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Unit 4: Set-off and Carry Forward of Losses

Notes
!
Caution Loss from the activity of owning and maintaining race horses cannot be set-off
against any other source/head of income.

Self Assessment

State whether the following statements are true or false:
24. Provisions of section 74 A (3) deals with the losses incurred by an assessee from the activity
of owning and maintaining race horses.
25. Losses incurred by an assessee from the activity of owning and maintaining race horses can
be carried forward for a maximum period of 8 assessment years.

4.10 Section 78 and Section 79

The Section 78 and Section 79 of the Income Tax Act, 1961, deals with the treatment of setoff and
carry forward of losses in case of change in constitution of firm or succession and of closely held

companies respectively.

Carry Forward and Set-off of Losses in Case of Change in Constitution of Firm or
Succession (Section 78)

Where there is a change in the constitution of a firm, so much of the loss proportionate to the

share of a retired or deceased partner remaining unabsorbed, shall not be allowed to be carried

forward by the firm. However, unabsorbed depreciation can be carried forward.
Where any person carrying on any business or profession has been succeeded in such capacity
by another person otherwise than by inheritance, such other person shall not be allowed to carry
forward and set off against his income, any loss incurred by the predecessor.

Example: X carrying on a business as sole proprietor, died on 31st March, 2012. On his
death, the same business was continued by his legal heirs, by forming a firm. As on 31st March

2012, a determined business loss of 5 lakhs is to be carried forward under the Income-tax Act,

1961. Does the firm consisting of all legal heirs of Mr. X, get a right to have this loss adjusted
against its current income?
Solution: Section 78(2) provides that where a person carrying on any business or profession
has been succeeded in such capacity by another person, otherwise than by inheritance, then,
the successor is not entitled to carry forward and set-off the loss of the predecessor against his
income. This implies that generally, set-off of business losses should be claimed by the same
person who suffered the loss and the only exception to this provision is when the business passes
on to another person by inheritance.
The facts of case given in the question are similar to the case CIT v. Madhukant M. Mehta (2001)
247 ITR 805, where the Supreme Court has held that if the business is succeeded by inheritance,

the legal heirs are entitled to the benefit of carry forward of the loss of the predecessor. Even if the

legal heirs constitute themselves as a partnership firm, the benefit of carry forward and set off of
the loss of the predecessor would be available to the fi rm.
In this case, the business of X was continued by his legal heirs after his death by constituting a

firm. Hence, the exception contained in section 78(2) along with the decision of the Apex Court
discussed above, would apply in this case. Therefore, the firm is entitled to carry forward the

business loss of ` 5 lakhs of X.

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