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The Concept Of Capital Gains And The Concept Of Set-Off Carry Forward Under The Income Tax Act

Capital gains arise from the sale of assets other than those held in the ordinary conduct of business. In India, capital gains tax is levied within the framework of Indian Income Tax Act, 1961. Sections 45 to 55A of the Act relate to the taxation of capital gains. Since capital gains are not annual accruals from a given source but represent appreciation in the market value of assets over a period of time, they are treated on a different footing. The preferential treatment is given to long-term capital gains only.1

When one aspires to earn the profit, there is an equally likely chance of incurring losses too. However, the Income-tax law in India does provide taxpayers some benefits of incurring losses too. The law contains provisions for set-off and carry forward of losses. Set off means adjusting the losses against the profit of that Financial Year.

In case there are no adequate profits to set off the entire losses, it can be adjusted in the coming financial years according to the statute. A set-off could be: An intra-head set-off: The losses from one source of income can be set off against income from another source under the same head of income. An Intra-head set off : After the intra head adjustments, the taxpayers can set off remaining losses against income from other heads.

Introduction:
Gain arising on transfer of capital asset is charged to tax under the head "Capital Gains". Income from capital gains is classified as "Short Term Capital Gains" and "Long Term Capital Gains." This is concept was introduced to provide relief to taxpayers who incur losses in a particular financial year.

The Set-off and carry forward of loss assist taxpayers to settle the losses they incurred against the income they gained or the profit they made. Sometimes, all the losses do not settle against this year's profit if the losses are high compared to the gains. In such cases, those losses can be carried forward into the profits of subsequent years.

Set-off and carry forward of loss happens when you calculate your capital gains, and the capital gains appear to be lesser than the cost of acquisition. Set-off and carry forward of loss can be measured by adjusting the gain or loss of that specific year. However, the rule is that the losses from capital gain cannot be set off against income in any other way. It could only be settled with capital gains.

For example, loss from property investment can only be settled against the profit of another property investment. You cannot fix these losses with other income, such as bonds and stocks. This is the set-off and carries forward of losses meaning.

Meaning of Capital Gains

Profits or gains arising from transfer of a capital asset are called "Capital Gains" and are charged to tax under the head "Capital Gains".

Definition of Capital Gains
Section 45 of Income Tax Act, 1961 provides that any profits or gains arising from the transfer of a capital asset effected in the previous year will be chargeable to income-tax under the head 'Capital Gains'. Such capital gains will be deemed to be the income of the previous year in which the transfer took place. In this charging section, two terms are important. One is "capital asset" and the other is "transfer".

Definition of Capital Asset

According to section 2(14), a capital asset means:
  1. property of any kind held by an assessee, whether or not connected with his business or profession;
  2. any securities held by a Foreign Institutional Investor which has invested in such securities in accordance with the SEBI regulations.
However, it does not include:
  1. Any stock-in-trade consumable stores or raw materials held for the purpose of the business or profession of the assessee;
  2. Personal effects, that is to say, movable property (including wearing apparel and furniture) held for personal use by the assessee or any member of his family dependent on him, but excludes:
    1. Jewelry;
    2. Archaeological collections;
    3. Drawings;
    4. Paintings;
    5. Sculptures; or
    6. Any work of art.
    7. Rural agricultural land in India
  3. 6% Gold Bonds, 1977, or 7% Gold Bonds, 1980, or National Defence Gold Bonds, 1980, issued by the Central Government;
  4. Special Bearer Bonds, 1991 issued by the Central Government;
  5. Gold Deposit Bonds issued under the Gold Deposit Scheme, 1999 notified by the Central Government.
     

Short Term and Long Term Capital AssetsThe short-term capital asset is a capital asset held by an assessee for not more than 36 months immediately preceding the date of its transfer. Therefore, a capital asset held by an assessee for more than 36 months immediately preceding the date of its transfer is a long-term capital asset.

However, a security (other than a unit) listed in a recognized stock exchange, or a unit of an equity oriented fund or a unit of the Unit Trust of India or a Zero Coupon Bond will be considered as a long-term capital asset if the same is held for more than 12 months immediately preceding the date of its transfer. In the case of Immovable Property (land or building or both) hold for more than 24 months then it will be treated as a long-term capital asset.

This implies that an unlisted security and unit of a debt-oriented mutual fund would qualify as a "long-term capital asset" and be eligible for the benefit of indexation and a concessional rate of [email protected]% only if it is held for "more than 36 months".

Tax on Long-Term Capital Gains

Where securities transaction tax is applicable (in case of equity shares and equity-oriented MF): If securities transaction tax is applicable, the long-term capital gain is taxable at the rate of 10% + Surcharge and Education Cess. Although such capital gain up to Rs.1,00,000 is not taxable under section 112A.

In all other The long-term capital gain is taxable at 20% + Surcharge and Education Cess.

Tax on Short-Term Capital Gains

Where securities transaction tax is applicable (in case of equity shares and equity-oriented MF): If securities transaction tax is applicable, the short-term capital gain is taxable at the rate of 15% + Surcharge and Education Cess.

In all other cases: The short-term capital gain is taxable according to the income tax slab rate.

Mode of computation of capital gains

  1. he income chargeable under the head 'capital gains' shall be computed by deducting the following items from the full value of the consideration received or accruing as a result of the transfer of the capital asset:
    1. Expenditure incurred wholly and exclusively in connection with such transfer.
    2. The indexed cost of acquisition and indexed cost of any improvement thereto.
  2. However, no deduction shall be allowed in computing the income chargeable under the head "Capital Gains" in respect of any amount paid on account of securities transaction tax under Chapter VII of the Finance (No.2) Act, 2004.

    As per section 48, the cost of acquisition will be increased by applying the Cost Inflation Index (CII). Once the cost inflation index is applied to the cost of acquisition, it becomes an indexed cost of acquisition. This means an amount which bears to the cost of acquisition, the same proportion as CII for the year in which the asset is transferred bears to the CII for the first year in which the asset was held by the assessee or for the year beginning on 1st April 2001, whichever is later.

    Similarly, indexed cost of any improvement means an amount which bears to the cost of the improvement, the same proportion as CII for the year in which the asset is transferred bears to the CII for the year in which the improvement to the asset took place.
     
  3. Special provision for non-residents
    In order to give protection to non-residents who invest foreign exchange to acquire capital assets, section 48 contains a proviso.

    Accordingly, in the case of non-residents, capital gains arising from the transfer of shares or debentures of an Indian company is to be computed as follows:

    The cost of acquisition, the expenditure incurred wholly and exclusively in connection with the transfer and the full value of the consideration are to be converted into the same foreign currency with which such shares were acquired.

    The resulting capital gains shall be reconverted into Indian currency. The aforesaid manner of computation of capital gains shall be applied for every purchase and sale of shares or debentures in an Indian company. Rule 115A is relevant for this purpose. Non-residents and foreign companies to be subject to tax at a concessional rate of 10% (without indexation benefit or currency fluctuation) on long-term capital gains arising from the transfer of unlisted securities [Section 112].
Meaning of set off of Losses under Income Tax Act, 1961: Set off means setting of losses against profits of same head of income or may be different during the year.

Meaning of carry forward of losses under Income Tax Act, 1961:Carry forward of losses means carrying the losses amount to be set off against profits of one head or other head.

Provisions of carry forward of losses:

  1. Intra head adjustments:
    Intra head adjustments are relating to set off losses of same head with profits of same head but there are exceptions of it are as follows:
    • Speculation losses of business:
      Speculation losses of business are only set off against speculation business not of any normal business profit.
       
    • Losses of long term capital gains:
      Losses of long term capital gains are only set off against profits of long term capital gains.
       
    • Losses of short term capital gains:
      Losses of short term capital gains are only set off against profits of short term capital gains.
       
    • Losses from casual:
      loss from lottery, crossword puzzles, or any game sort like this or gambling or betting
       
    • Losses from owning and maintaining horse races:
      the losses of owning and maintaining horse races are only to be set off against profits of owning and maintaining of race horses.

     
  2. Inter head adjustments:
    Inter head adjustments are the adjustments of losses with other heads of income . but there are some exceptions of it are as follows:
    •  Losses of business and business and profession cannot be set off against profits of salary head.
    • Losses of capital gains cannot be set off against with other heads. In case , of house property; loss more than 2 lakhs cannot be adjusted against other head incomes.
    • Speculation business
      Speculation business losses cannot be set off against profits of normal business , it only to set off against profits of speculation business. Losses of long capital gains :- losses of long capital gains are only to be set off against profits of long capital gains .. not from the profits of short term capital gains Losses of short term capital gains :- losses of short term capital gains are only to set off against profits of short term capital gains.
       
    • Losses from lotteries, crossword puzzles , or any game sort like this , gambling or betting .. are only to be set off against profits of casual income.
    • Losses from owning and maintaining of horses race are only to set off and carried forward against profits of maintaining of horse races.

Conclusion:
The set-off and carry forward of loss is a technique implemented by the government to help taxpayers with losses. Such losses can be settled against profits from the same year and a few subsequent years. Losses from one head can also be resolved with earnings from other categories. The set-off is of two types: The intra-head set-off and the inter-head set-off. The profits from activities like gambling, card games, horse care, and lotteries are not considered during set off. There is a period beyond which the loss cannot be carried forward.

References:
  1. https://www.indianjournals.com/ijor.aspx?target=ijor:vjit&volume=1&issue=1&article=006
  2. https://unacademy.com/content/upsc/study-material/commerce/set-off-and-carry-forward-of-loss/
  3. https://www.hostbooks.com/in/capital-gains-income/
  4. https://www.hostbooks.com/in/capital-gains-income/
  5. https://taxguru.in/income-tax/provisions-set-carry-losses.html

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