Last updated: February 14th, 2020 3:35 PM

Business Loss Setoff

Business losses incurred by taxpayers in previous financial years can be adjusted against the taxable income of the current financial year. In keeping with the principles of natural justice, the Income Tax Act allows such adjustments to be made. Hence, the Income Tax Act has provisions for business loss setoff. In this article, we look at the different types of business loss and their implications under the Income Tax Act.

Conditions for Set-off

A business trading loss is deductible in computing the profit earned by a business if the following conditions are satisfied:

• The loss should be a real loss and not notional or fictitious.
• The loss should be a loss on revenue account and not on the capital account.
• The loss must have actually arisen and been incurred, not merely anticipated or certain to occur in the future.
• The loss should be one that is incidental to the carrying on of the business and must arise or spring directly from or be incidental to the carrying out of the operation of the assessee's business.
• There should be no prohibition mentioned in the provisions of the Income Tax Act, against its deductibility.

Business Losses Deductible under Income Tax

The following types of business loss are considered to be incidental to the business and are deductible under the Income Tax Act:

• Loss on account of embezzlement by an employee is allowed as a deduction in the year in which such embezzlement is discovered.
• Loss of stock-in-trade by fire or other natural calamities or due to the negligence of employees is deductible.
• Loss on account of robbery or theft provided it is in the course of business and incidental to the trade is deductible.
• Loss caused on account of fluctuation in the exchange rate at the time of remitting the money for the purchase of raw materials is deductible.
• Loss caused due to non-recovery of advances made in the course of business, providing it is a trading loss is deductible under the Income Tax Act.
• Loss caused due to a breach of contract for the delivery of goods by either party is deductible.
• Loss of raw material or finished goods in transit is tax-deductible.
• Loss caused by forfeiture of security deposits given at the time of submission of tenders is deductible.
• Loss by the failure of a bank in which money is deposited is tax-deductible.
• Any loss incurred due to non-recovery of advance given to salvage the capital, if it is in the revenue field, is an admissible deduction.

Business Loss Not Allowed under Income Tax

The following types of business loss are not deductible from business income:

• Losses sustained before the business is commenced
• Losses incurred in the closing down of a business.
• Losses incurred due to damage, destruction, etc., of capital assets.
• A loss which is not incidental to the carrying on of the business of the assessee.
• Loss due to the sale of securities held as investments as it will be a capital loss and not the business loss.
• Loss caused by forfeiture of advance given for the purchase of capital assets.
• Violation of the law is not a normal incident of trade and an expense incurred by way of penalty for infraction of laws is not allowed for deduction as a business loss.
• Trading loss due to loss of goods in transit in the normal course of business.

To know about the concept of tax audit turnover in Income Tax, click here.