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Incurring losses? Don't be scared, here's help

Meenakshi Subramaniam | September 01, 2008

Gains and losses are a part of the investment game. But while gains always bring a smile to the face, losses make one cringe. But then, losses are not too bad, especially if you know how to take advantage of them. Avoid the blues by proper tax planning.

As far as the capital market goes, if you are holding loss-making shares for over a year, it won't be possible to set them off against any income. However, a slew of other financial transactions can be used to reduce the tax outgo when losses are incurred.

For instance, loss on sale of property, dwindling salaries or falling profits - a simple rule for the taxpayer is to play off losses against gains. You can carry forward losses for eight long years. And even a fall in share prices or net asset values of mutual funds can be carried forward for four years.

In the income tax returns forms, there are schedules for showing carry forward of losses. The income tax department studies them, allows carry forward and adjusts the income tax to be paid in the current financial year. Besides this, here's how you can book losses and bask in profits:

Dwell, on this:

First, in case you have sold a house in distress, the loss incurred can be set off against the capital gains in the future. Also, a self-occupied property can also fall in value because the notional income is nil or zero and the interest payout on a home loan results in negative income.

Further, one house's income loss can be set against another's income (profit), if there are two dwellings. However, remember to pay the municipal taxes without fail, or claims would be rejected. Where one property is rented out, you can set off the interest portion of the equated monthly instalment against rent earned.

Business losses:

If you have two businesses or more, it's easy to neutralise losses from one against the other's profits. In fact, the tax rules allow carrying forward of losses, with intention of setting them off against a new business too.

The business income of spouse, clubbed together can be also used to offset business losses. If there are bad debts, like forfeiture of advance for raw material supply, you can classify them under losses.

Other income:

It is essential that any losses under income form other sources is adjusted in this financial year. Otherwise, they would lapse. For example, an insurance agent can offset commission loss against rent from plot from land.

Letting out machines or furniture, interest on bank deposit and examination papers checking are examples of income from other sources.

Make capital from falls:

If the value of shares, worth Rs 500,000 fall to Rs 200,000 after a sharp market fall, selling them at a loss of Rs 300,000 would lead to short-term capital loss. This amount can be set off against any other short-term capital gains.

A word of caution - do not set off short-term capital losses against long-term capital gains. It would be bad tax planning. For instance, a short-term capital loss, say in shares, should not be set against long-term gains from mutual fund units or profitable listed shares.

This is because there is no tax on them. However, if unavoidable, try to adjust them against long-term gains on gold, estate or debt mutual funds because they are taxed, but at a lower rate.

Don't sell listed shares and equity mutual fund units, if you have held them for more than one year. Long-term capital losses in either category can't be set off or carried forward, at all. However, long-term losses on debt funds and exchange-traded funds, if required can be set off against long-term gains from gold.

In case of fall in mutual funds after it has been held over a year:

  • Book losses and cut tax outgo by selling it to a relative, friend or spouse, at market rate at a loss. This can be shown and claimed as losses.
  • Debt funds, if sold after a year, attract 10 per cent capital gains tax (without indexation) or 20 per cent (with indexation). Holding them for five years and choosing the 10 per cent option would that reduces the tax outgo. (see table: Benefits of long term)

Cut loss through depreciation:

Make sure to claim depreciation, as they can be easily set off against your business profits. They would effectively reduce income from business. During the current financial year, if business earnings/profits are not sufficient, remember to carry depreciation forward for next assessment year.

Benefits of long term
Suppose a person buys debt mutual fund units, costing Rs 25,000 in 2001 and sells them for Rs 500,000 in 2006.
Let's take index for 2001 as 259 and index for 2006 as 497
Option 1 
Cost of units = Rs 25,000 
Sale of units = Rs 500,000 
Indexed cost = Rs 25,000 @ 497/ 259 = Rs 47,973 
Capital gains = Rs 500,000 - Rs 47,973 = Rs 452, 027 
Capital gains tax = Rs 452,027 @ 20% = Rs 90,405.40  
Option 2 
Cost of units = Rs 25,000 
Sale of units = Rs 500,000
Capital gains = Rs 500,000 - Rs 25,000 = Rs 475,000 
Capital gains tax = Rs 475000 @10% = Rs 47,500 
Hence, option 2 is better

The advantage is that unabsorbed depreciation can be set off in subsequent years against any head, like house or income from other sources, and not just business alone.

Apparatus, fixtures or machinery - all suffer erosion in value and are covered. Computers (including software), cars and furniture also show depreciation. Mobile phones too can be placed under the depreciation head. The most important advantage is that any unabsorbed dip in depreciation can be filed, for years, and years.

In fact, they can be carried forward, indefinitely. All other miscellaneous expenses like stamp duty, registration charges in house property transactions and legal and travel fees in share deals can be claimed when losses are set off or carried forward.

Indexation is a great tool when selling property. It must be diligently calculated and availed to keep pace with inflation. It reduces the tax liability as well.

Always remember that there are tax laws that allow you to reduce the burden when you are in financial distress. The lesson here is simple - don't get scared when losses are staring at you. Instead, work your way out of it.

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