Set-off and carry forward losses: How they help reduce your tax burden

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What is set-off and carry forward of losses

In taxation, set-off and carry forward are the rules that allow taxpayers to balance losses against tax payable on taxable income. "Set-off" is balancing losses from one source of income against income from another in the same year. "Carry forward" is carrying forward unbalanced losses into later years so they are balanced against subsequent income. These rules are very useful for investors and business firms to reduce tax bills legally.

How set-off of loss works

Set-off is allowed in the same year and is used to offset income from different sources. For example, if you have a loss that arises from a business activity, you can set-off such a loss against your earnings from a different source such as salary or rent income, within certain restrictions under the Income Tax Act. There are intra-head set-off (matching of losses in the same head of income) and inter-head set-off (correction of losses in other heads of income). This reduces your overall taxable income for the year.

Knowing carry forward of losses

Where losses cannot be fully set off in the current year, the Income Tax Act gives relief for some of the losses to be carried forward to later years. These losses can then be brought forward and offset against future years' income subject to some conditions. Carry forward of losses is generally allowed for 8 years for the majority of business losses, and 4 years for certain capital losses. But in order to benefit from this relief, taxpayers must submit income tax returns within the time limit prescribed by the Income Tax Department.

Major heads of losses which can be set-off and brought forward

Some of the common examples of losses which can be set-off and brought forward are trade losses, capital losses, and losses of house property. However, there are some prescribed rules for each of them. For instance, losses arising from the sale of a capital asset (capital losses) can be set off only against capital gains and not against any other heads of income. Similarly, losses that belong to the category "income from house property" can usually be deducted from income from any other category but are limited to unabsorbed loss limits.

Benefits of knowledge about such provisions

Good understanding of set-off and carry forward rules can lead to humongous tax savings. Businesses can plan their business and investments with an eye to the impact of loss on their tax liability. For an individual, it can imply better management of rental income, capital gains, and other income to minimize tax expense. It also provides relief during bad years since losses can be strategically utilized in the subsequent profitable years.

FAQs

1. Is it possible to offset business income against capital losses?

No, the capital losses can be offset against the capital gains alone and not against the business income or any other heads.

2. Can losses be carried forward for how many years?

The majority of the business losses can be carried forward for 8 years, while some of the capital losses can be carried forward for 4 years.

3. Is filing a tax return necessary to carry forward losses?

Yes, filing your income tax return within the due date is mandatory to claim the benefit of carrying forward losses.