The Income Tax Act, 1961 (the Act) includes provisions for the set off of losses under sections 70 and 71 for taxpayers who have incurred losses during the year. Section 70 allows for intra-head set off, meaning that losses from one source can be set off against income from other sources within the same head of income. On the other hand, section 71 allows for inter-head set off, which allows losses under one head to be set off against income from another head.
With the implementation of the Finance Act of 2002, aimed at removing inconsistencies in the tax treatment of capital gains, taxpayers are now allowed to set off short-term capital losses against any other capital gains, whether they are short-term or long-term. However, losses arising from the transfer of long-term capital assets can only be set off against long-term capital gains. This distinction is made because long-term capital gains are subject to a lower tax rate.
Short-term capital gains (STCG) are taxed at different rates depending on the nature of the short-term capital assets. In simple terms, STCG covered under section 111A is taxed at a rate of 15% (plus applicable surcharge and cess). On the other hand, STCG, other than those covered under section 111A, is taxed at the normal rate based on the taxpayer's total taxable income.
In light of the above, a question arises as to whether a short-term capital loss (STCL), subject to a lower tax rate, can be set off against a STCG that is taxable at a higher rate?
The answer to this question was recently provided by the Income Tax Appellate Tribunal, 'I' Bench Mumbai (ITAT) in its judgement, which we have extensively discussed below and provided our analysis throughout.
Rule of Interpretation of tax laws
Before we proceed, it is important to understand certain principles of interpreting laws, especially tax laws.
One of well-known principles of interpretation of tax laws is that if a provision is capable of two meanings, construction beneficial to assessee should be adopted. However, this principle is applicable only when there is reasonable and genuine doubt in regard to interpretation of statute. It has no application to a case where provision is clear and law is well settled.
Additionally, according to the General Principles of Interpretation, when different words used in a statute for same subject matter, then prima facie, one has to construe that these different words must have been used to mean differently.
In summary, these principles guide the interpretation of tax laws, ensuring that in case of ambiguity, the interpretation favouring the taxpayer is chosen, while also recognizing that clear provisions and established legal principles have their own weight.
Facts of the case
- In present case the Assessee was a non-resident registered as Foreign Institutional Investor (FII) in India.
- At the time of filing return of income for the Assessment Year (A.Y) 2016-17, the assessee disclosed its income, inter alia, under the head “Capital Gains” as net STCL resulting from its investments in the Indian capital markets. The break-up of which is tabulated below (for easy understanding we have assumed figures):
Assumed amounts in ₹
STCG covered u/s 111A and taxable at the rate of 15%
Add: STCG other than covered under section 111A taxable at the rate of 30%
Less: STCL covered u/s 111A and taxable at the rate of 15%
- In absence of any specific provisions under the Act in relation to the manner of set-off of loss against the gains, the assessee has set-off its STCL in following sequence:
- First against the STCG chargeable to normal tax at the rate of 30%, amounting to Rs.5,000/-, and
- The balance loss of Rs. 1,45,000/- has been then set-off against the STCG of Rs. 45,000/- chargeable to tax at the rate of 15%.
- The balance loss of Rs. 1,00,000/- was carried forward to subsequent A.Y. as per law.
- However, the Assessing Officer (A.O.) rejected the said manner of set-off of STCL adopted by the assessee.
- Upon first appeal by assessee u/s 246A, CIT(A) passed an order in favour of the assessee for the A.Y. 2016-17.
- Aggrieved by the said order of CIT(A), the Revenue had preferred an appeal before the ITAT u/s 253(2) of the Act.
Relevant Provision in brief:
Section 70: Set off of loss from one source against income from another source under the same head of income.
(2) Where the result of the computation made for any assessment year under sections 48 to 55 in respect of any short-term capital asset is a loss, the assessee shall be entitled to have the amount of such loss set off against the income, if any, as arrived at under a similar computation made for the assessment year in respect of any other capital asset.
Section 74: Losses under the head "Capital gains".
(1) Where in respect of any assessment year, the net result of the computation under the head "Capital gains" is a loss to the assessee, the whole loss shall, subject to the other provisions of this Chapter, be carried forward to the following assessment year, and—
(a) in so far as such loss relates to a short-term capital asset, it shall be set off against income, if any, under the head "Capital gains" assessable for that assessment year in respect of any other capital asset;
(b) in so far as such loss relates to a long-term capital asset, it shall be set off against income, if any, under the head "Capital gains" assessable for that assessment year in respect of any other capital asset not being a short-term capital asset;
Observations and comments:
To enhance comprehension of the ITAT's decision in this matter, we have divided the judgment into various sections and have included our analysis as well.
Source of income does not mean head of income:
The ITAT referred to a significant decision of the Bombay High Court in the case of Fort Properties Pvt. Ltd. vs Commissioner of Income-Tax, which took place on 16 July 1993. In this case, the court provided an explanation regarding the distinction between two terms used in the Income Tax Act: "source of income" and "head of income."
The term "source of income" refers to the origin or the specific activity or transaction from which income is generated. It focuses on the nature of the activity or the source from which the income arises. On the other hand, the term "head of income" refers to the classification or categorization of income based on its nature or type. The Income Tax Act has various heads of income, such as salary, house property, business or profession, capital gains, and so on.
The Court stated that every spring of income is a different source of income for an assessee and for that matter, the transfer of one property may be one source of income different from the transfer of another property which would be again another source of income.
Whereas, head of income is provided for clubbing of those like-minded incomes derived from different sources for the purpose of aggregation and allowable deductions. What is taxed by the Income-tax Act is not different sources of income independently, but income from different sources clubbed under respective heads and finally aggregated into the total income.
By referencing this decision, the ITAT sought to provide a clear understanding of the difference between the terms "source of income" and "head of income" as they are used within the Income Tax Act.
Income under the same head may be derived from various sources:
In relation to the computation of income from short-term capital assets, it is important to note that each transaction involving a property is considered a distinct source of income for the taxpayer. Consequently, each transaction contributes to the creation of different sub-sources of income, resulting in either short-term capital gains or losses. These gains or losses are categorized as one of the sources of income under the "Capital gains" head, alongside long-term capital gains or losses.
This is reflected in the scheme of computation of capital gains provided in section 48 where gains or loss is computed on the basis of individual asset and transaction and not on the basis of class of assets.
ITAT, highlighting the provisions of section 70, emphasized that it allows for the set off of losses from one source against income from another source within the same head of income. In doing so, ITAT referred to its previous decision and reiterated that it is possible for an assessee to incur a loss from one source while earning income from another source. The law permits the assessee to offset the loss from one source against the income from another source within the same head of income.
In essence, this means that a separate source of income, such as STCL, can be set off against another separate source of income, namely short-term or long-term capital gains. According to the provisions of section 70, there is no requirement for further sub-identification of sources of income under capital gains for the set off of a loss from a particular source.
Meaning of term “computation” and “similar computation” under section 70(2) of the Act:
The term “computation” used in first half of provision under section 70(2) mentioned above, refers to the process of calculating or determining a specific value or result. It is used in the context of determining the income from short-term capital asset for any assessment year under sections 48 to 55.
Similarly, the term "Similar computation" used in second half of aforesaid provision refers to a computation that is alike to the previously mentioned computation. It is used to describe the type of computation made for the assessment year in respect of any other capital asset.
In terms of grammatical classification, "similar computation" is a noun phrase. It functions as a noun and refers back to the term "computation" mentioned earlier in the sentence. It specifies the type of computation being discussed.
Hence, ITAT in its decision held that the words 'similar computation' would only mean the computation as made u/s. 48 to 55 of the Act, and nothing more.
Similar manner of set off already approved subsequently:
ITAT observed that that for the A.Y 2018-19 and 2021-22, similar manner of set off of loss was made by the assessee while filing the return of income and the same was accepted by the A.O.
In conclusion, based on the observations made, the ITAT has upheld that the computation of income from short-term capital assets remains the same regardless of whether it is subject to a special tax rate of 15% or the normal tax rate of 30%.
The ITAT has recognized the validity of the assessee's argument that, regardless of the specific source of income, it is permissible to set off the loss from one source against the income from another source, as long as both fall under the same head of income.
 CBDT circular no. 8/2002 dated 28-7-2002 https://incometaxindia.gov.in/communications/circular/910110000000000601.htm
 Para 9.8 of Taxmann’s Interpretation of Statutes by V.S. Datey September 2019
 Para 4.7 ibid
 ITA No.2862/Mum/2022
 In matter of Montgomery Emerging Markets Fund [(2006) 100 ITD 217] passed by Special Bench of Jurisdictional Mumbai Tribunal