Depreciation as per Income Tax Act: Depreciation Rates for FY 2023-2024
Updated: Nov 28
Depreciation is the inevitable deterioration that assets experience over time. It may seem straightforward in ordinary situations, but it is crucial when it comes to company and taxes. It is an allowance provided by the Income Tax Act for the deterioration of assets utilised in a business or profession from a tax standpoint. It is a non-cash expense that lowers taxable income and saves firms money on taxes in the long run. According to the Income Tax Act, the depreciation rate varies according to the asset's kind. The owner of the asset (whether a business, partnership firm, or individual) may claim the depreciation on it. In this comprehensive guide, we will explain the concept of depreciation as per the Income Tax Act.
Table of Contents
What is Depreciation as per Income Tax Act?
According to the Income Tax Act, depreciation is the reduction in an asset's value brought on by use, deterioration, aging, or obsolescence. The Income Tax Act permits businesses to deduct their depreciation costs from their taxable income. Since depreciation is a non-cash expense, there is no cash withdrawal from the organisation. Rather, it symbolises the distribution of an asset's cost throughout its useful life. This allocation lowers the entity's taxable revenue and thus its tax obligation.
It's crucial to remember that depreciation can only be applied to tangible assets like furniture, machines, buildings, and cars. Patents, trademarks, copyrights, and goodwill are a few examples of intangible assets that are not depreciated. When determining their taxable income, entities must compute and claim depreciation on their assets. The tax authorities may impose penalties and interest charges for failure to comply.
The concept of depreciation is used for writing purposes of the cost of an asset over its useful life. Depreciation is a necessary deduction in profit and loss statements of an organization using the depreciable assets and the act allows the deduction either using the straight line or written down value method.
Depreciation is calculated under the WDV method. This method is widely used. But in the case of undertaking power generation, distribution. There is an option to choose the straight-line method. In certain situations, the act allows deduction in the additional depreciation during the purchase year.
Reasons for Depreciation
Business use of an asset causes wear and tear: As an asset is used in business operations, it experiences physical wear and tear, which can reduce its functionality and value. This is particularly true for tangible assets like machinery, equipment, and vehicles.
The passage of time reduces the functionality of an asset: Even if an asset is not actively used, it can still deteriorate over time due to factors such as exposure to the elements, technological advancements, and obsolescence.
Technical or other changes can lead to obsolescence: Assets can become obsolete when new technologies or processes render them outdated or less efficient. This can happen due to advancements in technology, changes in consumer preferences, or regulatory requirements.
Decrease in market value: The market value of an asset can decline due to various factors, including economic conditions, changes in supply and demand, and the availability of substitutes. This can occur even if the asset itself remains functional and useful.
Concept of Block of Assets
To compute depreciation, one has to know the WDV of an asset block. A group of assets from the same asset class that are gathered together as a block of assets consists of:
Examples of tangible assets are furniture, appliances, plants, and buildings.
Knowledge, patents, copyrights, trademarks, licences, franchises, and any other similar business or commercial rights are some instances of intangible assets.
The asset block is recognised according to its type, life, and comparable application. In addition, the percentage of depreciation within each asset class needs to be considered when classifying assets. A block of the asset will be identified for each of these asset classes that have the same rate of depreciation. Because depreciation is based on a group of assets rather than individual assets, under the Income Tax Act, individual assets lose their individuality.
Factors Affecting Eligibility for Claiming Depreciation as per Income Tax Act
To be eligible for the depreciation deduction, an assessee needs to fulfil several requirements. The prerequisites are listed below:
Classifications of Assets: To receive the benefits of depreciation, the asset's owner must be an assessee. Both tangible and intangible assets are possible. A house, factory, machinery, or furniture are examples of tangible assets. Patent rights, copyrights, trademarks, licences, franchises, and similar property acquired on or after April 1, 1998, are examples of intangible properties. When determining depreciation, the income tax agency only accounts for the house's depreciation. It's possible that they didn't account for the cost of the land the building is situated on. The argument that the land does not lose value owing to usage or wear and tear serves as justification for not including the cost of the property in the house.
Ownership vs. Lease: Only capital assets that an assessee owns are eligible for depreciation claims. The assessee must be the owner of such properties to benefit from the allowance for property depreciation. An assessee doesn't need to be the property owner. An assessee is entitled to a credit for depreciation on dwellings in cases when he builds one but the property is owned by someone else. If the assessee lives in and utilises the house, he is not eligible to request the deduction. An assessee is eligible for depreciation allowances if he constructed a home on the land and took out a mortgage on it. In the case of hire and buy, an assessee is not entitled to a deduction if he leases the equipment for a short period. Nonetheless, in the case of a loan, an assessee is qualified to get the deduction if he purchases the property and becomes the buyer.
Co-ownership: A co-owner of an asset has the option to record depreciation on the asset as well.
Used for Business or Professions: A business or vocation may have used the commodity to be eligible for the depreciation credit. On the other hand, an assessee is not obliged to claim the depreciation credit, for which the asset must be used during the fiscal year. Consequently, the taxpayer is entitled to depreciation deductions even if he only uses the asset for a brief period throughout an accounting year. Consider every seasonal factory to understand this concept.
Depreciation on Sold Assets: An assessee is not permitted to deduct depreciable assets. An object cannot be deducted by the assessee if it is sold, removed, or damaged in the same year that it was purchased.
Conditions to Claim Depreciation as Per the Income Tax Act
The Income Tax Act and the Companies Act of 1956 have different rules on depreciation. Consequently, regardless of the depreciation rates recorded in the books of accounts, the Income Tax Act's prescribed depreciation rates are the only ones that are allowed.
Depreciation must be allowed or assumed to have been approved as a deduction starting with the fiscal year 2002–03, independent of a taxpayer's claim in the profit and loss account.
If the presumptive taxation plan is employed, the deemed profit is considered to have taken depreciation into account. This means that the taxpayer can carry forward the WDV after subtracting the depreciation amount.
The assets must be used in conjunction with the taxpayer's business or occupation, and they must be owned fully or partially by the assessee.
The permissible depreciation will be commensurate with the duration of time the assets are utilised for business purposes, even if they are utilised for non-business purposes. Co-owners may deduct depreciation up to the value of their joint assets, and Section 38 of the Act gives the Income Tax Officer the authority to determine the proportionate share of depreciation.
Land purchase price and goodwill cannot be depreciated.
Depreciation Rates as per Income Tax for FY 2023-24
Depreciation Calculation Example:
Name of Asset | Block 1 (Machine – 15%) | Block 2 (Furniture – 10%) | Block 3 (Car – 15%) |
Opening Value | ₹0 | ₹0 | ₹0 |
Add – Purchases (≥ 180 days) | ₹6,00,000 | ₹50,000 | ₹4,00,000 |
Add – Purchases (< 180 days) | ₹60,000 | ₹30,000 | ₹1,50,000 |
Less – Sold during the year | ₹0 | ₹0 | ₹0 |
Closing value of block before depreciation | ₹6,60,000 | ₹80,000 | ₹5,50,000 |
Depreciation | ₹99,000 [(6,00,000 × 15%) + (60,000 × 15% × ½)] | ₹8,000 (80,000 × 10%) | ₹41,250 (4,00,000 × 15%) + (1,50,000 × 15% × ½) |
Closing WDV after depreciation | ₹5,61,000 | ₹72,000 | ₹5,08,750 |
Written-Down Value (WDV) of Assets
According to section 32(1) of the IT act, the depreciation amount is determined by applying the prescribed percentage on the asset's WDV, as per the Income Tax Act. The asset's true cost determines its WDV. To calculate depreciation, we must understand what "WDV" and "Actual Cost" entail.
WDV is defined under the Income Tax Act as:
The true cost of the assets if they were purchased in the prior year
Under the Income Tax Act, if the difference was brought in an earlier year, the difference between the real cost and the depreciation is allowed.
Methods of Calculating Depreciation as per Income Tax Act
Different assets may have different depreciation schedules and usable lives. For accounting and taxation purposes, it might also vary depending on the asset type and industry. The Straight Line Method and Written Down Value Method are the most often used techniques for depreciation. The fundamental distinctions between the methods utilised for depreciation calculation under the Companies Act and the Income Tax Act, aside from depreciation rates, are as follows.
Depreciation methods in accordance with the Companies Act of 1956 (Based on Specified Rates) are:
Straight Line Method
Written Down Value Method
Conversely, the Companies Act, 2013 lists the following methods based on the useful life of assets:
Straight Line Method
Written Down Value Method
Unit of Production Method
The Income Tax Act, 1961 relies on the following based on specified rates:
Written Down Value Method (block wise)
Straight Line Method for power generating units
Formula for Calculating Depreciation by the Straight-Line Method (SLM)
1. Rate of Depreciation under SLM = [(Original Cost – Residual Value) / Useful Life] x 100
2. Depreciation = Original Cost x Rate of Depreciation under SLM (as calculated in (1))
Analysis of AS-22 / IND AS 12 with Reference to Depreciation
The method used for calculating depreciation differs between taxation and accounting purposes. This results in differences in the depreciation amount, leading to a timing difference. These timing differences must be quantified in financial statements as deferred tax liability or asset.
Under Accounting Standard-22 (AS-22) or IND AS 12, deferred tax refers to income tax that will be payable or recoverable in future periods due to temporary differences.
Temporary DifferencesThese arise due to the difference between the carrying amount of an asset or liability in the financial statements and its tax base (the value attributed to the asset or liability for tax purposes).
Illustration: Deferred Tax Liability Calculation
An asset has:
Cost: ₹200
Carrying Amount: ₹120
Cumulative Depreciation (tax purposes): ₹110
Tax Rate: 30%
Tax Base Calculation:
The tax base of the asset is:₹200 (cost) – ₹110 (cumulative depreciation) = ₹90
To recover the carrying amount of ₹120, the entity must earn taxable income of ₹120. However, it will only be able to claim depreciation of ₹90. The difference of ₹30 (₹120 – ₹90) represents taxable income for which the entity will incur tax.
Tax Liability:
The tax on this difference is:₹30 × 30% = ₹9
Temporary Difference:
The difference between the carrying amount (₹120) and the tax base (₹90) is a taxable temporary difference of ₹30.
Deferred Tax Liability:
The entity recognizes a deferred tax liability of ₹9 (₹30 × 30%), which reflects the income taxes it will pay when it recovers the carrying amount of the asset.
Amount of Depreciation Allowed
Except for businesses involved in the production or distribution of electricity, these businesses may choose to claim depreciation using the Straight-Line or WDV methods, provided that option is used before the deadline for filing the return.
In the event of a demerger or amalgamation, the combined depreciation allowance will be divided between the resultant business and the merging firm, respectively. The computation of the aggregate depreciation would be done as though the demerger or amalgamation had never happened.
In the event of a financing lease transaction, the lessee is required to capitalise the assets in its books in accordance with AS-19, the Accounting Standard on Leases. The allocation will be made according to the number of days the assets were utilised by said companies. In certain situations, the lessee is permitted to take depreciation since he has the ability to execute the owner's rights on his own.
Section 32 of the Income Tax Act
The Income Tax Act of 1961's Section 32 contains the depreciation allowed provision. The Income Tax Rules, 1962, Rule 5 governs this part. If the cost of the tangible or intangible asset used by the assessee drops, the Income Tax Act allows for the deduction. The asset's life cycle cost, not the asset's entire cost, is used by the income-tax department to calculate the depreciation at the time of the deduction. The written line method or the straight-line approach can be used by an assessee to calculate the amount that depreciation has reduced the asset's value. The income tax agency uses the written line approach among other methods of depreciation.
Conclusion
Depreciation is a method used to account for an asset's gradual value decrease. For a number of reasons, it is essential for income tax and business. It assists you in keeping tabs on the price and lifespan of your assets and balancing the benefit of their use with the income they produce. Moreover, depreciation costs might lessen the taxable income of your company, which in turn lowers your tax liability. This can assist you with investing in new assets and offer a tax incentive.
FAQ
Q1. What is depreciation for tax purposes?
The depreciation for tax purposes should include a written down value method and fulfill the conditions under section 32 of the Income Tax Act.
Q2. What are the rates of depreciation?
The asset class affects the rate of depreciation. For instance, it is 10% for fixtures and furnishings and 5% for residential constructions.
Q3. How do I calculate the depreciation rate?
You can calculate depreciation using methods such as the written-down value method or the straight-line method.
Q4. Who decides depreciation rates?
In India, the depreciation rates are decided by the Ministry of Commerce.
Q5. What is the depreciation rate on computers as per the Income Tax Act?
The depreciation on computer hardware and software is considerable, at 40%. This means that the assessee may deduct 40% of the cost of computers and software from their taxable business revenue.
Q6. What is the depreciation rate on plant and machinery as per the Income Tax Act?
A 15% rate of depreciation applies to any type of equipment and plant that is not covered by another block, including cars that are not used for commercial purposes.
Q7. What is the depreciation rate of the solar power generating system?
The depreciation rate is 40% for a solar power generating system.
Q8. Is depreciation applicable to intangible assets?
No, depreciation does not apply to intangible assets like patents and copyrights.
Q9. Are there any assets exempted from depreciation?
Certain assets like land, and goodwill are not used for business purposes. So, they are not eligible for depreciation under the Income Tax Act.
Q10. Can depreciation be claimed on the assets used partially for personal purposes?
Yes, depreciation can be claimed on the assests used partly for business and personal purposes. However, only half a portion of the asset used for business purposes can be claimed for the deduction from the total income.
Q11. What is the vehicle depreciation rate under income tax?
The depreciation rate on motor vehicles used for business purposes is 30% if purchased between October 1, 2020, and March 31, 2021. For other cases, it is 15%.
Q12. What is the depreciation rate for tools and equipment?
Tools and equipment are generally categorized under plant and machinery, and the depreciation rate as per the Income Tax Act is 15%.
Q13. How is depreciation on mobile phones calculated as per income tax?
Mobile phones are classified under computers and accessories, attracting a depreciation rate of 40% as per the income tax depreciation rates.
Q14. Is there a special depreciation rate for electric vehicles under income tax?
Yes, the depreciation rate for electric vehicles is 40% as per the Income Tax Act, providing significant tax benefits to businesses.
Q15. What is the depreciation rate for furniture and fittings?
The depreciation rate as per the Income Tax Act for furniture and fittings is 10%.
Q16. Are there different depreciation rates for residential and non-residential buildings?
Yes, the depreciation rate is 5% for residential buildings and 10% for non-residential buildings used for business purposes.
Q17. What is the depreciation rate on car as per income tax?
For cars used for business purposes, the depreciation rate is 15%. However, for vehicles acquired for commercial use, higher rates may apply.
Q18. How is the depreciation chart used for tax calculations?
The depreciation chart lists rates applicable to different asset classes, helping taxpayers determine the amount to be deducted for depreciation under the Income Tax Act.
Q19. What is the depreciation rate on plant and machinery for renewable energy?
For renewable energy devices like windmills and solar plants, the depreciation rate as per income tax is 40%.
Q20. Is depreciation applicable to leased assets?
Yes, depreciation can be claimed on leased assets if the lease is classified as an operating lease and the lessor owns the asset.
Q21. How is depreciation calculated for assets acquired during the year?
For assets used for less than 180 days, depreciation is allowed at 50% of the applicable rate as per the income tax depreciation chart.
Q22. Can depreciation be claimed on fully depreciated assets?
No, once an asset’s written down value becomes zero, no further depreciation can be claimed.
Q23. Is depreciation mandatory for all assets?
Depreciation must be claimed on all eligible assets used for business or professional purposes as per the Income Tax Act.
Q24. What is the depreciation rate on software?
Software is treated as part of computers, and the depreciation rate as per income tax is 40%.
Q25. How is depreciation on vehicles calculated for individuals?
For individuals using vehicles for both personal and business purposes, only the business-use portion qualifies for depreciation as per income tax.
Q26. Are depreciation rates the same under GST and income tax?
No, depreciation rates under the Income Tax Act and GST are different, with income tax rates typically being higher.
Q27. Can depreciation be claimed on capitalized repairs?
Yes, if repairs enhance the asset's life or utility and are capitalized, depreciation can be claimed on the increased value.
Q28. How is depreciation for tools and equipment calculated?
Tools and equipment are classified under plant and machinery, attracting a standard depreciation rate of 15% as per the Income Tax Act.
Q29. Is goodwill eligible for depreciation?
Goodwill is not eligible for depreciation as per the latest amendments to the Income Tax Act.
Q30. What is the accelerated depreciation rate?
Accelerated depreciation, applicable to certain assets like renewable energy devices, allows higher deductions in the initial years, often at rates of 40%.
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