Secondly, depreciation is a non-cash expenditure–it does not involve an outflow of cash from the business, and therefore results in the accumulation of funds. But since it is debited to the profit and loss account like any other expense, it reduces the taxable profits and, therefore, the burden of tax. It acts as a source of internal financing for replacement of an asset at the end of its useful life.
Computation under the Companies Act. Depreciation is computed using either the straight-line method (where the amount of depreciation is uniform for all the years) or the written-down value method (where the amount of deprecation is highest in the first year and goes on reducing year after year).
Under the Income Tax Act. Depreciation is charged on the ‘block of assets’, and not on individual assets. The block represents the group of assets for which the same rate of depreciation applies. Under the Income Tax Act, depreciation is computed using the written-down value method, except in case of an undertaking engaged in generating and distributing power.
While the actual cost of new asset is added to the block, the amount received on the sale of an asset (including scrap value) is reduced from it. Depreciation at the prescribed rates is computed on the written-down value of the block as on the last day of the financial year–typically 31 March. This value is the aggregate cost of acquisition of the assets in a block as reduced by the depreciation charged in previous years.
New Rates. The rates of depreciation under the Income Tax Act are not linked to the useful life of the asset. Mobile phones are treated as plant and machinery, and are entitled to depreciation at the rate of 15 per cent.
Condition for allowability
The following fundamental conditions need to be fulfilled to claim depreciation:
(1) The person claiming depreciation must be the owner or the co-owner of the asset;
(2) The asset must be(put to use) used in the business. If it is only partly used for business, depreciation would be allowable on pro-rata basis;
(3) The asset must be used during the relevant financial year. If an asset is purchased and put to use for less than 180 days, that is, on or after the first day of October, only 50 per cent of the normal depreciation will be allowed in that year. In the subsequent years however, the asset will be subject to depreciation at the normal rates. So if an assessee buys a machine on 1 September 2009 but does not put it to use before 1 December 2009, he will be allowed depreciation at 7.5 per cent (instead of the normal 15 per cent) for the financial year ended 31 March 2006. The crucial date is the date of putting the asset to use.
Suppose a Person purchased a Car on 31st March and put to use on same date even then he can claim 50% of the depreciation of the full year i,e 7.5%(50% of 15%)
Download Depreciation rate for Income Tax Act and Companies ACT
Hire-purchase or lease?
In case an asset is purchased under a hire-purchase scheme, the depreciation is available to the hirer (the user of the asset). But if it is taken on lease, depreciation is allowed to the lessor (the financer). Hence, acquiring an asset on hire purchase is a better option than acquiring the same under lease, if the intention is to avail deduction for depreciation.
However, in a lease, although a lessee (the user) loses the benefit of depreciation, he can treat the lease rentals as an expense and reduce his taxable income accordingly. The decision to go in for lease or hire purchase should depend on when the asset will be put to use, the rate of depreciation available on the asset and the cash flow position of the user, among others.
Claim of depreciation :optional /mandatory ?
Until 31 March 2001, a taxpayer could choose whether or not to claim depreciation. From 1 April 2001 onwards, however, the claim of depreciation is no longer optional and the amount of depreciation will be compulsorily treated as deduction, irrespective of whether or not the claim has been made.
Unabsorbed depreciation(set off and carry forward)
If, in a particular year there are losses or inadequate profits, depreciation amount may not be fully deductible. In such cases, the amount that cannot be deducted wholly or partially can be set off against any other income.
If such ‘unabsorbed depreciation’ cannot be adjusted against the income of the same year, it can be carried forward to next year and can be adjusted against any income of the next year and so on. Unabsorbed depreciation can be carried forward for any number of years without any limitation.