Analysis, Income Tax

Depreciation: Top 5 issues and their answers

Depreciation is the decline in the real value of an asset (both tangible and intangible) because of consumption, wear and tear or obsolescence. The Income Tax Act (IT Act) provides for writing off the cost of an asset against profit over its life. Depreciation allowance can be claimed on an asset if:

  1. The assets is owned, wholly or partly, by the assessee
  2. The asset is actually used for the purpose of business or profession of the assesse
  3. Where the asset is not exclusively used for the purpose of business or profession, the depreciation will be allowed proportionate to its usage for business or profession

Section 32(1) of the IT Act provides that depreciation will be computed at the prescribed percentage on the written down value of the asset (“WDV”). WDV is the actual cost incurred less depreciation actually allowed under the IT Act.

We have identified some key issues arising under this topic and also discussed the leading cases on those issues below.

Can a person who is not a legal owner of the property but has dominion over the property claim depreciation?

Short answer: Yes

Case: Mysore Minerals Ltd vs Commissioner of Income tax 

Civil Appeal No. 5374 of 1994, Supreme Court (cited 105+times)

Reasoning: It was held that, the assesse who has made part payment followed by the delivery of possession of the house by the Housing board, was entitled to the depreciation. There cannot be two owners of the property in the same sense of the term. Depreciation must be allowed to the person in whom for the time being vests the dominion of the building and who is entitled in his own right and using it for the purpose of a business or profession. The intention of not transferring the conveyance deed to the assesse by the Housing board was to ensure regular schedule of payment.

“It is well-settled that there cannot be two owners of the property simultaneously and in the same sense of the term. The intention of the legislature in enacting s. 32 of the Act would be best fulfilled by allowing deduction inrespect of depreciation to the person in whom for the time being vests the dominion over the building and who is entitled to use it in his own right and is using the same for the purposes of his business or profession. Assigning any different meaning would not subserve the legislative intent.”

Is depreciation on goodwill allowed?

Short answer: Yes

CIT vs Hindustan Coca Cola Beverages

ITA 1531 of 2010, Delhi High Court (cited +44 times)

Reasoning: The court in the case of Hindustan Coca Cola Beverages considered issue whether the definition of “asset” u/s 32 would include goodwill within its ambit. Explanation 3 of section 32 reads as follows:

Explanation 3.—For the purposes of this sub-section, the expression “assets” shall mean—

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

(b) intangible assets, being know-how, patents, copyrights, trade marks, licences, franchises or any other business or commercial rights of similar nature.

Interpreting the phrase “similar nature” in Explaination 3(b) in the specific context of claim for depreciation in goodwill, the court held that intangible advantages or assets in the form of know-how, trade style or goodwill etc. were depreciable assets.

Double tax deduction: Can depreciation u/s 32 be claimed on assets where deduction u/s 35 has been granted

Short answer: No

Escort India Ltd vs Union of India 

WP No. 90 of 1981, Supreme Court (cited 80+ times)

Reasoning: The question that arose in the case was that whether an assessee can simultaneously claim allowance or deduction in respect of the same expenditure once u/s 32 for depreciation and again u/s 35 for expenditure on scientific research. The court clearly laid down the principle that double deduction will not be allowed until and unless specifically provided by the Act.

“If the intention of the Legislature/Parliament was to provide more than 100 per cent deduction, they would have said so, as they have done in cases where they provided for what is called `weighted deduction’. [For example, see s. 35B of 1961 Act). A double deduction cannot be a matter of inference, it must be provided for in clear and express language, regard having to its unusual nature and its serious impact on the revenues of the State. Now, what does cl. (iv) of s. 35(2) say? It says that during the years or the year in which the assessee avails of the deduction under s. 35(1)(iv) he shall not avail of the deduction on account of depreciation provided by cls. (i), (ii) and (iii) of sub-s. (1) and sub-s. (1A) of s. 32.”

Also Read: Possibility of personal use cannot be a reason to disallow depreciation claim

Can depreciation be claimed on the property acquired by a trust for charitable purpose u/s 11

Short answer: Yes

CIT vs Institute of Banking and Personnel

IT Ref. No. 197 of 1997, Bombay High Court (cited 70+times)

Reasoning: Section 11 of the it Act states that the income from property held for charitable purpose shall be excluded from the total income to the extent to which income is applied for such purposes in India. In the case of CIT vs Institute of Banking and Personnel, the assesse-trust had acquired assets using the income from property of the trust which were allowed as application of income u/s 11 and therefore not included in the total income. The point of dispute was that whether depreciation can be allowed where tax benefit has already been given on the purchase of such assets u/s 11. The court held that the provisions u/s 32 deal with the computation of income from business and profession and not a trust.  Depreciation will be computed u/s 11 providing for normal depreciation. The principle laid down in Escort India Ltd vs Union of India  will not be applicable in the present case because the provision to determine the taxable income of a trust are different.

“In all such cases, s. 32 of the IT Act providing for depreciation for computation of income derived from business or profession is not applicable. However, the income of the trust is required to be computed under s. 11 on commercial principles after providing for allowance for normal depreciation and deduction thereof from gross income of the trust.”

Can unabsorbed depreciation be carried forward indefinitely

Short answer: Yes

CIT vs Jaipuria China Clay Mines,

Civil appeal no. 307 of 1964, Supreme Court, (cited +50 times)

The Supreme Court held that unabsorbed depreciation of past year(s) cannot be kept out of the accounts in determining the net income of an assessee for a year, and the depreciation can be carried forward indefinitely. The words ‘profits or gains chargeable for that year’ are not confined to profits and gains derived from the business whose income is being computed under s.10, of IT Act 1922, but they refer to the totality of the profits or gains computed under the various heads and chargeable to tax.

Section 32 of IT Act, 1961 does not prescribe any time limit for carry forward of the loss and time limit under Section 72 cannot be attributed to carry forward of depreciation because Section 72 deals with carry forward of business loss and not depreciation. From the provisions of the IT Act and case laws, following steps must be taken into account while dealing with unabsorbed depreciation;

  • Depreciation is first deductible from the income under business and profession
  • If the profits are inadequate, then the depreciation will be deducted from income chargeable under other heads of income (except income under head “salaries”)
  • If the depreciation is still unabsorbed, it can be carried forward to subsequent assessment year(s) by the same assesse indefinitely since S. 32 does not define any time limit

(Written by Anuj Sharma, Product Counsel @ Riverus)

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