Depreciation Rates Under the Companies Act & Income Tax Act
Accounting & Bookkeeping

Depreciation Rates Under the Companies Act & Income Tax Act

6 Mins read

When you buy machinery, a vehicle, or even a building for your business, you know these assets lose value over time. This reduction in value is called depreciation. For businesses in India, there are two primary laws governing how depreciation should be calculated—the Companies Act of 2013 and the Income Tax Act of 1961. Although both serve the purpose of tracking the decline in asset value, they have distinct rules, rates, and methodologies for calculating depreciation.

In this blog, we shall explain depreciation, how it is calculated under both the Companies Act and the Income Tax Act, the differences between them, and why understanding these rules is important for your business.

What is Depreciation?

Depreciation is a gradual decrease in an asset’s value over time due to wear and tear or usage. It is an accounting method used to allocate the cost of a tangible asset over its useful life. Instead of counting the full cost of an asset in the year it was purchased, depreciation spreads that cost out over several years, reflecting how the asset loses value as it’s used. Depreciation is applicable to both tangible and intangible assets, such as buildings, vehicles, computers, furniture, patents, copyrights, software, etc.

For example, if you buy a computer for ₹50,000 and expect it to last for five years, you might depreciate its value by ₹10,000 each year for five years.

Depreciation Under the Companies Act, 2013

The Companies Act of 2013 provides a method for corporate financial reporting in India. Under this Act, businesses must follow certain guidelines when calculating depreciation for their assets.

Methods of Depreciation under the Companies Act

  • Straight Line Method (SLM):
    • In this method, depreciation is charged equally over the asset’s useful life.
    • For example, if an asset is expected to last 5 years and costs ₹50,000, then depreciation will be ₹10,000 per year.
  • Written Down Value (WDV) Method:
    • In this method, depreciation is calculated on the book value of the asset at the start of each year, after deducting any previous depreciation.
    • This means the depreciation expense will decrease over time as the asset’s book value decreases.

Useful Life of Assets (Schedule II)

Under the Companies Act, Schedule II specifies the useful life of different types of assets. The useful life is the period over which the company expects the asset to be of economic use.

Depreciation rates for the most common assets:

Sr. No. Asset Class and Type Useful Life Depreciation Rate
       I. Residential buildings (excluding boarding houses and hotels) 60 years 5%
      II. Furniture, including electrical fittings 10 years 10%
    III. Motor cars (excluding those used in a business of running them on hire) 10 years 15%
    IV. Computers 3 years 40%

Note: These rates are not fixed in stone and can vary depending on the actual usage of the asset. Furthermore, companies can also revalue their assets periodically, in which case depreciation must be recalculated based on the new value and adjusted for the remaining useful life.

No Depreciation on Land:

It is pertinent to note that land is not depreciable. While buildings or machinery might lose value over time, land tends to appreciate in most cases and is therefore not subject to depreciation under the Companies Act.

Depreciation Under the Income Tax Act, 1961

The Income Tax Act of 1961 deals with how businesses should account for depreciation to reduce taxable income and save on taxes. The rules for depreciation under the Income Tax Act differ from those under the Companies Act in several ways, especially when it comes to rates and methods.

Depreciation Calculation Method

Under the Income Tax Act, depreciation can only be calculated using the Written Down Value (WDV) Method. This method is similar to that used in the Companies Act but is focused more on reducing tax liabilities.

Depreciation Rates Under the Income Tax Act

The Income Tax Act prescribes different depreciation rates for various assets, and they might differ from the rates under the Companies Act. It is pertinent to note that the rate of depreciation under the Income Tax Act of 1961 depends on the Union Budget of each Financial Year.

Sr. No. Asset Type Depreciation Rate
            I. Buildings that are used for residential purposes, excluding hotels, guest houses, and boarding houses. 5%
           II. Motor cars, other than those used in a business of running them on hire, are acquired on or after the 23rd day of August 2019 but before the 1st day of April 2020 and are put to use before the 1st day of April 2020. 30%
         III. Life-Saving Medical equipment 40%
        IV. Plastic Containers or Containers where Glass is used as refills 40%
          V. Cinematograph Firms, Studio Lights bulbs 40%
        VI. Gas cylinders, its regulators and valves 40%
       VII. Franchise, trademark, patents, license, copyright, know-how or other commercial or business rights of similar nature 25%

Accelerated Depreciation:

The Income Tax Act of 1961 allows accelerated depreciation for certain assets like machinery and equipment. Businesses can claim a higher depreciation in the initial years of an asset’s life, which helps reduce taxable income significantly in the short term. Accelerated Depreciation is beneficial for industries with heavy capital investments.

Block of Assets:

Under the Income Tax Act, all similar assets (such as plant and machinery, vehicles, or furniture) are grouped into a block. Depreciation is then calculated on the aggregate value of the block rather than on individual assets. This makes the process simpler, as it eliminates the need to calculate depreciation for each individual asset.

No Depreciation on Land:

Like the Companies Act, the Income Tax Act of 1961 does not allow depreciation on land. However, buildings, machinery, and other assets related to land usage are eligible for depreciation.

Key Differences Between Depreciation Under the Companies Act, 2013 and Income Tax Act, 2013

Aspect Companies Act, 2013 Income Tax Act, 1961
Method of Depreciation Straight Line Method (SLM) or Written Down Value (WDV) Only Written Down Value (WDV)
Depreciation Rates Prescribed based on the useful life of assets in Schedule II Prescribed specific rates for different assets under Section 32
Focus For financial reporting purposes (showing a genuine financial position) For tax purposes (reducing taxable income and tax liability)
Accelerated Depreciation Not allowed Allowed for certain assets like machinery
Block of Assets Not applicable Depreciation is calculated on a block of assets
Depreciation on Land Not allowed Not allowed

Requirements to Claim Depreciation under the Income Tax Act

  • The asset should be owned by someone either wholly or partially. In the case of co-ownership of an asset, depreciation can be claimed by each owner on the basis of their ownership share in the asset.
  • The asset must be used for the business or profession of the taxpayer.
  • The Depreciation Rate prescribed under the Income Tax Act must be followed; it is immaterial if different rates are followed in the company’s financial statement as per the Companies Act, 2013.

How to claim Depreciation under the Income Tax Act, 1961

To claim depreciation under the Income Tax Act, you need to determine the type of asset you own and group it into a “block of assets” (like machinery, buildings, etc.). Depreciation is calculated based on the written down value (WDV) of the asset at the beginning of the financial year, using specific rates provided in the Income Tax Rules. The depreciation claim can be made while filing your Income Tax Return (ITR) under the “Schedule DEP” section, provided the asset is used for business. Depreciation is claimed in the year when you buy a new asset, and if you sell an asset, depreciation is claimed only until the date of sale.

Conclusion

In conclusion, depreciation plays a key role in both business accounting and tax planning. It allows businesses to account for the gradual loss in value of assets over time, such as machinery, vehicles, and buildings. The Companies Act and the Income Tax Act both provide guidelines for calculating depreciation, but they differ in their methods and purposes. The Companies Act focuses on financial reporting and allows businesses to choose between the Straight Line Method (SLM) and the Written Down Value (WDV) method, depending on the nature of the asset. On the other hand, the Income Tax Act only allows the WDV method and provides opportunities for accelerated depreciation on certain assets to reduce tax liabilities on the taxpayers. It is essential for businesses to understand the difference in the rate of depreciation of assets between the two statutes. By doing so, companies can optimize their depreciation claims, reduce tax burdens, and maintain accurate financial records. Consulting with professionals is essential and advisable to ensure the best approach is taken in managing depreciation for long-term growth and compliance.

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FAQs

1. Can a company choose between SLM and WDV for all assets?

No, the Companies Act allows both methods, but particular assets must use a specific method like SLM or WDV based on their nature.

2. Is depreciation mandatory for all businesses in India?

Yes, all businesses must account for depreciation in their financial reporting and tax filings.

3. Can land be depreciated under either the Companies Act or Income Tax Act?

No, land cannot be depreciated under either the Companies Act or Income Tax Act.

4. Which method of depreciation is better for tax savings?

The Written Down Value (WDV) method is often better for tax savings due to its accelerated depreciation benefits.

5. Can a company change its depreciation method during the year?

Yes, a company can change its method of depreciation, but it must disclose the change in its financial statements and justify the reason.

6. Is accelerated depreciation allowed under the Companies Act?

No, the Companies Act does not allow accelerated depreciation.

7. How is depreciation treated for intangible assets like patents?

Under the Income Tax Act, intangible assets like patents are eligible for depreciation at a rate of 25%.

8. Do the depreciation rates vary by industry?

Yes, different industries might apply different useful life estimates for assets, which impacts the depreciation calculation.

9. What happens if a business revalues its assets?

If a company revalue its assets, depreciation must be recalculated based on the new value and the remaining useful life of the asset.

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