Under the Income Tax Act, depreciation is allowed. An Income Tax Act deduction allows a taxpayer to deduct a reduction in the real value of a tangible or intangible asset.

Depreciation – what is it?

Depreciation refers to writing off the cost of an asset over its useful life. An entity using depreciable assets must deduct depreciation in its profit and loss statements, and it can deduct it using either the Straight-Line method or the Written Down Value (WDV) method.

It is widely used to calculate depreciation using the WDV method. However, if the undertaking generates or distributes power, the straight-line method can be chosen.

The concept of a block of assets

A block of assets is depreciated based on its WDV. An asset block is a group of assets that belong to a particular asset class and include:

  • Buildings, machinery, plants, and furniture are tangible assets
  • Knowledge, patents, copyrights, trade-marks, licenses, franchises, and other intangible assets such as patents and copyrights

Asset blocks are identified based on their life, nature, and similar uses. For asset classification, the depreciation percentage within each asset class must also be considered. Identical classes of assets with the same depreciation rate as per income tax act will be identified as blocks.

Since depreciation is calculated on the block of assets rather than on individual assets, individual assets lose their identity under Income Tax Act.

Depreciation Claims Conditions

  • The assessee must own the assets, either wholly or partially.
  • Taxpayers must use their assets for their business or profession. In the case of assets that are not exclusively used for the business, but also for other purposes, the depreciation allowable would be proportional to the use of the assets for the business. A proportionate part of the depreciation may also be determined by the Income Tax Officer under Section 38 of the Act.
  • Depreciation can be claimed by co-owners up to the value of the assets they own.
  • The cost of land and goodwill cannot be depreciated.
  • The deduction for depreciation is mandatory from A.Y. 2002-03 and shall be allowed or deemed to have been allowed as a deduction irrespective of a claim made by a taxpayer in the profit & loss account. As a result, the taxpayer can carry forward the WDV after reducing the depreciation amount.
  • Presumptive taxation scheme considers the effect of depreciation in the deemed profit.
  • Depreciation under the Companies Act, 1956 is different from that of Income Tax Act. Accordingly, depreciation rates prescribed under the Income Tax Act are only allowed irrespective of the depreciation rates charged in the books of accounts.a

Written Down Value- Meaning

In accordance with Section 32(1) of the IT Act, depreciation is computed on the WDV of the asset, which is calculated based on the actual cost of the asset. Defining the terms ‘WDV’ and ‘Actual Cost’ is important when computing depreciation.

According to the Income Tax Act, WDV means:

  • The WDV shall be determined based on the actual cost of the asset acquired in the previous year.
  • In the case of an asset acquired in an earlier year, the WDV shall be equal to the actual cost incurred less depreciation actually allowed.

Allowable amount of depreciation

  • Under the WDV method, depreciation is calculated. The depreciation rates are listed in Appendix 1.
  • The option to depreciate using WDV or Straight-Line method is available to most undertakings, except for those engaged in power generation or its generation and distribution.
  • After an amalgamation or demerger, the aggregate depreciation allowance is allocated between the amalgamating company and the amalgamated company, or between the demerged company and the resulting company. As if there hadn’t been an amalgamation or demerger, the aggregate depreciation would have been computed. Such companies shall be apportioned based on the number of days they used the assets.
  • Finance lease transactions require the lessee to capitalise assets in its books in accordance with AS-19 – the Accounting Standard on Leases. Lessees are allowed to take depreciation in such cases, since they can exercise the rights of owners in their own right.

Depreciation Methods

Depreciable assets have varying methods of depreciation and useful lives. In addition to asset types and industries, accounting and taxation methods can also differ. In most cases, straight line depreciation and written down value depreciation are used for depreciation.

Other than depreciation rates, the basic difference between income tax and company law is how depreciation is calculated.

Company Act, 1956 (Based on Specific Rates) depreciation methods:

  • The straight line method
  • The written down value method

According to the Companies Act, 2013, there are three methods of depreciation based on the useful life of assets:

  • Method of Straight Lines
  • Method of Writing Down Values
  • Method of Unit of Production

Specified rates of depreciation under the Income Tax Act, 1961:

  • The Written Down Value Method (Block-by-Block)
  • For power generating units, use the straight line method

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