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Depreciation under Income Tax - Explained
Depreciation means reduction in the value of asset. The value of assets decreases with passage of time mainly.
This document covers
- Reasons to use Depreciation
- Conditions to claim Depreciation
- Factors considered in the measurement of Depreciation
- Methods of Computing Depreciation
- Rates of Depreciation as per WDV Method
- Depreciation as per Companies Act 2013
- When one should use depreciation of an asset?
- Is it mandatory?
- Where should we represent the depreciation schedule in ITR ?
- What is the advantage of considering depreciation vs booking a full value as expense?
1. Reasons to Depreciation
- Business use of an asset causes wear and tear
- The Passage of Time reduces the functionality of an asset
- Technical or other changes can lead to obsolescence
- Decrease in Market Value
Tangible and intangible capital assets can be depreciated. Section 32 of the 1961 Income Tax Act refers to depreciation. Capital assets lose value through depreciation. Businesses reduce taxed earnings using depreciation. It is considered as a non-cash expense.
2. Conditions to claim Depreciation
The business must meet these standards to claim depreciation.
- Depreciable assets must fall into one of the following categories.
- The tangible assets include buildings, machinery, and furnishings
- Intangible assets like patents, copy rights, trademarks, licenses, franchises, and other business or commercial rights.
Note: Despite being a tangible asset, land cannot be depreciated.
- Taxpayers should use assets for business or profession during the fiscal year.
- Depreciation cannot be claimed if the asset is not used in the same year as purchase. Its cost might be added to the block of assets by the taxpayer.
- If the asset is used for less than 180 days, 50% of permissible depreciation is allowed. The year of acquisition is restricted, but not following years.
- The taxpayer must own the assets wholly or partly.
- Depreciation will be allowed only to the owner of the asset.
- If the asset is on lease, the taxpayer (Lessee) cannot claim depreciation.
3. Factors considered in the measurement of Depreciation
The computation of depreciation involves lot of estimation. The following are the factors considered in computing the depreciation.
- Asset cost includes installation, commissioning, trial run, etc.
- Asset lifespan estimate
- Estimated asset scrap value after use.
4. Methods of Computing Depreciation
There are several methods to compute Depreciation.
- Straight Line Method — Most commonly used method
- Written Down Value Method (WDV) — Most commonly used method
- Sum of Years of Digits Method
- Machine Hour Method
- Production units method
- Depletion Method
5. Rates of Depreciation as per WDV Method
| S.No | Block of Assets | Rate of Depreciation |
|---|---|---|
| 1 | Buildings which are used mainly for residential purposes except hotels and boarding houses | 5% |
| 2 | Buildings other than those used mainly for residential purposes and not covered by sub-items (1) above and (3) below | 10% |
| 3 | Buildings acquired on or after the 1st day of September, 2002 for installing machinery and plant forming part of water supply project or water treatment system and which is put to use for the purpose of business of providing infra- structure facilities under clause (i) of sub- section (4) of section 80-IA | 40% |
| 4 | Purely temporary erections such as wooden structures | 40% |
| 5 | Furniture and fittings including electrical fittings | 10% |
| 6 | Computers including computer software | 40% |
| 7 | Plant & Machinery other than those specified | 15% |
| 8 | Motor cars, other than those used in a business of running them on hire | 15% |
| 9 | Motor buses, motor lorries and motor taxis used in a business of running them on hire | 30% |
| 10 | Aeroplanes – Aeroengines | 40% |
| 11 | Intangible Assets | 25% |
6. Depreciation as per Companies Act 2013
The depreciation rates as per companies act 2013 differs with Income Tax. Every Private limited company or public companies or OPC should record the depreciation in the books of accounts as per companies act 2013.The rate of depreciation as per Straight line Method and Written down value method is as follows
| S.No | Nature of Assets | Rate (SLM Method) | Rate (WDV Method) |
|---|---|---|---|
| 1 | Building other than factory buildings (RCC Frame Structure) | 1.58% | 4.87% |
| 2 | Building other than factory buildings) other than RCC Frame Structure) | 3.17% | 9.50% |
| 3 | Factory buildings | 3.17% | 9.50% |
| 4 | Other (including temporary structure, etc) | 31.67% | 63.16% |
| 5 | General furniture and fittings | 9.50% | 25.89% |
| 6 | Furniture and fittings used in hotels, restaurants and boarding houses, schools, colleges etc | 11.88% | 31.23% |
| 7 | Motor cycles, scooters and other mopeds | 9.50% | 25.89% |
| 8 | Motor buses, motor lorries, motor cars and motor taxies used in a business of running them on hire | 15.83% | 39.30% |
| 9 | Motor buses, motor lorries, motor cars and motor taxies other than those used in a business of running them on hire | 11.88% | 31.23% |
| 10 | Computers and data processing units- Servers and networks | 15.83% | 39.30% |
| 11 | Computers and data processing units- , desktops, laptops, etc | 31.67% | 63.16% |
| 12 | Plant and Machinery other than continuous process plant not covered under specific | 6.33% | 18.10% |
| 13 | Continuous process plant for which no special rate has been prescribed under (ii) below | 11.88% | 31.23% |
7. When one should use depreciation of an asset?
The assets purchased by the business will help them in generating the revenue over the years. Hence the part of cost of asset should be allocated as a expense in each of financial year over the useful life of asset. The business needs to use depreciation when there is a purchase of fixed asset and the asset is available for ready to use by the business.
8. Is it mandatory? If not how one can consider representing the expense in IT Filing?
The business should consider only depreciation for the specified Assets as per Income Tax Act 1961 and Companies Act 2013. There is no other option to show the cost of asset as a expenses. The business cannot claim the entire cost of asset as expense
9. Where should we represent the depreciation schedule in ITR ? Things to consider when doing so?
- If the taxpayers are claiming Depreciation, they should fill only ITR 3 (Individuals/HUF), ITR 5(Firm/LLP), ITR 6(Pvt Ltd/OPC), ITR 7(Trust) depending on the constitution of business.
- The taxpayers filing Income Tax Return should disclose Depreciation in Schedule Profit and Loss @ Row 52
- Post filling Sch PL , the taxpayer needs to enter the ope Balance, purchase and sell details in Sch DPM, DOA. These balances will be carried forward to Schedule BP. The taxpayer will get depreciation benefit only if he fills this schedule.
10. What is the advantage of considering depreciation vs booking a full value as expense?
Generally, the business cannot book the full value of the asset as an expense instead of depreciation due to the following factors
- Section 32 of Income Tax Act, 1961: Income Tax Act provides for the depreciation on the tangible and intangible assets. It has specified the list of assets along with rates of depreciation.
- Accounting Rules and Standards: Generally Accepted Accounting principles (GAAP) and accounting standard prescribed the procedure for computation of Depreciation over the useful life of asset.
- True Economic cost of Asset: Booking the entire cost as an expense does not reflect the true economic cost of asset as the assets will be used in the business for their useful life and they generate revenue over the years.
- Consistent and accurate Financial Statements: Claiming Depreciation over the useful life of the asset helps the business in representing the consistent and accurate financials as the asset would be valued at cost – depreciation in Balance sheet over the useful life of asset