Calcium Notes CA Final DT
Chapter Index Section Master ← Chapter 6 Chapter 8 →
Income-tax Act, 2025 • Tax Year 2026-27 • AY 2027-28

Chapter 7: Aggregation of Income, Set-off and Carry Forward of Losses

Comprehensive CA Final Direct Tax notes covering Sections 108 to 121 of the Income-tax Act, 2025 (formerly Sections 70 to 80 of the 1961 Act). Explains inter-source and inter-head adjustments, house property loss ceiling of ₹2,00,000 and default regime bar, capital losses, speculation business loss ring-fencing, amalgamation and demerger fresh 8-year clock u/s 116, closely-held companies 51% voting test and startup exceptions u/s 119, mandatory order of set-off, Section 121 return of loss mandates, all 6 ICAI Illustrations and all 5 Test Your Knowledge practical questions.

Statutory Framework

7.1 Concept of Set-off and Carry Forward of Losses

Chapter VII of Income-tax Act, 2025 • Sections 108 to 121 • Corresponding 1961 Act: Sections 70 to 80

Under the Income-tax Act, 2025, taxable total income is computed by determining the net result of all sources under each of the five heads of income, consolidating them into Gross Total Income (GTI), and then allowing permissible deductions. When an assessee sustains a negative income (loss) from any activity, specific statutory rules govern whether, to what extent, and against which incomes such loss may be adjusted in the same tax year ("set-off") or carried forward into future tax years ("carry forward and set-off").

"Set-Off" (Intra-Year Adjustment)

Set-off means the adjustment of losses incurred in a given tax year against eligible profits/income from another source under the same head (Inter-source / Intra-head u/s 108) or against income under another head (Inter-head u/s 109) during the same tax year.

"Carry Forward" (Inter-Year Transfer)

If a loss cannot be fully set off in the same tax year due to absence or inadequacy of eligible income under the permissible heads, the unabsorbed balance is carried forward to subsequent tax years, subject to statutory time limits (4 years, 8 years, or indefinitely) and specific ring-fenced source rules.

Cardinal Principles Governing Set-Off & Carry Forward
  • Two-Step Sequence: An assessee must exhaust Inter-source set-off (Section 108) first. Only the net deficit under a head may then be considered for Inter-head set-off (Section 109). Unabsorbed losses are then carried forward under specific sections (110 to 115).
  • Exempt Income Loss Rule: If income from a particular source is exempt from tax (e.g., agricultural income u/s 10, share of profit from firm u/s 19), loss from such exempt source cannot be set off against any taxable income under any source or head.
  • Casual Income Ring-Fencing [Section 94]: No loss whatsoever (whether business, house property, or capital loss) can be set off against casual income such as winnings from lotteries, crossword puzzles, races (including horse races), gambling, betting, or card games. Such income is taxed at flat rates without any loss offset.
  • Brought Forward Losses are Head-Restricted: As a general rule, once a loss is carried forward to subsequent years, it loses its inter-head mobility and can only be set off against income under the same head (or even the same specific source, as in speculation and race horses).
Section 108

7.2 Inter-Source Adjustments (Intra-Head Set-off) [Section 108]

Corresponding 1961 Act: Section 70 • General Rule & Specific Exceptions

Section 108(1) enacts the fundamental rule of intra-head aggregation: where the net result for any tax year in respect of any source falling under any head of income (other than capital gains) is a loss, the assessee is entitled to have the amount of such loss set off against income from any other source under the same head of income for that tax year.

General Rule Application
  • House Property: Loss from Let-Out Property A (say ₹1,50,000) can be adjusted against positive Net Annual Value / income of Let-Out Property B (say ₹2,20,000). Net HP income = ₹70,000.
  • Business or Profession: Loss from textile manufacturing business (say ₹3,00,000) can be adjusted against profits of wholesale trading or software consultancy business (say ₹5,00,000). Net business profit = ₹2,00,000.
Mandatory Statutory Exceptions to Intra-Head Set-Off [Section 108(1)]

Inter-source set-off within the same head is strictly prohibited or restricted in the following four cases:

  1. Long-Term Capital Loss [Section 108(2)]: LTCL cannot be set off against Short-Term Capital Gains (STCG). It can only be set off against Long-Term Capital Gains (LTCG). (Short-term capital loss, however, can be set off against both STCG and LTCG).
  2. Loss from Speculation Business [Section 113(1)]: A loss incurred in a speculation business can be set off only against profits and gains of another speculation business. It cannot be set off against profits of any non-speculative business or profession. (However, loss from non-speculative business can be set off against profits of a speculation business).
  3. Loss from Specified Business u/s 46 [Section 114(1)]: In case an assessee has opted out of the default tax regime, any loss computed in respect of any specified business covered under Section 46 (e.g., cold chain, warehousing, 100-bed hospital, affordable housing) can be set off only against profits of another specified business. It cannot be set off against profits of normal businesses. (Normal business losses can, however, be adjusted against profits of specified business).
  4. Loss from Activity of Owning and Maintaining Race Horses [Section 115(1)]: Loss incurred in the activity of owning and maintaining race horses can be set off only against income from the same activity. It cannot be set off against any other source under "Income from Other Sources" or any other head.
Section 108(2)

7.2B Long-Term Capital Loss Restriction [Section 108(2)]

Corresponding 1961 Act: Section 70(3) • Capital Gains Asymmetry Rule

Under Section 108(2), the set-off of capital losses within the head "Capital Gains" is asymmetrical:

Nature of Capital Loss Incurred Set-off against STCG? Set-off against LTCG? Statutory Rationale
Short-Term Capital Loss (STCL) Allowed ✓ Allowed ✓ STCL can be absorbed by both short-term and long-term capital gains.
Long-Term Capital Loss (LTCL) Not Allowed ✗ Allowed ✓ LTCL is subject to concessionally taxed regimes (e.g., Section 197 / 198); therefore, statute does not allow LTCL to dilute normal/higher taxed STCG.
Impact of Section 198 (Equities Taxed at 12.5%): Full Set-Off Eligibility

Under Section 198 (formerly Section 112A), long-term capital gains exceeding ₹1,25,000 on equity shares, units of equity-oriented funds, or units of business trusts on which STT has been paid are chargeable to tax @ 12.5%.

Since these transactions are legally chargeable to tax, any long-term capital loss arising on transfer of such STT-paid listed equity shares/units is an eligible capital loss. By virtue of Section 108(2) and Section 111, such LTCL is fully eligible to be set off against any LTCG (whether taxable u/s 197 or u/s 198) and to be carried forward for 8 tax years!

Section 109

7.3 Inter-Head Adjustments [Section 109]

Corresponding 1961 Act: Section 71 • Cross-Head Set-off Rules and Regime Constraints

Where the net result of computation under any head of income for any tax year is a loss, Section 109 permits the assessee to set off such loss against income assessable under any other head of income for that same tax year, subject to strict statutory restrictions.

Loss Head Eligible for Inter-Head Set-off? Specific Conditions / Ineligible Offsets
Loss from House Property
Section 109(1)		 Capped / Regime Dependent Normal Regime (Opted out): Set off against ANY other head (including Salaries, Business, Capital Gains, Other Sources) up to a maximum ceiling of ₹2,00,000 in the tax year. Unabsorbed excess (> ₹2,00,000) must be carried forward u/s 110.
Default Regime u/s 202: House property loss CANNOT be set off against any other head of income at all! (And cannot be carried forward).
Profits & Gains of Business or Profession
Section 109(2)		 Allowed (Except Salaries) Section 109(2) Bar: Business/profession loss cannot be set off against "Salaries".
It can be set off against House Property, Capital Gains, and Income from Other Sources.
Capital Gains (STCL or LTCL)
Section 109(3)		 Strictly Prohibited ✗ Loss under the head "Capital Gains" (whether short-term or long-term) cannot be set off against income under ANY other head! It remains strictly ring-fenced within the head "Capital Gains".
Speculation Business Loss
Section 113		 Strictly Prohibited ✗ Cannot be set off against any other head (nor against non-speculation business).
Specified Business Loss u/s 46
Section 114		 Strictly Prohibited ✗ Cannot be set off against any other head (nor against general business profits).
Race Horses Loss
Section 115		 Strictly Prohibited ✗ Cannot be set off against any other head or other sources.
Inter-Head Set-off Master Equation (Normal Regime)
$$ ext{GTI} = ext{Salaries} + \max(0, ext{HP} - \min( ext{HP Loss}, 200000)) + ( ext{PGBP} \pm ext{Permissible Set-offs}) + ext{Capital Gains} + ext{IFOS}$$
Note: PGBP loss cannot reduce Salaries. Capital losses can never reduce any other head.
Section 110

7.4 Carry Forward & Set-Off of Loss from House Property [Section 110]

Corresponding 1961 Act: Section 71B • 8 Tax Years Carry Forward & Default Regime Disallowance

Where for any tax year, the net result of computation under the head "Income from house property" is a loss, Section 110 governs its carry forward and subsequent absorption:

Scenario A Assessee Opts Out of Default Regime (Normal Regime)
  • Current Year Inter-Head: Set off against income under any other head up to ₹2,00,000 [Section 109(1)].
  • Unabsorbed Loss: The excess loss exceeding ₹2,00,000 is carried forward to the following tax year.
  • Carry Forward Period: Carried forward up to 8 tax years immediately succeeding the tax year in which the loss was first computed.
  • Head of Set-Off in Subsequent Years: Once carried forward, it can be set off ONLY against "Income from house property".
  • Return Filing Requirement: House property loss carry forward is NOT restricted by Section 121. Even if the return of income is filed belatedly after the Section 263(1) due date, HP loss carry forward is valid!
Scenario B Assessee Pays Tax Under Default Tax Regime [Section 202(1)]
  • Applicable Assessees: Individual, HUF, AOP (other than Co-op), BOI, or Artificial Juridical Person paying tax u/s 202(1).
  • Inter-Head Set-off: STRICTLY DISALLOWED. Loss under the head "Income from house property" is not allowed to be set off against income under any other head!
  • Carry Forward: STRICTLY PROHIBITED. The unabsorbed loss cannot be carried forward to any following tax year.
  • Absolute Lapse: House property loss is effectively dead/lost for tax purposes in that year.
Position for Companies, Firms & Co-operative Societies

In the case of Companies, Partnership Firms, and Co-operative Societies:

  • HP loss can be set off against any other head during the same year up to ₹2,00,000.
  • Unabsorbed HP loss can be carried forward for 8 tax years to be set off against HP income.
  • This holds true irrespective of whether or not the company has opted for Section 200/201 (concessional corporate tax rates) or the co-operative society has opted for Section 203/204!
ICAI Illustration 1

House Property Loss: Normal Regime vs Default Regime u/s 202

Problem Statement:

Mr. Kamal (aged 35 years) submits the following particulars pertaining to the tax year 2026-27:

Particulars Amount (₹)
Income from salary (computed) 4,20,000
Loss from let-out property (-) 2,30,000
Business loss (-) 1,20,000
Bank interest (FD) received 85,000

Compute the total income of Mr. Kamal for the tax year 2026-27, assuming that:

(i) He has exercised the option of shifting out of the default tax regime (Normal Provisions).

(ii) He pays tax under the default tax regime [Section 202(1)].

Solution:

(i) Computation of Total Income under Normal Provisions of the Act (Opted out of Default Regime)

Particulars Amount (₹) Amount (₹)
Income from salary 4,20,000
Less: Loss from house property of ₹2,30,000 restricted to ₹2,00,000 by virtue of Section 109(1) (-) 2,00,000 2,20,000
[Balance loss of ₹30,000 from house property is carried forward to following tax year u/s 110]
Income from other sources (Interest on fixed deposit with bank) 85,000
Less: Business loss of ₹1,20,000 set off to the extent of ₹85,000 (-) 85,000 Nil
[Balance business loss of ₹35,000 (₹1,20,000 - ₹85,000) cannot be set off against salary u/s 109(2); carried forward to next tax year u/s 112]
Gross Total Income 2,20,000
Less: Deductions under Chapter VIII Nil
Total Income ₹ 2,20,000
Notes for Option (i):
  1. Gross Total Income includes salary income of ₹2,20,000 after adjusting loss of ₹2,00,000 from house property. The balance loss of ₹30,000 from house property is carried forward to the following tax year for set-off against income from house property of that year u/s 110.
  2. Business loss of ₹1,20,000 is set off against bank interest of ₹85,000. The remaining business loss of ₹35,000 will be carried forward as it cannot be set off against salary income by virtue of Section 109(2).

(ii) Computation of Total Income under Default Tax Regime [Section 202(1)]

Particulars Amount (₹) Amount (₹)
Income from salary 4,20,000 4,20,000
[Under Section 202, loss from house property of ₹2,30,000 can NEITHER be set off against any head NOR carried forward. It lapses completely!]
Income from other sources (Interest on fixed deposit with bank) 85,000
Less: Business loss of ₹1,20,000 set off to the extent of ₹85,000 (-) 85,000 Nil
[Balance business loss of ₹35,000 carried forward to following tax year u/s 112]
Gross Total Income / Total Income ₹ 4,20,000
Notes for Option (ii):
  1. Under the default tax regime, loss from house property cannot be set off against income under any other head and cannot be carried forward to the following tax year.
  2. Business loss of ₹1,20,000 is set off against bank interest of ₹85,000 and remaining business loss of ₹35,000 will be carried forward as it cannot be set off against salary income.
Section 111

7.5 Carry Forward & Set-Off of Losses from Capital Gains [Section 111]

Corresponding 1961 Act: Section 74 • 8 Tax Years Carry Forward & Head Ring-Fencing

Where for any tax year, the net result under the head "Capital gains" is a loss, Section 111 specifies the rules for its carry forward and subsequent adjustment in succeeding tax years.

Short-Term Capital Loss (STCL)
  • Where the loss carried forward is a Short-Term Capital Loss, it can be set off in succeeding years against any Capital Gains, whether short-term or long-term.
  • STCL enjoys broader absorbability because short-term capital assets do not enjoy indexation or lower tax rates.
Long-Term Capital Loss (LTCL)
  • Where the loss carried forward is a Long-Term Capital Loss, it can be set off in succeeding years ONLY against Long-Term Capital Gains (LTCG).
  • LTCL cannot be set off against Short-Term Capital Gains in either the current year or in any carried-forward year.
Strict Statutory Limits on Capital Loss Absorption
  • Complete Inter-Head Prohibition: Net loss under the head "Capital gains" (whether STCL or LTCL) can never be set off against income under any other head (Salaries, House Property, PGBP, or Other Sources).
  • Maximum Carry Forward Period: Any unabsorbed capital loss can be carried forward to the following tax year for a maximum period of 8 tax years immediately succeeding the tax year for which the loss was first computed.
  • Mandatory Return Filing [Section 121]: Capital loss cannot be carried forward unless the return of loss for the year in which the loss occurred is filed on or before the due date specified under Section 263(1)!
Set-off of LTCL on Listed Equity Shares/Units Taxed u/s 198

Long-term capital gains exceeding ₹1,25,000 arising on sale of equity shares, equity-oriented mutual fund units, or business trust units on which STT is paid (both at acquisition and sale for shares, and at sale for units) is taxable under Section 198 @ 12.5%.

Long-term capital loss arising on sale of such shares/units is an eligible capital loss. It can be set off against any long-term capital gains (e.g., LTCG u/s 197 or u/s 198) and carried forward for 8 tax years pursuant to Section 108(2) and Section 111.

ICAI Illustration 2

Carry Forward and Set-off of STCL and LTCL

Problem Statement:

During the tax year 2026-27, Mr. Chetan has the following income and brought forward losses:

Particulars Amount (₹)
Short term capital gains on sale of shares 1,75,000
Long-term capital loss of tax year 2025-26 (96,000)
Short term capital loss of tax year 2025-26 (42,000)
Long term capital gain u/s 197 85,000

What is the capital gain taxable in the hands of Mr. Chetan for the tax year 2026-27?

Solution:

Computation of Taxable Capital Gains of Mr. Chetan for Tax Year 2026-27

Particulars Amount (₹) Amount (₹)
Short-term capital gains on sale of shares 1,75,000
Less: Brought forward short-term capital loss of tax year 2025-26 (-) 42,000 1,33,000
Long-term capital gain u/s 197 85,000
Less: Brought forward long-term capital loss of tax year 2025-26 of ₹96,000 set-off to the extent of ₹85,000 (-) 85,000 Nil
Taxable Short-Term Capital Gains ₹ 1,33,000
Key Statutory Note:

Long-term capital loss cannot be set off against short-term capital gain [Section 108(2) & 111]. Hence, the unadjusted long-term capital loss of tax year 2025-26 of ₹11,000 (i.e., ₹96,000 − ₹85,000) has to be carried forward to the next tax year (2027-28) to be set off against long-term capital gains of that year. It can be carried forward for up to 7 more tax years.

Section 112

7.6 Carry Forward & Set-Off of Business Losses [Section 112]

Corresponding 1961 Act: Section 72 • 8 Tax Years Carry Forward & PGBP Ring-Fencing

Under Section 112, where for any tax year, the net result of computation under the head "Profits and gains of business or profession" (other than speculation business) is a loss, and such loss cannot be wholly set off against income under any other head (other than salaries) in the same tax year under Section 109, the unabsorbed loss is carried forward to subsequent tax years.

Essential Conditions for Carry Forward and Set-off u/s 112
  1. Loss under PGBP Head: The loss must be a loss computed under the head "Profits and gains of business or profession".
  2. Non-Speculative Nature: The loss must not be a loss from speculation business (which is separately governed by Section 113).
  3. Inter-Business Fungibility: The carried forward business loss can be set off against the profits and gains of ANY business or profession carried on by the assessee in the subsequent year. It is not necessary that the same business in which the loss was incurred continues to be carried on!
  4. Strict Head Ring-Fencing in Subsequent Years: Once carried forward, a business loss can NEVER under any circumstances be set off against income under any other head (such as Salaries, House Property, Capital Gains, or Other Sources). It can only be set off against profits under the head "Profits and gains of business or profession".
  5. Identity of Assessee Rule: Only the person who incurred the loss is entitled to carry forward and set off the loss. A successor to a business cannot carry forward the predecessor's loss, EXCEPT in the case of succession by inheritance [Section 119(2)].
  6. 8-Year Time Limit: Carried forward business loss can be carried forward for a maximum period of 8 tax years immediately succeeding the tax year in which the loss was first computed.
  7. Timely Filing Mandate [Section 121]: The business loss cannot be carried forward unless the return of loss is furnished on or before the due date specified under Section 263(1).
ICAI Illustration 3

Comprehensive Set-Off under Default Tax Regime [Section 202(1)]

Problem Statement:

Mr. Vikas, a resident individual, furnishes the following particulars for the tax year 2026-27:

Particulars Amount (₹)
Income from salaries (computed) 8,50,000
Income from house property (24,000)
Profits from non-speculative business (24,000)
Profits from speculative business (6,000)
Short-term capital losses 25,000
Long-term capital gains taxable u/s 197 21,000

What is the total income chargeable to tax for the tax year 2026-27, assuming that he pays tax under section 202(1) (Default Tax Regime)?

Solution:

Total Income of Mr. Vikas for the Tax Year 2026-27 (Default Regime u/s 202)

Particulars Amount (₹) Amount (₹)
Income from salaries 8,50,000
Income from house property Nil
[Loss from house property can NEITHER be set off NOR be carried forward, since Mr. Vikas pays tax under the default tax regime u/s 202(1)]
Profits and gains of business and profession Nil
[Non-speculative business loss of ₹24,000 cannot be set off against Salaries u/s 109(2); carried forward u/s 112]
[Speculative business loss of ₹6,000 cannot be set off against any non-speculative income; carried forward u/s 113]
Capital Gains:
Long-term capital gain taxable u/s 197 21,000
Less: Short-term capital loss of ₹25,000 set off against LTCG to the extent of ₹21,000 (-) 21,000 Nil
[Balance STCL of ₹4,000 (₹25,000 − ₹21,000) cannot be set off against other heads; carried forward to next tax year u/s 111]
Total Income Chargeable to Tax ₹ 8,50,000
Explanatory Notes:
  1. Business Loss: Business loss of ₹24,000 cannot be set off against salary income by virtue of Section 109(2). It will be carried forward to the following tax year u/s 112.
  2. Speculative Loss: Loss of ₹6,000 from speculative business cannot be set off against any income other than speculative business profits [Section 113(1)]. It will be carried forward to the following tax year u/s 113(2).
  3. Capital Loss: Short-term capital loss of ₹25,000 is allowed to be set off against long-term capital gains of ₹21,000 u/s 108(2). The unabsorbed short-term capital loss of ₹4,000 cannot be set off against any other head of income [Section 109(3)] and will be carried forward to the following tax year u/s 111.
  4. Default Tax Regime Bar: Since Mr. Vikas is paying tax under default tax regime u/s 202(1), house property loss of ₹24,000 cannot be set off against income under any other head and cannot be carried forward to the following tax year.
Section 113

7.7 Losses in Speculation Business [Section 113]

Corresponding 1961 Act: Section 73 • 4 Tax Years Carry Forward & Strict Ring-Fencing

A speculation business is treated by law as distinct and separate from any other business carried on by an assessee. Section 113 provides a strict ring-fencing mechanism for losses incurred in speculative transactions.

Ring-Fenced Speculative Losses
  • One-Way Street: Loss in a speculation business can be set off ONLY against profits and gains of another speculation business [Section 113(1)].
  • Speculative losses cannot be set off against normal business profits, salaries, house property, capital gains, or other sources.
  • Carry Forward Period: Carried forward up to a maximum period of 4 tax years immediately succeeding the tax year for which the loss was first computed [Section 113(2)].
Permissible Inbound Offsets
  • Normal Business Loss against Speculation Profit: While speculative loss cannot touch normal profits, a loss from non-speculative business or profession CAN be set off against profits from a speculation business during the tax year!
  • Derivative Trading: Eligible transactions in derivatives carried out on a recognized stock exchange are statutorily excluded from the definition of speculative transactions under Section 66(31) / Section 43(5). Hence, losses from F&O trading are treated as normal business losses and can be carried forward for 8 tax years u/s 112!
Deemed Speculation Business for Companies Trading in Shares [Explanation to Section 113]

Where any part of the business of a company consists in the purchase and sale of shares of other companies, such company shall, for the purposes of Section 113, be deemed to be carrying on a speculation business to the extent to which its business consists of purchase and sale of such shares.

Statutory Exceptions to the Deeming Fiction: The deeming provision does NOT apply to:

  1. Investment Companies: A company whose Gross Total Income consists mainly of income chargeable under the heads "Interest on securities", "Income from house property", "Capital gains" and "Income from other sources".
  2. Financial & Trading Entities: A company whose principal business is the business of trading in shares or banking or the granting of loans and advances.

If a company falls under either of these two exceptions, its losses on share trading will be treated as normal business losses (carry forward 8 years) rather than speculation losses (carry forward 4 years).

Section 114

7.8 Carry Forward & Set-Off of Losses from Specified Businesses [Section 114]

Corresponding 1961 Act: Section 73A • Indefinite Carry Forward & Section 46 Linkage

Section 114 governs the set-off and carry forward of losses sustained by an assessee from any "Specified Business" eligible for deduction under Section 46 (formerly Section 35AD), such as cold chain facilities, warehousing for agricultural produce, 100-bed hospitals, affordable housing projects, cross-country petroleum pipelines, etc.

Rules Governing Specified Business Loss [Section 114]
  • Strict Intra-Head Ring-Fencing: Where an assessee opts out of the default tax regime, any loss computed from a specified business u/s 46 can be set off ONLY against profits and gains of any other specified business [Section 114(1)]. It cannot be set off against normal business profits or any other head.
  • Inbound Fungibility: Losses from other general businesses can be set off against profits and gains from specified businesses!
  • Cross-Offset Between Eligible & Non-Eligible Specified Businesses: The loss of an assessee claiming deduction u/s 46 in respect of a specified business can be set off against the profits of another specified business under Section 114, irrespective of whether the latter business is eligible for deduction under Section 46!
    Practical Exam Rule: An assessee can set off the current loss of a newly established hospital (with 100 beds) claiming 100% deduction u/s 46 against the operating profits of an older existing hospital (with 100 beds) or a two-star hotel, even if the older unit was set up before the Section 46 commencement date and never claimed Section 46 deduction!
  • Indefinite Carry Forward: There is NO time limit specified in the Act for carry forward and set-off of losses from specified businesses. Such unabsorbed loss can be carried forward indefinitely until fully absorbed against future profits of any specified business!
  • Default Regime Ineligibility: Companies opting for Section 200/201, Co-operatives opting for Section 203/204, and Individuals/HUFs/AOPs/BOIs paying tax under default regime u/s 202(1) are not entitled to claim deduction under Section 46.
Section 115

7.9 Losses from Activity of Owning & Maintaining Race Horses [Section 115]

Corresponding 1961 Act: Section 74A(3) • 4 Tax Years Carry Forward & Exclusive Ring-Fencing

Section 115 regulates losses sustained from the specific activity of owning and maintaining race horses.

Statutory Term Legal Meaning & Definition [Section 115]
Specified Activity The activity of owning and maintaining race horses.
Horse Race A horse race upon which wagering or betting may be lawfully made.
Income by way of Stake Money The gross amount of prize money received on a race horse or race horses by the owner thereof on account of the horse winning a position in a horse race.
Loss from Specified Activity $$ ext{Loss} = ext{Revenue Expenditure for Owning/Maintaining Race Horses} - ext{Income by way of Stake Money}$$ Note: Capital expenditure cannot be deducted in computing such loss.
Operational Rules for Section 115 Losses
  • Exclusive Set-Off: Loss from the activity of owning and maintaining race horses can be set off ONLY against income from the activity of owning and maintaining race horses. It cannot be set off against any other income under IFOS or any other head.
  • Carry Forward Period: Carried forward up to a maximum period of 4 tax years immediately succeeding the tax year for which the loss was first computed.
  • Distinction from Casual Betting Winnings: Owning and maintaining race horses must never be confused with casual betting winnings on horse races. Winnings from betting on horse races fall under casual income governed by Section 94, against which NO loss can ever be set off!
  • Scope Confined to Race Horses Only: As clarified by judicial precedents, Section 115 applies strictly to race horses. Loss from owning and maintaining other animals (e.g., camels for racing) is governed by general business loss provisions u/s 112 (8 years carry forward) and not Section 115!
ICAI Illustration 4

Set-off of Carried Forward Race Horses Loss vs Business Loss

Problem Statement:

Mr. Dinesh has the following income for the tax year 2026-27:

Particulars Amount (₹)
Income from the activity of owning and maintaining race horses 75,000
Income from textile business 95,000
Brought forward textile business loss (relating to tax year 2025-26) 50,000
Brought forward loss from the activity of owning and maintaining race horses (relating to tax year 2025-26) 96,000

What is the total income in the hands of Mr. Dinesh for the tax year 2026-27?

Solution:

Computation of Total Income of Mr. Dinesh for Tax Year 2026-27

Particulars Amount (₹) Amount (₹)
Income from the activity of owning and maintaining race horses 75,000
Less: Brought forward loss of ₹96,000 from owning and maintaining race horses set off to the extent of ₹75,000 u/s 115(2) (-) 75,000 Nil
[Balance loss of ₹21,000 (₹96,000 − ₹75,000) from activity of owning & maintaining race horses is carried forward to tax year 2027-28 u/s 115]
Income from textile business 95,000
Less: Brought forward business loss from textile business u/s 112 (-) 50,000 45,000
Total Income ₹ 45,000
Statutory Note:

As per Section 115, loss from the activity of owning and maintaining race horses cannot be set off against any other source or head of income (such as textile business). It can only be set off against income from the same activity. The balance unabsorbed loss of ₹21,000 can be carried forward for up to 3 more tax years.

Section 116

7.10 Carry Forward & Set-Off in Amalgamation, Demerger & Business Reorganisation [Section 116]

Corresponding 1961 Act: Section 72A • Fresh 8-Year Clock for Business Loss & Indefinite Depreciation

Section 116 enacts special liberal provisions enabling the carry forward and set-off of accumulated business losses and unabsorbed depreciation in qualifying corporate restructurings, including amalgamations, demergers, and conversions of firms/proprietorships into companies or LLPs.

1. Amalgamation of Companies [Section 116(1) to (3)]

Section 116 applies where there has been an amalgamation of:

  • A company owning an industrial undertaking, a ship, or a hotel with another company; or
  • A banking company with a specified bank; or
  • One or more public sector company or companies with one or more public sector companies; or
  • An erstwhile public sector company with one or more companies (where disinvestment resulted in reduction of Government shareholding to below 51% and transfer of management control).
Statutory Effect Treatment in Hands of Amalgamated Company

The accumulated loss and unabsorbed depreciation of the amalgamating company shall be deemed to be the loss or allowance for depreciation of the amalgamated company for the tax year in which the amalgamation was effected.

Fresh 8-Year Clock: Accumulated business loss gets a fresh lease of 8 tax years starting from the tax year of amalgamation! (Even if only 1 year was left in the amalgamating company). Unabsorbed depreciation can be carried forward indefinitely.

Statutory Meaning "Industrial Undertaking" Defined

An undertaking engaged in:

  • Manufacture or processing of goods;
  • Manufacture of computer software;
  • Generation or distribution of electricity or any other form of power;
  • Providing telecommunication services (basic or cellular);
  • Mining; or
  • Construction of ships, aircraft, or rail systems.
Entity Mandatory Statutory Conditions [Section 116(2)]
Amalgamating Company
(Transferor Company)
  1. Must have been engaged in the business, in which the accumulated loss occurred or depreciation remains unabsorbed, for at least 3 years prior to amalgamation.
  2. Must have held continuously as on the date of amalgamation at least 3/4th (75%) of the book value of fixed assets held by it 2 years prior to the date of amalgamation.
Amalgamated Company
(Transferee Company)
  1. Must hold continuously for a minimum period of 5 years from the date of amalgamation at least 3/4th (75%) of the book value of fixed assets of the amalgamating company acquired in the scheme.
  2. Must continue the business of the amalgamating company for a minimum period of 5 years from the date of amalgamation.
  3. Must fulfill production levels prescribed under Rule 60 of Income-tax Rules, 2026: achieve at least 50% of the installed capacity before the end of 4 years from amalgamation and maintain it till the end of the 5th year.
  4. Must furnish an annual certificate in prescribed form verified by an Accountant along with the return of income.
Consequences of Failure to Comply with Conditions

If any of the prescribed conditions are not complied with by the amalgamated company, the total amount of loss or unabsorbed depreciation set off in any earlier tax year shall be deemed to be the income of the amalgamated company chargeable to tax in the tax year in which there is a failure to fulfill the conditions!

2. Demerger of Undertakings [Section 116(4) & (5)]

In the case of a demerger, the accumulated business loss and unabsorbed depreciation of the demerged company shall be transferred to the resulting company as follows:

  • Directly Relatable: If the loss or unabsorbed depreciation is directly relatable to the undertaking transferred, it shall be transferred entirely to the resulting company.
  • Not Directly Relatable (Common Pool): If not directly relatable, it shall be apportioned between the demerged company and the resulting company in the ratio of the assets of the undertakings retained by the demerged company and transferred to the resulting company.
Landmark Supreme Court Precedent: CIT v. KBD Sugars and Distilleries Ltd. [2023] 454 ITR 800 (SC)

Issue: Can a resulting entity set off and carry forward the accumulated losses and unabsorbed depreciation of a dysfunctional / non-operating unit of a demerged company?

Revenue's Contention: The Assessing Officer contended that since the demerged unit was closed down and not functioning, the demerger was not on a "going concern" basis under Section 2(35)(f), and thus losses could not be carried forward.

Supreme Court Ruling: The Supreme Court affirmed the High Court ruling in favour of the assessee. The Scheme of Demerger stood duly sanctioned and approved by the High Court. The phrase "going concern basis" does not require that every single unit must be actively manufacturing on the appointed date; if a unit were running and highly profitable, there would be no need for corporate restructuring or rehabilitation. Accordingly, the resulting entity is fully entitled to carry forward and set off the accumulated losses and unabsorbed depreciation of the dysfunctional unit!

3. Business Reorganisations: Firm/Proprietorship to Company or LLP [Section 116(6) & (7)]

Where a partnership firm or sole proprietary concern is succeeded by a company under Section 70(1)(zd) / Section 70(1)(zf), or a private/unlisted company is converted into an LLP under Section 70(1)(ze):

  • The accumulated business loss and unabsorbed depreciation of the predecessor firm/proprietorship/company becomes the loss and depreciation of the successor entity.
  • For reorganisations effected on or after 01.04.2025, the accumulated loss shall be carried forward in the hands of the successor entity for not more than 8 tax years immediately succeeding the tax year for which the loss was first computed in the hands of the original predecessor entity.
  • If the statutory conversion conditions are violated in any subsequent year, all set-offs previously allowed shall be recaptured as deemed income of the successor entity.
Section 117

7.11 Carry Forward & Set-Off in PSU & Banking Amalgamations [Section 117]

Corresponding 1961 Act: Section 72AA • Public Sector Banks, Disinvestments & General Insurance

Section 117 provides for the carry forward and set-off of accumulated loss and unabsorbed depreciation in schemes of amalgamation involving:

  1. Banking Company: Amalgamation of one or more banking companies with any other banking institution under a scheme sanctioned by the Central Government u/s 45 of Banking Regulation Act, 1949, or following a strategic disinvestment.
  2. Corresponding New Banks: One or more corresponding new banks (nationalised banks) with any other corresponding new bank under Section 9 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970/1980.
  3. Government General Insurance Companies: One or more Government companies with any other Government company under Section 16 of the General Insurance Business (Nationalisation) Act, 1972.
Operational Mechanism & 8-Year Clock [Section 117]
  • The accumulated loss and unabsorbed depreciation of the amalgamating banking/PSU entity is deemed to be the loss and unabsorbed depreciation of the amalgamated entity for the tax year of amalgamation.
  • For amalgamations brought into force on or after 01.04.2025: Any accumulated loss shall be carried forward in the hands of the successor entity for not more than 8 tax years immediately succeeding the tax year for which the loss was first computed in the hands of the original predecessor entity.
  • Accumulated loss specifically excludes speculation business losses.
Section 118

7.12 Business Reorganisation of Co-operative Banks [Section 118]

Corresponding 1961 Act: Section 72AB • Amalgamation, Demerger & Split-Year Accounting Rule

Section 118 governs the tax treatment of accumulated loss and unabsorbed depreciation in business reorganisations of co-operative banks (amalgamation or demerger).

Predecessor Co-operative Bank Conditions
  • Must have engaged in banking business for 3 or more years.
  • Held at least 3/4th (75%) of the book value of fixed assets as on the date of reorganisation continuously for 2 years prior to reorganisation.
Successor Co-operative Bank Conditions
  • Holds at least 3/4th (75%) of book value of fixed assets for at least 5 years.
  • Continues banking business for a minimum of 5 years.
  • Fulfills RBI-prescribed revival and rehabilitation conditions.
Demerger Apportionment Formula for Co-operative Banks
$$ ext{Loss / Depr allocated to Resulting Co-op Bank} = ext{Total Unabsorbed Loss / Depr} imes rac{ ext{Assets of Undertaking Transferred}}{ ext{Total Assets of Demerged Co-op Bank}}$$
Unique Exam Feature: The "Split-Year Rule" for Co-operative Banks

Where a business reorganisation of a co-operative bank takes place during a tax year, Section 118 prescribes that:

  • The period commencing from the beginning of the tax year and ending on the date immediately preceding the reorganisation date (Pre-reorganisation period); and
  • The period commencing from the reorganisation date and ending on the last day of the tax year (Post-reorganisation period)

shall be treated as TWO SEPARATE TAX YEARS for the purposes of set-off and carry forward of business losses and unabsorbed depreciation!

Example: If reorganisation occurs on 01.11.2026, the period 01.04.2026 to 31.10.2026 is Year 1, and 01.11.2026 to 31.03.2027 is Year 2. Both count as two separate elapsed years against the 8-year clock!

Section 119

7.13 Carry Forward & Set-Off of Losses Not Permissible in Certain Cases [Section 119]

Corresponding 1961 Act: Sections 78 & 79 • Firms, Inheritance & Closely-Held Companies 51% Rule

Section 119 lays down anti-abuse provisions restricting the carry forward and set-off of losses when there is a change in the constitution of a firm, change in ownership of a business, or substantial change in the shareholding of a closely-held company.

1. Change in Constitution of a Firm [Section 119(1)]

Where a change has occurred in the constitution of a partnership firm (e.g., retirement or death of a partner):

Proportionate Lapsing of Outgoing Partner's Loss

So much of the loss proportionate to the share of a retired or deceased partner as exceeds his share of profits, if any, in the previous year in the reconstituted firm, shall NOT be allowed to be carried forward and set off by the firm.

  • Unabsorbed Depreciation Exemption: This restriction applies strictly to business losses. Unabsorbed depreciation of the firm can be carried forward without any restriction, regardless of partner retirement or death!
  • Change in PSR Without Retirement: If all existing partners continue in the firm and only their profit-sharing ratio changes, Section 119(1) does NOT apply! The entire brought forward loss remains available for set-off.

2. Succession of Business & The Inheritance Exception [Section 119(2)]

As a cardinal rule, when a person carrying on any business or profession is succeeded by another person, the successor cannot carry forward and set off any loss incurred by the predecessor.

Statutory Exception Succession by Inheritance

Where succession is by inheritance, the legal heirs are entitled to set off and carry forward the business losses incurred by the predecessor!

If the legal heirs continue the deceased proprietor's business in partnership, the partnership firm is legally entitled to carry forward and set off the business losses of the deceased predecessor.

Landmark Case Law Matrix
  • CIT v. Madhukant M. Mehta [2001] 247 ITR 805 (SC): Sole proprietor died; legal heirs constituted a partnership firm and continued the identical business. Supreme Court held the firm is entitled to carry forward and set off the deceased's business losses under Section 119(2).
  • Saroj Aggarwal v. CIT [1985] 156 ITR 497 (SC): Upon death of a partner, legal heirs admitted as partners in reconstituted firm. Firm entitled to carry forward deceased partner's share of loss.
  • Pramod Mittal v. CIT [2013] 356 ITR 456 (Delhi): Firm was dissolved and one partner took over running business as proprietor. Held: Takeover upon dissolution is an agreement, NOT succession by inheritance; loss cannot be carried forward!

3. Closely-Held Companies & 51% Voting Power Rule [Section 119(3)]

In the case of a company in which the public are not substantially interested (closely-held company / private limited company), Section 119(3) imposes a strict condition on carrying forward business losses:

The 51% Beneficial Ownership Continuity Test

No loss incurred in any year prior to the tax year shall be carried forward and set off against the income of the tax year, unless:

$$ ext{Voting Power of Continuing Shareholders on Last Day of Current Year} \ge 51\% ext{ of Total Voting Power}$$

That is, persons who beneficially held shares carrying not less than 51% of the voting power on the last day of the tax year in which the loss was incurred must continue to beneficially hold shares carrying not less than 51% voting power on the last day of the current tax year.

Start-Up Special Relief Eligible Start-ups [Section 140 / Section 80-IAC]

For an eligible start-up company, the 51% voting power continuity condition is relaxed. The loss can be carried forward and set off even if voting power falls below 51%, provided:

  • 100% Continuity of Original Shareholders: ALL the shareholders of such company who held shares carrying voting power on the last day of the year in which the loss was incurred continue to hold shares on the last day of the current tax year; AND
  • 10-Year Incorporation Window: Such loss was incurred during the period of 10 years beginning from the year in which the company was incorporated.
Statutory Carve-Outs: Where Section 119(3) Restrictions Do NOT Apply
  1. Death or Gift to Relative: Change in voting power takes place on account of death of a shareholder or on account of transfer of shares by way of gift to any relative.
  2. Amalgamation/Demerger of Foreign Parent: Change in shareholding of an Indian subsidiary occurs due to amalgamation or demerger of a foreign company, provided 51% shareholders of amalgamating foreign company continue as shareholders of amalgamated foreign company.
  3. Insolvency Resolution Plan (IBC): Change in shareholding pursuant to a resolution plan approved under Section 31 of the Insolvency and Bankruptcy Code, 2016, after affording reasonable opportunity of being heard to the jurisdictional PCIT/CIT.
  4. NCLT Suspended Board / Oppression & Mismanagement: Company whose Board of Directors was suspended by NCLT u/s 241/242 of Companies Act, 2013, and new directors appointed, and change in shareholding is pursuant to an NCLT approved plan.
  5. RBI Directive: Change in shareholding taken place in accordance with directions issued by the Reserve Bank of India.
  6. Disinvested Erstwhile PSU: Erstwhile public sector company whose strategic disinvestment was completed, provided the ultimate holding company continues to hold at least 51% voting power.
  7. Unabsorbed Depreciation: Section 119(3) applies strictly to business losses. It has no application to unabsorbed depreciation! Unabsorbed depreciation can be carried forward and set off without any 51% shareholding constraint (*CIT v. Concord Industries Ltd.*).
Section 120

7.14 Bar on Set-Off Against Undisclosed Income Found in Search / Survey [Section 120]

Corresponding 1961 Act: Section 79A • Search u/s 247, Requisition u/s 248 & Survey u/s 253

Section 120 mandates that no set-off of any loss (whether brought forward from earlier tax years or sustained during the current tax year, under any head of income) shall be allowed against undisclosed income discovered or assessed as a consequence of:

  • A search initiated under Section 247 (formerly Section 132); or
  • Books of account, other documents, or any assets requisitioned under Section 248 (formerly Section 132A); or
  • A survey conducted under Section 253 (formerly Section 133A), other than a survey under Section 253(4) (TDS/TCS survey).
Statutory Scope of Undisclosed Income [Section 301]

"Undisclosed income" includes any money, bullion, jewellery, virtual digital assets, valuable articles, entry in books of account, or other transactions representing wholly or partly income which has not been disclosed, or which would not have been disclosed, in the return of income.

Under Section 120, such undisclosed income must be subjected to tax in full at the penal rates specified under Section 199 (formerly Section 115BBE) without allowing any adjustment of current year or carried forward losses or unabsorbed depreciation!

Statutory Hierarchy

7.15 Statutory Order of Set-off of Losses & Allowances

Sections 33(1), 33(11), 45, 112 & 32(i) • Compulsory Sequence of Deduction

When computing taxable business profits of an enterprise having current allowances, brought forward business losses, and unabsorbed depreciation, the statute dictates a compulsory chronological sequence of deductions to maximize the assessee's preservation of expiring allowances:

Priority Rank Nature of Allowance / Loss Governing Section Time Limit for Carry Forward
Rank 1 Current Year Depreciation Section 33(1) Adjusted against current year profits
Rank 2 Current Year Capital Exp. on Scientific Research & Family Planning Section 45(1)(a) / Section 32(i) Adjusted against current year profits
Rank 3 Brought Forward Loss from Business / Profession Section 112(1) 8 Tax Years (Must be set off first before unabsorbed depr because it has an 8-year expiry clock!)
Rank 4 Unabsorbed Depreciation Section 33(11) Indefinite (Can be carried forward indefinitely and set off against any head except Salaries)
Rank 5 Unabsorbed Capital Expenditure on Scientific Research Section 45(7) Indefinite (Treated on par with unabsorbed depreciation)
Rank 6 Unabsorbed Expenditure on Family Planning Section 32(i) Indefinite (Carried forward indefinitely for corporate assessees)
Key Distinction: Unabsorbed Depreciation vs Brought Forward Business Loss

As per Section 33(11)(b), unabsorbed depreciation brought forward from a previous year is deemed to be part of current depreciation. Consequently:

  • It can be set off against income assessable under ANY head of income (House Property, Business, Capital Gains, Other Sources), except Salaries!
  • It is NOT treated as a business loss under Section 112, and hence it is NOT subject to the 8-year time limit. It can be carried forward indefinitely.
  • It is NOT subject to the timely filing restrictions of Section 121.
ICAI Illustration 5

Comprehensive Multi-Head Aggregation & Set-off

Problem Statement:

Mr. Varun has furnished his details for the tax year 2026-27 as under:

Particulars Amount (₹)
Income from salaries (computed) 1,70,000
Income from speculation business 60,000
Loss from non-speculation business (40,000)
Short term capital gain 90,000
Long term capital loss of tax year 2024-25 (30,000)
Winning from lotteries (gross) 20,000

What is the taxable income of Mr. Varun for the tax year 2026-27?

Solution:

Computation of Taxable Income of Mr. Varun for Tax Year 2026-27

Particulars Amount (₹) Amount (₹)
Income from salaries 1,70,000
Profits and gains of business and profession:
Income from speculation business 60,000
Less: Loss from non-speculation business [Section 108(1)] (-) 40,000 20,000
Capital gains: 90,000
[Short-term capital gain = ₹90,000. Carried forward LTCL of ₹30,000 cannot be set off against STCG u/s 111; carried forward to tax year 2027-28]
Income from other sources: 20,000
[Winnings from lotteries = ₹20,000 taxable u/s 94 at flat rate without any deduction or set-off]
Taxable Income ₹ 3,00,000
Notes:
  1. Loss from non-speculation business can be set off against speculation business profits under Section 108(1).
  2. Long-term capital loss can be set off only against long-term capital gain [Section 108(2) & 111]. Therefore, brought forward long-term capital loss of ₹30,000 cannot be set off against short-term capital gain of ₹90,000 and will be carried forward to the next tax year.
  3. No loss can be set off against lottery winnings under Section 94.
ICAI Illustration 6

Depreciation Priority, Composite Tea Income & Brought Forward Losses

Problem Statement:

Compute the Gross Total Income of Mr. Fadnis for the tax year 2026-27 from the information given below:

Particulars Amount (₹)
Income from house property (computed) 1,25,000
Income from business (before providing for depreciation) 1,35,000
Short-term capital gains on sale of shares 56,000
Long-term capital loss from sale of property (brought forward from tax year 2023-24) (90,000)
Income from tea business 1,20,000
Dividend from Indian companies carrying on agricultural operations (Gross) 1,20,000
Current year depreciation 26,000
Brought forward business loss (loss incurred six years ago) (45,000)
Solution:

Gross Total Income of Mr. Fadnis for the Tax Year 2026-27

Particulars Amount (₹) Amount (₹)
Income from house property 1,25,000
Profits and gains of business and profession:
Profits from business before depreciation 1,35,000
Less: Current year depreciation [Section 33(1)] (-) 26,000
Business profit after current depreciation 1,09,000
Add: Income from tea business [Rule 8: 40% of ₹1,20,000 is business income] 48,000
Total business profit 1,57,000
Less: Brought forward business loss (incurred 6 years ago; within 8-year limit u/s 112) (-) 45,000 1,12,000
Capital gains: Short-term capital gains 56,000
[Brought forward LTCL of ₹90,000 cannot be set off against STCG; carried forward for 5 more years u/s 111]
Income from other sources: Dividend from Indian companies 1,20,000
Gross Total Income ₹ 4,13,000
Detailed Explanatory Notes:
  1. Dividend Income: Dividend from Indian companies of ₹1,20,000 is taxable in the hands of the shareholders under the head "Income from other sources". Even though the paying company carries on agricultural operations, dividend distributed out of agricultural income is NOT agricultural income in the hands of the shareholder (*CIT v. Mrs. Bacha F. Guzdar [1955] 27 ITR 1 (SC)*).
  2. Composite Tea Income: 60% of income from growing and manufacturing tea (₹72,000) is treated as agricultural income under Rule 8 and is exempt from tax under Section 10(1). Only the balance 40% (₹48,000) is chargeable as business income.
  3. LTCL Set-Off Restriction: Long-term capital loss can be set off only against long-term capital gains [Section 108(2) & 111]. Therefore, brought forward long-term capital loss of ₹90,000 cannot be set off against short-term capital gains of ₹56,000. It can be carried forward for 5 more tax years.
  4. Order of Set-off: Current year depreciation is deducted first [Section 33(1)], and brought forward business loss is adjusted thereafter against the remaining business profits [Section 112(1)].
Section 121

7.16 Mandatory Submission of Return of Losses [Section 121]

Corresponding 1961 Act: Section 80 • Filing on or Before Section 263(1) Due Date

Section 121 provides that an assessee claiming carry forward of losses under the Act must mandatorily furnish a return of loss on or before the due date specified under Section 263(1) (formerly Section 139(1)).

Losses Subject to Mandatory Timely Filing Losses Disentitled if Filed Belatedly

The following losses CANNOT be carried forward if the return is not filed on or before the Section 263(1) due date:

  • Loss under the head "Capital Gains" [Section 111(1)];
  • Loss from business or profession [Section 112(1)];
  • Loss from speculation business [Section 113(2)];
  • Loss from specified business [Section 114(2)];
  • Loss from activity of owning and maintaining race horses [Section 115(2)].
Statutory Exemptions Carry Forward Allowed Even on Belated Filing

The condition of timely return filing under Section 121 DOES NOT APPLY to:

  • Loss from House Property [Section 110]: An assessee is entitled to carry forward house property loss even if the return of income is filed after the Section 263(1) due date (e.g. belated return u/s 263(4))!
  • Unabsorbed Depreciation [Section 33(11)]: Unabsorbed depreciation is an allowance governed by Section 33(11) and not a loss governed by Section 121. Hence, unabsorbed depreciation can be carried forward indefinitely even if the return of loss is submitted belatedly!
Subsequent Years' Return Filing

The condition of timely filing under Section 121 applies to the tax year in which the loss was incurred. In a subsequent tax year in which an already brought-forward loss is set off against profits, filing the subsequent year's return after the due date does not bar the set-off of such brought-forward loss, provided the loss was duly determined in a timely return filed for the year of incurrence!

Practical Examination Focus

Test Your Knowledge: Practical Comprehensive Problems

ICAI CA Final Direct Tax Case Studies • Questions 1 to 5 with In-Depth Solutions

The following 5 practical problems from the ICAI CA Final Study Material test advanced application of loss ring-fencing, inheritance exceptions, corporate amalgamations, partnership restructuring, and statutory return filing deadlines.

TYK Question 1

Succession by Inheritance: Deceased Proprietor's Business Loss in Legal Heirs' Firm

Problem Statement:

X, carrying on a business as a sole proprietor, died on 31st March, 2027. On his death, his legal heirs formed a partnership firm and continued the identical business. The business suffered a loss of ₹5,00,000 for the tax year 2026-27.

Question: Does the firm consisting of all the legal heirs of Mr. X get a right to have this loss adjusted against its business income for subsequent tax years?

Statutory Analysis & Solution:
Statutory Framework: Section 119(2) [Corresponding 1961 Act: Section 78(2)]

Section 119(2) provides that where a person carrying on any business or profession has been succeeded in such capacity by another person, the successor shall not be entitled to have the business loss incurred by the predecessor set off against his income, EXCEPT where the succession is by inheritance.

Application of Supreme Court Precedent: CIT v. Madhukant M. Mehta [2001] 247 ITR 805 (SC)

The facts of the present case are on all fours with the landmark ruling of the Supreme Court in CIT v. Madhukant M. Mehta. In that case, the sole proprietor expired and his legal heirs formed a partnership firm to carry on the identical business of the deceased.

The Supreme Court held that:

  • Succession by inheritance is an expressly carved out statutory exception under the Act.
  • When legal heirs inherit a business and form a partnership firm to continue that very business, the succession of the business by the firm is a succession by inheritance.
  • The partnership firm is merely an association of the legal heirs who have jointly stepped into the shoes of the deceased predecessor.
Conclusion

Yes, the partnership firm consisting of all the legal heirs of Mr. X is fully entitled to carry forward and set off the business loss of ₹5,00,000 against its business income for subsequent tax years up to the balance unexpired period of 8 tax years under Section 112 read with Section 119(2).

TYK Question 2

Amalgamation: Excess Depreciation Recapture, Speculation Exclusion & Multi-Loss Priority

Problem Statement:

ABC Limited, owning an industrial undertaking, was amalgamated with XYZ Limited on 01.04.2026. ABC Limited had the following assessed losses relating to tax year 2025-26 carried forward:

Particulars Amount (₹ in lakhs)
(i) Speculative Loss 4.00
(ii) Unabsorbed Depreciation 18.00
(iii) Unabsorbed capital expenditure on scientific research 2.00
(iv) Business Loss 120.00

XYZ Limited has computed a profit of ₹140 lakhs for the tax year 2026-27 before setting off the brought forward losses of ABC Limited. The profit of ₹140 lakhs was arrived at after charging depreciation of ₹22.50 lakhs on assets acquired on amalgamation from ABC Limited. The value of these assets was accounted for in XYZ Limited's books at ₹150 lakhs, whereas the Written Down Value (WDV) in the books of ABC Limited was ₹100 lakhs.

The profit of ₹140 lakhs includes a speculative profit of ₹10 lakhs.

Requirement: Compute the total income of XYZ Limited for the Tax Year 2026-27 and indicate the losses/allowances to be carried forward.

Solution:

Computation of Total Income of XYZ Limited for Tax Year 2026-27

Particulars Amount (₹ in lakhs) Amount (₹ in lakhs)
Business income before setting off brought forward losses of ABC Ltd. 140.00
Add: Excess depreciation claimed on assets acquired on amalgamation [Section 33 / Proviso to Section 32(1)]:
  • Value accounted by XYZ Ltd: ₹150 lakhs
  • WDV in books of ABC Ltd: ₹100 lakhs
  • Excess value recorded: ₹50 lakhs
  • Excess depreciation claimed [₹50 lakhs × 15%]: ₹7.50 lakhs
 7.50
Adjusted Business Profits before Set-Off 147.50
Less: Set-off of brought forward business loss of ABC Ltd. [Section 112 read with Section 116(1)] (See Notes 2, 3 & 4) (-) 120.00
Less: Set-off of unabsorbed depreciation under Section 33(11) read with Section 116(1) (-) 18.00
Less: Set-off of unabsorbed capital expenditure on scientific research under Section 45(1)(a) read with Section 45(7) (-) 2.00 (-) 140.00
Taxable Business Income / Total Income ₹ 7.50 lakhs
Detailed Explanatory Notes:
  1. Validity of Amalgamation: It is presumed that the amalgamation satisfies all statutory conditions under Section 116(2) of the Income-tax Act, 2025.
  2. Deemed Loss & Fresh Lease: Under Section 116(1), the accumulated business loss and unabsorbed depreciation of the amalgamating company (ABC Ltd.) is deemed to be the loss and depreciation of the amalgamated company (XYZ Ltd.) for the tax year 2026-27. Business loss gets a fresh 8-year clock.
  3. Speculation Loss Bar [Section 116(13)]: As per the statutory definition in Section 116(13), "accumulated loss" to be carried forward specifically excludes loss sustained in a speculation business! Consequently, the speculative loss of ₹4.00 lakhs of ABC Ltd. cannot be carried forward or set off by XYZ Ltd. against its speculative or non-speculative profits. It lapses completely.
  4. Normal Loss Absorption against Speculation Profit: The restriction in Section 113 is only that speculation loss cannot be set off against normal profits. However, brought forward general business loss (₹120 lakhs) can be set off against both non-speculative business profit (₹137.50L) and speculative profit (₹10L)!
  5. Depreciation Recapture: In a scheme of amalgamation, the actual cost/WDV to the amalgamated company cannot exceed the WDV in the hands of the amalgamating company. Excess depreciation of ₹7.50 lakhs claimed on inflated value is disallowed and added back.
  6. Summary of Carry Forward: All eligible losses (₹120L business loss, ₹18L unabsorbed depr, ₹2L scientific research) have been 100% absorbed against current year profits. Therefore, NIL loss or allowance remains to be carried forward to future years.
TYK Question 3

Scope of Section 115: Owning and Maintaining Camels for Races

Problem Statement:

Examine in brief the treatment to be given under the Income-tax Act, 2025 in the following case:

"A loss of ₹85,000 was sustained by Simran in the activity of owning and maintaining camels for races in Rajasthan. Can this loss be set off against other business income or carried forward?"

Statutory Solution:
Statutory Scope of Section 115 [Corresponding 1961 Act: Section 74A(3)]

Section 115 lays down specific ring-fencing provisions for the set-off and carry forward of loss from the "specified activity".

By statutory definition under Section 115, the scope of "specified activity" is strictly confined to the activity of owning and maintaining race horses.

Tax Treatment of Camel Racing Activity
  • Camels are not horses; hence, the restrictive 4-year ring-fenced provisions of Section 115 do not apply to the activity of owning and maintaining camels for races.
  • The activity of owning and maintaining camels for races constitutes a regular business or profession governed by the general provisions of the Act.
  • Current Year Set-Off [Section 108 & 109]: The loss of ₹85,000 can be set off against income from any other business under Section 108, or against any other head of income (except Salaries) under Section 109.
  • Carry Forward [Section 112]: Any unabsorbed loss can be carried forward to the following tax year under Section 112 for up to 8 tax years to be set off against future business profits.
TYK Question 4

Partnership Reconstitution: Mere Change in Profit Sharing Ratio (PSR)

Problem Statement:

M/s. JKLM, a firm, consists of four partners namely, J, K, L and M. They shared profits and losses equally up to the tax year 2025-26.

On 01.04.2026, the partners decided to change their profit sharing ratio to 15:15:20:50 for J, K, L and M respectively. No partner retired and no new partner was admitted.

The brought forward business loss relating to the tax year 2025-26 is ₹3,60,000. The business income of the firm for the tax year 2026-27 is ₹3,30,000.

Requirement: Compute the amount of business loss relating to the tax year 2025-26 which the firm is entitled to set off against its business income for the tax year 2026-27, and state the amount to be carried forward.

Statutory Solution:
Applicability of Section 119(1) [Corresponding 1961 Act: Section 78(1)]

Section 119(1) restricts the carry forward and set-off of losses in the case of a change in the constitution of a firm. It provides that where a partner retires or dies, so much of the loss proportionate to his share cannot be carried forward by the reconstituted firm.

However, Section 119(1) is attracted ONLY upon retirement or death of a partner. It has NO application to a case where there is merely a change in the profit-sharing ratio among existing continuing partners without any exit of partners!

Particulars Amount (₹)
Business income of M/s JKLM for the tax year 2026-27 3,30,000
Less: Brought forward business loss of tax year 2025-26 set off under Section 112 (Full ₹3,60,000 available without restriction) (-) 3,30,000
Taxable Business Income of Firm for Tax Year 2026-27 Nil
Balance Unabsorbed Business Loss to be Carried Forward to Tax Year 2027-28 ₹ 30,000
Conclusion:

The firm is entitled to set off its brought forward business loss of ₹3,60,000 to the extent of its full business income of ₹3,30,000. The balance unabsorbed loss of ₹30,000 will be carried forward to the tax year 2027-28 and can be set off for up to 7 more tax years under Section 112.

TYK Question 5

Belated Return u/s 263(4): Carry Forward of Unabsorbed Depreciation

Problem Statement:

An assessee sustained an unabsorbed depreciation in the tax year 2026-27, which was not determined in a return filed on or before the due date specified under Section 263(1).

The return of income was filed belatedly under Section 263(4).

Question: Can the unabsorbed depreciation be carried forward to the following tax year?

Statutory Solution:
Interplay between Section 121 [Sec 80] and Section 33(11) [Sec 32(2)]

Section 121 (formerly Section 80) mandates that an assessee claiming carry forward of losses under Section 111(1) [Capital Gains], Section 112(1) [Business Loss], Section 113(2) [Speculation Loss], Section 114(2) [Specified Business Loss] and Section 115(2) [Race Horses Loss] must file the return on or before the due date specified under Section 263(1).

Section 121 Does Not Cover Unabsorbed Depreciation: Section 121 conspicuously omits Section 33(11) (unabsorbed depreciation). Under the scheme of the Act, depreciation is an allowance forming an integral part of computation, rather than an assessed loss.

Legal Conclusion

YES. The unabsorbed depreciation CAN be carried forward to the following tax year, even though the return of income was filed belatedly under Section 263(4). The condition of filing the return on or before the Section 263(1) due date does not apply to unabsorbed depreciation!

Comparative Matrix

7.18 Master Statutory Matrix: Income-tax Act, 2025 vs 1961 Act

Direct Cross-Reference Table • Complete Chapter VII Mapping

The table below provides a comprehensive section-by-section comparison between Chapter VII of the Income-tax Act, 2025 and the legacy provisions under the Income-tax Act, 1961.

Section (2025 Act) Section (1961 Act) Subject Matter & Key Statutory Provisions Carry Forward Limit
Section 108(1) Section 70(1) Inter-source adjustment of loss within the same head of income (Intra-head set-off). Current Year
Section 108(2) Section 70(3) Long-term capital loss can be set off ONLY against long-term capital gains (cannot set off against STCG). Current Year
Section 109 Section 71 Inter-head set-off. Restrictions: Business loss cannot set off against salaries; Capital loss cannot set off against any other head; House property loss capped at ₹2,00,000 (disallowed under Section 202 default regime). Current Year
Section 110 Section 71B Carry forward and set-off of loss from house property against income from house property only. (Disallowed under Section 202 default regime). 8 Tax Years
Section 111 Section 74 Carry forward and set-off of losses under head "Capital gains". STCL against STCG/LTCG; LTCL against LTCG only. 8 Tax Years
Section 112 Section 72 Carry forward and set-off of business losses against business/profession profits only. 8 Tax Years
Section 113 Section 73 Losses in speculation business. Set-off and carry forward strictly against speculation profits. Deemed speculation company share trading. 4 Tax Years
Section 114 Section 73A Carry forward and set-off of losses from specified businesses u/s 46 against any specified business profits. Indefinite
Section 115 Section 74A(3) Losses from the activity of owning and maintaining race horses against income from owning and maintaining race horses only. 4 Tax Years
Section 116 Section 72A Carry forward of accumulated business loss (fresh 8-year clock) and unabsorbed depreciation (indefinite) in amalgamation, demerger, or conversion of firm/proprietorship into company/LLP. Fresh 8 Tax Years / Indefinite
Section 117 Section 72AA Carry forward and set-off of accumulated losses and unabsorbed depreciation in amalgamation of banking companies, public sector banks, and Government companies. 8 Tax Years / Indefinite
Section 118 Section 72AB Accumulated loss and unabsorbed depreciation in business reorganisation of co-operative banks (Split-year accounting rule). 8 Tax Years / Indefinite
Section 119(1) Section 78(1) Change in constitution of firm (death/retirement): proportionate share of deceased/retired partner's business loss lapses. N/A (Lapses)
Section 119(2) Section 78(2) Succession of business: successor cannot carry forward predecessor's loss, EXCEPT in case of succession by inheritance (*CIT v. Madhukant M. Mehta*). Balance of 8 Tax Years
Section 119(3) Section 79 Closely-held companies: 51% voting power continuity test. Special startup exception: 100% shareholder continuity within 10 years of incorporation. Governed by Sec 112
Section 120 Section 79A No set-off of any losses against undisclosed income discovered in search (Sec 247), requisition (Sec 248), or survey (Sec 253). Prohibited
Section 121 Section 80 Mandatory submission of return of loss on or before Section 263(1) due date to carry forward capital, business, speculation, specified business, and race horses losses. (Exempts HP loss and unabsorbed depr). Due Date Mandate

Master Summary Table: Absorption Rules, Periods & Permissible Incomes

Type of Loss / Allowance Intra-Head Set-off Inter-Head Set-off Carry Forward Period Permissible Set-Off in Subsequent Years Section 121 Due Date Mandate?
House Property Loss
Section 110		 Allowed ✓ Normal Regime: Max ₹2,00,000
Default Regime: Disallowed 		8 Tax Years
(Normal regime only)		 Income from House Property only NO (Belated allowed)
Business Loss (Non-Speculative)
Section 112		 Allowed ✓ Allowed against any head except Salaries 8 Tax Years Profits and gains of business or profession only YES (Mandatory)
Speculation Business Loss
Section 113		 Only against other speculation profits Not Allowed ✗ 4 Tax Years Speculation profits only YES (Mandatory)
Specified Business Loss u/s 46
Section 114		 Only against other specified business profits Not Allowed ✗ Indefinite Profits of any specified business only YES (Mandatory)
Short-Term Capital Loss
Section 111		 Against STCG and LTCG Not Allowed ✗ 8 Tax Years STCG and LTCG YES (Mandatory)
Long-Term Capital Loss
Section 111		 Only against LTCG Not Allowed ✗ 8 Tax Years LTCG only YES (Mandatory)
Race Horses Loss
Section 115		 Only against race horses income Not Allowed ✗ 4 Tax Years Race horses income only YES (Mandatory)
Unabsorbed Depreciation
Section 33(11)		 Allowed Allowed against any head except Salaries Indefinite Any head of income except Salaries NO (Belated allowed)