CHAPTER 1

INTRODUCTION
The public finance domain of Economics deals with principles/cannons of taxations. There are
various models of Taxation but in the developing economies progressive system of taxation has been
advocated which means a person having larger income should contribute more to the public
exchequer in comparison to the person having lesser income.
While dealing with the subject, it has been envisaged that if a person has profits/income he should
pay taxes if he has profit and losses simultaneously he should pay tax on net profit after deducting
the losses and if he has resultant loss or only loss he is not required to pay taxes. However, due to the
complexity and need it has been thought of to incorporate the provisions relating to set off and carry
forward of losses. Additional complexity has been created and the losses have been restricted to be
set off due to greediness of the legislators and tax administrators.
The set off and carry forward of losses can be sub divided into two broad categories:1. Set off of losses.
2. Carry forward and Set off of losses.

Set-Off of Losses:
The adjustment of losses from one head against the income, profits or gains of any other head of
income during the same tax year is called set-off of losses.

Carry-Forward of Losses:
Where the losses are not fully adjusted against the income of the same tax year and such losses are
transferred to the next tax year, this process of transferring un- adjustable losses to the next year is
known as carry-forward of losses.

CHAPTER 2
PROCEDURES AND STEPS TO SET OFF

Income Tax Ordinance, 2001 has provided the specific procedure for adjustment and carry forward
of losses sustained by a taxpayer during the tax year.
If a loss cannot be set off either under the same head or under the different heads due to absence
/adequacy of the income during the same year, such loss may be carried forward to the next year to
be set off against the income of that year.

In the present context the losses can be carried forward to be set off against the income other
subsequent year is possible in the following heads of income:-

1. Loss from house property.

2. Loss from business and profession:a) Loss from non speculation business.
b) Loss from speculation business
c) Loss on account of depreciation.
Capital Expenditure on Scientific Research and Family Planning.

3. Loss on account of capital gain:-

a) Loss on account of short term capital gain.

b) Loss on account of long term capital gain.

4. Loss from other sources:-

a) Only from the activity of owning and maintaining race horses.

Set off and carry forward of loss

House Property

(i) In any assessment year, if there is a loss under the head Income from house property, such loss
will first be set-off against income from any other head during the same year.

(ii) If such loss cannot be so set-off, wholly or partly, the unabsorbed loss will be carried forward to
the following assessment year to be set-off against income under the head Income from house
property.
(iii) The loss under this head is allowed to be carried forward upto 8 assessment years immediately
3

succeeding the assessment year in which the loss was first computed.

For example, loss from one house property can be adjusted against the profits from another house
property in the same assessment year. Any loss under the head Income from house property can be
set off against any income under any other head in the same assessment year. However, if after such
set off, there is still any loss under the head Income from house property, then the same shall be
carried forward to the next year.

Business Losses

Under the Act, the assessee has the right to carry forward the loss in cases where such loss cannot be
set-off due to the absence or inadequacy of income under any other head in the same year. The loss
so carried forward can be set-off against the profits of subsequent previous years.
Section 72 covers the carry forward and set-off of losses arising from a business or profession.
Conditions
(i) The loss should have been incurred in business or profession.
(ii) The loss should not be in the nature of a loss in the business of speculation.

(iii) The loss may be carried forward and set-off against the income from business or profession
though not necessarily against the profits and gains of the same business or profession in which the
loss was incurred. However, a loss carried forward cannot, under any circumstances, be set-off
against the income from any head other than Profits and gains of business or profession.
(iv) The loss can be carried forward and set off only against the profits of the assessee who incurred
the loss. That is, only the person who has incurred the loss is entitled to carry forward or set off the
same. Consequently, the successor of a business cannot carry forward or set off the losses of his
4

predecessor except in the case of succession by inheritance.

(v) A business loss can be carried forward for a maximum period of 8 assessment years immediately
succeeding the assessment year in which the loss was incurred.

(vi) The assessee must have filed a return of loss under section 139(3) in order to carry forward and
set off a loss. In other words, the non-filing of a return of loss disentitles the assessee from carrying
forward the loss sustained by him. Such a return should be filed within the time allowed under
section 139(1). However, this condition does not apply to a loss from house property carried forward
under section 71B and unabsorbed depreciation carried forward under section 32(2).
Losses in Speculation Business

(i) The meaning of the expression speculative transaction as defined in section 43(5) and the
treatment of income from speculation business has already been discussed under the head Profits
and gains of business or profession.

(ii) Since speculation is deemed to be a business distinct and separate from any other business
carried on by the assessee, the losses incurred in speculation can be neither set off in the same year
against any other non-speculation income nor be carried forward and set off against other income in
the subsequent years.

(iii) Therefore, if the losses sustained by an assessee in a speculation business cannot be set-off in
the same year against any other speculation profit, they can be carried forward to subsequent years
and set-off only against income from any speculation business carried on by the assessee.

(iv) The loss in speculation business can be carried forward only for a maximum period of 4 years
from the end of the relevant assessment year in respect of which the loss was computed. Loss from
the activity of trading in derivatives, however, is not to be treated as speculative loss.

Specified Businesses

(i) Any loss computed in respect of the specified business referred to in section 35AD shall be set off
only against profits and gains, if any, of any other specified business.

(ii) The unabsorbed loss, if any, will be carried forward for set off against profits and gains of any
specified business in the following assessment year and so on.

(iii) There is no time limit specified for carry forward and set-off and therefore, such loss can be
carried forward indefinitely for set-off against income from specified business.

Capital Gains

Section 74 provides that where for any assessment year, the net result under the head Capital gains
is short term capital loss or long term capital loss, the loss shall be carried forward to the following
assessment year to be set off in the following manner:

(i) Where the loss so carried forward is a short term capital loss, it shall be set off against any capital
gains, short term or long term, arising in that year.

(ii) Where the loss so carried forward is a long term capital loss, it shall be set off only against long
6

term capital gain arising in that year.

(iii) Net loss under the head capital gains cannot be set off against income under any other head.
(iv) Any unabsorbed loss shall be carried forward to the following assessment year up to a maximum
of 8 assessment years immediately succeeding the assessment year for which the loss was first
computed.

Owning and Maintaining Race Horses

(i) According to provisions of section 74A(3), the losses incurred by an assessee from the activity of
owning and maintaining race horses cannot be set-off against the income from any other source other
than the activity of owning and maintaining race horses.

(ii) Such loss can be carried forward for a maximum period of 4 assessment years for being set-off
against the income from the activity of owning and maintaining race horses in the subsequent years.
(iii) For this purpose, the amount of loss incurred by the assessee in the activity of owning and
maintaining race horses means the amount by which such income by way of stake money falls short
of the amount of revenue expenditure incurred by the assessee for the purpose of maintaining race
horses. i.e. Loss = Stake money revenue expenditure for the purpose of maintaining race horses.
(iv) Further, the expression horse race means a horse race upon which wagering or betting may be
lawfully made.

(v) Income by way of stake money means the gross amount of prize money received on a race
horse or race horses by the owner thereof on account of the horse or horses or any one or more of the
7

horses winning or being placed second or in any lower position in horse races.
Briefly speaking:
We may categories the losses under different heads of income in the following manner:

1) Category "A"
i) Loss from non-speculation business
ii) Loss from other sources
2) Category "B"
Loss from speculation business
3) Category "C"
Loss from capital assets:
i) Loss from any head under category "A" may be set off against all categories like "A", "B" and "C"
ii) Loss from category "B" may be set-off only against any other income from category "B".
iii) Loss from category "C" may be set-off only against any other income from category "C"
Notes:
i) Where a person incurs losses under more than one head of income, including "Income from
Business", the business loss shall be set-off at last.
ii) If an income from a source is exempt from tax, the loss from such source may not be set-off or
carry forward.

Procedure for setting off losses:

Step 1. Set-off loss from same head of income Intersource adjustment
Step 2. If the loss is still existing, loss can be set-off from other heads of income (subject to certain
restrictions) Inter-head adjustments
Step 3. If loss still persists, the same can be carried forward to the subsequent assessment years
Carry forward of losses
Inter-source and inter-head Set-off [Section 70 & 71]

Section

Provision

Exception

70

Set off of loss from one source i) Loss from Speculative business
against income from another
source under the same head ofii) Loss from specified business under section
income/inter-

source

set-off35 AD

under the same head of income

Any loss in respect of oneiii) Long term capital loss
source shall be set-off against
income
under

from
the

other

same

sourceiv) Loss from the activity of owning and

head ofmaintaining race horses

income. But, there are some

exception to this.

v) No loss can be set- off against casual

income i.e. Income from lotteries, cross word
puzzles, betting gambling and other similar
games
vi) Loss from an exempted source cannot be
set off against from a taxable source of
9

income.(e.g.

Share

of

loss

of

firm,

agricultural losses, cultivation expenses)

Section

Provision

Exception
i) Loss under the head Profits and gains of
business or profession cannot be set off
against income under the head Salaries

Set Off of Loss from one headii) No expenses can be claimed against
against income from another/casual income
Inter
71

head

adjustment Loss

under one head of income caniii) Loss under the head Capital gains
be

set-off

against

incomecannot be set off against income under any

assessable under any other headother head.

of income.
iv) Speculation loss and loss from the activity
of owing and maintaining race horses cannot
be set-off against income under any other
head.

Step 1 - Inter source adjustment:

10

Under each head of income mentioned, there may be more than one source of income. For example,
a person can have two or more businesses under the head Business Income. Under the IT Act, loss
from one source of income can be set-off against another source of income under the same head
i.e. Loss from a cloth business can be set-off against gain in a catering business.
The restrictions to this form of setting off are as follows:
a. Loss from speculative business can be set-off only against gain from speculative business and not
any other business income.
b. Loss from the activity of owning and maintaining race horses can be set-off only against gain
arising from the activity of owning and maintaining race horses and not any other income.
c. Long term capital loss can be set-off against long term capital gains and not short term capital
gains.
Step 2 - Inter head adjustment:
If the losses cannot be set-off fully through inter source adjustment, they can next be set-off against
other heads of income. This is called inter-head adjustment.
The IT Act has prescribed specific rules setting off of losses between different heads of income,
which are summarized in the following tables:

11

Incom

Salar

House

es

Propert
y

Business/

Capital

Other Sources

Gains
Professional Income
Non

Speculati

Lon

Short Owing & Winnings

Other

speculati

ve

-term maintenan

ve

term

from

ce of race lotteries
horses.

crossward
s, puzzles
etc

Loss from House Property

Loss
under
the
head
houseproper
ty
Loss from business/professional income

Speculati
ve
business
loss

12

Other
business/
professio
nal loss
Loss from capital gains

Long
term
capital
loss
Short
term
capital
loss
Loss from other sources

Loss from
owning
and
maintenan
ce of race
horses
Loss from
card
games etc

13

Step 3 - Carry forward of losses:

Carry forward and Set-off of brought forward losses
If a loss cannot be set off either under the same head or under the different heads because of absence
or inadequacy of the income of the same year, it may be carried forward and set off against the
income of the subsequent year.
However, the loss so carried forward can be set-off only against same head of income, i.e. the benefit
of inter-source adjustment is lost.

Income against which theMaximum

Section

Nature of loss to bebrought forward loss canperiod [from the end of the
carried forward

be set off in subsequentrelevant assessment year]

years.

71B

72

73

Unabsorbed loss fromIncome

house property

from

House

Property

8 assessment years

Profit and gains from

business
business or profession8 assessment years
loss (non- speculative)
(non- speculative)
Loss from speculationIncome from speculation
business
from

business
specifiedProfit

from

4 assessment years

specified

business under sectionbusiness under sectionIndefinite period

35AD

74

for carry forward of losses

Unabsorbed

Loss
73A

permissible

35AD

Long-term capital loss Long-term capital gains 8 assessment years

14

74

Short-term capital loss

Short/Long-term

capital

gains

8 assessment years

Loss from the activityIncome from the activity

74A

of

owning

andof owing and maintaining4 assessment years

maintaining race horses race horses.

Remarks:
Past year losses can be set-off against income from that respective head of income (Inter head
adjustment is not possible)
Important Note:a) Mandatory Filing of IT return in order to carry forward and set-off of a loss in stipulated time
As per section 80, the assesses must have filed a return of loss under section 139(3) in order to
carry forward and set off a loss. In other words, the non-filing of a return of loss disentitles the
assesses from carrying forward the loss sustained by him. Such a return should filed within the time
allowed under section 139(1).
However, this conditions does not apply to a loss from house property carry forward under section
71B and unabsorbed depreciation carry forward under section 32(2).
However in case return is filed late CBDT has a power to condone delay Circular No. 8/2001 dt
16-05-2001
If return of the current year is not submitted in time, losses of the past years are not affected.
Return of loss in the case of a sick company

15

If a sick company fails to file the return of loss within the stipulated time specified in section 139(3),
and a scheme made pursuant to an order under section 17(3) of the Sick Industrial Companies
(Special Provisions) Act, 1985 is sanctioned by the Board for Industrial and Financial
Reconstruction under section 18 of that Act, specifying a particular tax treatment for the carry
forward and set off of loss incurred by the sick company, the said scheme will have overriding effect
over the provisions of section 80 of the Income-tax Act. In such a situation the Assessing Officer will
have to take cognisance of the scheme and give effect to the carry forward and set off of loss
provided for under the schemeCircular No. 576, dated August 31, 1990.
Earlier the Board had issued Circular No. 523, dated October 5, 1988 in connection with the
procedure to be followed in respect of grant of consent by the Central Government in cases
involving financial assistance to be given under direct tax laws for rehabilitating sick industries
under Sick Industrial Companies (Special Provisions) Act, 1985 (SICA).
Withdrawal of circulars The Board had withdrawn with immediate effect the above Circular Nos.
523 and 576 vide its letter of even number dated December 30, 1993. The said letter to AAIFR and
BIFR clarified that each case of fiscal concession of financial assistance under direct tax laws will
now be considered in each individual case on merits. The model agency for coordination between
the Board for Industrial and Financial Reconstruction (BIFR) and Central Board of Direct Taxes and
Appellate Authority for Industrial and Financial Reconstruction (AAIFR) and Central Board of
Direct Taxes will be the Director General of Income-tax (Admn.), 7th Floor, Mayur Bhawan, New
Delhi-110001. Cases already decided in accordance with Circular Nos. 523 and 576 were, however,
not required to be reopened Circular No. 683, dated June 8, 1994.
b) What is Speculation business ?
Defined u/s 43(5) as transaction in which a contract for purchase or sale of any commodity,
including stocks and shares, is periodically or ultimately settled otherwise than by actual delivery or
transfer of the commodity or scrips.
The explanation to this section provides that where any part of business of a company consists in
the purchase and sale of the shares of other companies, such a company shall be deemed to be
16

carrying on speculation business to the extent to which the business consists of the purchase and
sales of shares.
However, this deeming provision does not apply to the following companies
1) A company whose gross total income consists of mainly income chargeable under the heads
Interest on securities, Income from house property, Capital gains and Income from other
sources.
2) A company, principle business in which is
i) the business of trading in shares; or
ii) the business of banking; or
iii) the grating of loans and advances.
Thus, these companies would be exempted from the operation of this explanation. Accordingly, if
these companies carry on the business of purchase and sales of shares of other companies, they
would not be deemed to be carrying on speculation business.
Transactions of trading in derivatives entered into on recognized stock exchange through a broker,
or SEBI recognized intermediary and supported by a time stamped contract note is excluded from
the definition of speculative transaction u/s. 43(5)(d). Thus, loss from such transactions can be set
off against any other income.
In simple words, Trading in derivatives shall not to be treated as speculation business.
It may be noted that the losses on derivatives trading were treated as speculation losses upto a/y
2005-06. The profit/losses on derivative trading are treated as normal business income/losses from
a/y 2006-07. Therefore the losses on derivative incurred upto a/y 2005-06 can not be setoff against
the profit form derivative trading in a/y 2006-07 and future assessment years speculation losses cant
be set=off against non speculative income.

17

 Trading in commodity derivatives carried out in a recognized association and chargeable to

commodities transaction tax under Chapter VII of the Finance Act, 2013 shall not be considered to
be a speculative transaction
c) Order of set-off of losses
As per provisions of section 72(2), brought forward business loss is to be set-off before setting off
unabsorbed deprecation. In case where profits are insufficient to absorb brought forward losses,
current depreciation and current business losses, the same should be deducted in the following
order :
i) Current year depreciation/ current year capital expenditure on scientific research and current year
expenditure on family planning, to the extent allowed.
ii) Brought forward loss from business/profession.
iii) Unabsorbed expenditure on family planning
iv) Unabsorbed depreciation
v) Unabsorbed capital expenditure on scientific research
d) Important notes on capital gains
Capital gain resulted from the transfer of an depreciable asset held for a period of more than three
years, can be set off against the brought forward loss from the long term capital assets.
Losses of the taxable long term capital gains to be set off only taxable long term capital gains and
not against exempt long term capital gains. However set-off of indexed long term capital loss can be
set off against long term capital gain without indexation.
Long-term Capital Gains in respect of equity shares sold in recognized stock exchange and units of
equity oriented mutual fund which has suffered Securities Transaction Tax (STT) are exempt u/s.

18

10(38) with effect from 1/10/2004.

However long term gains is not exempt in case where STT is not paid on sale e.g. off market
transactions, off market buyback, etc.
f) Loss when clubbing provision apply
When clubbing provisions apply, loss is required to be clubbed in the same manner as income.
Such clubbed loss can be set off and carried forward, as if it is loss determined in the taxpayers own
case. The successor of business can carry forward and set off the loss of his predecessor, if such
succession is by way of inheritance.
Business income of wife or minor child, clubbed under provision of section 64, with the income
of assessee can be set off against any loss brought forward by assessee in respect of a business
carried on by himCIT v. J.H. Gotla [1985] 156 ITR 323 (SC).
f) Other Issue
Loss can be carried forward by the assesses who incurs the loss
Exceptions

Accumulated business loss of an amalgamating company/demerged (section 72A).

Accumulated loss of a proprietary concern or a firm when its business is taken over by a
company by satisfying conditions of section 47(xiii)/(xiv) (section 72A).

Accumulated business loss of a demerged company

Loss of business acquired by inheritance (section 78).CIT v. Bai Maniben [1960] 38 ITR 80
(Bom.).

Loss cannot be carried forward for more than eight assessment years

19

Exceptions

Unabsorbed business loss in respect of rehabilitated business referred to in section 33B (such
loss can be carried forward for eight assessment years after the business is revived including
the year of revival).

Unabsorbed business loss in respect of non-speculation business discontinued and after

discontinuation there is receipt deemed as business income u/s 41(1), (3),(4) or (4A) [(section
41(5)].

CHAPTER 3
SET-OFF AND CARRY FORWARD OF LOSSES OF BANKING
COMPANY

A banking company may set-off and carry forward its losses upto a period of 10 years if the
following conditions are fulfilled:
i) The banking company is wholly owned by the Federal Government as on 01- 06- 2002
ii) It has been approved by the State Bank of Pakistan (SBP) for banking business.

20

iii) Loss occurred during the period of 01-07-1995 to 30-06-2001.

Group Taxation: [59AA]
1) Holding companies and subsidiary companies of 100% owned group may opt to be taxed
as one fiscal unit. In such cases, besides consolidated group accounts as required under the
Companies Ordinance, 1984, computation of income and tax payable shall be made for tax
purposes.
2) The companies in the group shall give irrevocable option for taxation under this section as
one fiscal unit.
3) The group taxation shall be restricted to companies locally incorporated under the
Companies Ordinance, 1984.
4) The relief under group taxation would not be available to losses prior to the formation of
the group.
5) The option of group taxation shall be available to those groups companies which comply
with such corporate governance requirements as may be specified by the Securities and
Exchange Commission of Pakistan from time to time and are designated as company entitled
to avail group taxation.
6) Group taxation may be regulated through rules as may be made by the Board.
Set Off and Carry Forward of Losses under Group (Group relief):[59B]
1) Subject to sub-section (2), any company, being a subsidiary of a holding company, may
surrender its assessed loss (excluding capital loss) for the tax year (other than brought
forward losses and capital losses), in favour of its holding company or its subsidiary or
between another subsidiary of the holding company:
Provided that where one of the company in the group is a public company listed on a
registered stock exchange in Pakistan, the holding company shall directly hold 55% or more
21

of the share capital of the subsidiary company. Where none of the companies in the group is a
listed company, the holding company shall hold directly 75% or more of the share of capital
of the subsidiary company.
2) The loss surrendered by the subsidiary company may be claimed by
the holding company or a subsidiary company for set off against its income under
the head Income from Business in the tax year and the following two tax years
subject to the following conditions, namely:
a) There is continued ownership for five years, of share capital of thesubsidiary company to
the extent of 55% in the case of a listed company, or 75% or more, in the case of other
companies;
b) A company within the group engaged in the business of trading shall not be entitled to
avail group relief;
c) Holding company, being a private limited company with 75% of ownership of share
capital gets itself listed within three years (3) from the year in which loss is claimed;
d) The group companies are locally incorporated companies under the Companies Ordinance,
1984;
e) The loss surrendered and loss claimed under this section shall have approval of the Board
of Directors of the respective companies;
f) The subsidiary company continues the same business during the said period of three years;
g) All the companies in the group shall comply with such corporate governance requirements
as may be specified by the Securities and Exchange Commission of Pakistan from time to
time, and are designated as companies entitled to avail group relief; and

22

h) Any other condition as may be prescribed.

3) The subsidiary company shall not be allowed to surrender its assessed losses for set
off against income of the holding company for more than three (3) tax years.
4) Where the losses surrendered by a subsidiary company are not adjusted against income of
the holding company in the said three tax years, the subsidiary company shall carry forward
the unadjusted losses in accordance with section 57.
5) If there has been any disposal of shares by the holding company during the aforesaid
period of five (5) years to bring the ownership of the holding company to less than 55% or
75%, as the case may be, the holding company shall, in the year of disposal, offer the amount
of profit on which taxes have not been paid due to set off of losses surrendered by the
subsidiary company.
6) Loss claiming company shall, with the approval of the Board of Directors, transfer cash to
the loss surrendering company equal to the amount of tax payable on the profits to be set off
against the acquired loss at the applicable tax rate. The transfer of cash would not be taken as
a taxable event in the case of either of the two companies.
7) The transfer of shares between companies and the share holders, in one direction, would
not be taken as a taxable event provided the transfer is to acquire share capital for formation
of the group and approval of the Security and Exchange Commission of Pakistan or State
Bank of Pakistan, as the case may be, has been obtained in this effect. Sale and purchase
from third party would be taken as taxable event.

23

CHAPTER 4
SET OFF OF BUSINESS LOSS CONSEQUENT TO AMALGAMATION

1) The assessed loss (excluding capital loss) for the tax year, other than brought forward and
capital loss, of the amalgamating company or companies shall be set off against business
profits and gains of the amalgamated company, and vice versa, in the year of amalgamation
24

and where the loss is not adjusted against the profits and gains for the tax year the unadjusted
loss shall be carried forward for adjustment upto a period of six tax years succeeding the year
of amalgamation.
2) The provisions of sub-section (4) and (5) of section 57 shall,mutatis mutandis, apply for
the purposes of allowing unabsorbed depreciation of amalgamating company or companies in
the assessment of amalgamated company and vice versa.
Provided that the losses referred to in sub-section (1) and unabsorbeddepreciation referred to
in sub-section (2) shall be allowed set off subject to the condition that the amalgamated
company continues the business of the amalgamating company for a minimum period of five
years from the date of amalgamation.
2A) In case of amalgamation of Banking Company or Non-banking Finance Company,
Modarabas or insurance company, the accumulated loss under the head Income from
Business (not being speculation business losses) of an amalgamating company or companies
shall be set off or carried forward against the business profits and gains of the amalgamated
company and vice versa, up to a period of six tax years immediately succeeding the tax year
in which the loss was first computed in the case of amalgamated company or
amalgamating company or companies:
Provided that the provisions of this sub-section shall in the case of Banking companies be
applicable from July 1, 2007.
3) Where any of the conditions as laid down by the State Bank of Pakistan or the Securities
and Exchange Commission of Pakistan or any court, as the case may be, in the scheme of
amalgamation, are not fulfilled, the set off of loss or allowance for depreciation made in any
tax year of the amalgamated company or the amalgamating company or companies shall be
deemed to be the income of that amalgamated company 7[or the amalgamating company or
companies, as the case may be, for the year in which such default is discovered by
the Commissioner or taxation officer, and all the provisions of this Ordinance shall apply

25

accordingly.

CHAPTER 5
LOSSES OF BUSINESS EXEMPT FROM TAX

26

There are two types of business exempted from tax:

1) Business permanently exempt from tax:
Losses of such business may not be set-off or carried forward. Under the Income Tax
Ordinance, 2001, if an income from a source is exempt from tax, the loss from such source
may not be set-off or carried forward.
2) Business exempt for a specific period (Tax holiday)
A loss incurred during the exemption period may be carried forward and set off after the
expiry of exemption period. Such losses may be carried forward upto a period of six years

CHAPTER 6
SECTION 32(2): SET OFF AND CARRY FORWARD OF UNABSORBED
DEPRECIATION
27

With effect from AIY 2002-03 depreciation which remains unadjusted as either there is no
income or less income in the relevant previous year, it can be carried forward till it is fully
adjusted from any income during the succeeding previous years. It shall be treated as
depreciation of the succeeding previous year.

In case there is C/F business as will as C/F unabsorbed depreciation, then his following order
should be followed for set off.

(t) Firstly Current depreciation

(u) Secondly Brought forward business loss

(iii) Thirdly Brought forward/unabsorbed depreciation.

The respected SC IN CASE OF VIRMANI INDUSTRIES LTD. V CIT has set the following
rules and steps for set off and carry forward of unabsorbed depreciation

Step 1: Where there is current years depreciation relating to a business then it should be set
off from the amount of profits the same business.
Step 2: If full depreciation can not be set off under step 1 then set off the unabsorbed
depreciation against the profits of any business or from income of profession carried on by
the assessee.

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Step 3: If still full depreciation cannot be set off under step 2 then it can be set off from the
incomes of any other head of income, except from the income under the head salary and
winning from lotteries etc.
Step 4: If full deprecation cannot be set off under step 3 then it shall be carried forward to
next previous year.
Step 5: Add such unabsorbed depreciation to the amount of depreciation of such previous
year in which it has been brought forward. Brought forward depreciation shall be treated as
part of current years depreciation. Now set off aggregated depreciation as per steps 1 to 3.
Step 6: Repeat steps 1 to 5 without any time limits. This means that unabsorbed depreciation
can be carry forwarded for unlimited period of time.
However step 5 and 6 are subject to the conditions of section 72(1). This means that if there
is any brought forward loss of the business then it shall be set off in priority to such
unabsorbed depreciation.

CHAPTER 7

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SUMMARISATION
While one endeavors to derive income, the possibility of incurring losses cannot be ruled out.
Based on the principles of natural justice, a set-off should be available for loss incurred. The
income tax laws in India recognise this and provide for adjustment and utilisation of the
losses. However, there are conditions which have been introduced to prevent misuse of such
provisions.
To the common taxpayer, income tax is a crunch into the income earned. Accordingly,
awareness of the relevant provisions pertaining to set off and carry forward of losses is
essential in order to maximize tax benefits. The relevant provisions have been summarised
here:
A) Set off of loss under the same head of income.(section 70) (Intra-head set off)
The process of adjustment of loss from a source under a particular head of income against
income from other source under the same head of income is called intra-head adjustment, e.g.
Adjustment of loss from business A against profit from business B.
Income of a person is computed under five heads. Sources of income derived by an
individual may be many but yet they could be classified under the same head. For instance,
an individual may have a dual employment, yet the income would be classified under the
head Salaries. However, given the mechanism of computing taxable salary income, it would
be safe to say that an individual cannot incur losses under this head of income.
Consider a situation where Harsh has two properties one, occupied by him and the other, let
out. Harsh pays interest on loan of Rs 1.50 lakh on the property occupied and derives net
rental income of Rs 1.50 lakh from the let-out property. In case of a self-occupied property,
income is computed as nil and interest expenditure results in loss. The loss of Rs 1.50 lakh
can be set off against rent income of Rs 1.50 lakh; the income chargeable under the head
House property will be Nil.

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An exception to intra head set off is loss under the head Capital gains, which may arise
from transfer of any capital asset. Long-term capital loss arises from transfer of shares or
units where holding period is more than 12 months and in respect of other assets holding
period is more than 36 months prior to sale. Transfer of assets held for less than prescribed
period results in short-term capital loss. Long-term capital loss cannot be set off against
short-term capital gains.
Further, loss incurred from speculation loss (eg. from shares or commodities) cannot be set
off against any other income.
Also, it is unlikely that the benefit of set off of loss under an activity or source will be
available, where the income from an activity or source is exempt from taxation.
Summary of exceptions to Intra-head set off:
1.

Loss from speculation business cannot be set of against profit from an non speculation

business
(Interpretation: Loss from non speculative business can be set-off against speculation
income)
2.

LTCL can only be set off against LTCG and cannot be set off against STCG

(Interpretation: STCL can be set off against LTCG)

3.

No loss can be set-off against casual income i.e. Income from lotteries, crossword

puzzles, race including horse race, card game, and any other game of any sort or from
gambling or betting of any form or nature.
4.

No expenses can be claimed against casual income

5. Loss from the business of owning and maintaining race horses cannot be set off against
any income other than income from the business of owning and maintaining race horses.

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6.

Loss from an exempted source cannot be set off against taxable Income- If income from

a particular source is exempt from tax, then loss from such source cannot be set off against
any other income which is chargeable to tax. E.g., Agricultural income is exempt from tax,
hence, if the taxpayer incurs loss from agricultural activity, then such loss cannot be adjusted
against any other taxable income.
7. Loss from business specified under section 35AD cannot be set off against any other
income except income from specified business (section 35AD is applicable in respect of
certain specified businesses like setting up a cold chain facility, setting up and operating
warehousing facility for storage of agricultural produce, developing and building a housing
projects, etc.).
B) Set off Loss from one head against Income from another Head (Inter head set off)
After making intra-head adjustment (if any) the next step is to make inter-head adjustment. If
in any year, the taxpayer has incurred loss under one head of income and is having income
under other head of income, then he can adjust the loss from one head against income from
other head, E.g., Loss under the head of house property to be adjusted against salary income.
A person may have various sources of income computed under different heads of income.
Loss under one head of income is generally allowed to be set off against income under
another head.
For instance, X has only one property, which is occupied by him and the loss is Rs 1.50 lakh.
He derives salary of Rs 10 lakh during the year. Here, he can set off the loss of Rs 1.50 lakh
against his salary income by making appropriate declarations to his employer, thereby
making his net taxable income Rs 8.50 lakh.
Certain exceptions to the provisions are that the loss from business or profession cannot be
set off against salary income. Capital loss, whether long term or short term, can be set off
only against capital gains income.
Where during a given year, there is no sufficient income to absorb the loss, unabsorbed loss
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can be carried forward and set off against income, in the future years as explained here.
Summary of exceptions to Inter-head set off:
1. Before making inter-head adjustment, the taxpayer has to first make intra-head
2. Loss from speculative business cannot be set off against any other income. However, nonspeculative business loss can be set off against income from speculative business. For
Example: House property loss can be set-off against Speculative Incomes but speculation
loss cannot be set off against House property)
3.

Business loss cannot be set-off against salary income. (It can be set-off against other

incomes)
4. Loss under the head Capital Gains (LTCL or STCL) cannot be set-off against any other
head.
(Interpretation: Loss from other heads can be set-off against Capital Gains)
For Example: HP loss can be set-off against CG but LTCL or STCL cannot be set off against
HP
5. No loss can be set off against Casual income from winnings from lotteries, crossword
puzzles, race including horse race, card game, and any other game of any sort or from
gambling or betting of any form or nature.
6.

No expenses can be claimed against casual income

7. Loss from the business of owning and maintaining race horses cannot be set off against
any other income.
8.

Loss from an exempted source cannot be set off (e.g. Share of loss of firm, agricultural

income, cultivation expenses)

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9. Loss from business specified under section 35AD cannot be set off against any other
income (section 35AD is applicable in respect of certain specified businesses like setting up a
cold chain facility, setting up and operating warehousing facility for storage of agricultural
produce, developing and building housing projects, etc.)
C) Carry forward and set off of losses
Carry forward of unadjusted loss for adjustment in next year
Many times it may happen that after making intra-head and inter-head adjustments, still the
loss remains unadjusted. Such unadjusted loss can be carried forward to next year for
adjustment against subsequent year(s) income Separate provisions have been framed under
the Income-tax Law for carry forward of loss under different heads of income.
Unabsorbed loss under house property, capital loss and business loss can be carried forward
for 8 years. Unabsorbed speculation business loss can be carried forward only for a period of
4 years.
Loss can be carried forward and set off even if the business in respect of which it was
incurred has been discontinued. However, such loss cannot be set off against income under
any other head. An exception exists in respect of unabsorbed depreciation from business
which can be set off against any other source of income in the absence of business income
and can be carried forward indefinitely, even if the business through which depreciation was
incurred has ceased to exist.
Carry forward of losses (other than loss from house property and unabsorbed depreciation) is
permissible if the return of income for the year, in which loss is incurred, is filed in time. The
late filing of return should not impact the status of carry forward of loss of previous years.
When clubbing provisions apply, loss is required to be clubbed in the same manner as
income. Such clubbed loss can be set off and carried forward, as if it is loss determined in the
taxpayers own case. The successor of business can carry forward and set off the loss of his

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predecessor, if such succession is by way of inheritance.

In light of the above, taxpayers are advised to be mindful of the relevant provisions and seek
guidance, where required, to effectively utilise their losses and achieve optimum tax results.
Conditions in brief related to carry forward and set-off of losses :1. Past year losses can be set-off against income from that respective head of income (Inter head
adjustment is not possible)
(e. g. Unadjusted loss of HP for the year 2004-05 c/f Rs. 20,000. This loss can be set-off only
against HP income of the year 2007-08 and not under any other head)
1. The above rule (1) is not applicable to unabsorbed depreciation, which can be set-off against
any other head
2. All losses (Except loss due to owning and maintaining of race horses) can be carried forward
and set-off for 8 subsequent financial years following the Previous Year in which such loss
arose.
3. Unadjusted loss due to owning and maintaining of race horses can be carried forward and
set-off for 4 subsequent financial years following the Previous Year in which such loss arose.
4. Unabsorbed depreciation can be carried forward for an unlimited period.
D) Order of Set-off of losses
In case where profits are insufficient to absorb brought forward losses, current depreciation
and current business losses, the same should be deducted in the following order

Current scientific research expenditure [Sec. 35(1)].

Current depreciation [Sec. 32(1)].

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Brought forward business losses [Sec. 72(1)].

Unabsorbed family planning promotion expenditure [Sec. 36(1)(ix)].

Unabsorbed depreciation [Sec. 32(2)].

Unabsorbed scientific research capital expenditure [Sec. 35(4)].

Unabsorbed development allowance [Sec. 33A(2)(ii)].

Unabsorbed investment allowance [Sec. 32A(3)(ii)].

Important Case laws:

Losses in illegal business must be taken into account for computation of real profits of the
illegal business. However loss for illegal business cannot be set off against profits of legal
business CIT v/s Kurji Jinabhai Kotecha (1977) 107 ITR 101 (SC).

Losses in one business can be set off from profits in another business CIT v/s Muthuram
Chettiar (1962) 44 ITR 710(SC).

Loss of dead business cannot be set off against the gains of a going concern
C.G.A (Punjab) Ltd. v/s CIT (1937) 5 ITR 279 (Lahore) & South Indian Industrials Ltd.
(1935) 3 ITR 11(Mad) (applicable upto A.Y.1999-2000).

Loss from exempt source of income cannot be set off against income from a different source
or

income

under

CIT v/s Thiagarajan (1981) 129 ITR 115 (Mad)

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different

head

Partial set off and partial carry forward is not permissible Atherton & Company v/s CIT
(1989) Tax LR 13 (Cal.).

Unabsorbed loss to be carried forward without interruption Hiralal Jeramdas v/s CIT
(1965) 58 ITR 1 (Bom.)

No option given to assessee to show profit as income from one source and carry forward the
loss from another source of income to the next year CIT v/s Milling Trading Company. (P)
Ltd. (1994) 76 Taxman 389 (Guj.)

Loss from exempt source of income cannot be carried forward (CIT v/s Harprasad & Co. (P)
Ltd. (1975) 99 ITR 118 (SC).

Current depreciation must be deducted first before deducting the unabsorbed carried forward
business losses of earlier years CIT v/s Mother India Refrigeration Industries (P) Ltd. 155
ITR 711 (SC)

Whether losses may be carried forward and set off in the following year u/s 72 to be
determined by the assessing officer dealing with the assessment in the subsequent year (CIT
v/s Manmohan Das (1966) 59 ITR 699 (SC)

Carry forward of losses returns allowable even if return of losses is filed within extended
period prescribed u/s 139(3) of the Act (I.e within one year from the end of the assessment
year) [CIT v/s Glucose Products Ltd. (2001) 250 ITR 512(AP)]

The term inheritance means only a transmission of the assets and liabilities of one person
to another by the personal law applicable to them and not by any other mode of transfer
known to lawHindustan Aeronautics Ltd. v. CIT [1983] 15 Taxman 265 (Kar.).

Where legal heirs of a deceased-proprietor enters into partnership and carries on the same
business in the same premises under the same trade name, there is succession by inheritance
as contemplated in section 78(2) and assessee-firm is entitled to carry-forward and set-off of
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the deceaseds business loss against its income for subsequent yearsCIT v. Madhukant M.
Mehta [2002] 124 Taxman 130 (SC).

Loss incurred in speculative business in banned items cannot be carried forward to the next
yearCIT v. Kurji Jinabhai Kotecha [1977] 107 ITR 101 (SC).

A transaction cannot be described as a speculative transaction where there is a breach of

contract and on a dispute between the parties damages are awarded as compensation by an
arbitration awardCIT v. Shantilal (P.) Ltd. [1983] 14 Taxman 1 (SC).

CONCLUSION

As we have seen different heads of income and their provision related to set off and carry
forward, we can say that loss should be set off inter source in the same AY and if still there is
a loss then only inter head set off is allowed. After completing first two steps only if any loss
remains then it will be carry forward and will set off in next AY under the same head of
income and not different head. But there still exception to it for example Losses in
Speculation Business can only be set off against the same head for that particular AY.

BIBILOGRAPHY
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http://taxguru.in/income-tax/carry-set-losses-tabular-form-faqs.html
http://i2biz.blogspot.in/2010/03/set-off-and-carry-forward-of-losses.html

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