Depreciation in case of Sale of Fixed Assets (Income-tax)

Introduction

When a fixed asset is transferred, the treatment thereof shall depend on the method of depreciation followed by the assessee, i.e., WDV method or SLM method.

In case of WDV, the sale proceeds shall be reduced from the WDV of block of asset. If block of asset ceases to exist and the value of block is nil, the resultant gain or loss shall be taxable under the head Capital Gains. If assessee follows SLM method, the deficiency or surplus amount shall be allowed as terminal depreciation or as balancing charge, as the case may be.

1. Treatment if WDV Method is followed?

1.1. In General

If an entity is not engaged in generation or generation and distribution of power, the depreciation, as per Income-tax Act, shall be calculated on block of assets basis as per WDV method. When a fixed asset is sold or transferred during the year, the sale proceeds are reduced from the existing value of block of assets and depreciation is calculated on resultant figure of WDV.

1.2. If block of assets ceases to exist

If entire block of assets has been transferred or it ceases to exist, the scheme of depreciation comes to an end. In other words, if as on the last day of tax year the block of asset is empty, no depreciation shall be allowed on that block. In this situation, difference between sales consideration received on transfer of assets and its written down value shall be chargeable to tax as short-term capital gains or short-term capital loss, as the case may be, under Section 74.

1.3. If written down value is nil

In case of partial sale of block of assets, if sale consideration exceeds the aggregate of written down value of the block, the provisions of Section 74 for calculation of capital gain shall be applicable and no depreciation shall be allowed on the respective block in the year of transfer or in subsequent year. However, if the consideration is less than the WDV of the block, provisions of depreciation shall remain operative.

2. Treatment if SLM Method is followed?

If an entity is engaged in generation or generation and distribution of power, the depreciation, as per Income-tax Act, shall be calculated on individual assets as per SLM method. When a fixed asset is sold or transferred during the year, the provisions of terminal depreciation or balancing charge may be operative to allow the unclaimed cost or to tax the surplus.

2.1. Terminal depreciation

If any asset is sold, discarded, demolished or destroyed by an electricity undertaking in the tax year, and the money payable (plus scrap value of the asset) falls short of its written-down value, such deficiency is deductible by way of terminal depreciation. Intangible assets of an electricity undertaking are not covered under the scheme of terminal depreciation. Thus, any loss arising from sale of intangible asset shall be allowed as capital loss under Section 75.

The aforesaid provisions of terminal depreciation do not apply if any asset is sold in the tax year itself in which it was first brought to use. In that event, the deficiency is allowed as short-term capital loss.

2.2. Balancing charge

If any asset is sold, discarded, demolished or destroyed by an electricity undertaking in the tax year, and the money payable (plus scrap value of the asset) exceeds its written-down value such excess amount, to the extent of depreciation allowed in earlier years, is taxable as balancing charge. If such excess amount is more than depreciation allowed, the amount in excess of aggregate of written down value and depreciation already allowed shall be taxable as short-term capital gain. Intangible assets of an electricity undertaking are not covered under the scheme of balancing charge. Thus, any gain arising from sale of intangible asset shall be taxable as capital gains under Section 75.

The aforesaid provisions of balancing charge do not apply if any asset is sold in the tax year itself in which it was first brought to use. In that event, the surplus is taxable as short-term capital gain.

2.2-1. Meaning of Money

The term money payable includes insurance, salvage or compensation money payable in this respect. However where the building, machinery, plant or furniture is sold, money payable means the price for which it is sold.

The term ‘money payable’ as used above shall be interpreted to mean only actual money or cash and not as any other thing or benefit which could be evaluated in terms of money. Thus, where insurance company restores the destroyed assets to the insured assessee, the excess of market value of replaced assets over the written-down value of the destroyed asset cannot be taxed as balancing charge

References

CIT v. Kasturi and Sons Ltd. (1999) 237 ITR 24 (SC)

This article is general information and not tax advice. Provisions change. Confirm your position with a qualified professional before acting.