Depreciation is discussed in Section 32 of the Income Tax Act of 1961. Depreciation is characterised as a decrease in the value of an object caused by wear and tear. People claim depreciation deductions only for accounting or taxation purposes
The concept of depreciation is allowed under the Income Tax Act. 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.
Get a quick understanding of the following things about depreciation here:
- What is Depreciation
- Concept of Block of Assets
- Conditions for claiming Depreciation
- Meaning of the WDV (Written Down Value)
- Amount of Depreciation allowed
- Depreciation Rates for FY 2024-25
- Depreciation Rates as per Income Tax
- Methods of Calculating Depreciation
- Formula for Calculating Depreciation
- Analysis of AS 22 and IND AS 12
What is Depreciation?
The concept of depreciation is used for the purpose of writing off the cost of an asset over its useful life. Depreciation is a mandatory deduction in the profit and loss statements of an entity using depreciable assets and the Act allows deduction either using the Straight-Line method or Written Down Value (WDV) method.
The calculation for depreciation under the WDV method is widely used. However, in case the undertaking is engaged in power generation or its generation and distribution, there is an option to choose the straight-line method.
In certain circumstances, the Act also allows a deduction for additional depreciation in the year of purchase. To read about additional depreciation visit- Additional Depreciation Under the Income Tax Act.
Block of Assets
Depreciation is calculated using the WDV of a Block of assets. A block of assets is a collection of assets from the same asset class that includes-
- Buildings, machinery, plants, and furnishings are examples of tangible assets.
- Intangible assets include know-how, patents, copyrights, trademarks, licences, franchises, and any other comparable business or commercial rights.
The asset block is identified based on its life, type, and similar use. Furthermore, for asset classification, the depreciation percentage within the asset class must be addressed. Each such asset class with the same depreciation rate will be identified as a block of the asset.
Individual assets lose their individuality under the Income Tax Act because depreciation is calculated on a group of assets rather than individual assets.
Rates of Depreciation
Assets | Rates of Depreciation |
Residential Building | 5% |
Non-residential Building | 10% |
Furniture and Fitting | 10% |
Computers and Software | 40% |
Plant and Machinery | 15% |
Personal Use Motor Vehicle | 15% |
Commercial Use Motor Vehicle | 30% |
Ships | 20% |
Aircraft | 40% |
Tangible Assets | 25% |
Conditions for Claiming Depreciation
- The assets must be owned, wholly or partly, by the assessee.
- The assets must be in use for the business or profession of the taxpayer. If the assets are not used exclusively for the business, but for other purposes as well, depreciation allowable would be proportionate to the use of business purpose. The Income Tax Officer also has the right to determine the proportionate part of the depreciation under Section 38 of the Act.
- Co-owners can claim depreciation to the extent of the value of the assets owned by each co-owner.
- You cannot claim depreciation on Goodwill and cost of land.
- 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. That is, the taxpayer can carry forward the WDV after reducing the depreciation amount.
- If opted for presumptive taxation scheme, the deemed profit is said to have considered the effect of depreciation.
- Depreciation under the Companies Act, 1956 is different from that of Income Tax Act. Therefore, depreciation rates prescribed under the Income Tax Act are only allowed irrespective of the depreciation rates charged in the books of accounts.
Claiming Depreciation as Per Income Tax Act
An assessee must meet certain requirements to claim the depreciation deduction. Below are the conditions:
Assets Classifications
The owner of the asset must be an assessee to benefit from depreciation. The asset can be both real and intangible. In terms of a tangible asset, it can be a home, equipment, factory, or furniture. Intangible properties may be patent rights, copyrights, trademarks, licences, franchises, or something of a similar type gained on or after April 1, 1998.
The income tax department estimates only the depreciation on the house when estimating depreciation. They may not factor in the expense of the property on which the building is built. The justification for not incorporating the cost of the property in the house is that the land does not depreciate due to wear and tear or use.
Lease Vs Ownership
An assessee can seek depreciation only on capital assets that he owns. If the assessee wishes to take advantage of the allowance for property depreciation, the assessee must be the owner of such properties. An assessee doesn’t need to be the owner of the property. Where an assessee constructs a house but the property belongs to someone else, he is entitled to a credit for depreciation on houses.
The assessee cannot seek the deduction if he is a resident who uses the house. Where an assessee has taken a mortgage on the property and built a dwelling on that land, he is entitled to depreciation allowances. In the case of hire and buy, if an assessee contracts the equipment for a brief amount of time, he cannot demand the deduction.
However, in the event of a loan, if an assessee acquires the property and becomes the purchaser, he is eligible to receive the deduction.
Used for Professions or Business
The commodity may have been used for a company or occupation to qualify for the credit for depreciation. However, it is not required to claim the credit on depreciation, for which an assessee must use the asset during the fiscal year.
Thus, if the assessee uses the asset for a short amount of time within an accounting year, he is entitled to depreciation deductions. Take, for example, every seasonal factory.
On Sold Assets
Depreciable assets cannot be deducted by an assessee. If an object is sold, removed, or damaged in the same year that it was bought, the assessee is not eligible to receive the deduction.
Co-ownership
If an asset has a co-owner, the co-owner may report depreciation on the asset as well.
FAQs
Written Down Value(WDV) of Assets?
As per Section 32(1) of the IT Act depreciation should be computed at the prescribed percentage on the WDV of the asset, which in turn is calculated with reference to the actual cost of the assets. In the context of computing depreciation, it is important to understand the meaning of the term ‘WDV’ & ‘Actual Cost’.
WDV under the Income Tax Act means:
- 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.
Amount of Depreciation Allowed?
- The depreciation is calculated under the WDV method. The depreciation rates are given in Appendix 1 .
- Except in the case of undertakings engaged in power generation or its generation and distribution, such undertaking has an option to claim depreciation on WDV method or Straight-Line method – if such option is exercised before the due date of filing the return.
- In the case of amalgamation or demerger, the aggregate depreciation allowance shall be apportioned between the amalgamating and the amalgamated company, or the demerged and the resulting company. The aggregate depreciation would be computed as if the amalgamation or demerger had not taken place. It shall be apportioned based on the number of days the assets were used by such companies.
- In case of a finance lease transaction, the lessee has to capitalise the assets in its books as per AS-19 – the Accounting Standard on Leases. In such cases, the lessee can exercise the rights of the owner in his own right and hence the depreciation is allowed to be taken by the lessee.