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Depreciation under the Income Tax Act: What You Should Understand


Last Updated on February 10, 2024 by Kanakkupillai

The idea of depreciation gains legitimacy as a vital financial instrument within the context of the Income Tax Act. Depreciation, which functions as a deduction, is a mechanism to address the reduction in the inherent value of the taxpayers’ tangible and intangible assets. This reduction considers the steady loss in value these assets experience due to their involvement in business operations. Buildings and machinery are tangible assets that steadily lose value over time due to usage, wear and tear, and obsolescence. Similarly, intangible assets like patents and copyrights may lose their economic value when used or older. The Income Tax Act’s depreciation deduction provision highlights a fair approach to tax law by allowing firms to account for the natural decline in asset value in their financial projections.

The Income Tax Act recognizes the economic fact that assets, regardless of their nature, tend to depreciate over time by providing depreciation deductions. This understanding is consistent with the overarching objective of delivering a truthful and honest portrayal of a taxpayer’s financial situation, considering the actual depreciation of assets during operational use. Using this clause, taxpayers can deduct expenses from the asset’s original cost to account for the asset’s use or value loss. Depreciation expenses that result from this help firms plan their finances and make decisions. It also helps income represent income more accurately. Ultimately, the Income Tax Act’s definition of depreciation demonstrates how the legal system can adjust to economic realities and create an environment where firms can successfully manage the intricacies of asset management and taxation.

Overview of Depreciation

Depreciation is the systematic distribution of an asset’s depreciable value throughout its useful life. An asset’s depreciable amount is its cost or an amount substituted in its place, less any residual value.

Depreciation is mostly used to spread out the costs of assets throughout their useful life. According to the law, a mandatory reduction in a business’s financial records employing depreciable assets is required. The straight-line approach or the written-down value method may be used to claim this deduction. The written-down value approach is widely used in the computation of depreciation. A straight-line strategy is an option for businesses producing or distributing electricity.

The Block of Assets

Depreciation is generally calculated using the diminished value of a “block of assets,” a group of assets. This block includes material possessions like equipment, furniture, and buildings. Intangible assets like patents, copyrights, trademarks, and other similar business rights are also included.

The selection of a particular asset block is determined by its shared goal and natural lifespan. All asset classifications should acknowledge different depreciation percentages within the asset category. An asset block is a collection of items subject to the same depreciation rate. Individual assets lose their separate identity due to the Income Tax Act’s rules, which causes depreciation to be calculated for the entire asset block rather than individual assets.

Conditions for Claiming Depreciation

  1. The assets should be owned partially or completely by the income taxpayer

To be eligible for depreciation, the taxpayer must wholly or substantially own depreciable assets. Even though these assets may have alternative applications, they should be used for business. The amount that can be depreciated should correspond to the volume of business use. According to Section 38 of the act, the Income Tax Officer has the jurisdiction to determine the depreciation percentage.

The portion of the asset’s value jointly owned by co-owners in co-ownership scenarios can also be depreciated.

  1. You cannot claim any depreciation on the goodwill or the cost of the land

Between the fiscal years 2000 and 2003, depreciation was required. Regardless of whether the taxpayer formally claims it in the profit and loss statement, it must be considered a deduction. This enables the taxpayer to carry forward the modified written-down value on an ongoing basis once depreciation has been considered.

The impact of depreciation is considered when choosing a presumptive taxation scheme because it affects the deemed profit.

It’s important to remember that the Income Tax Act and the Companies Act 1956 have different depreciation treatment rules. No matter what alternative rate is utilized in the accounting records, the depreciation rate determined by the Income Tax Act is the one that applies.

Meaning of Written Down Value

The written-down value is calculated based on the asset’s initial actual cost. When calculating depreciation, it’s critical to understand the relevance of the written-down value in proportion to the real asset cost. The written-down value corresponds to the asset’s acquisition value in the prior year, regarded as its reduced value under the Income Tax Act. The written-down value for assets accounted for in the prior year equals the actual cost minus depreciation.

Total Amount Of Depreciation Allowed

The written-down value approach calculates depreciation, with a special provision for businesses engaged in power production or other related activities. In such cases, there is a choice between calculating depreciation using the straight-line approach or the written-down method. This decision must be made before submitting the sales tax return deadline.

Methods to Calculate Depreciation with Explanations

Different asset types and industries have different depreciation methods and usable lives for depreciable assets, which meet tax and accounting purposes. The written-down value and straight-line approaches are the two most used depreciation strategies. The process used in calculating depreciation differs significantly between the Income Tax Act and the Companies Act, as does the rate of depreciation.

The Companies Act of 2013 approved three depreciation techniques: the written-down value method, a unit of production method, and the straight-line method.

The Formula for calculating Depreciation

By subtracting the residual value from the original price of clothing, dividing the result by the useful lifespan, and then multiplying by 100, the straight-line technique determines depreciation.

The original cost multiplied by the straight-line method rate equals depreciation.

Different depreciation methods are used for tax and accounting purposes, which results in variances in the depreciation amount and timing discrepancies. Financial statements should reflect these temporal fluctuations as either assets or deferred tax liabilities. Deferred tax largely refers to prospective future income tax payments or recoveries resulting from momentary taxable discrepancies under Accounting Standard 22. variances in the carrying amounts of different asset types on the balance sheet cause these transient variances.


In conclusion, the Income Tax Act’s idea of depreciation is a key mechanism for recognizing the gradual loss in value of tangible and intangible assets. It functions as a deduction, enabling taxpayers to consider this declining value as assets are used to support business activities. The distinction between intangible assets like patents and copyrights and tangible assets like buildings and machinery highlights the necessity of this deduction to appropriately reflect the economic realities.

By allowing depreciation deductions, the rules of the Income Tax Act emphasize fairness and accuracy in financial reporting. Businesses can more accurately reflect income and align their financial statements with their assets’ true value through these deductions. This leads to better financial planning and decision-making. The opportunity to select between straight-line or written-down depreciation techniques and acknowledge co-ownership scenarios further exemplifies how the tax system may be tailored to the complex nature of asset management.

The connection between the Income Tax Act and the Companies Act of 1956 further highlights the complex nature of depreciation treatment. While the Income Tax Act’s depreciation rate is the most common, the Companies Act 2013’s various depreciation calculation techniques are tailored to meet the demands of particular industries.

In the end, depreciation captures not only the economic effects on enterprises but also the balancing of economic realities with legal requirements, resulting in a setting where asset management and taxation may live successfully.

Seeking professional advice becomes crucial for thoroughly understanding depreciation under the Income Tax Act and related issues. Kanakkupillai, a reputed service provider known for its legal and tax competence, is one such knowledgeable source. An experienced team ensures proper financial reporting and adherence to tax laws by offering significant guidance and a thorough understanding of depreciation restrictions. Kanakkupillai is a dependable partner when negotiating the complexity of depreciation and its repercussions, providing specialized advice that promotes informed decision-making and strict adherence to legal standards.

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