Depreciation Under Income Tax Act

Introduction

Depreciation under Income Tax Act, of 1961, is a deduction allowed for the wear and tear of an asset over time due to its use in business or profession. This deduction, outlined in Section 32 of the Income Tax Act, is essential for reducing the taxable income of taxpayers, as it accounts for the reduction in the value of tangible and intangible assets.

Depreciation is primarily claimed for accounting or taxation purposes, allowing businesses to recover the cost of assets used in generating revenue. The Income Tax Act permits depreciation deductions on both tangible assets like buildings, machinery, and furniture, as well as intangible assets such as patents, trademarks, copyrights, and licenses.

Block of Assets

Depreciation is calculated on the Written Down Value (WDV) of a “Block of Assets.” A block of assets refers to a group of assets within the same class and category that are depreciated at the same rate. For instance:

• Tangible assets: Includes buildings, machinery, plants, and furniture.
• Intangible assets: Includes patents, trademarks, copyrights, licenses, franchises, and other similar commercial rights.

Assets within the same block lose their individuality under the Income Tax Act as depreciation is calculated collectively on the block rather than on individual assets.

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Rates of Depreciation

The rate of depreciation under the Income Tax Act vary depending on the type of asset. The rates are as follows:

Claiming Depreciation as Per Income Tax Act

To claim a depreciation deduction under the Income Tax Act, certain conditions must be met:

1. Asset Classification

Under the Income Tax Act, assets are classified into different categories based on their nature and use. These categories determine the depreciation rates applicable to each asset. The common classifications include:

1.1 Building:

Depreciation rates vary depending on whether the building is used for residential or commercial purposes. For example, factories and commercial buildings may have a higher depreciation rate compared to residential properties.

1.2 Plant and Machinery:

This category covers equipment and machinery used in manufacturing or other business activities. Higher depreciation rates are typically allowed for machinery, especially those prone to faster wear and tear.

1.3 Furniture and Fixtures:

Items like tables, chairs, and office furnishings fall under this category. Depreciation rates for furniture are generally lower compared to machinery.

1.4 Vehicles:

Cars, trucks, and other vehicles used for business purposes can be depreciated, with rates varying based on the vehicle type (e.g., motor cars, commercial vehicles).

1.5 Intangible Assets:

Patents, trademarks, and software are considered intangible assets. Although they are non-physical, businesses can still claim depreciation on them at prescribed rates.

2. Lease vs. Ownership

The eligibility to claim depreciation differs based on whether the asset is owned or leased:

2.1 Owned Assets:

Depreciation can only be claimed on assets that are owned by the taxpayer. Ownership implies that the taxpayer holds legal title to the asset and bears the economic risk associated with it. Businesses can claim depreciation even if the asset is partly financed through loans.

2.2 Leased Assets:

Depreciation is not allowed for assets that are leased. The lessee (the one who uses the asset) cannot claim depreciation since they do not own the asset. Instead, the lessor (the one who provides the asset on lease) is entitled to claim depreciation. However, lease payments made by the lessee can be claimed as an expense for tax purposes.

3. Used for Business or Profession

Depreciation can only be claimed on assets that are used for business or professional purposes. Personal assets are not eligible for depreciation claims:

3.1 Business Use:

The asset must be actively used in the operations of the business. For instance, machines used in a factory for manufacturing or vehicles used by sales teams are eligible for depreciation.

3.2 Partial Use:

If an asset is used for both business and personal purposes, depreciation can be claimed only on the portion used for business. For example, if a car is used 60% for business and 40% for personal use, depreciation can only be claimed on 60% of the asset’s value.

3.3 Temporary Non-Use:

Depreciation can still be claimed if the asset was temporarily out of use due to maintenance, repair, or other business-related reasons, provided the business ownership remains intact.

4. On Sold Assets

When an asset is sold during the financial year, special provisions apply to how depreciation is claimed:

4.1 No Depreciation for the Year of Sale:

The taxpayer cannot claim depreciation for the financial year in which the asset is sold, as the asset is no longer part of the business’s asset pool. Depreciation can be claimed for the period the asset was in use before the sale, but after the sale, it ceases to be eligible.

4.2 Balancing Charge and Capital Gains:

If an asset is sold for more than its written down value (WDV), the excess amount is considered as capital gains, and it is taxable. Conversely, if the sale price is lower than the WDV, the loss can sometimes be deducted, depending on the asset classification and tax rules.

5. Co-Ownership

Depreciation can also be claimed on assets that are co-owned, provided the following conditions are met:

5.1 Proportionate Ownership:

Each co-owner can claim depreciation based on their share in the asset. For example, if two partners own machinery with equal stakes, each partner can claim 50% of the depreciation on the asset.

5.2 Business Use Requirement:

Similar to individually owned assets, the co-owned asset must be used for business purposes to be eligible for depreciation. Both co-owners should use the asset in their respective business activities.

5.3 Proper Documentation:

It is essential that the ownership shares are properly documented, and both parties maintain accurate records for tax purposes. This ensures smooth processing during tax assessments.

Claiming depreciation as per the Income Tax Act helps businesses reduce their taxable income, thus lowering their overall tax liability. Understanding these rules ensures compliance and optimal tax planning, benefiting businesses financially.

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Conditions for Claiming Depreciation

• Goodwill and Land: Depreciation cannot be claimed on goodwill or the cost of land.
• Mandatory Depreciation: Since the financial year 2002-03, claiming depreciation is mandatory, whether or not the taxpayer includes it in their profit and loss account.
• Presumptive Taxation Scheme: When using this scheme, the deemed profit is considered to have accounted for depreciation.
• Depreciation Methods: The depreciation method under the Income Tax Act may differ from that under the Companies Act. The rates specified by the Income Tax Act must be followed.
• Asset Usage: Depreciation is allowable only if the asset is used for business or professional purposes during the financial year.

Different Methods of Depreciation Calculation

The method of depreciation and the useful life of assets can vary depending on the type of asset, industry, and whether it is for accounting or taxation purposes.

1. Depreciation as per Companies Act, 1956:

• Straight Line Method (SLM): Depreciation is calculated as a fixed percentage of the original cost.
• Written Down Value Method (WDV): Depreciation is calculated on the reducing balance of the asset’s value.

2. Depreciation as per Companies Act, 2013:

• Straight Line Method (SLM): Similar to the Companies Act, 1956.
• Written Down Value Method (WDV): Similar to the Companies Act, 1956.
• Unit of Production Method: Depreciation is based on the number of units produced by the asset.

3. Depreciation as per Income Tax Act, 1961:

• Written Down Value Method (Block wise): Depreciation is calculated collectively on a block of assets.
• Straight Line Method (For Power Generating Units): Depreciation is calculated as a fixed percentage of the original cost.

Conclusion

Depreciation can be claimed from the 1st day of the financial year if the asset is put to use before that date. For assets used in a business or in a business of manufacturing, transportation, or services, depreciation becomes a crucial part of tax calculations. Specifically, assets used in a business of running them on hire (like taxis or trucks) can claim depreciation as long as they are actively involved in a business of providing transportation services.

The Income Tax Act allows businesses to optimize tax savings by ensuring proper calculation of depreciation as per the prescribed rates. Whether the asset is owned individually or as part of running them on a lease, it can still qualify for depreciation if it supports a business of running core operations effectively.