Depreciation under Income Tax Act

Depreciation as per slab rates mentioned in the Income Tax Act are allowable expenditure against the profits or gains from the business or profession. Depreciation under the Income Tax Act is a deduction allowed for the reduction in the real value of a tangible or intangible asset used by a taxpayer.

Depreciation

Depreciation refers to reduction in the value of asset over a period of time. The main causes of depreciation are the usage, wear and tear and obsolescence of the asset. Since assets are used in the business/profession therefore some amount of such asset can be logically debited to the Profit and Loss Account as a non cash expenditure and is an allowable expense.

Depreciation is allowable as expense in Income Tax Act, 1961 on basis of block of assets on Written Down Value (WDV) method. Depreciation on Straight Line Method (SLM) is not allowed. Block of assets means group of assets falling within a class of assets for which same rate of depreciation is prescribed.

Which Depreciation Method Is Used for Tax Purposes?

The financial depreciation is calculated using the straight-line method which results in an even distribution of the expense over the life of the asset, tax depreciation is calculated using the Modified Accelerated Cost Recovery System, or MACRS. You divide the cost of an asset, minus its salvage value, over its useful life. That determines how much depreciation you deduct each year.

Conditions for claiming depreciation

• Condition 1: The asset must be owned by the assessee. (If partly owned, proportionate depreciation is allowed as a deduction)
• Condition 2: It must be used for the purpose of business or profession.
• Condition 3: It should be used during the relevant previous year.If asset is not put to use in the year of purchase or put to use for less than 180 days even then full depreciation is allowed in the subsequent years if Depreciation is allowed on whole block of asset even if only a single asset in that block is used during the year at any point of time.
• Condition 4: Depreciation is available on tangible as well as intangible assets (Note: Goodwill and land are not eligible for depreciation)

Methods of Depreciation

Depreciation is a mandatory deduction in the profit and loss statements of an entity, and the Act allows deduction either in the Straight-Line method or the written-down value (WDV) method. (WDV is a widely used mechanism except in the power generation units)

• Straight-Line Depreciation.
• Declining Balance Depreciation.
• Sum-of-the-Years’ Digits Depreciation.
• Units of Production Depreciation.

Block of assets concept

Depreciation is calculated on the WDV of a Block of assets. A block of assets is a group of assets falling within a class of assets comprising:

• Tangible asset
• Intangible asset

These may be further classified based on similar use, life, and nature of the asset.

Written Down Value –Meaning

In the context of computing depreciation, it is important to understand the meaning of the term ‘WDV’ & ‘Actual Cost. WDV under the Income tax return filing:

Where the asset is acquired in the previous year, the actual cost of the asset shall be treated as WDV
Where the asset is acquired in an earlier year, the WDV shall be equal to the actual cost incurred, less depreciation actually allowed under the Act

Calculation of Depreciation

If the amount of WDV comes at a negative amount then no depreciation is allowed and the amount will be considered as capital gain and the closing WDV will be zero.

If such amount is positive and no asset exists in the block then such amount will be treated as short term capital loss and no depreciation is allowed.

Rates of Depreciation as per Income Tax ACT

Additional Depreciation as per Income Tax Act

Apart from Normally allowable depreciation, business organisations can claim additional depreciation under clause (iii) of Section 32(1) of the Income Tax Act 1961 with respect to new machinery or plants other than ships and crafts.
The assessed should be engaged in the following business to avail such depreciation; they are as follows

• Business or organization, or
• Production of any article or a thing or
• In the business of generation or generation and distribution of power

The depreciation is eligible for a further sum of 20% of the actual cost of such machinery or plant.

Non-eligibility for claiming additional depreciation

No deduction under additional depreciation shall be allowed in respect of

• any machinery or plant which, before its installation by the assessee, was used either within or outside India by any other person (second-hand or used plant and machinery )or
• any machinery or plant installed in any office premises or any residential accommodation, including accommodation in the nature of a guest house, or
• any office appliances or road transport vehicles, or
• any machinery or plant, the whole of the actual cost of which is allowed as a deduction (whether by way of depreciation or otherwise) in computing the income chargeable under the head “Profits and Gains from Business or Profession” of any previous year.
• 100% Depreciable assets like Pollution Control Equipment

Carry Forward Provisions

Additional depreciation can also be carried forward in subsequent years. (i.e. the asset is put to use in less than 180 days, 50% of additional depreciation will be claimed in the previous year and the remaining 50% of additional depreciation can be claimed in the subsequent year)

No additional depreciation if opting for a lower rate of 22%

Domestic companies which are engaged in the business of manufacture or production of any article or thing or generation, transmission of power and tax audit limit for business and profession of 22%, such companies will not be allowed a deduction for additional depreciation as per Section 32(1)(iia) [Section 115BAA(2)(i)].

Further, additional depreciation will also not be allowed to be adjusted while computing taxable income as per section 115BAA(1). However, if prior to AY 2020-21 any additional depreciation as per Section 32(1)(iia) has not been given full effect to, then it will be allowed to be adjusted in WDV of a relevant block of assets as on 1 April 2019, if opted for section 115BAA for AY 2020-21 on or before the due date of filing ITR as specified u/s 139(1) [Proviso to Section 115BAA(3)].

Similar to section 115BAA, in view of section 115BAB(2)(c) if lower rate of 15% is claimed then deduction of additional depreciation will not be allowed.

Impact of section 43A adjustment

If the actual cost of any asset, which is eligible for additional depreciation, is increased or decreased due to adjustment by application of section 43A, then it seems that the additional depreciation should accordingly be adjusted in the tax computation of said year.

Additional depreciation with respect to setting up units in backward areas:

As per the proviso to Section 32 (1)(iia)

Additional depreciation shall be allowed on new plant and machinery (other than ships, aircraft, vehicle, office appliances, second hand plant or machinery, etc.) shall be allowed subject to certain conditions.

Such additional depreciation to be allowed to all taxpayers which set up an undertaking or enterprise for production or manufacture of any article or thing in any notified backward area in the state of Andhra Pradesh, Bihar, Telangana or West Bengal.

Note:

1. The manufacturing unit should be set up on or after April 1, 2015.
2. New plants and machinery should be acquired and installed on or after April 1, 2015, but before April 1, 2020.

Thus, Additional depreciation is to be allowed at 35 % of the actual cost of the new plant and machinery.

However, if an asset is acquired and put to use for less than 180 days during the previous year, 50% of additional depreciation shall be allowed in the year of acquisition and the balance 50% in the next year.