How To Carry Forward Business Loss
It is obvious that business profit cannot be computed without allowing a business loss. Hence, the Income Tax Act has provisions for business loss setoff. In this article, we look at the different types of business loss and its implication under the Income Tax Act.
Trading Loss
A business trading loss is deductible in computing the profit earned by a business if the following conditions are satisfied:
- The loss should be a real loss and not notional or fictitious.
- The loss should be a loss on revenue account and not on the capital account.
- The loss must have actually arisen and been incurred, not merely anticipated or certain to occur in the future.
- The loss should be one that is incidental to the carrying on of the business and must arise or spring directly from or be incidental to the carrying out of an operation of the business.
- There should be no prohibition in the Income Tax Act, against its deductibility.
Business Loss Allowed under Income Tax
The following types of business loss are considered to be incidental to the business and are deductible under the Income Tax Act.
- Loss on account of embezzlement by an employee is allowed as a deduction in the year in which such embezzlement is discovered.
- Loss of stock-in-trade by fire or other natural calamities or due to the negligence of employees is deductible.
- Loss on account of robbery or theft provided it is in the course of business and incidental to the trade is deductible.
- Loss caused on account of fluctuation in exchange rate at the time of remitting the money for purchase of raw material is deductible.
- Loss caused due to non-recovery of advances made in the course of business, providing it is a trading loss is deductible under the Income Tax Act.
- Loss caused due to a breach of contract for delivery of goods by either party is deductible.
- Loss of raw material or finished goods in transit is tax deductible.
- Loss caused by forfeiture of security deposits given at the time of submission of tenders is deductible.
- Loss by the failure of a bank in which money is deposited is tax deductible.
- Any loss incurred due to non-recovery of advance given to salvage the capital, if it is in the revenue field, is an admissible deduction.
Business Loss Not Allowed under Income Tax
The following types of business loss are not deductible from business income:
- Loss sustained before the business is commenced
Losses incurred in the closing down of a business. Losses incurred due to damage, destruction, etc., of capital assets. A loss which is not incidental to the carrying on of the business of the assessee. Loss due to the sale of securities held as investments as it will be a capital loss and not the business loss. Loss caused by forfeiture of advance given for purchase of capital assets. Violation of law is not a normal incident of trade and an expense incurred by way of penalty for infraction of laws is not deduction as a business loss. Trading loss due to loss of goods in transit in the normal course of business. Period of Business Loss Carry Forward
Business loss can be carried forward for a period of 8 years. However, each year’s loss must be treated as a separate loss.
Though business loss can be carried forward for eight years only, the following types of expenses can be carried forward indefinitely:
- Unabsorbed depreciation.
- Unabsorbed capital expenditure on scientific research.
- Unabsorbed expenditure on family planning.
Order of Set Off of Business Loss
As mentioned above, unabsorbed depreciation, unabsorbed capital expenditure on scientific research and unabsorbed expenditure on family planning can be set off. However, a business loss must be set off before set off of unabsorbed expenses. Therefore, the order of set off of business loss is as under:
- Current year depreciation.
- Current year capital expenditure on scientific research and current year expenditure on family planning to the extent allowed.
- Brought forward business or profession losses.
- Unabsorbed depreciation.
- Unabsorbed capital expenditure on scientific research.
- Unabsorbed expenditure on family planning.
Due Date for Filing Loss Return
Income tax return in which loss is declared must be filed before the due date to carry forward the business loss. If a loss return is filed after due date, the amount of business loss mentioned in the return cannot be carried forward.
Business Loss Must Be Adjusted Against Business Income
Business loss can be carried forward to the subsequent assessment year and set off only against business income of the subsequent year. Also, business loss can be adjusted against business income from any other head of income except salary in the same assessment year. However, when the business loss is carried forward to the subsequent year, it can be adjusted only against business income.
Business May or May Not Be Continued
The business loss can be carried forward and set off in the subsequent year even if the business which incurred the loss is not carried on, in which the loss is sought to be carried forward and set off.
Business Loss Can Be Set Off Only By Assessee Who Incurred the Loss
Only the person who has incurred the loss can use the brought forward business losses for set off. Hence, business loss can be set off only by the same assessee and cannot be transferred to another entity or person. However, the following are exceptions to the above condition:
Inheritance: If a business is carried on by one person and is acquired by another person through an inheritance, the loss can be carried forward by the successor. However, such a business loss can be carried forward by the successor only for the balance number of years for which the original assessee could have carried forward the loss.
Amalgamation: Business losses and unabsorbed depreciation of an amalgamating company can be set off against the income of the amalgamated company.
Conversion of Proprietorship or Partnership into a Company: In case of a reorganisation of a business whereby a proprietorship or a partnership firm is converted into a company, the accumulated business loss and the unabsorbed depreciation of the predecessor firm can be carried forward by the company.
Conversion of Company into LLP: If due to a business reorganisation, a private limited company or unlisted public company is succeeded by a LLP, then the business loss and unabsorbed depreciation of the predecessor company can be transferred to the LLP.