Depreciation under Income Tax Act

Depreciation is an allowance given by the Income Tax Act for the wear and tear of assets used in business or profession. It is a non-cash expense that reduces the taxable income and ultimately results in tax savings for businesses. The depreciation rate as per Income Tax Act varies depending on the nature of the asset. The depreciation can be claimed by the owner of the asset, whether it is a company, a partnership firm, or an individual. 

What is Depreciation in the Income Tax Act?

Depreciation as per Income Tax Act is defined as the decrease in the value of an asset due to its usage, wear and tear, the passage of time, or obsolescence. The Income Tax Act allows for the deduction of depreciation expenses while computing the taxable income of an entity.

Depreciation is a non-cash expense, which means that it does not involve any outflow of cash from the entity. Instead, it represents the allocation of the cost of an asset over its useful life. This allocation helps in reducing the taxable income of the entity and results in lower tax liability.

The rate of depreciation for various assets is specified under the Income Tax Act and varies depending on the type of asset, its useful life, and other factors. For example, the depreciation rate for buildings is lower than that for plant and machinery, which is further lower than that for computer software.

It is important to note that only tangible assets such as buildings, machinery, furniture, and vehicles are eligible for depreciation. Intangible assets such as goodwill, patents, trademarks, and copyrights do not qualify for depreciation.

Depreciation is calculated on the original cost of the asset, less any residual value or scrap value, which is the estimated value of the asset at the end of its useful life. The resulting amount is then divided by the number of years of useful life to arrive at the annual depreciation expense.

It is mandatory for entities to calculate and claim depreciation on their assets while computing their taxable income. Failure to do so can result in penalties and interest charges levied by the tax authorities.

Block of Assets- Concept

A Block of Assets is a group of assets that share similar characteristics and are subject to the same rate of depreciation. This group of assets can be comprised of tangible or intangible assets that have the same useful life, similar nature to the asset, and are used for the same purpose in a business. 
Examples of tangible assets that can be included in a Block of Assets are buildings, machinery, plants, and furnishings. Intangible assets such as patents, copyrights, trademarks, licenses, and franchises can also be included in a Block of Assets. The depreciation on a Block of Assets is calculated based on the Written Down Value (WDV) of the assets in the block.
 

Conditions For Claiming Depreciation

In order to claim depreciation, there are certain conditions that need to be met as per the Income Tax Act. These conditions are:

●    The asset should be owned by the assessee.
●    The asset should be used for business or professional purposes.
●    The asset should have a useful life of more than one year.
●    The asset should not have been acquired for personal use or for any other non-business purpose.
●    The asset should be put to use during the financial year for which the claim is being made.
●    The asset should not have been fully depreciated or claimed as an expense in the previous years.
●    The Companies Act of 1956 has different provisions for depreciation as compared to the Income Tax Act. Therefore, the depreciation rates prescribed by the Income Tax Act are permissible irrespective of the depreciation rates charged in the books of accounts. This means that even if a company charges a different rate of depreciation in its books of accounts, the Income Tax Act allows only the rates prescribed by it for the purpose of calculating depreciation for income tax purposes.
●    The assets must be used in connection with the taxpayer's business or profession. If the assets are utilized for objectives other than business, the permitted depreciation will be adequate for the length of time the assets are employed for business. Section 38 of the Act gives the Income Tax Officer the authority to calculate the proportional amount of depreciation.

If these conditions are met, the taxpayer can claim depreciation on the asset in the relevant financial year. It is important to keep proper records and documentation of the asset and its usage to support the claim for depreciation.
 

Claiming Depreciation as Per Income Tax Act

In order to claim depreciation, certain conditions should be met:

●    The asset must be owned, either wholly or partly, by the assessee.
●    The asset must be used for the purpose of business or profession. If the asset is used for other purposes as well, depreciation allowable will be proportionate to the amount of time the asset is used for business.
●    Co-owners of an asset can claim depreciation to the extent of the value of the asset owned by each co-owner.
●    An assessee is not eligible to claim depreciation on depreciable assets that have been sold, removed, or damaged in the same financial year in which they were acquired.
 

Calculation of Depreciation

There are several methods for calculating depreciation under the Income Tax Act. The most commonly used methods are:

Straight Line Method

In this method, depreciation is calculated by dividing the cost of the asset by the number of years of its useful life. The same amount of depreciation is charged every year, and at the end of the asset's useful life, the book value of the asset is zero.

Written Down Value (WDV) Method

In this method, the depreciation is calculated on the basis of the written down value of the asset. The WDV is calculated by deducting the accumulated depreciation from the cost of the asset. The depreciation is charged as a percentage of the WDV, and the amount of depreciation decreases every year as the WDV reduces.

Unit of Production Method

Under this, the depreciation is charged on the basis of the number of units produced by the asset. The cost of the asset is divided by the estimated number of units that the asset can produce during its useful life, and the depreciation is charged on the basis of the actual number of units produced.

Sum of Years' Digits Method

In this method, the depreciation is calculated on the basis of the sum of the digits of the useful life of the asset. The amount of depreciation is highest in the first year and decreases every year as the useful life of the asset progresses.

Double Declining Balance Method

In this method, the depreciation is calculated on the basis of twice the straight-line depreciation rate. The amount of depreciation charged is highest in the first year and decreases every year as the asset's book value approaches its salvage value.

The choice of method used to calculate depreciation depends on the type of asset and its estimated useful life and is decided by the assessee.
 

Depreciation Rates as per the Income Tax Act

Here is a table containing different depreciation rates for different forms of assets as per the Income Tax Act:

Conclusion

In conclusion, depreciation is an essential aspect of the Income Tax Act, and it allows businesses to recover the cost of their assets over their useful life. The depreciation rates vary based on the type of asset, and it is essential to use the correct method of calculation. Claiming depreciation has certain conditions that need to be met, and it cannot be claimed on certain assets like goodwill and land. It is crucial to comply with the regulations related to depreciation to avoid any legal issues and ensure the smooth functioning of the business.