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How to Calculate Depreciation U/s 32 of Income Tax Act

How to Calculate Depreciation U/s 32 of Income Tax Act. In the previous article, we have given How to Check Income Tax Refund Status Online and How to Calculate Advance Tax, Due Dates and PaymentToday we are providing the complete details of Deprecation under section 32 of Income tax act. Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life. Businesses depreciate long-term assets for both tax and accounting purposes. For tax purposes, businesses can deduct the cost of the tangible assets they purchase as business expenses. however, businesses must depreciate these assets in accordance with IRS rules about how and when the deduction may be taken.

How to Calculate Depreciation U/s 32 of Income Tax Act

How to Calculate Depreciation U/s 32 of Income Tax Act

1. Basics of Depreciation

a) Depreciation is allowable as an expense in Income Tax Act, 1961 on the basis of a block of assets on Written Down Value (WDV) method.

b) Block of assets means a group of assets falling within a class of assets for which the same rate of depreciation is prescribed.

c) GOODWILL & LAND is not eligible for depreciation.

d) Depreciation is allowable only to the owner of the asset.

  • A lessee is not the owner of the property, therefore, depreciation is allowed only to a lessor. If the lessee constructs furniture or any part, then depreciation on that is allowed to lessee.
  • If property purchased under hire purchase contract, then depreciation is allowed to the purchaser.
  • In the case of co-ownership, depreciation is allowable in the ratio of their ownership.

e) The asset must be used for the purpose of business or profession.

f) If the assessee doesn’t claim the amount of depreciation as the deduction, even then the amount of WDV carried forward to next year is reduced by the depreciation amount.

g) If profit is calculated on presumptive basis u/s 44AD or 44AE, then such reported profit is considering after all the expenses and depreciation allowable under section 32.

h) Depreciation under Income Tax Act is different from that of Companies Act, 1956. Therefore depreciation rates prescribed under income tax is only allowable whatever the depreciation is charged in books of accounts.

i) If a new addition is made in an existing asset then it is considered as an asset if it increases the capacity of the existing asset or reduces per unit cost otherwise, it should be treated as an expense.

j) If there are some spare parts/machines and they are not actually used, depreciation is allowable on them because they are used for the purpose of business/profession.

k) Lower Depreciation – Depreciation can be claimed at a lower rate as per income tax act. But for the next year your wdv will be considered as reduced by the percentage of depreciation prescribed. For, e.g., if an asset is of Rs. 1 lakh and 80% depreciation is prescribed for the asset and you charge only Rs. 30,000 as depreciation, in this case, next year wdv will be considered as Rs. 20,000 only not Rs. 70,000.

2. Depreciation in the Year in which the Asset is Purchase

  • Depreciation is allowed only if the asset is put to use in the year of purchase.
  • The degree of utilization of assets will not be considered while determining whether the asset is put to use or not. For example, if the asset is used for the trial run then it is considered the asset is put to use.
  • If the asset is put to use for less than 180 days then amount equal to 50% of the amount calculated using normal depreciating rates is allowed as depreciation.
  • Depreciation will be allowed on the basis of a block of asset method.

3. Depreciation in Subsequent Years

  • If the asset is not put to use in the year of purchase or put to use for less than 180 days even then, full depreciation is allowed in the subsequent years if the below condition satisfies.
  • Depreciation is allowed on the whole block of the asset even if only a single asset in that block is used during the year at any point in time.

4. Calculation of Deprecation

  • WDV of an asset = Actual cost to the assessee – All depreciation actually allowed to him (included unabsorbed depreciation, if any)
  • WDV of Block of Assets

Aggregate of WDV of all the assets falling within
that block at the beginning of the year                                                                           XXX

Add: Actual cost of any assets falling within block
acquired during the previous year                                                                                   XXX

Less: Money received or receivable in respect of any
asset in the block which is sold, discarded, demolished
or destroyed during the previous year                                                                            XXX

WDV at the end of the year                                                                                               XXX

Less: Depreciation at block rate (if WDV at the end of year is positive)                XXX

Closing value of the block of the asset at the end of the year                                     XXX

If the amount of WDV comes at a negative amount then no depreciation is allowed, and the amount will be considered as capital gain and the closing WDV will be zero.

If such amount is positive and no asset exists in the block, then such amount will be treated as a short-term capital loss and no depreciation is allowed.

5. Calculation of Purchase Cost of an Asset

Book value (also carrying value) is an accounting term used to account for the effect of depreciation on an asset. While small assets are directly held on the books at cost, larger assets like buildings and equipment must be depreciated over time. The asset is still held on the books at cost, but another account is created to account for the accumulated depreciation on the asset. Learning how to calculate book value is as simple as subtracting the accumulated depreciation from the asset’s cost.

6. Calculation of Capital Gain on Sale of Depreciable Asset

The capital gain/loss from depreciable assets is always treated as short term irrespective of the fact that asset is held for more than three years or not.

Calculation of Capital Gain/Loss

Aggregate of WDV of all the assets falling within
that block at the beginning of the year                                                                               XXX

Add: Actual cost of any assets falling within block
acquired during the previous year                                                                                       XXX

Less: Money received or receivable in respect of any
asset in the block which is sold, discarded, demolished
or destroyed during the previous year                                                                                XXX

WDV at the end of the year                                                                                            XXX

If the above calculations result in a negative WDV, then such amount will be considered as short-term capital gains. If such amount is positive and no asset exists in the block, then such amount will be treated as a short-term capital loss.

7. Rate of Depreciation

See this list for all depreciation rates.

8. Additional Depreciation U/S 32(1)(iiA)

Additional depreciation shall be allowed if the following conditions are fulfilled by the assessee:

Additional depreciation is allowed only on new machinery or plant excluding ships and aircraft which has been purchased and installed after 31-03-2005

The assessee shall be engaged in the business of manufacturing and production of any article or thing (computers used for data processing in industrial premises are eligible for additional depreciation). From the financial year, 2016-17 additional depreciation is also allowed to assessees engaged in the business of generation and distribution of power.

Printing and Publishing are also considered as manufacturing.

Depreciation @ 20% of actual cost of assets is allowed as additional depreciation.

If assessee is engaged in production or manufacturer of any article or thing on or after 1st Apr, 2015 in any notified backward area of Andhra Pradesh, Bihar, Telangana, West Bengal and acquires and installs any new machinery or plant during 1st April, 2015 to 31st March 2020 then additional depreciation is allowed at the rate of 35%.

However, if the asset is put to use for less than 180 days, then additional depreciation will be allowed at half of actual rate i.e., 10% or 17.5% as the case may be.
From the financial year 2015-16, if additional depreciation is allowed in the year of putting to use at half of the rate then remaining half depreciation is allowed in the succeeding year.

Specific cases in which depreciation is not allowed

  • Second-hand plant and machinery – Plant and machinery which, before installation by the assessee, was used whether inside and outside India by any person.
  • Any office appliance or road transport vehicle.
  • Any machinery or plant installed in any office premises or any residential accommodation, including accommodation like guest house
  • Any plant and machinery, the whole of the actual cost of which is allowed as a deduction (whether by way of depreciation or otherwise) in computing income chargeable under the head “Profits and gains of business or profession” of any on the previous year.

9) Unabsorbed Depreciation

If there is a loss of business and profession and the reason for such loss is depreciation, then it is called unabsorbed depreciation, and it shall be allowed to be carried forward.

Additional Points

a) The depreciation shall be carried forward even the business/profession to which relates even of the business/profession not in existence.

b) Return of loss is not required to be submitted for carry forward of unabsorbed depreciation

c) The assessee should set off brought forward losses in the following manner: –

  • First of all current year depreciation will be adjusted.
  • Then brought forward business losses will be set off (speculative or non-speculative)
  • Then unabsorbed depreciation will be set off against business income.

d) Unabsorbed depreciation can be carried forward for an indefinite number of years.

e) Unabsorbed depreciation can be set off from any head of income other than Salary and Capital Gain in any year

Bare Act Section 32

In respect of depreciation of

(i) buildings, machinery, plant or furniture, being tangible assets;

(ii) know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature, being intangible assets acquired on or after the 1st day of April 1998,

owned, wholly or partly, by the assessee and used for the business or profession, the following deductions shall be allowed—

(i) in the case of assets of an undertaking engaged in generation or generation and distribution of power, such percentage on the actual cost thereof to the assessee as may be prescribed.

(ii) in the case of any block of assets, such percentage on the written down value thereof as may be prescribed.

Section 50

Notwithstanding anything contained in clause (42A) of section 2, where the capital asset is an asset forming part of a block of assets in respect of which depreciation has been allowed under this Act, the provisions of sections 48 and 49 shall be subject to the following modifications:

(1) where the full value of the consideration received or accruing as a result of the transfer of the asset together with the total amount of such consideration received or accruing as a result of the transfer of any other capital asset falling within the block of the assets during the previous year, exceeds the aggregate of the following amounts, namely :—

  • expenditure incurred wholly and exclusively in connection with such transfer or transfers;
  • the written down value of the block of assets at the beginning of the previous year; and
  • the actual cost of any asset falling within the block of assets acquired during the previous year,

such excess shall be deemed to be the capital gains arising from the transfer of short-term capital assets;

(2) where any block of assets ceases to exist as such, for the reason that all the assets in that block are transferred during the previous year, the cost of acquisition of the block of assets shall be the written down value of the block of assets at the beginning of the previous year, as increased by the actual cost of any asset falling within that block of assets, acquired by the assessee during the previous year and the income received or accruing as a result of such transfer or transfers shall be deemed to be the capital gains arising from the transfer of short-term capital assets.

On analyzing the above two provisions, one can easily make out that once depreciation is claimed on any capital assets, the capital gain on it will always be short-term. Now coming to the point of making the claim mandatory, if the above provision of being the claim of depreciation mandatory was not there the assessee would never claim any depreciation on it, to benefit himself with the following, since:

  • if the assessee claims depreciation, the capital gain would be Short-term (by virtue of Section 50 and the assessee would be taxed @30%, rather if he does not claim depreciation he will be taxed @20% (long term) subject to the provisions of period of holding, so claiming depreciation at one stage ultimately give rise to more tax liability on the later stage of taxation;
  • also if he claims depreciation he would not be eligible to claim the indexation benefit on Cost of Acquisition and Cost of improvement under the second proviso to Section 48 which will invariably reduce the cost that is to be deducted from the Sales/Net the cost that is to be deducted from the Sales/Net consideration, and will ultimately increase the capital Gain resulting in more tax;
  • the other benefit the assessee would be getting by not claiming the depreciation would be the benefit of Section 54, 54F and other series of Section 54.

Since the assessee can involve himself in the practice of not claiming the depreciation to avail the above benefits the claim for depreciation has been made mandatory to defeat any such tax planning by the assessee.

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