Section 78 of Income Tax Act,1961: Carry forward and set off of losses in case of change in constitution

The Income Tax Law does acknowledge the necessity of offsetting a loss from one year against income from another year before determining the assessor’s “total income,” on which tax is due. However, subject to meeting certain requirements and restrictions as laid down in the Act, such losses are permitted to be carried forward and set off. Contrary to popular belief, not all losses can be used to offset income in the same year or can be carried forward and used to offset income in the following year. In order to take full advantage of this provision and to minimize taxes, it is crucial to be aware of the conditions and restrictions.

Carry forward of loss in case of change in the constitution of business: In the event of a change in the constitution of business, the person who suffers a loss only has the right to carry it forward to be adjusted in future years. However, the reconstituted entity is permitted to carry forward the unadjusted loss of the predecessor entity in certain circumstances of business reconstitution, such as amalgamation, demerger, conversion of a proprietary firm into a company, conversion of a partnership firm into a company, etc. (provided that conditions specified in this regard are satisfied).

Provisions relating to the carry forward of loss in the case of the retirement of a partner from a partnership firm: If a partner’s death or retirement results in a change in the partnership firm’s structure, Section 78 contains provisions relating to the carry forward and set off of losses (i.e., when a partner goes out of the firm by retirement or death). In this scenario, the firm is unable to carry forward the portion of the loss that is attributable to the departing partner. Section 78’s restriction only applies to losses; it does not apply to adjustments of unabsorbed depreciation, unabsorbed capital expenditures for scientific research, or unabsorbed family planning expenditures.