1. Introduction: Why Loss Set-Off Rules Matter
The Indian Income-tax Act, 1961 follows a net income principle – tax should be levied on real income after adjusting for genuine business and investment losses, subject to safeguards. Businesses, professionals and investors face fluctuating profits and losses across years. Without provisions for loss set off and carry forward, taxpayers could be taxed heavily in profitable years while getting no relief for loss years, which would be both unfair and economically distortive.
To address this, the Act prescribes detailed rules on intra-head set off, inter-head set off and carry forward of unabsorbed losses. At the same time, it builds in strict conditions such as timely return filing, continuity rules for certain companies, and head-wise restrictions, so that losses cannot be misused solely as tax shields divorced from genuine commercial activity.
2. Basic Concepts: Set Off vs Carry Forward
2.1 Set Off of Loss – Same Year Adjustment
Set off refers to adjusting a loss against income so that tax is computed on the net figure. If a business shows a loss and there is income under the same or another head, the law may allow the loss to be adjusted against that income, subject to specified restrictions. Set off operates in two layers:
- Intra-head set off – loss from one source against income from another source under the same head; and
- Inter-head set off – loss under one head against income under another head.
Only after all permissible intra-head and inter-head set offs are made do we know whether any unabsorbed loss remains that can be carried forward to future years.
2.2 Carry Forward of Loss – Future Year Adjustment
If a loss cannot be fully absorbed in the same year, even after applying all allowable set offs, the remaining portion can sometimes be carried forward to subsequent assessment years. In those years, the Act again specifies against which income such loss can be set off, for how many years it can be carried forward, and what conditions must be satisfied.
Carry forward is not automatic – it is conditional and head-specific. Some losses can be carried forward for 8 assessment years; some, such as unabsorbed depreciation, can be carried forward indefinitely; and some are subject to additional structural controls (for example, shareholding continuity rules for closely held companies).
3. Intra-Head and Inter-Head Set Off – Current Year Rules
3.1 Intra-Head Set Off
Under intra-head set off, loss from one source can be set off against income from another source under the same head, with certain exceptions:
- Speculation business loss can be set off only against profit from speculation business.
- Specified business loss (eligible under special deduction provisions) can be set off only against income from specified business.
- Long-term capital loss can be set off only against long-term capital gains, whereas short-term capital loss can be set off against both STCG and LTCG.
- Loss from owning and maintaining race horses is confined to that activity alone.
Apart from these ring-fenced categories, ordinary losses within a head are freely adjustable – for example, loss from one shop against profit of another shop under the same business head.
3.2 Inter-Head Set Off
After intra-head set off, if loss still remains, it may be set off across heads within the same year, subject to specific prohibitions:
- Capital loss cannot be set off against income under any other head – it must stay within “Capital gains”.
- Business loss (non-speculative) can be set off against any head except salary.
- Loss under Income from house property can be set off against other heads, but inter-head set off is typically capped (e.g., up to a specified rupee limit per year), with any excess carried forward.
- Loss from speculation business, specified business, and race horses cannot be set off against other heads.
Inter-head rules provide limited smoothing across different heads of income while protecting the tax base from erosion through specially incentivised or high-risk activities.
4. Business Losses (Non-Speculative) – Carry Forward and Set Off
4.1 Nature of Business Loss
Business losses arise from the ordinary operations of a business or profession, excluding speculative transactions and specially treated activities like race horses or specified businesses. These losses fall under the head “Profits and gains of business or profession”.
For tax purposes, business losses are treated differently from speculative loss, specified business loss and capital loss, each of which has its own ring-fencing rules.
4.2 Set Off in the Same Year
In the year in which the loss arises:
- First, it is set off against other business income (intra-head adjustment).
- If any loss remains, it can be set off against income under other heads, except salary (inter-head adjustment).
Any portion still unabsorbed after these adjustments becomes a carried forward business loss.
4.3 Carry Forward Rules
Key conditions for carried forward business loss:
- The return of income must generally be filed within the due date to preserve the right to carry forward the loss.
- The loss can usually be carried forward for 8 assessment years immediately following the year of loss.
- In future years, such carried forward business loss can be set off only against business income – it cannot be set off against salary, capital gains or house property income.
- Continuity of the exact same business is not mandatory; as long as there is business income, set off is normally permitted, subject to special rules for certain companies.
4.4 Special Rule for Closely Held Companies
For closely held companies, there are additional restrictions on use of carried forward business losses. Generally, if there is a substantial change in shareholding between the year in which the loss was incurred and the year in which it is sought to be set off, such loss may be disallowed.
In broad terms, if shareholders who held at least a specified percentage of voting power in the year of loss are not substantially the same in the year of set off, the company may lose the right to utilise those losses. Exceptions exist for certain genuine changes, such as succession on death, transfers to relatives, or some eligible start-ups under prescribed conditions. The intent is to prevent “loss trafficking” by buying companies only to use their accumulated losses as tax shields.
5. Speculation Loss, Specified Business Loss and Other Ring-Fenced Losses
5.1 Speculation Business Loss
Speculation business involves transactions where contracts are settled otherwise than by actual delivery of goods or securities, subject to defined exclusions. Loss from such speculation business is tightly controlled:
- It can be set off only against profits of another speculation business, not against ordinary business income.
- It can usually be carried forward for 4 assessment years and set off only against speculation profits during those years.
5.2 Specified Business Loss
Certain activities considered as specified businesses enjoy special deductions for capital expenditure. Loss from such specified business is treated as a separate basket:
- It can be set off only against income from specified business.
- Unabsorbed loss from specified business can typically be carried forward indefinitely until fully set off against specified business profits.
This framework ensures that generous incentives for specified businesses do not spill over and erode tax on unrelated activities.
5.3 Loss from Owning and Maintaining Race Horses
Loss from owning and maintaining race horses is another ring-fenced category:
- It can be set off only against income from the same activity.
- It can usually be carried forward for 4 assessment years and set off against income from owning and maintaining race horses only.
6. Capital Losses – Short-Term and Long-Term
6.1 Intra-Head Capital Loss Rules
Under the head “Capital gains”, losses are categorised and treated as follows:
- Short-Term Capital Loss (STCL) can be set off against both short-term capital gains and long-term capital gains in the same year.
- Long-Term Capital Loss (LTCL) can be set off only against long-term capital gains.
Capital loss cannot be set off against salary, house property income, business profits, or income from other sources.
6.2 Carry Forward of Capital Losses
For carried forward capital losses:
- The return claiming the loss must generally be filed within the due date to preserve the right of carry forward.
- Brought forward capital losses can be carried forward for up to 8 assessment years.
- In those years, brought forward STCL can be set off against any capital gains (STCG or LTCG), whereas brought forward LTCL can be set off only against LTCG.
7. Loss from House Property – Special Flexibility
7.1 Set Off in Current Year
Loss from house property typically arises when interest on borrowed capital (housing loan) and other deductions exceed the income from that property. In the same year:
- House property loss can be set off against income from other properties (within the head).
- Subject to a monetary limit, it can also be set off against other heads of income (e.g., salary, business) as an inter-head adjustment.
Any house property loss beyond the permitted inter-head limit must be carried forward to future years.
7.2 Carry Forward of House Property Loss
Key points:
- House property loss can be carried forward for up to 8 assessment years.
- In subsequent years, it can be set off only against income from house property, not against other heads.
- Carry forward of house property loss is generally allowed even if the return is filed belatedly, provided the loss is otherwise correctly determined.
8. Unabsorbed Depreciation and Other Allowances
8.1 Unabsorbed Depreciation
Depreciation has a distinct and more flexible treatment compared to ordinary business loss:
- If current year depreciation cannot be fully set off against business income, it can be set off against other heads of income (except salary) in the same year.
- Any unabsorbed depreciation is carried forward indefinitely – there is no time limit.
- In future years, it can again be set off against income under most heads (except salary).
- The strict due-date condition that applies to carrying forward business and capital losses generally does not apply in the same way to unabsorbed depreciation.
This makes unabsorbed depreciation a particularly powerful smoothing tool for long-term tax planning.
8.2 Other Unabsorbed Allowances
Certain other allowances, such as unabsorbed capital expenditure on scientific research or family planning, may also be carried forward and treated similarly to business loss or depreciation, depending on the specific provisions. In practice, they are tracked head-wise in the return, similar to other carried forward items.
9. Conditions for Valid Carry Forward
9.1 Timely Filing of Return
For several categories of loss, the right to carry forward depends on filing the return on time:
- Business loss (non-speculative), speculation loss and capital loss require the return to be filed within the due date to preserve carry-forward rights.
- If the return is filed late, such losses can still be set off within the current year but usually cannot be carried forward.
- House property loss and unabsorbed depreciation are exceptions; carry forward is generally allowed even with a belated return.
9.2 Proper Disclosure and Tracking
Assessees must properly compute and disclose losses in the return, maintain year-wise and head-wise records of carried forward amounts, and claim set off in later years in the correct order. Tax audit reports and ITR schedules help structure this information.
Mistakes in classification, omission of losses, or incorrect priority in set off can lead to disputes or denial of carry forward. Accurate bookkeeping and reconciliations are therefore crucial.
10. Practical Hierarchy of Set Off in Business Cases
In practice, when computing business income in a subsequent year, a rough priority order is typically followed (subject to detailed provisions):
- First, set off current year depreciation.
- Then, set off current year business loss.
- Next, set off brought forward business losses (within the 8-year window).
- Finally, set off unabsorbed depreciation from earlier years.
This order ensures that time-limited losses are utilised before indefinite items like unabsorbed depreciation, optimising long-term tax efficiency.
11. FAQs on Carry Forward and Set Off of Losses
FAQ 1: Can I carry forward a loss if I file my return late?
For business loss (non-speculative), speculation loss and capital loss, carry forward is typically allowed only if the return is filed within the prescribed due date. If you file late, you may still set off the loss in the same year, but you usually lose the right to carry it forward. House property loss and unabsorbed depreciation are more flexible and can generally be carried forward even if the return is belated.
FAQ 2: What is the difference between business loss and unabsorbed depreciation?
Business loss arises from operational deficits (expenses exceeding income) and can be carried forward for 8 assessment years, to be set off only against business income, subject to timely return filing. Unabsorbed depreciation arises when depreciation exceeds business profits, can be carried forward indefinitely, and can be set off against income under most heads (except salary). It is therefore more flexible and long-lasting than ordinary business loss.
FAQ 3: Can I set off my business loss against my salary income?
No. Business loss cannot be set off against salary income. In the year of loss, it can be set off against other heads like house property or income from other sources, but not salary. In subsequent years, carried forward business loss can be set off only against business income.
FAQ 4: How are capital losses treated?
Short-term capital loss can be set off against both STCG and LTCG; long-term capital loss can be set off only against LTCG. Both types can be carried forward for up to 8 assessment years if the return is filed on time. In any year, capital loss cannot reduce salary, house property, business, or other source income.
FAQ 5: Is there any benefit to intentionally generating losses?
The law permits relief for genuine commercial losses, but entering into transactions solely to manufacture losses with no real business purpose can attract anti-avoidance scrutiny. Artificial loss schemes or sham transactions can be disallowed and may trigger penalties or prosecution. Loss utilisation is meant to reflect real economic outcomes, not to facilitate tax games.
FAQ 6: What happens to brought forward losses if my company’s shareholding changes?
For closely held companies, a substantial change in shareholding may restrict the use of brought forward business losses. If the continuity thresholds for key shareholders are not met, such losses may not be allowed to be set off. There are exceptions for certain genuine or regulated changes and for specified start-ups. Unabsorbed depreciation is generally not affected by these shareholding tests and can usually continue to be carried forward.
FAQ 7: Can I carry forward my house property loss indefinitely?
No. House property loss can be carried forward for up to 8 assessment years. In each of those years, it can be set off only against income from house property, not against other heads. However, there is no strict due-date condition for carry forward of house property loss in the same way as business and capital loss.
FAQ 8: What is “ring-fencing” of losses?
Ring-fencing means limiting a category of loss to be set off only against income from the same category. Examples include speculation loss, specified business loss and loss from owning and maintaining race horses. This prevents such targeted or high-risk activities from eroding tax on unrelated incomes.
FAQ 9: How should I plan practically for losses?
Practically, you should:
- File returns on or before the due date to preserve carry-forward rights.
- Maintain clear head-wise, source-wise and year-wise records of losses and set offs.
- Prioritise utilisation of time-bound losses before indefinite items like unabsorbed depreciation.
- Consider shareholding implications if you are a closely held company with large carried forward losses.
- Avoid artificial loss schemes; focus on genuine, commercially justified decisions.
12. Conclusion
The rules on carry forward and set off of losses form a cornerstone of a fair and rational income-tax system. They ensure that tax is imposed on long-term net income rather than isolated profitable years, while preventing misuse of losses as tradable tax shields. Through head-wise restrictions, time limits, filing conditions and special controls for speculative and company losses, the Act balances relief for genuine losses with protection of the revenue.
For taxpayers, understanding which losses can be set off against which incomes, in which years, and under what conditions is essential for accurate computation and prudent planning. With disciplined compliance, proper documentation and thoughtful strategy, it is possible to smooth tax burdens across years while staying fully aligned with the spirit and letter of the Income-tax Act, 1961.