs. 5,00,000 Depreciation allowance for 2001-02 (half year) : Rs. (5,00,000 0.2)/2 = Rs. 50,000 WDV on March 31, 2002 after depreciation: Rs. 5,00,000 50,000 = Rs 4,50,000 WDV on March 31, 2003 before depreciation: Rs. 4,50,000 4,10,000 = Rs. 40,000 As the block has become empty and the WDV is +ve, it becomes a case of capital loss of Rs. 40,000. We take this value below. S. No. Income for the previous year 2002-03 Amount 1. Income from business (After deducting all Rs. 1,00,000 Rs.1,00,000 expenses other than depreciation allowance) 2. Short-term capital loss from sale of land Rs. 5,000 Short term capital gain from sale of laptops Rs. 10,000 Short term capital loss from sale of car Rs. 40,000 Total short term capital gain (loss) Rs. 35,000 Long-term capital gain from sale of land Rs. 20,000 Total Capital gain Rs. 35,000 + 20,000 = Rs. 15,000 3. Income from other sources Rs. 10,000 Rs. 10,000 Total Taxable amount Rs.1,10.000 Remarks Rs. 15,000 is the short term loss which should be carried forward to the next year for adjustment against long term or short term capital gain.