Exempt Income, Set-off, Loss Carry Forward in Draft I-Tax Rules 2026: Analysis

The Draft Income Tax Rules, 2026 released for public consultation by the Central Board of Direct Taxes introduce a more structured and rationalised procedural framework for dealing with exempt income, set-off of losses, and carry forward of losses under the Income-tax Act, 2025. This segment is especially relevant for corporate taxpayers, investment funds, and groups undertaking restructuring or long-term tax planning.

While entitlement to exemption or loss adjustment flows from the Act, the Draft Rules prescribe computation mechanisms, conditions, and reporting requirements. These provisions are proposed to apply from 1 April 2026, that is, from financial year 2026-27, subject to final notification.

Structural Rationalisation Under the Draft Rules

Under the Income-tax Rules, 1962, procedures relating to exemptions and losses were dispersed across multiple rules and schedules. The Draft Income Tax Rules, 2026 consolidate these provisions and align them with the architecture of the new Act. This segment of the draft rules broadly covers:

• Computation and disclosure of exempt income.
• Procedural conditions for set-off of losses.
• Carry forward of business losses and unabsorbed depreciation.
• Special rules for amalgamation, demerger, and restructuring cases.

The emphasis is on formula-based computation and standardised disclosure.

Computation and Disclosure of Exempt Income: Rules 139 to 145

The Draft Income Tax Rules, 2026 contain a dedicated cluster of rules governing computation of exempt income, particularly for specified funds and non-resident investors. Key provisions include:

• Rule 139: Computation of exempt income of specified funds attributable to units held by non-residents.
• Rule 140: Determination of income of specified funds attributable to non-resident unit holders that is chargeable to tax.
• Rules 141 to 143: Computation of exempt income and taxable income attributable to offshore banking units and investment divisions operating in International Financial Services Centres.
• Rule 144: Conditions required to be fulfilled by specified funds for availing exemption.
• Rule 145: Prescribed statements and disclosures relating to exempt income.

These rules rely on structured tables and allocation formulas, reducing discretion and improving uniformity in exemption claims.

Set-off of Losses: Procedural Alignment with the Act

Set-off of losses under various heads of income continues to be governed by the Income-tax Act, 2025. The Draft Rules supplement these provisions by prescribing procedural discipline. Key aspects include:

• Losses must be computed head-wise and source-wise in the prescribed manner.
• Set-off must follow the sequencing laid down under the new Act.
• Mandatory disclosure of loss set-off in prescribed schedules of return forms notified under Appendix III.

Failure to comply with procedural requirements may result in denial of set-off, even where substantive eligibility exists.

Carry Forward of Losses and Unabsorbed Depreciation: Rule 60

Rule 60 of the Draft Income Tax Rules, 2026 governs carry forward and set-off of accumulated losses and unabsorbed depreciation in special cases, including amalgamation and restructuring. Key features include:

• Continuity of shareholding and business conditions for carry forward of losses.
• Distinct treatment of business losses and unabsorbed depreciation.
• Requirement that statutory conditions under the Act are fully satisfied.

This rule is particularly significant for corporate groups involved in mergers, demergers, or internal reorganisation.

Special Cases: Amalgamation, Demerger and Restructuring

The Draft Rules recognise that restructuring transactions require tailored procedural treatment. In such cases:

• Loss carry forward is permitted only where prescribed conditions are met.
• Allocation of losses must follow prescribed computation mechanisms.
• Supporting documentation and disclosures are mandatory.

These safeguards are designed to prevent misuse while facilitating genuine business reorganisations.

Reporting and Compliance Requirements

Claims relating to exempt income, loss set-off, and carry forward must be supported by:

• Proper computation statements.
• Disclosure in prescribed schedules of return forms under Appendix III.
• Audit reports or certificates, where required under specific provisions.

The reduced number of forms and standardised data fields are intended to enable automated reconciliation and system-based verification.

Practical Impact on Corporate Tax Planning

The revised framework under the Draft Income Tax Rules, 2026 is expected to:

• Improve clarity in exemption computation.
• Tighten procedural discipline for loss carry forward.
• Reduce interpretational disputes through formula-based methods.
• Increase importance of accurate disclosure and documentation.

Corporate taxpayers will need to align tax planning strategies with these procedural requirements to ensure sustainability of exemption and loss claims.

Areas Requiring Early Review

Before the start of financial year 2026-27, businesses should:

• Review existing carried-forward losses and exemption positions.
• Evaluate restructuring plans against Rule 60 conditions.
• Update internal computation models and compliance checklists.
• Ensure correct disclosure in revised return forms and schedules.

Early preparation will help minimise litigation and compliance risk.

Conclusion

The exempt income, set-off, and loss carry forward provisions under the Draft Income Tax Rules, 2026 focus on procedural rationalisation rather than substantive policy change. By consolidating exemption computation rules, clarifying carry forward conditions in restructuring cases, and standardising reporting, the draft framework seeks to enhance certainty and discipline in corporate tax planning.

The effectiveness of these changes will ultimately depend on clarity in the final notified rules, consistency in administrative application, and readiness of taxpayers to adapt processes from financial year 2026-27 onward.