Depreciation as per Income-tax Act
Introduction
A business entity can claim depreciation in respect of tangible and intangible assets, not being goodwill, as per block of asset method using written down value method. However, for an entity engaged in generation or distribution of power, there is an option to calculate depreciation as per written down value method or as per the straight line method. Depreciation shall be calculated as per the prescribed rates.
1. About
1.1. What is depreciation?
The term ‘depreciation’ means decrease or reduction in the value of an asset over a period of time due to wear and tear or obsolescence. In other words, depreciation is a systematic allocation of cost of a capital asset over its useful life.
1.2. Methods of depreciation
There are several methods for charging depreciation but the most commonly employed methods are - Straight Line Method (SLM) and Written Down Value (WDV) method. Accounting Standard 10 - (Property, Plant and Equipment) allows a business entity to choose a method of depreciation that reflects the pattern in which benefits from commercial production or supply of service is received by it. Selection of method of depreciation is a matter of judgment and is applied consistently over the period of useful life of item of asset.
The Income-tax Act allows a business entity to follow only WDV method for computation of depreciation. However, an entity, engaged in generation or generation and distribution of power, can follow either of the two methods mentioned above to claim depreciation on fixed assets.
The undertakings engaged in the business of generation or generation and distribution of electricity has an option to use WDV method for the purpose of claiming depreciation. Such undertaking is required to exercise the option for claiming depreciation as per WDV method on or before the due date prescribed under section 263(1) for furnishing return of income for the tax year in which it begins to generate power. The option exercised in the first tax year will be applicable in subsequent years as well.
1.3. Rate of depreciation
Depreciation is allowed at the rates specified in the New Appendix I on the written-down value of block of assets which are used for the purposes of business or profession of the assessee at any time during the tax year. The rates of depreciation under straight line method are prescribed under Appendix II.
1.4. Types of depreciation
1.4-1. Normal Depreciation
Depreciation on tangible and intangible assets, not being goodwill of a business or profession, shall be calculated as per written down value method or straight-line method. The method for computation of depreciation shall depend on nature of business the assessee is engaged in. An assessee engaged in generation or generation and distribution of power can claim depreciation as per SLM method. While as all other assessee can claim depreciation as per written down value method.
1.4-2. Additional Depreciation
An assessee, engaged in the business of manufacture or production of any article or thing, is entitled to claim additional depreciation at the rate of 20%. Thus, an assessee engaged in the any profession or business of trading or investment can’t claim the additional depreciation.
1.5. Depreciation claim isn’t optional
The depreciation under Income-tax Act is available even if assessee has not claimed the deduction while computing his total income. Thus, if assessee omits to claim depreciation in Income-tax return, the written down value of the block of asset shall be adjusted assuming that the assessee has claimed and he has been allowed the depreciation claim.
1.6. Ceiling limit on depreciation allowance
Where an assessee has exercised the option to pay taxes at concessional rate as prescribed under section 199, Section 200, Section 201, Section 202, Section 203 or Section 204 and rate of depreciation allowable in respect of any block of the asset is more than 40%, then allowance for such depreciation shall be restricted upto 40% of the WDV of such block of the asset.
1.7. Conditions to claim higher depreciation on machinery
A new plant or machinery shall be treated as a part of the block of the asset on which depreciation is available at the rate of 40% of the WDV, provided following conditions are satisfied:
(a) Such plant or machinery is installed for the purpose of business of manufacture or production of any article or thing;
(b) Manufacture or production is made by using any technology (including any process) or know-how developed in the laboratory or such article or thing is invented in such laboratory;
(c) Such laboratory must be owned or financed by the government or owned by a public sector company or a university or an institution recognised in this behalf by the Secretary, Department of Scientific and Industrial Research, Government of India. Here laboratory financed by government means a laboratory owned by anybody and financed wholly or mainly by the government;
(d) The right to use such technology (including any process) or other know- how or to manufacture or produce such article or thing has been acquired from the owner of such laboratory or any person deriving title from such owner;
(e) The return furnished, whether for his own income or for income of any other person which is assessable in the hands of the assessee, for the tax year in which such plant or machinery is acquired, shall be accompanied with the certificate from the Secretary, Department of Scientific and Industrial Research, Government of India to the effect that manufacture or production has been made in compliance with the conditions prescribed; and
(f) Such plant or machinery is not used for the purpose of business of manufacture or production of any article or thing specified in the list in the Schedule XIII to the Act.
2. When is depreciation allowed?
An assessee can claim the depreciation on fixed assets if it satisfies the following conditions:
(a) The fixed asset is owned by the assessee;
(b) It is used for the purpose of business or profession;
(c) It is put to use during the relevant tax year; and
(d) It is eligible for depreciation.
2.1. Assessee should own the asset
Depreciation is allowed on the fixed assets which are owned by the assessee, wholly or partly, during the relevant tax year. It is only the owner of the assets who is entitled to claim depreciation on them. The following factors may be relevant to identify if assessee can claim depreciation on an asset.
2.1-1. Registered ownership is not mandatory
It is not necessary that the assessee should be the registered owner of an asset to claim the depreciation in respect thereof. An assessee can claim depreciation in respect of all those assets which are owned by him. The term ‘owned’ as occurring in this provision is assigned a wider meaning than just registered ownership. Thus, where an assessee has taken possession of an asset by making part payment, to the exclusion of others, he is deemed to be the owner of such asset for the purposes of claiming of depreciation even though no conveyance deed has been executed in his favour
If partners have brought assets as their capital contribution, the firm is entitled to depreciation in respect of such assets even if partnership deed provides that building would go back to the partner on dissolution of the firm
2.1-2. Leasehold improvements
Where a business is carried on in a building not owned by the assessee but in respect of which he holds a lease or other right of occupancy, he is entitled to claim depreciation on any capital expenditure incurred by him on the construction of any structure or any improvement, renovation or extension.
Example, if assessee builds up cubicles in a rented office premise, he is entitled to claim depreciation on the structure built up by him.
2.1-3. Lessor v. Lessee
As per Accounting Standard 19 – Leases, a lease can be classified into the following:
(a) ‘Finance Lease’ – It is a lease in which all risk and rewards relating to the leased asset are transferred by the lessor to the lessee. The lessee can capitalize the value of assets obtained under the finance lease in its books of accounts.
(b) ‘Operating Lease’ – Any lease other than a financial lease shall be considered as an Operating Lease.
Refer AS 19 to understand when a lease is classified into finance and operating lease and to understand its accounting treatment.
The CBDT has clarified
The Tribunal
2.1-4. Hire purchase transactions
The CBDT has clarified
2.2. Used wholly and exclusively for business or Profession
The depreciation is allowed if depreciable asset is owned by the assessee and used wholly and exclusively for the purpose of his business or profession in the accounting year. Following factors may be relevant to identify if an asset has been used for the business or not.
2.2-1. Assets used by Employees
If residential quarters are occupied by the employees, whose residence is subservient to and necessary for business, it is considered to be used for the business purpose. The assessee can claim depreciation on such quarters. Similarly, fans, air-conditioners, refrigerators, furniture, etc., owned by the assessee and provided to the employees at their quarters are eligible to depreciation.
2.2-2. Stand by Assets
The manufacturing concerns have to keep in readiness additional generators for the unforeseen contingencies or breakdowns. Depreciation on such assets is also allowed. Similarly, where a building is purchased for shifting the factory in a particular tax year but actual shifting is done in the subsequent year, depreciation would be allowed for the year of purchase
2.2-3. Assets partly used for business
By virtue of Section 28(2), where a depreciable asset, being building, machinery, plant and furniture, is not exclusively used for business purposes, the depreciation shall be restricted to the proportion which Assessing Officer determines having regard to its use for the business purposes. However, if an intangible asset is used partly for business purposes and partly for other purposes, no disallowance shall be made.
2.2-4. Trial run of machine
Trial run of machinery would be deemed to be used for the purpose of business. In that case, the assessee cannot be denied the benefit of depreciation on the ground that the machinery was used for the shorter duration during trial run
2.3. Asset must be used during relevant year
The asset must be used during the relevant tax year for the purpose of claiming depreciation. It is not necessary that the asset should have been used for the purpose of business or profession throughout the tax year. Even use during any part of the year would be sufficient to enable the assessee to claim depreciation for the whole year. Once an asset becomes part of a block of assets and depreciation is granted on that block, it cannot be denied in its subsequent year on the ground that one of the assets is not used by the assessee during the relevant year
2.3-1. Asset put to use for part of the year
If an asset falling within a block of assets is acquired by the assessee during the tax year and is put to use for the purposes of business or profession for less than 180 days in that year, depreciation shall be restricted to 50% of the depreciation allowable for the complete year at prescribed rates.
2.3-2. Asset used for part of the year
Main article: Proportionate Depreciation
If an asset or block of asset has been transferred in succession or scheme of amalgamation or demerger, the depreciation on such asset or block of asset shall be apportioned between the predecessor and successor in proportion to the number of days for which the asset were used by them.
2.3-3. Ready to use v. Put to use
An asset can be said to be in use when it is kept ready for use Thus, if a depreciable asset is ready for use in business, though it may not have actually been used in the accounting year, the depreciation on such asset shall be allowed
2.4. Asset must be eligible for depreciation
The depreciation is allowed on the following assets:
(a) Tangible Assets, being building, machinery, plant or furniture.
(b) Intangible Assets, being know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature not being goodwill of a business or profession.
The CBDT
2.4-1. Building doesn’t include land
The term ‘building’ means the superstructure only and does not include land. As land neither requires repair nor does it depreciate in value by use. So, the depreciation is provided only in respect of building and not lands
3. When is depreciation not allowed?
3.1. Cash payments
Where assessee incurs any expenditure for acquisition of any depreciable asset or part thereof and the payment in respect of which is made otherwise than by an account payee cheque/draft or ECS or through other prescribed electronic modes, the payment so made shall not be eligible for depreciation if it exceeds Rs. 10,000 to a person in a day, in a single payment or in aggregate.
3.2. Intangible assets not owned by assessee
Any payment made for use of intangible rights, not owned by the assessee, would not be covered under the scheme of depreciation. Such payment may be allowed as revenue expenditure under Section 34(1).
3.3. BOT Toll Roads and Bridges
In Build-Operate-Transfer (BOT) arrangements for development of roads or highways, the possession of land is handed over to the developer for construction of project. The developer only gets the right to develop and maintain such asset and title in the land remains vested with the Govt. or its agencies. Thus, a developer cannot be treated as an owner of the property, for the purposes of allowability of depreciation.
The CBDT has clarified
For Example, A developer enters into a BOT agreement in respect of a road for a period of 15 years. The construction of road is completed within 5 years on which he incurred Rs. 10,00,000.
Such developer is allowed to amortize cost of construction over remaining period i.e. 10 years evenly, which means he can amortize Rs. 1 lakh every year for the remaining period.
3.4. Block ceases to exist or WDV is nil
Main article: Sale of fixed assets
No depreciation shall be admissible on a block of asset if written down value of such block has been reduced to zero or block of asset itself ceases to exist on the last day of the tax year. These situations generally arise when assets are transferred during the year.
4. Others
4.1. Depreciation in business reorganization
Main article: Proportionate Depreciation
If there are cases of succession, amalgamation or demerger, the depreciation in such cases is computed as if succession or amalgamation or the demerger had not taken place. The depreciation is allowed to both the entities on a proportionate basis.
4.2. Set-off and carry forward of depreciation
Main article: Unabsorbed depreciation
Depreciation is allowed to be set-off to the extent of profits and gains of business and profession. If profits are not sufficient to absorb the full amount of depreciation, the balance amount of depreciation is treated as unabsorbed depreciation, which can be set-off against any other income except for income taxable under the head ‘Salaries’ subject to certain restrictions.
If current year depreciation cannot be set off in accordance with above provision, the unabsorbed portion can be carried forward to subsequent years for set-off against income of those years.
References
Mysore Minerals Ltd. v. CIT [1999] 106 Taxman 166 (SC)
CIT v. Amber Corporation (1994) 207 ITR 435 (Raj.)
Circular No. 2 of 2001, dated February 9, 2001.
Industrial Finance Corporation of India v. CIT [2005] 4 SOT 223 (Delhi)
Circular No. 9 dated 23.3.1943 and Instruction No. 1097 dated 19-09-1977
CIT v. O.P. Khanna & Sons (1982) 10 Taxman 243 (P&H)
CIT v. Ashima Syntax Ltd. [2001] 251 ITR 133 (Guj.)
CIT v. Galileo India (P.) Ltd. [2016] 52 ITR (Trib.) 294 (Delhi)
CIT v. Geo Tech Construction Corporation [2000] 112 Taxman 373 (Ker.)
Circular No. 20/2019, dated 19-8-2019
CIT v. Alps Theatre (1967) 65 ITR 377 (SC)
Circular No. 9/2014, dated April 23, 2014
This article is general information and not tax advice. Provisions change. Confirm your position with a qualified professional before acting.