Unabsorbed Depreciation

Introduction

Unabsorbed depreciation is the amount of depreciation which could not be claimed as deduction due to inadequacy or absence of profits. In that situation, the unabsorbed depreciation can be set-off against any other income in the current year except income under the head salary. If some depreciation still remains unabsorbed, it can be carried forward to set-off against income of subsequent years. Business losses get priority over unabsorbed depreciation in the matter of set off.

1. About

1.1. What is unabsorbed depreciation?

Depreciation of current year is allowed to be set-off to the extent of the profits and gains of the business profession. Where profits are not sufficient to absorb the full amount of depreciation, the balance amount of depreciation is termed as ‘Unabsorbed Depreciation’.

Example, if depreciation claim for the current year is Rs. 1,50,000 and the business profits as per Income-tax Act is Rs. 1,00,000. The depreciation to the extent of Rs. 1,00,000 can be claimed against business profit and the remaining unclaimed amount of Rs. 50,000 shall be deemed as unabsorbed depreciation.

1.2. Treatment of unabsorbed depreciation

1.2-1. First Preference: Set-off against other business profit

If assessee carries on multiple business, the unabsorbed depreciation arising in one business can be set-off against profits of any other business or profession carried on by the assessee if it is assessable to tax in that tax year.

Example, unabsorbed depreciation of a timber business can be set-off against the assessable profits of sugar business.

1.2-2. Second Preference: Set-off against other income

If current year depreciation cannot be fully set-off against the profits of any other business, it can be set-off against the income taxable under any other head. However, unabsorbed depreciation cannot be set-off against salary income and lottery winnings or similar income as referred to in Section 194.

Example, unabsorbed depreciation from a business can be set-off against income from house property, capital gains, interest, etc.

1.2-3. Third Preference: Carry forward to next year

If current year depreciation couldn’t be set-off against business income or any other income, it shall be carried forward to next year. There is no limit on the number of years for which the unabsorbed depreciation can be carried forward. It shall be carried forward for indefinite years even if the business is not continued in that year. In subsequent year, if there is no brought forward business loss, the unabsorbed depreciation is added to the depreciation of that year. In other words, the depreciation carried forward from earlier years is deemed as depreciation of the current year. This depreciation will be adjusted against taxable income in the same hierarchy as discussed above, i.e., set-off against business profits first, then against any other income except income under the head ‘Salary’.

1.3. Order of Set-off of unabsorbed depreciation

The unabsorbed depreciation shall be set-off in following sequence.

Preference 1: Set-off depreciation of current year

Reduce the current year depreciation from the business profit of current year. If, before setting-off the current year depreciation, there is a loss from business or profession, the whole amount of depreciation remains unabsorbed.

Preference 2: Set-off business losses

If some profit remains after setting-off the current year depreciation in Step 1, the unabsorbed losses shall be set-off first against such profit subject to Section 108, Section 109 and Section 114.

Preference 3: Unabsorbed depreciation

If some profit remains after setting-off the current year depreciation and unabsorbed losses, the unabsorbed depreciation shall be set-off first against such profit.

For the purposes of setting-off brought forward business loss or unabsorbed depreciation, business profits shall include any income from a business activity even if it has been classified for the purposes of computation of income under any other head

(a) Interest on securities held as stock-in-trade.

(b) Rent earned by exploitation of business assets

(c) Interest earned from investment of surplus funds in short-term bank deposits

(d) Balancing Charge to the extent of depreciation allowed.

(e) Surplus of speculation business.

(f) Withdrawal from special reserve as referred under section 36(1)(viii).

1.4. Condition for carry forward of Depreciation

For carry forward of unabsorbed depreciation assessee must be same, i.e. the person in whose business depreciation remains unclaimed and the person claiming its set off must be same. However this rule is subject to some exceptions, such as:

(a) In case of amalgamation referred under section 116 & section 117

(b) In case of demerger as referred under section 116

(c) In case a firm or a sole proprietary concern is succeeded by a company as referred under section 70(1)(b) and section 70(1)(zf).

References

CIT v. Chungandas & Co. (1965) 55 ITR 17 (SC)

CIT v. Smt. Indermati Jatia (19) 77 ITR 133 (All.)

Snam Progetti v. Addl. CIT (1981) 132 ITR 70 (Del.)

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