Set-Off of Losses
Set-off of losses is the mechanism under Sections 70–74 of the Income Tax Act allowing taxpayers to reduce taxable income or capital gains in the current year by netting eligible losses incurred in the same financial year against eligible gains.
Set-off operates at two levels: intra-head set-off (within the same head of income) and inter-head set-off (across different heads). For capital gains, Section 70 permits short-term capital losses to be set off against both short-term and long-term capital gains of the same year. Section 74 governs the specific rules for capital loss set-off and carry-forward.
A critical asymmetry governs capital loss set-off: long-term capital losses can only be set off against long-term capital gains — not against short-term capital gains. Conversely, short-term capital losses can be set off against both short-term and long-term capital gains. This means an investor who booked a large LTCG in March cannot fully neutralise it with a short-term loss realised in the same year — the STCL can offset LTCG, but LTCL cannot offset STCG.
Capital losses — whether short-term or long-term — cannot be set off against any other head of income such as salary, house property income, or business income. The segregation of capital gains as a distinct head of income creates this limitation. Business losses (other than speculative losses), however, can be set off against capital gains under the broader inter-head set-off rules, making the nature-of-income classification highly significant.
For equity investors, set-off of losses is particularly relevant at financial year-end when a portion of the portfolio is in loss. Deliberately realising losses on underperforming positions before March 31 to offset gains realised earlier in the year is called 'tax loss harvesting.' This strategy can reduce current-year tax liability meaningfully, provided the transactions are genuine and the investor is comfortable with the portfolio rebalancing they imply.
Set-off must be claimed in the ITR of the year in which the loss occurs — it cannot be retrospectively applied. If losses cannot be fully absorbed in the current year (because gains are insufficient), the unadjusted portion can be carried forward to subsequent years subject to the carry-forward rules. Failing to report losses in the ITR is one of the most common and costly oversights in tax planning, as it permanently forfeits the carry-forward benefit.