Past carried forward business loss can be set off against income arising from business or profession though assessable under some other head of income.

[C.A. DEV KUMAR KOTHARI]

Relevant references and links:

Sections  28, 71, 71A,71B ,72,73 and 74 of the Income-tax Act, 1961.

CIT Vs. Cocanada Radhaswami Bank Ltd 1965 -TMI - 49308 – (SUPREME Court). 

CIT vs. Excellent Commercial Enterprises & Investments Ltd. 2005 -TMI - 9541 – (DELHI High Court).

Digital Electronics Ltd. v. ACIT135 TTJ 419 (Mum ITAT) 

Income from business or profession may be of the following types:-

(1)   Regular business income like on purchase or sale of traded goods or on rendering of services;

(2)   Unearned income like interest earned on deposits made in the course of business or investments made in course of business for example securities and fixed deposits made for the purpose of business and deposited as security with third parties.  The income by way of interest or dividend received on such investments are profits or gains of business or profession.

(3)   Rental income in course of business – for example rent received from employees, contractors etc. for hiring or letting out of plant and machinery or buildings for business purposes.

(4)   Any incidental income arising in the course of business – profit or gains arising from business or profession but taxable under other heads of income.  Some incomes arises in the course of business or profession but they may be taxable under some other heads for example :-

(a)   In case of property dealer or developer rental income in the course of business is arising from the business or profession but may be taxable under the head “income from house property”.

(b)  Dividend or interest earned in respect of securities held as stock in trade in the course of business of trader or held in the course of other business like banking business, trading and manufacturing business wherein securities may have to be held for the purpose of business.  Such interest or dividend income arises from the business but may be taxable under the head “income from other sources or income from interest on securities”(when this head was in the statute book).

(c)   The businessman may sell some of his business assets like fixed assets used for   trading and manufacturing activity in the course of business.  The income may be taxable under the head capital gains but the fact remains that the profit or gain earned is arising from the business or profession carried by the assessee for example capital gain may arise on sale of plant and machinery used for the purpose of business.

(d)  In some cases a professional carrying out practice may be doing some profession work for some clients / parties on part time salaried basis, the employer-employee relationship exists, therefore, the income may be taxable under the head salaries but the earnings are in the course of exercise of profession though in capacity of an employee.

Such incomes is earned while carrying  business or profession.

The incomes as discussed earlier are arising from the exercise of the business or profession and they are business income in common and commercial parlance.  Therefore, they can be considered as business income u/s 28 read with section 145 of the I.T. Act, 1961.  However, sometimes these incomes are considered as income falling under some other heads like “income from house property”, “capital gains”, “other sources” or “salary”.  The assessee can also consider such income under the head “business or profession” as he may treat such receipts as a benefit or perquisite arising from the business or profession fallin within various clauses of section 28.  However, certain heads of income are specific and therefore, certain incomes though arising from business or profession are computed and included under some other heads. Even otherwise the AO may dispute and consider such income falling under other heads of income.

Requirement for set off of past loss is that the incomes should be in nature of profit or gains

In this regard the relevant part of section 72 reads as follows:-

Section 72. Carry forward and set off of business loss…………..

Sub-section (1) ……………..be carried forward to the  following assessment year,  and –

(i)    It shall be set off against the profit and gains, if any, of any business or  profession carried on by him and assessable for that assessment year.

(ii) if the loss can not be wholly so set off, the amount of loss not so set off shall be carried forward to the following assessment year and so on;

On reading of the above provision it is clear that the provision is mandatory as the words ‘shall be set off’ are used.  The profits and gains, if any of any business or profession is relevant and it is not necessary that such profits and gains should fall under the head “income from business or profession”.

Head wise set off is subsequently mentioned on review of other provisions of set off

We find that when a loss carried forward from earlier year is to be set off only against income falling under the same head of income then it has been specifically mentioned that in the relevant provision for example:-

Section 71A prescribes that the loss carried forward under the head “income from house property” should be set off against the income under that head (up to assessment year 1994-95)

As per section 71B loss under the head “income from house property” assessable for subsequent year although in this new section which came into effect from assessment year 1999-2000.  The word head of income is not used however, the wordings income from house property implies the income from house property taxable under that head.  However, it appears that a case can be made out to set off loss under the head income from house property carried forward in earlier years against income from house property arising in subsequent year which may be assessable under the head “business or profession” but the past loss fall under the head income from house property can also be set off.

In section 73 it has been specifically mentioned that speculation loss carried forward shall be set off against the profits and gains if any of speculation business.

In section 74 it has been specifically mentioned that carried forward loss under the head “capital gains” shall be set off only against income under the head “capital gains” in subsequent year.

The above schemes of provisions  clearly shows that when individual set off under specific head is contemplated the provisions have been drafted accordingly.  In case of business or profession we find that income being profit or gains should arise from business or profession though they may be assessable under some other heads of income.

Income arising from business may fall under other heads of income:

As discussed earlier  it is usual that income is earned from business and in course of business and while carrying business from properties or assets held  or carry some activities earning of which may fall as taxable under  some other head like income from house property, income from capital gains and income from other sources. However fact may remain that the income is earned from business carried by assessee.

For example a property dealer or developer may let out some properties for some time to earn some income so that inventory carrying costs are reduced, some gains are made and property is held for some time to sell when its price improves. Therefore, holding of property is for the purpose of business and in the interest of business there is some temporary letting out of property to earn some income by way of rent from property owned. This rental income will fall under the head ‘income from house property’.

Similarly suppose some machinery are given to others for temporary use, the rental income may fall under the head ‘other sources’. Similarly interest on securities like bonds, debentures, fixed deposits may be taxable under the head ‘other sources’. However fact remains that the income is earned from business carried by assessee.

Two aspects of income arising from business:

Income arising from business is one aspect, and its inclusion in taxable income through any head of income other than income from business and profession, is another legal aspect as per the scheme of Income Tax Act. However, fact remain that as per general and commercial understanding it is considered that the income is income from business carried by business man. There is a difference between simple earning of rent from property owned and let out by an investor in property and letting out of property by a person who acquired and hold property for the purpose of business of trading or other adventure in nature of trade, commerce or industry.

Set off is permissible:

As per discussion of provisions referred to earlier the current business loss can be set off against income from capital gains, house property and other sources even if such income are not earned while carrying business. However, once business loss is carried forward, it can be set off only against income earned from business in subsequent years. The requirement is that income should be earned from business. There is no requirement that the income should also be taxable under the head ‘business’.

If rental income or interest is earned but such earning is not from business, then past carried forward business loss shall not be set off.

However, when rental income is earned from business carried by assessee say by letting out stock-in-trade, or interest is earned on fixed deposits connected with business e.g. FDR taken for margins, then such rental income and interest income are arising from business.

Similarly suppose certain business assets are sold and capital gains are earned, the income may fall under the head ‘capital gains’, but fact remain that the capital gains arose from business carried by assessee.

These may be taxable under the head income from house property or other sources or capital gains, but fact is that all such income are earned while carrying business.  

For eligibility of set off of past loss- the condition is income from business:

For set off of past business loss, the only condition laid down in S. 72 (1) (i) is that the income should be earned from business and head of income to which such income belongs will not make any difference. When such income arose from the business carried and in course of business,  past business losses are also eligible for set off against such  income, though computed under head ‘income from house property’, capital gains or other  sources.

The setoff of past business loss is permissible as per clear provisions of  S. 72 (1) (i) and also as per  law clarified and settled long ago  in  CIT Vs. Cocanada Radhaswami Bank Ltd 1965 -TMI - 49308 – (SUPREME Court). 

Judgment of Delhi High Court – In CIT vs. Excellent Commercial Enterprises & Investments Ltd. 2005 -TMI - 9541 – (DELHI High Court) the question arose as to whether dividend earned on shares held by a share trader can be set off against the past business losses .  The facts were as follows:-

The assessee-company was engaged in trading in shares.  During the assessment year 1996-97 it had not done any business of sale and purchase of shares and had derived only dividend income.  The assessee had brought forward the loss and claimed the set-off of the same against the dividend income.  The claim was disallowed by the Assessing Officer and an addition thereto was made.  On appeal., The Commissioner (Appeals) held that since the dividend income arose from the stocks that were held as business commodity traded in, income whether directly arising out of such commodity on its sale or income arising incidental to holding shares as stock-in-trade, would constitute its business income and, therefore, directed the Assessing Officer to set-off the business loss against such dividend income.  On the revenue’s appeal, the Tribunal also affirmed the Commissioner (Appeals)’s order.

 

On consideration of the above facts and finding of the Tribunal the Honorable High Court after consideration of several judgment as mentioned below held as follows:-

It is a very well settled position of law that income from dividend would be relatable to the business activity of the assessee of the instant kind and would not be an income from other sources.

The Tribunal had affirmed a finding of the Commissioner (Appeals) that the company in the interest of its business and to earn additional profits arising from such stock-in-trade had invested its money which was earning dividends on shares held as stock-in-trade.  Thus, Tribunal had rightly treated as income form business and not income from other sources.  Even otherwise, it would be a finding of fact based and referable to the records which were produced before the tribunal.

Once it was held that the shares held by the assessee as a stock-in-trade and the income whether directly or incidental to holding of such shares as stock-in-trade was business income, then it could not be said that the dividend income would fall as an income from other sources as contemplated under section 56 and that set-off of losses under section 72 in subsequent year would not be permissible.  Consequently, it was clear that no question, much less a substantial question of law, arose for consideration in the instant case.  The appeal was to be dismissed.

In this case it was held that dividend fell under the head business, author submit that even if dividend was assessed under the head ‘other sources’ still past business loss could be set off as dividend was earned from business of share trading carried by assessee. The dividend is nothing but profits or gains of the share trader.  It is a benefit or perquisite or reward arising from the holding of stock of shares for the purpose of trading.

Set off against capital gains arising from business:

Recently a dispute arose about set off of brought forward business losses against the gains capital gains arising from any business or profession which are chargeable under head other than business that is ‘capital gains’,

In Digital Electronics Ltd. v. ACIT135 TTJ 419 (Mum ITAT) the Tribunal allowed such set off.

During the previous year relevant to the  assessment year 2005-06, the assessee  had sold fixed assets of business namely  factory building, plant and machinery, furniture and fixtures on which assessee had earned capital gains taxable as short term capital gains u/s 50 as assets were depreciating assets. The assessee  had set off unabsorbed depreciation and brought forward business losses against the short term capital gains on sale of  these business assets. The Assessing Officer disallowed the claim of the set off of brought forward business losses on the ground that the same cannot be set off against any other head of income other than profits and gains of business or profession. The CIT(A) also confirmed the order of the AO. Therefore, the assessee had to prefer an appeal before the Tribunal against the order of the CIT(A) on the issue “ Whether brought forward business losses can be set off against the profits on sale of business assets which are assessed to tax as capital gains?” 

Tribunal considered relevant provisions and took view that as per the provisions of the Act, for setting off the income, while the loss carried forward has to be under the head “Profits and gains of business or profession”, the gains against which such loss can be set off, has to be profits of “any business or profession carried on by the taxpayer and assessable to tax in that assessment year”.

The Tribunal considered that while one set of provisions, i.e., the nature of loss incurred by the taxpayer, classifies the same on the basis of income being taxable under a particular head for the purpose of computation of the net income, the other set of provisions is concerned only with the nature or source of gains should be from business and the head of income is not relevant.

The profits and gains are in the nature of business profits and gains, even if these profits are liable to be taxed under a head other than income from business and profession, the loss carried forward  under the head ‘business or profession’ can also be set off against such profits.

Accordingly the Tribunal held that income earned by the assessee  on sale of business assets arose from business carried by assessee although not taxable as “Profit and gains of business or profession” was in the nature of income of business though assessed as capital gains and hence the assessee is entitled to set off of brought forward business losses against the said capital gains which were from a business carried on by the taxpayer. 

Authors comments:

The above ruling is in tune with clear and unambiguous provisions of S. 72 and is also in accordance with  law laid down by the  supreme Court as discussed earlier. The author is of opinion that there is no change in law in this regard and the provisions considered by the Supreme court and the provisions which prevail now are same , similar in all respect. Decision of Tribunal  clearly shows that the legal position settled by the Supreme Court long, still hold good and  brought forward business losses can be set off against the gains arising from any business or profession, though chargeable to tax under any other head of income.

Un-necessary dispute and harassment:

From above discussion it  is clear that the set off of past business loss was permissible as per clear provisions of  S. 72 (1) (i) and also as per  law clarified and settled long ago  in  CIT Vs. Cocanada Radhaswami Bank Ltd 1965 -TMI - 49308 – (SUPREME Court).  However, tax authorities did  not allow such set off even when claimed by assessee. The tax authorities should allow such benefit even if assessee fails to claim such benefit of set off or  adjustment due to complexity of law, ignorance and when assessee adopts 'play safe' approach to avoid interest ,penalty, and litigation in case AO do not allow the benefit.
Finding such cases taking place in appellate forum can be considered as an indicator of harassment to which assessee is put by revenue authorities by not following even judgments of the Supreme Court.
In this case the assessee Brought forward business losses can be set off against the gains arising from any business or profession, though chargeable to tax under any other head of income  Digital Electronics Ltd had to prefer an appeal before the ITAT, this means that the CIT(A) also did not follow judgment of the Supreme Court and the harassment initiated by the AO by disallowing the  relief admissible was further perpetuated by the CIT(A), by not allowing the relief.
Let us hope that the assessee shall not be put to further harassment by the revenue by filing an appeal before the High Court against the decision of the Tribunal.

However, unfortunately the counsels of revenue also just suggest preferring filing of appeal even on such settled matter- why they think personal gains above the national interest by suggesting their client that is the revenue to indulge in litigation on such settled matters?.

Author on behalf professionals like  CA,CWA,CS and advocates thank the revenue for indulging into such litigation which provide importance to such professionals and also jobs for them. However, considering the fact that these are remunerative but unproductive work, author feels that such unproductive work of litigation should come to an end so that our social resources are not wasted, there is no brain drain and we can concentrate more on productive work. Because for society at large wealth can be generated only when really productive work is performed.