Depreciation Rate as per Income Tax Act

  • Author :
  • TATA AIG Team
  • Published on :
  • 24/11/2023

Let's start with the basics. You bought a car worth ₹10 lakhs, used it for five years, and now plan to sell the older car to buy a new one. You find the buyer, but unfortunately, he only pays ₹3,00,000, citing depreciation as the reason.

Depreciation is the normal wear and tear that assets undergo throughout their life. In normal circumstances, it might sound simple, but in the context of business and taxation, it holds great importance.

Let's discuss the concept of depreciation of fixed assets as per the Income Tax rules.

Different Types of Depreciation Method

The three most common and widely accepted depreciation methods are:

Straight Line Method

It is the most common method of depreciation. It allocates a fixed amount of depreciation every year over the asset's useful life. The formula for the straight-line method is:

Depreciation: (Asset Cost — Asset's Salvage Value) ÷ (Asset's Useful Life)

Here is an example:

Suppose you buy a machine for ₹1,00,000, which has a useful life of 10 years and a salvage value of ₹10,000. The depreciation per year using the straight-line method is:

Depreciation = (1,00,000 — 10,000) ÷ (10)

= ₹9,000

Pros of this method:

It is easy to understand and apply.

It provides a consistent amount of depreciation every year, making it suitable for assets with uniform usage and benefits over their life.

It matches the expense with the revenue the asset generates, which follows the matching accounting principle.

Cons of this method

It does not reflect the actual pattern of the asset's consumption, as the asset may lose more value in earlier than later years.

It overstates the profits and the book value of the asset in the earlier years, which may affect the dividend policy and the borrowing capacity of the business.

It underestimates the asset's maintenance costs and replacement needs in the later years, which may affect the cash flow and the business's budgeting.

Written Down Value Method

Also known as WDV in Income Tax, this method applies a fixed percentage of depreciation on the reducing balance of the asset every year. Here is the formula for WDV:

Depreciation = Depreciation Rate × Asset's Book Value at the Start of the Year

Suppose you buy the same machine as the above, which costs ₹1,00,000, has a useful life of 10 years, and a salvage value of ₹10,000. Assume that the rate of depreciation is 15%. The depreciation per year using the written down value method is:

Year Value at the Beginning  Depreciation  Value at the End
1 1,00,000 15000 85000
2 85000 12750 72250
3 72250 10838 61413
4 61413 9212 52201
5 52201 7830 44371
6 44371 6656 37715
7 37715 5657 32058
8 32058 4809 27249
9 27249 4087 23162
10 23162 3474 19688

This means you will charge different depreciation amounts yearly, depending on the machine's book value at the beginning of the year. The machine's book value at the end of 10 years will be ₹19,688, which is higher than the salvage value of ₹10,000.

Pros of this method:

It reflects the actual pattern of the asset’s consumption, as the asset loses more value in earlier than later years.

The higher depreciation in the earlier years reduces the taxable income and the business's tax liability.

Cons of this method:

It is more complex to apply than the straight-line method, as it requires calculating the asset's book value every year.

It provides an inconsistent amount of yearly depreciation, making it unsuitable for assets with uniform usage and benefits over their life.

It makes it difficult to compare the performance and the profitability of different assets and businesses, as the depreciation varies depending on the rate and the method used.

Unit of Production Method

It is a less popular depreciation method, but it is useful for assets that have variable output or usage. It allocates depreciation based on the actual output or usage of the asset rather than the time period. The formula for the unit of production method is:

Depreciation Per Unit = (Asset's Cost – Asset's Salvage Value) ÷ (Asset's Total Estimated Output)

Depreciation for the Year = Depreciation Per Unit × Actual Asset Usage for the Year

Proceeding with the same example, assume that the total estimated output of the machine is 50,000 units. The depreciation per unit and per year using the unit of production method is:

Depreciation per Unit = (1,00,000 — 10,000) ÷ (50,000)

= 1.8

Year Machine's Actual Output for the Year Depreciation for the Year Book Value at the End of the Year
1 10000 18000 82000
2 8000 14400 67600
3 6000 10800 56800
4 5000 9000 47800
5 4000 7200 40600
6 3000 5400 35200
7 2000 3600 31600
8 1500 2700 28900
9 1000 1800 27100
10 500 900 26200

Pros of this method

It is fair and accurate, as it charges depreciation according to the actual benefit derived from the asset.

It correlates with the wear and tear of the asset, as the more the asset is used or produced, the more it depreciates.

It adjusts for fluctuations in the output or usage of the asset, which may be affected by external factors such as demand, supply, and technology.

Cons of this method

It is variable and dependent on the estimates of the total output or usage of the asset, which may be inaccurate or unrealistic.

It is unsuitable for assets that are idle or have fixed usage, as they will not depreciate or depreciate very slowly.

It requires measuring and recording the output or usage of the asset, which may be costly or impractical.

Depreciation Rate as Per Income Tax Act

The Income Tax Act prescribes different depreciation rates for various blocks of assets. A block of assets is a group of assets falling within a class of assets with the same depreciation rate.

For example, buildings, furniture, machinery, intangible assets, etc., are different blocks of assets. The depreciation rate depends on the asset's type, nature, and use.

<td>Hotels and boarding houses</td>
<td>0.1</td>
<td>Temporary constructions like those made of wood</td>
<td>0.4</td>
<td>Motor cars, not including vehicles used for hire business on or after August 23, 2019, but prior to April 1, 2020, are utilised for business before April 1, 2020.</td>
<td>0.3</td>
<td>Motor buses/ Lorries/ Taxis used in hire business </td>
<td>0.3</td>
<td>Motor buses/ Lorries/ Taxis used in hire purchase business on or after August 23, 2019, but prior to April 1, 2020, and are utilised for business before April 1, 2020.</td>
<td>0.45</td>
<td>Computer and its software </td>
<td>0.4</td>
<td>Books you own to carry business</td>
<td>1</td>
<td>Books you own for doing a business that publishes every year.</td>
<td>0.6</td>
<td>Books you own for running a lending library </td>
<td>1</td>
Asset Class Asset Type  Depreciation
Building  Residential buildings, excluding hotels and boarding houses 0.05
Furniture  Any furniture or fittings, such as electrical fittings  0.1
Plant and Machinery Depreciation Rate Motor cars, not including vehicles used for business purposes 0.15
Intangible Assets Patents, franchises, copyrights, trademarks, licenses, know-how, or other business rights of an identical nature 0.25

Detailed Depreciation Rate Chart

Now that you have understood the basics, let's talk about income tax depreciation rate in detail.

<td>2</td>
<td>Buildings, excluding those primarily used for residential purposes and not covered under 1 and 3 </td>
<td>0.1</td>
<td>3</td>
<td>Buildings were acquired on or after September 1, 2002, for plant and machinery installation as part of a water supply project, used to provide infrastructure facilities under Section 80-IA (i) (4).</td>
<td>0.4</td>
<td>4</td>
<td>Temporary constructions like those made of wood</td>
<td>0.4</td>
Part-A Tangible Assets
Asset Class  Serial number  Asset Type  Depreciation Rate
Building   1 Building that you use for residential purpose (excluding  0.05
Furniture and fittings  Any furniture or fittings, such as electrical fittings  0.1
Plant and Machinery  1 Plant and machinery other than those covered under 1,2 and 8 0.15
2 Motor cars, other than those employed in a business of operating them for hire, acquired or utilised on or after April 1, 1990. 15% 
3 Cars, excluding those used in the business of renting them out, acquired between August 23, 2019, and April 1, 2020, and put into use before April 1, 2020 0.3
3(i) Aero engines and airplanes  0.4
3(ii) (a) Motor buses, lorries, and taxis used in the lease hire business 0.3
(b) Taxis, buses, and lorries meant for hire purchase business, obtained between August 23, 2019, and April 1, 2020, and put into operation before April 1, 2020. 0.45
3(iii) A business vehicle you acquired between or after October 1, 1998, and April 1, 1999, and employed for any duration before April 1, 1999, for professional or business purposes under the third provision to Section 32's clause (ii) of sub-section (1). 0.4
3(iv) A new commercial vehicle obtained on or after October 1, 1998, but before April 1, 1999, as a replacement for a condemned vehicle older than 15 years. This new vehicle is utilised for any duration before April 1, 1999, for business or professional purposes under the third provision to clause (ii) of sub-section (1) of section 32. 0.4
3(v) If you got a new commercial vehicle between April 1, 1999, and April 1, 2000, to replace a vehicle that's more than 15 years old and started using it for your profession or business before April 1, 2000, as allowed by the second condition in section 32(1)(ii). 0.4
3(vi) If you acquired a new commercial vehicle between April 1, 2001, and April 1, 2002, and started using it for your profession or business before April 1, 2002. 0.4
If you obtained a new commercial vehicle between January 1, 2009, and October 1, 2009, and began using it for your business or profession before October 1, 2009. 0.4
3(vii) Moulds used in plastic and rubber factories 0.3
3(viii) Air pollution control tool 0.4
Scrubber 
Felt-filer machine
Electrostatic precipitation systems
Dust collector systems
Venture/ packed bed/ cyclonic scrubbers/ counter current 
Ash handling system 
Evacuation system 
3(ix) Water pollution control system  0.4
Air compressor 
Aerated detritus chambers
Mechanical screen tool 
Oil removal systems
Mechanically skimmed grease
Flash mixing equipment
Mechanical reactors
Chemical feed systems
Mechanical flocculators
Diffused air systems
Aerated activated sludge
Air floatation systems
Methane
(vi) Solar crop system 
(vii) Solar steels system 
(viii) Solar refrigeration and cold storages
(ix) Solar-thermal conversion 0.4
(x) Solar power generating equipment 
(xi) Solar-photovoltaic panels 
14. Windmills and devices operative on windmills on or after April 1, 2014
15. Special equipment includes wind energy generators and electric pumps installed on or after April 1, 2014.
16. Books you own as an assessee for carrying out business 
(i) Books (annually published) 0.4
(ii) Books other than those under (i) 0.4
(iii) Books engaged in running lending library business  0.4
Ships 4(i) Ocean-going ships that include barges, tugs, dredgers, and survey launches 0.2
4(ii) Vessels operating on inland waters and are not covered under (iii) 0.2
4(iii) Speed boats typically operate on inland waters. 0.2
Part B Intangible Assets Depreciation
Trademarks, licences, franchises, patents, copyrights, know-how, or other business rights of identical nature. 0.25

Conditions for Claiming Depreciation Under the Income Tax Act

As per Section 32 of the Income Tax Act 1961, the following are the conditions for claiming depreciation in Income Tax in India:

As an assessee, you must own the asset wholly or partly. However, there is no compulsion to be a registered owner.

Use the asset for business or profession. If the asset is used for other purposes, the depreciation allowable would be proportionate to business purposes.

The asset must have a useful life of more than one year.

The asset must have been in use during the previous year. If the asset is used for over 180 days, 50% of depreciation is allowable in that year.

The depreciation computation must be per the WDV method of the block of assets, a group of assets falling within a class of assets with the same percentage of depreciation. However, if the undertaking is involved in power generation or both power generation and distribution, there is the flexibility to opt for the straight-line method.

Depreciation is obligatory from the Assessment Year 2002-03. It will be permissible or deemed to be permissible as a deduction, regardless of whether a taxpayer makes a claim in the profit and loss account.

Evaluation of AS-22/IND AS 12 in the Context of Depreciation

AS-22, or Accounting Standard 22, is a standard issued by the Institute of Chartered Accountants of India (ICAI) that deals with the accounting treatment of taxes on income. It is based on the concept of deferred tax, which is the difference between the tax liability computed per income tax laws and the tax expense reported in the financial statements. IND AS 12 or Indian

Accounting Standard 12 is a standard issued by the Ministry of Corporate Affairs (MCA) that converges with the International Financial Reporting Standard (IFRS) 12. It also deals with the accounting treatment of taxes on income but with some differences from AS-22, such as the recognition criteria, measurement basis, presentation and disclosure requirements, etc.

Here is the evaluation in terms of buildings, patents, and machinery depreciation rate.

The amount of depreciation varies depending on whether it is calculated for tax or accounting purposes. This leads to a timing difference that has to be reflected in the financial statements as a deferred tax asset or liability.

Per Accounting Standard 22, deferred tax refers to the income tax that will be paid or received in future periods as a result of brief taxable differences.

Temporary differences arise when there are disparities between the value of a liability or asset in the balance sheet and its corresponding tax base.

Conclusion

Depreciation is accounting for the loss of value of an asset over time. It is vital for business and income tax for several reasons.

It helps you to track the cost and useful life of your assets and to match the benefit derived from their usage with the revenue they generate.

Further, depreciation expenses can reduce your business's taxable income, thus lowering the amount of taxes you owe. This can provide a tax incentive and help you invest in new assets.

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FAQS

What are the rates of depreciation?

The rate of depreciation varies based on the asset class. For example, it is 5% for residential buildings and 10% for furniture and fittings.

How do I calculate the depreciation rate?

You can calculate depreciation using a written-down value method or a straight-line method.

What is depreciation for tax purposes?

To compute depreciation for taxation purposes, you must use a written-down value method and meet the conditions under section 32 of the Income Tax Act.

Disclaimer / TnC

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