Set-off

&
Carry forward of losses

Ranjan Kumar Bhowmik FCMA

Member
National Board of Revenue

[1] Introduction

An assessee may have multiple sources of income. It is very common that loss will not generate
from each head. Thus losses from one head may be adjusted with income from other heads so
that net figure results income and tax can be imposed on it. However, if the total income from all
heads results losses, set-off cannot be done. In such a situation, loss of one year can be carried
forward to subsequent year or years for set off.

Set-off and carry forward of losses is practically significant to compute total taxable income and
these are the benefits enjoyed by assessees to cover up their losses before paying taxes to the
government. Set-off means the coverage of loss under one head against another head in a
specific year. Carry forward is the transferring of loss of one year to the succeeding year or years
for coverage if set-off was not possible or insufficient. Such set-off and carry forward facility can
be availed provided that certain conditions are fulfilled. After carry forward, losses from any head
cannot be set-off against income from any other heads and losses cannot be carried forward for
unlimited period. This paper presents these two issues in detail.

a) Set-off
b) Carry forward and then set-off

[2] Set-off of losses

Where, in respect of any assessment year, the net result of computation of income under any
head is a loss, the assessee shall, subject to certain exceptions, be entitled to have the amount
of such loss set off against his income, if any, assessable for that assessment year under any
other head. Loss sustained in any year under one head should be set-off against income under
another head in that year in order to arrive at the true total income of the assessee.

If after setting off losses against income under the same head the net result is still a loss, such
loss may be set-off against income of the same year under any other head. Second proviso of
section 37 provides that in computing any loss to be set-off any subsidy received in cash shall be
deducted from the loss and the resulting loss only shall be set-off.

Set-off & carry forward of losses Hand out prepared by Ranjan Kumar Bhowmik FCMA Member, NBR as on 21/03/2020 Page 1
The table produced below may be used as a short-cut guideline for set-off of losses:

Reference
Loss Restrictions to Set-off against
section
1. Business loss [1] Income from house property Section 37
(3rd proviso)
[2] Capital Gain Section 37
(1st proviso)
[3] Business income as per provision of section Section 30B
30B on disallowances under section 30
2. Speculation [1] Any income. Section 37
business loss [2] Set-off is only possible if there is income from (1st proviso)
another speculation business
4. Capital loss [1] Any income. Section 37
[2] Set-off is only possible if there is another (1st proviso)
capital gain during the year
6. Agricultural loss Capital gain Section 41
7. Loss at tax-free Any taxable income Section 37
income (1st proviso)
8. Loss at any head Any income Section
where minimum tax 82C(2)(e)
u/s 82C is applicable
9. Loss under any head Tobacco manufacturing business income Section 37
(4th proviso)

[3] Carry forward of losses

Carry forward is the transferring of loss of one year to the succeeding year or years for coverage
if set-off was not possible or insufficient. There are 4 types of losses which can be carried
forward for set-off against the same heads of income. These are:

[1] Business loss [Section 38]

[2] Speculation business loss [Section 39]
[3] Capital loss [Section 40]
[4] Agricultural loss [Section 41]

There is no provision of carry forward of the following losses:

[1] Salary loss [Though salary loss is not possible]

[2] Loss from interest on securities
[3] House property loss
[4] Loss under the head ‘Income from other sources’

[4] Carry forward of business loss and unabsorbed depreciation allowances [Section 38]

If business loss cannot be set-off under section 37 because of the absence or inadequacy of
income under any other head, it may be carried forward and set-off against the profits of a
subsequent year. The right of carry forward of business loss is subject to the following
restrictions:

[a] Loss cannot be carried forward beyond 6 successive years.

However as per section 42(6) unabsorbed depreciation allowances can be carried forward to any
subsequent year without any time limit. The unabsorbed depreciation is deemed to be part of the

Set-off & carry forward of losses Hand out prepared by Ranjan Kumar Bhowmik FCMA Member, NBR as on 21/03/2020 Page 2
depreciation allowance for a subsequent year and will enter into the computation of the income of
such subsequent year.

Section 42(7) requires that losses which have been carried forward from past years should first
be set-off against business profits and if any balance of profits still remains, then unabsorbed
depreciation allowances of past years can be carried forward under section 42(6) for set-off
against such balance of profit. The similar guideline given at 3 rd schedule [para-9(2)]

Loss during the tax holiday period cannot be carried forward beyond the tax holiday period as
mentioned at section 46BB (9) and 46CC (7)

[b] Loss may be carried forward and set-off against the profits and gains of the same business
or profession as that in which the loss was incurred.

[c] The business or profession in which the loss was originally sustained should continue to be
carried on by the assessee in the year in which the carried forward loss sought to be set-off.

Income from business or profession which has been discontinued at any time before the
commencement or during the courses of the said income year shall be chargeable to tax under
section 19(6) of ITO,1984 and the business shall be deemed to have been carried on during the
year. But no provision has been made for set-off of unabsorbed loss carried forward in that year.

The right of carry forward is still conditional upon the continuance of business in which the loss
was incurred. This condition necessarily involves the question whether a business carried on by
the assessee in a subsequent year is the same as the business in which the loss was incurred.

The right of carry forward and set-off of losses continues only so long as the business continues.
The right would be lost if the business ceases to be carried on. Therefore, if the business is
discontinued by the assessee, the loss which has been carried forward cannot be set-off against
the profits of any other business even if such other business was also carried on by the assessee
at the time when the loss was incurred. [CIT vs. International Industries Ltd. [1952] 22 ITR 44]

[d] The loss can be carried forward and set-off only against the profits of the assessee who
incurred the loss. The person who incurred the loss alone has the right to carry forward the same
and the successor in business cannot claim to carry forward the loss incurred by the predecessor
in business. The only exceptional case is that of succession by inheritance as mentioned at
section 42(4) of ITO,1984.

[5] Carry forward of speculative business losses [Section 39]

Speculative business is defined at section 2(61) where speculative transections carried on by an

assessee are of such a nature as to constitute a business; the business is regarded as
speculation business. If speculative business loss cannot be set-off under section 37 because of
the absence or inadequacy of income under the same head, it may be carried forward and set-off
against the speculative business profits of a subsequent year. The right of carry forward of
business loss is subject to the following restrictions:

[a] Loss cannot be carried forward beyond 6 successive years.

[b] Loss in a speculation business can be carried forward to a subsequent year and set-off only
against the profits of any speculation business carried on in that year, even if the profits are of a
speculation business in which the loss had been incurred.

[c] Like other business losses the right of carry forward of losses in speculation business only so
long as the speculation business continues. The right would be lost if the speculation business
ceases to be carried on.

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[6] Carry forward of Capital loss [Section 40]

If an assessee invests in a capital asset but sells it at a lower amount within the year to another
person the loss would be considered as capital loss. He has neither the right to set-off such loss
against income under any other head in the same year nor he has the right to carry forward against
for set-off against any business income of a subsequent year, while a business has both the rights.

If capital loss cannot be set-off under section 37 because of the absence or inadequacy of gain
under the same head, it may be carried forward and set-off against the capital gain of a
subsequent year. The right of carry forward of capital loss is subject to the following restrictions:

[a] Loss cannot be carried forward beyond 6 successive years.

[b] Capital loss can be carried forward to a subsequent year and set-off only against the capital
gain in that year.

[c] In the case of any assessee, the net loss relating to capital asset cannot be carried forward in
any case if the loss does not exceed Tk. 5,000. And where it exceeds Tk.5,000 only so much of
such loss shall be carried forward as exceeds Tk.5,000.

[7] Carry forward of Agricultural loss [Section 41]

If agricultural loss cannot be set-off under section 37 because of the absence or inadequacy of
income under any other or the assessee has only income under the head ‘capital gain’ such loss
may be carried forward and set-off against the agricultural income of a subsequent year. The
right of carry forward of agricultural loss is subject to the following restrictions:

[a] Loss cannot be carried forward beyond 6 successive years.

[b] Agricultural loss can be carried forward to a subsequent year and set-off only against the
agricultural income in that year.

[8] Carry forward of Partnership firm’s losses [Section 42]

In the case where the assessee is a firm, tax is levied on the firm directly as a distinct unit of
assessment. Any loss incurred by a firm may be set-off during the year by the firm itself against its
income from any other head and unabsorbed loss may be carried forward by the firm for set-off
against its profit in a subsequent year but no individual partner has the right to set-off his share of
the firm’s loss against his own income nor he has the right to carry forward his share of the firm’s
loss.

Generally the successor in business cannot claim to carry forward and set-off the loss of his
predecessor. The exception is the case where the succession is by inheritance. The heir would be
entitled to carry forward the loss incurred by the previous owner. The same principle is applicable
for partnership firm also. The firm shall not be entitled to carry forward and set-off so much of the
loss proportionate to the share of a retired or deceased partner.

Sources: [1] Income Tax Ordinance, 1984

[2] Court case references

The End

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