This article is written by Abdullah Mustaqueem, pursuing a Certificate course in Advanced Corporate Taxation from LawSikho.

Introduction

Depreciation plays a vital role in computation of taxable Income as per the Income Tax act, 1961. If we understand the applicability of depreciation then we would be able to decipher how assets are being treated as per the Act be it tangible or Intangible although there is a significant difference in treatment of depreciation when it comes to different businesses. In this article we would delve into the details of how depreciation is to be applied as per the provisions of the act.

Section 32 of Income Tax act, 1961 provides for depreciation as an allowable expense which is regulated by Rule 5 of Income tax rules. Whenever there is a wear and tear of a tangible or Intangible asset used by the assessee then the same can be claimed as depreciation under the provisions of the act. Depreciation is calculated as per the total cost of an asset over its useful life.

Deduction can be claimed as against the business profits in the form of depreciation as it is an allowable expense under Section 37(1) of the Income Tax act, 1961. But while calculation of depreciation we need to follow 2 methods namely:

1. Written down Value Method (WDV).
2. Straight Line Method (SLM).

There is also a concept of Additional depreciation which is provided U/s 32(1)(iia) which is only given in certain cases.

Written Down Value Method

As per the Written Down Value method (WDV) the depreciation is to be calculated on the actual cost of the asset and in order to understand better we need to know about the meanings of the terms “WDV” and ”Actual Cost”.

1. WDV is the cost at which the asset is acquired in the previous year for the current Assessment year.
2. When the asset is acquired in any other year under consideration then (WDV = ACTUAL COST – DEPRECIATION FOR THE YEAR UNDER CONSIDERATION ALLOWED AS PER THE ACT).

Straight Line Method

In the Straight Line Method of depreciation the value of an asset is reduced at a fixed amount or value over a financial year till it reaches it’s scrap value or salvage value. It is the most commonly used method of depreciation which does not involve any tedious calculations.

Annual Depreciation = (Cost of Asset) – (Salvage Value)

                                —————————————

                                        Useful Life of Asset  

Meaning of depreciation as under Income Tax Act, 1961

Depreciation can be defined as reduction in value of an asset due to its wear and tear by the assessee due to its usage. 

While claiming depreciation an Important concept is to be looked into which is the days of “put to use” that means the number of days since when the asset is being used in the course of business. Broadly we can say that if the number of days since the asset is being put to use is 180 days or more then we can claim depreciation as prescribed under the provisions of the act but if it is less than 180 days then only 50% of the prescribed rate can be claimed.

Rates prescribed as under the Income Tax Act, 1961

ASSET	S. NO	ASSET TYPE	RATE OF DEPRECIATION
BUILDING	1. 2. 3.	RESIDENTIAL (EXCLUDING BOARDING HOUSE AND HOTELS) COMMERCIAL  BUILDING USED FOR MANUFACTURING PURPOSE OR INSTALLING ANY PLANT OR MACHINERY	5% 10% 40%
PLANT AND MACHINERY	1. 2.	MOTOR CARS USED FOR PERSONAL PURPOSE MOTOR CARS USED FOR RUNNING ON HIRE BUSINESS	15% 30%
FURNITURE	1.	FURNITURE INCLUDING ELECTRICAL FITTINGS	10%
OTHERS	1.	EQUIPMENTS OR MOULDS USED IN PLASTIC OR RUBBER GOODS FACTORIES	30%
	2.	WATER AND AIR POLLUTION CONTROL EQUIPMENTS	40%
	3.	LIFE SAVING MEDICAL EQUIPMENTS	40%
	4.	COMPUTER INCLUDING SOFTWARE	40%
INTANGIBLE ASSETS	1.	PATENTS, COPYRIGHTS, FRANCHISE OR ANY OTHER RIGHT OF COMMERCIAL NATURE	20%

Prerequisites for claiming Depreciation 

1. TYPES OF ASSETS AND THEIR TREATMENT – When we are claiming depreciation under the income tax act we should know the very nature of the asset for which depreciation is being claimed. It may be a tangible or intangible asset both can claim depreciation be it a plant or machinery, building, furniture, copyrights, patents, trademarks or goodwill or franchise or any other right of similar nature against which depreciation can be claimed as per the provisions of the act. But there is an important point we need to look into that is while claiming depreciation we cannot claim it on land as income tax act bars us from doing so and as it is obvious that India being a developing country it is more likely that the cost of land would Increase over time rather than decreasing. For example- If the assessee owns a car which is used in the due course of the business then the same shall be depreciated due to its wear and tear during the year and similarly when we assess purchases a plot of land then the same shall not be depreciated as land is not a depreciable asset as per the provisions of the act instead the value of land is increased during the period for which it is being held by the assessee.
2. TREATMENT OF OWNERSHIP AND LESSEE – One of the prior conditions for claiming depreciation is that it should be owned by the assessee in order to claim depreciation when an assessee owns a building only then he can claim depreciation when we talk about building in specific then there is a important point to be looked into that is if the land belongs to someone else and the building to the assessee then he can claim depreciation on the said building as per the provisions of the income tax act but on the contrary if the assessee claims depreciation being a tenant then the same shall be disallowed by the Income tax department as is not an allowable expense under Section 37(1).When an assessee has entered into a lease agreement where he has taken the land on lease and constructed building on that land he is entitled to claim depreciation or any other expense relevant as per the provisions of the act. In case of a hire purchase agreement when the assessee acquires a machinery on hire purchase the hirer will be allowed to claim depreciation based on the old circular issued by CBDT in 1943. For example – If the assessee is a owner of a certain piece of land and constructs building on the same then he can claim depreciation on the constructed building the assessee can claim depreciation on the building but not on the land and similarly if the assessee has taken that constructed building on lease then the lessee can claim depreciation on the said building as it is allowed under the provisions of the act.
3. USE OF ASSETS – In order to claim depreciation we must know that the asset for which depreciation is being claimed must be used for the purpose of the business that means for the core activity of the business but not necessarily throughout the year it may be used for some part of the year and is used for some part of the year and may be kept idle for the rest. If a machine is used for some seasonal activity like in case of plantation Industry for ex- if we are using a happy seeder machine for plantation of crops the same can be used to claim depreciation. Section 38 of Income Tax Act provides that the AO has the right to determine the proportional depreciation. For example – If the assessee owns a car and claims depreciation on the same but the same is not used for the core activity of the business and in that case the expenditure so incurred shall be disallowed as the car is not used in the due course of the business.

Exceptions to claiming Depreciation

1. Depreciation cannot be claimed on the assets which are sold by the assessee during the FY under consideration it may also be noted that if the asset is destroyed/demolished or scrapped the cannot claim depreciation.
2. When an asset is purchased/owned in a partnership or has co owners then the same can claim depreciation but in proportion of their ownership.
3. As per section 43(1) of Income Tax Act any expenditure incurred by the assessee for purchase of any asset and for which payment is made which is more than 10,000 then such part of the payment made shall not be included in the actual cost of the asset.

Set-off and carry forward of unabsorbed depreciation

As per the provisions of Section 32 full allowance cannot be claimed and as per 32(1) if there are not sufficient profits during the FY under consideration the assessee might not be having sufficient profits or suffering from loss then in that case the assessee can carry forward the allowance to the next year may be partly or wholly as allowed under Section 72(2) & 73(3). This means that if the assessee couldn’t claim depreciation in any particular year due to insufficient profits then the same can be claimed in the coming subsequent years.

If during the year under consideration the assessee does not have sufficient profits then he can claim that part of depreciation in subsequent years may partly or wholly.

In respect of carry forward and set-off of unabsorbed depreciation, the following provisions are noteworthy-

1. Depreciation which is not utilised (UNABSORBED DEPRECIATION) or setoff in any particular then the same can be carried forward to the subsequent year and there is no limit on the number of years to which it can be carried forward.
2. Except for the income received under the head salaries all the other heads of income can be used to set off or carry forward the unabsorbed depreciation.
3. The order of set-off is given below-

(1) Depreciation in the current FY.

(2) Business losses from the previous year brought forward. 

(3) Unabsorbed Depreciation.

Methods of calculation of Depreciation

• Written Down Value Method (WDV)
• Straight Line Method (SLM)

Written Down Value Method (WDV)

Depreciation is calculated on the book value of an asset as per the provisions of the act. Due to the wear and tear of assets throughout the year there is a reduction in the value of the asset. When we come to the calculation of depreciation of an asset the Income Tax act provides for calculating it through WDV  method which takes into consideration the real life picture whereby depreciating the asset on it’s reduced value from the previous year. If the assessee acquires certain asset in any year the value of the same is added in the depreciation chart and it is depreciated as per the rates prescribed under the act.

Important points 

1. When the asset is acquired in the PY the actual cost of the asset shall be treated as WDV.
2. Where assets are acquired in earlier years then WDV shall be equal to actual.
3. Depreciation is allowed as per WDV for all the assets except the ones engaged in power generation and distribution.
4. As per Rule 5(2) of Income Tax rules if the conditions mentioned herewith the rules are satisfied then the rate of depreciation shall be 40%.

Additional Depreciation

If an Assessee is engaged in business of power generation and distribution or manufacture of any article or thing further sum of depreciation shall be allowed over and above the normal depreciation in case the assessee acquires a new asset in any PY after 31.03.2005.The rate of additional depreciation is 20% on the actual cost of asset if the asset is put to use for 180 days or more during the year under consideration and if it is less than 180 days then the same shall be depreciated at the rate of 10% but a sum of 10% is allowed in the immediate next PY.

If there is an establishment of an enterprise engaged in manufacture or production of any article or a thing in any of backward areas notified by central government in the states of Bihar, West Bengal, Telangana and Andhra Pradesh in a period between 01.04.2015 to 01.04.2020 the rates shall be 35% instead of 20% and 17.5% instead of 10%.

Additional depreciation cannot be claimed in the following conditions

1. Whereas the asset is purchased under some scheme and the same is allowed as deduction of its whole cost.
2. Any road transport vehicle or office appliances.
3. Any residential accommodation using a guest house or plant and machinery installed in the office.
4. Plant and Machinery already used by the assessee in India or outside.

Unabsorbed depreciation can be used to deduct against Income or any other head except salaries.

Depreciation in Backward areas

If assessee setups a manufacturing unit in any specified area as per central govt then W.e.f 1 April 2016 u/s 32(1)(iia) then assessee can claim additional depreciation Upto 35% however vessels or aircrafts are exempted from the same.

Depreciation as per Companies Act

Schedule II of Companies Act 2013 deals with depreciation which defines it as systematic allocation of depreciation over its useful life.

Depreciable amount = cost/real value – Residual value

Useful Life- The period prescribed under the act for which the asset is considered fit for the use for which it has been purchased.

As per Schedule II Amortisation is Included in the meaning of depreciation.

Schedule II of Companies Act, 2013

1. In Companies Act 1956, rates were prescribed for specified assets but not in case of new companies act 2013 where rates are not prescribed.
2. As per the new Companies act 2013 rates are calculated after consideration of the useful life of assets and its residual value.
3. Method of calculation of Depreciation once adopted cannot be changed in subsequent years be it WDV or SLM or vice versa.
4. It is mandatory for an assessee to charge depreciation as per the provisions of Companies Act.
5. Depreciation can be charged at the rate of 100% if the cost of the asset is upto Rs 5000/-.

Useful Life and Residual Value of Assets

• Useful life of an asset is prescribed under part C of Schedule 2 and the same should be considered or accepted as standard for calculation of depreciation and if there is some change then the same shall be approved by a technical expert or person authorised to do so and that change should also be disclosed in the financial statement of the company.
• Residual value/Scrap value of the asset is the value after deduction of depreciation on the cost of an asset and to be more specific it is value of an asset at the end of it’s useful life.
• As per the provisions of the act if the residual value is more than 5% of the original cost then technical validation is necessary.

When Depreciation is not Applicable

Depreciation provisions as under Schedule 2 are only applicable to tangible assets and not to Intangible assets. In case of Intangible assets AS(Accounting Standard) 26 and INDIAN AS (Accounting Standard) 38 is to be followed.

Depreciation when a part is Replaced

When asset is depreciated as per Schedule 2 of Companies Act 2013 and only a part of it is replaced while the other part remains useful then depreciation should be computed separately for such assets and while calculating depreciation the date of purchase of the asset should be considered while computing depreciation.

Important points relating to Depreciation

• Useful life is only relevant for single shift assets.
• For double shift assets 50% additional depreciation should be charged.
• For triple shift assets 100% additional depreciation should be charged.

Benefits/advantages of charging Depreciation

• It helps in reducing net profits hence reducing the net tax payable by the assessee.
• Ascertainment of true value of asset.
• It helps in recovering purchase cost of assets.

Conclusion

Depreciation plays a vital role in taxation of businesses as it is a genuine and allowable deduction against business income as per Section 32(1) of Income Tax act. If the assessee fails to claim depreciation in any F.Y. then he cannot claim it any further as per the provisions of the act. In many cases when assessee is claiming depreciation it further reduces the net Income under the head “PGBP” and thus results as a tax saving option. But the way depreciation is being charged as per the provisions of the Income Tax Act needs to be looked upon once again as there are several points which result in unnecessary litigation such as – days of put to use, rates of depreciation, methods of depreciation etc. Although the most important point is if the assessee fails to claim depreciation in one F.Y. then he cannot claim depreciation any further which is not beneficial on the part of the taxpayer that means if by mistake a return is being filed by the assessee without claiming depreciation then he cannot claim depreciation in subsequent years.

Depreciation is treated in a distinct manner in the UK as compared to India whereas per Indian Companies Act we can charge depreciation on corporate tax but in the UK we cannot charge depreciation and it is also not allowed as self assessment expenditure in the UK while in India it is an allowable self assessment expenditure. 

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