Income Tax

The Concept of Depreciation under Income Tax Act

The Concept of Depreciation under Income Tax Act

Depreciation under Income Tax Act refers to a deduction permitted for a reduction in the real value of a tangible/intangible asset used by the taxpayer. The depreciation is a mandatory deduction in the profit and loss statements of an entity, and the Income Tax Act allows deduction in straight line method or written down value method. Let us discuss more on it.

Methods for calculation of Depreciation under Income Tax Act

The methods of depreciation and life of depreciable assets vary from asset to asset. It may differ for accounting and taxation purposes based on the type of the asset and industry.

Two of the most commonly used methods of depreciation are:

Methods for calculation of Depreciation under Income Tax Act
  • Straight Line Method;
  • Written Down Value Method.

The major difference in calculation of depreciation under income tax act and companies act depreciation other than the rates of depreciation is the calculation method.

Depreciation according to Companies Act 1956

  • Straight line method;
  • Written down value method.

Depreciation according to Companies Act 2013

  • Straight line method;
  • Written down value method;
  • Unit of Production method.

Depreciation according to Income Tax Act 1961

  • Written down value method (block wise);
  • Straight line method for power generating units.

Grounds on which depreciation can be claimed

The following are the grounds for claiming depreciation:

  • The assets should be owned, either wholly or partly, by the assessee.
  • The assets should be used for the taxpayers’ business or profession. In case where the assets are not utilized exclusively for the business but for other purposes, depreciation allowed will be proportionate to the use of business purpose. Here the income tax officer can determine as to what is the proportionate part of the depreciation under section 38.
  • The co-owners may claim for depreciation to the extent of the value of assets owned by the co-owner.
  • One cannot claim depreciation on the cost of the land.
  • Depreciation is necessary from Annual Year 2002 and will be allowed or deemed to be allowed as a deduction regardless of the claim made by a taxpayer in the P&L account.
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To get the benefit of depreciation, the owner of the asset must be an assessee. The asset may be tangible or intangible. As far as tangible asset is concerned, the asset must be a building, machinery, plant or furniture and as far as intangible asset is concerned, the asset must be patent rights, copyrights, license, trademark, franchise. At the time of calculation of depreciation on building, the income tax department calculates depreciation only on building, and it doesn’t calculate the cost of the land where the building is situated. This is because the land doesn’t suffer depreciation due to wear and tear.

Further, an assessee can claim depreciation on capital assets that are owned by the assessee. In case the assessee wishes to avail deduction on depreciation of building, then the assessee has to be the owner of such buildings. It is not mandatory that the assessee has to be the owner of the land. If an assessee constructed a building, but the land is of someone else, then he has the right to claim deduction of depreciation on buildings. In case the assessee is a tenant, or if he is using the building, then he cannot claim deduction.

If the assessee takes the lease of the land and constructed a building on such land, then he can avail of the allowances of depreciation. In case of hire and purchase, if an assessee hires machinery for short duration, then he is not entitled to claim deduction, but if he becomes the owner of the property, then he can claim deduction.

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In order to avail allowance for depreciation, the asset should be used for the purpose of business or profession. However, it is not mandatory for gaining the allowance for depreciation for which the assessee is required to use the asset throughout the accounting year. If the assessee uses the asset for smaller period of time in an accounting year, then he can avail allowances for depreciation. Under Section 38 of the Income Tax Act 1961[1], the Income Tax Officer can determine the proportionate part of the depreciation, as also stated earlier.

Additional Depreciation under Income Tax Act

The income tax act allows the written down value method. In case of the Additional Depreciation, one can get the deduction on those assets only, which is used in the business or profession. However only when assets are used in the year when it was purchased, the assessee can avail deduction.

As per the amendment in the Income Tax Act, an assessee may be allowed depreciation of 20% on plants and machinery that have been engaged in the business of manufacture or production of an article.

From 2017-18 a new provision has been added in the Income Tax Act wherein assesses who are involved in profession of power can avail the benefits of Additional Depreciation.

Conclusion

In order to claim deduction under Section 32, an assessee should meet certain conditions. The method of written down is one of the best method for calculation of depreciation under Income tax Act. Depreciation is helpful for an assessee in many ways as it enables financial management and also serves as a tax saver.

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