Lossmaker's guide to tax savings

Praful Poladia, Outlook Money December 19, 2006

Income tax is a tax on income earned by a taxpayer in a given year. However, each and every activity of a taxpayer may not result in positive income. It may cause losses too. It would be unfair to tax a person on his income, while ignoring the loss. In recognition of this principle, there are elaborate provisions permitting adjustment of loss, including the provisions for carrying forward unadjusted (unabsorbed) loss to future years. Understandably, there are restrictions, which have been introduced to prevent misuse of artificial losses. Heads of income. Income of any assessee for the purpose of levy of income tax is computed under five heads-salary, house property, profits or gains of business or profession, capital gains and other sources. There are specific rules provided for computation of income under each of these heads of income. Considering the computation rules, no loss can occur under the head 'salaries'. Intra-head set off. Within each head of 'income', there could be more than one source of income. For example, a person may have two properties in different cities let out to different lessees. Each property is a source of income covered by the same head of income. The law requires adjustment of loss falling within the same head of income in priority of adjustment of loss against profits under any other head of income. Some Basic Rules. Adjustment or carry forward of loss is not an inherent right. One requires specific provision in the Act permitting such right. But, once such a right is available, an assessee cannot, by choice, forego it in one year and choose to exercise it in the second year, when he expects a much higher income. House property loss. Loss under the head 'house property' may occur when, say, in respect of a self-occupied house or a rented house, interest expenditure is incurred on the loan borrowed for acquisition of property. In case of a selfoccupied house, income is computed as nil and interest expenditure results in loss. Any such loss can be set off against income from any other head, including salary income. If there is no sufficient income to absorb the loss, unabsorbed loss can be carried forward for eight years to be set off against house property income, if any, in the future year. It cannot be set off, in the future year, against any other income head like salary. Business loss vs Salary income. Loss under the head 'profits and gains from business or profession' cannot be set off against salary income. This restriction has been introduced very recently to plug the unhealthy practice of salaried employees claiming artificial business losses for the purpose of setting it off against salary income. Business loss-Speculative vs normal. There is a distinction drawn between loss in speculative business and loss in any other business. Speculation loss can be set off only against speculation income. For example, loss from speculation in shares can be set off against income from speculation in commodities, but not against share brokerage income or salary income. Set-off, as a tax-saving instrument, works only under certain conditions and is not always helpful What is more, such speculation loss can be carried forward for a period of four years only. Even in those four years, it can be set off against income from speculation business only. Business loss & unabsorbed depreciation. Business loss is divided into depreciation loss and operating business loss. Say, a person is engaged in the business of software development and training, which requires investment in computers eligible for depreciation at a higher rate of 60 per cent. He may become entitled to claim a large depreciation (Rs 10 lakh for example) while his profit before depreciation is low (Rs 2 lakh for instance). Such loss (Rs 8 lakh) is known as depreciation loss.

The rules for carry forward of depreciation are different from rules for carry forward of unabsorbed business loss (see: Uneven Rules).

Loss under Capital Gains. Capital loss assessed under the head 'capital gains' cannot be set off against income under any other head. Capital loss can be set off against capital gains income only. Further, long-term capital loss cannot be set off against short-term capital gains. Unadjusted capital loss can be carried forward up to eight years. Long-term capital loss cannot be set off against short-term capital gains even during this period. Loss under Other Sources. Loss under the head 'other sources' can be adjusted against income under any other head in the same year. But, there are no provisions for carry forward of unadjusted loss incurred under this head to subsequent years. Unabsorbed loss under this head will, therefore, lapse in the same year. Submission of return within due date. One of the critical conditions for availing the benefit of carry forward of loss to future years is that the return of income for the year, in which loss has been incurred, should be furnished within the due date. This condition is applicable for carry forward of loss to next year and does not affect the right to adjust or set off loss in the same year. As a measure of relaxation, unadjusted depreciation can be carried forward even if there has been delay in furnishing the return. Conclusion. Tax provisions about setting off losses are, indeed, a bit complex, but so is life. One needs to file income tax returns within the due date for availing the benefit of losses to reduce future tax liability. Lossmaker's Guide to Tax Savings When you can set When you can't off losses House Property Can be set off against income from any other head, Setting off in future years against income such as salary or including salary. Can be carried forward for eight years for any head other than property income. setting off against house property income. Business Loss1 Speculation loss (for example, losses in share trading) can Cannot be set off against salary income. only be set off only against speculation income (example, speculation income from shares and commodities trading). Other business losses can be set off against any other income, except salary. Can be carried forward for four years. Capital Gains Capital loss can be set off only against capital gains income. Can be carried forward up to eight years. Other Sources Can be adjusted against income under any other head in the same year. 1 For depreciation, see Uneven Rules Long-term capital loss cannot be set off against short-term capital gains in current as well as future years.

Can't be carried forward. Unabsorbed loss will lapse in the same year.

Uneven Rules

Set off rules for depriciation vs business loss Unabsorbed depreciation Time limit for carry No time limit. forward to subsequent Can be carried years forward indefinitely Set off against Can be set off other heads in against any head subsequent years of income in subsequent years
The author is a member of the Bombay Chartered Accountants' Society.

Unabsorbed business loss Can be carried forward for eight years only Can be set off only against business income

Can a business loss be set off against salary income? A loss, if any, from a speculation business cannot be set off against income from other sources or other heads. It can only be set off against speculation income and the balance, if any, after such set off, can be carried forward and set off against speculation income within eight assessment years immediately succeeding the assessment year in which the loss was first computed. In case of business loss not being a speculative loss, it can be set off against income from other sources or other heads. It cannot, however, be set off against income under the head `salaries'. The balance, if any, can be carried forward and set off against business income within eight assessment years immediately succeeding the assessment year in which the loss was first computed. Unabsorbed depreciation can, however, be set off and carried forward and set off without any restriction either in the manner of set off or the timeframe for such set off.

For asessment year (AY) 2004-05, I have incurred a business loss of Rs 60000. My income from house property is Rs 50000. Hence, I have carried forward the entire business loss of Rs 60000 because house property income falls under the threshold limit of Rs 50000. Can the income-tax officer levy penalty on me if I have adjusted my carried-forward loss in the next year? There are five main heads of income under the Income Tax Act, 1961: income from salary, house property, business/profession, capital gains and other sources. As per sec 71 of the IT Act, if the net result of computation made for any year in respect of any head of income is a loss, the same can be set off against income from other heads. For example, if there is loss from business and income from house property, then it can be set off against each other and tax is to be paid only on the balance amount. However, in the following cases such inter-head setoff is not permissible: * Loss arising from speculation in business can be set off only against speculation income. * Loss under capital gains can be set off only against capital gains income. * Loss from the activity of owning and maintaining race horses can be set off only against income from such activity.

* Loss from business cannot be set off against salary income. * Loss cannot be set off against winnings from lotteries/puzzles/any sort of gambling or betting * Loss from a source, income from which is exempt, cannot be set off. Barring these exceptions, a loss has to be first adjusted against available income under other heads in all other cases. You cannot choose between setting off a loss or not setting off a loss. In CIT v Milling Trading Co Pvt Ltd, the Supreme Court held that loss can be carried forward only when such loss cannot be set off against income under any other head. Under the IT Act, there is no provision which gives an option to the assessee to show profit as income from one source and carry forward the loss from another source of income to the next year. In your case, you do not have the option of not setting off the business loss just because your house property income is below the threshold limit. You have to set off the business loss of Rs 60000 against house property income of Rs 50000. The balance business loss of Rs 10000 can be carried forward for setoff in future. However, note that such carried forward business loss can be adjusted only against business income in the subsequent year.

Suppose I have 100 shares in company A, purchased at the rate of Rs 100 per share five years ago. Now company A declares bonus of 1:1. So how do I write my accounts? Do I show 200 shares in company A at Rs 50 per share or 100 shares in company A at the acquisition rate of Rs 100 per share and 100 shares at the acquisition rate of nil per share. Are bonus shares considered to have zero acquisition value? My tax consultant tells me so! Kindly clarify. A related query is: if I sell the allotted bonus shares within one year of allotment, am I liable to pay short-term capital gain tax? Your tax consultant is correct. Section 55(2)(aa)(iiia) of the Income-Tax Act, 1961, supports his advice. As per the section, if one receives bonus shares on or after 1 April 1981 on the basis of holding of shares already purchased, then the cost of acquisition of such bonus shares will be taken as nil. For you, too, the cost of acquisition of bonus shares will be zero and not Rs 50 per share. As for your second query, the entire sale proceeds received on sale of such bonus shares will be liable to short-term capital gain tax provided the period of holding of such shares from the date of allotment of bonus shares to their date of sale is less than 12 months.

I understand from Capital Markets website that if I gift a certain amount, say Rs 1.2 lakh, to my wife, it will not be taxable in her hands as this is received as a gift from a relative. This will also not be taxable in my hands. So does my total taxable income reduces by the amount of the gift. How do I show this deduction in my taxable income? What are the documents to be submitted by the donor so that the taxable income is reduced by the amount of the gift? I give my wife Rs 10000 every month which she utilises for her own needs. What documents should I submit while filing returns? My wife is not liable to pay tax. If she does not have any other source of income, is she required to file returns with zero-tax liability? Gift tax has been abolished. But as per section 56(2)(v) of the Income-Tax Act, 1961, when an individual has received money exceeding Rs 50000 in aggregate from all persons without any consideration, then the entire amount received shall be taxed as income under the head, Income from other sources. The above

provision does not apply if money is received from a relative. The term relative includes spouse of the individual. As per the above provision, if you gift Rs 1.2 lakh to your wife, then it will not be taxable in her hands as it is received from a relative. However, clubbing provisions will get attracted, i.e., income arising from such gifted amount will be taxed in your hands. As per Section 64 (1)(iv), when an individual transfers any asset (other than house property) to his spouse otherwise than for adequate consideration, then income arising from such transferred asset shall be clubbed in the hands of the individual. Gift given by you to your wife is not allowed as a deduction in computing your taxable income. No documents are to be submitted for the gift given while filing return. A simple letter from the donor may be taken and kept on record and produced during assessment, if called for. If the gross total income of your wife is below the basic exemption limit of Rs 1.35 lakh (for 2006-07), then she need not file her return

I want to know about the limitation of gift tax receivable from an unrelated person and the number of gifts that can be received at a time from various unrelated persons in a particular year. Gift tax has been abolished. Section 56(2)(v) of the Income-Tax Act, 1961, talks of taxability of gifts received from an unrelated person as well as related person. If the aggregate sum of money received without consideration on or after 1 April 2006 from any person or persons not being relative exceeds Rs 50000, (the limit was earlier Rs 25000 per person in the period 1 September 2004 to 31 March 2006), then the entire sum will be liable to tax in the hands of the recipient of such money. The receiver of the money should be an individual/HUF. The money has to be received on or after 1 April 2006 that, too, without any consideration. If the money is received from relatives, as defined in the section, no tax will be leviable irrespective of the amount of gift. The total amount of money received in aggregate from all persons should exceed Rs 50000 to attract tax. If Mr A receives Rs 26000 as cash from Mr B and Rs 30000 from Mr C, then the entire Rs 56000 will be liable to income tax. The limit of Rs 50000 is not applicable to each payer of the gift. But gifts received from all the unrelated persons should be clubbed to find whether the limit of Rs 50000 has been crossed. However, gift in kind is not subject to tax. There is no restriction on the number of gifts from an unrelated person. But the amount of gift should not exceed Rs 50000. If Rs 5000 each is received as gift from nine unrelated persons (Rs 45000 in total), then the person will not be liable to pay tax on Rs 45000 as it is below the cap of Rs 50000.

Is the dividend income, received from investments in shares, taxable? Dividend, received from investment in shares, is not taxable in the hands of the recipient. The company, distributing the dividend, is required to deduct tax from the amount of dividend declared. Such tax deducted will not be entitled to TDS for the recipient. Do investments in shares have any Wealth Tax implications? Investments in shares do not have any Wealth Tax implications.

Do investments in shares have any Gift Tax implications? Investments in shares do not have any Gift Tax implications. Investment in shares in the name of some other person other than the investors has Income-tax (gift) implications with effect from Financial Year 2004. These shares will now be treated as income.

I am a female senior citizen, married into a middle class family. Recently, on sale of ancestral property, I received Rs 3 crore from my parents. Please guide me on the investment formalities. Long-term capital gains arising from sale of ancestral property is not chargeable to tax if the entire capital gains are invested in specified assets under sec 54EC (bonds of Nabard, RECL, NHB, Sidbi, NHAI) within six months from the date of transfer of ancestral property. The investment in these bonds is subject to a three-year lockin. The returns are between 5-6% per annum and are lower compared to other investment avenues. Exemption from long-term capital gains tax can also be claimed under sec 54 if the ancestral property sold is a residential property and the entire capital gains is invested in a new residential property. The income generated from investment of inherited money is taxable in your hands. The basic exemption limit for senior citizens is Rs 185000 under the Income Tax Act, 1961, Besides, deduction from income under sec 80C is available up to Rs 100000 on investment made in specified schemes like public provident fund (PPF), life insurance premium, National Saving Certificates (NSC), equity-linked saving schemes (ELSS) and repayment of housing loan. Thus, no tax is payable on income up to Rs 285000. Similarly, under sec 80D, deduction up to Rs 15000 is permitted for Mediclaim premium paid by a senior citizen. Calculating backwards, income up to Rs 3 lakh will not suffer any tax. You can consider the following avenues: * Invest the capital gains in sec 54 and 54EC instruments. * Rs 1 lakh can be invested in any specified sec 80C schemes so as to avail full tax benefit. * PPF gives 8% return. The maximum investment is Rs 70000 per annum Interest on PPF deposits is taxfree. * Senior Citizens' Saving Scheme gives 9% assured returns. The maximum investment is Rs 15 lakh. * There is no investment cap on investment in 8% RBI taxable relief bonds. * Post Office Monthly Income Scheme gives an interest of 8% per annum plus 10% bonus on maturity. Maximum permissible deposit is Rs 300000 in single name and Rs 600000 in joint account. * Investment in Kisan Vikas Patra will see your money double in eight years and seven months. There is no limit on investment. * Rs 100 invested in National Savings Certificate will grow to Rs 160 after six years. There is no maximum investment limit. About 10-15% of your portfolio can be invested in equities either through the stock market or through mutual funds. ELSS are also a good investment option. Most of the ELSS are presently giving more than 15% returns.

Consider debt schemes of mutual funds if you are not prepared to take risk. Pension plans offered by LIC and mutual funds can also be considered. Reduce your income burden by gifting some of your investment money to your kins who are in lower/nil tax bracket. Create a trust and transfer some of the funds there. The income of the trust is assessed separately. To sum up, invest after taking into consideration your risk tolerance level and after making provision for needs anticipated over the short, medium and long term. Emergency cash available should be approximately three times the average monthly household expenses. Create an income portfolio in such a manner that your regular interest income stream is equal to your fixed monthly house hold expenses. Regularly monitor your investments. In order to make your wealth grow you need patience, conviction and a professional approach to managing money. Follow a structured investment strategy. As Rs 3 crore is a big amount, it is critical to have a professional investment advisor whom you trust.