Depreciation

Depreciation

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What is Depreciation?

Depreciation usually means loss or decline in value which occurs gradually over useful life of a material thing, due to physical wear, tear and decay and is generally limited to losses or decline in value which cannot be restored by current repairs and maintenance.

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Conditions for Claiming Depreciation  assets should be owned by the assessee;  it must be used for the purpose of business or profession; and  it should be used during the relevant accounting year.

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Assets must be Owned by the Assessee  Registered Owner vs. Beneficial Owner: – Registered ownership is not necessary.( Mysore Minerals Ltd. Vs CIT (1999))

– Transferee is the owner of the asset even if no sale deed is executed and is entitled to depreciation. Some Cases decided on basis of sec 53A: •CIT vs. U. P. State Agro Industrial Corp Ltd. (1981). •Mysore Minerals ltd. Vs. CIT (1999) •CIT vs. Poddar Cements (P) Ltd. (1997) 4

Assets must be Owned by the Assessee Contd.

 The lessor is entitled to depreciation in respect of Capital expenditure on construction of any structure on building taken on lease, aft 31st Mar 1970.  Property of Partnership firm ( CIT vs. Amber Corp 1994)  Property take on hire-purchase.  Depreciation on fractional ownership: – amendment in sec 32(1) by Finance act 1996

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Asset must be used for business or Profession  Asset must have been used for purpose of business or profession.  The assessee can claim depreciation if (s)he can establish bona fide use of machinery for purpose of business. (CIT vs. Union Carbide (I) Ltd. 2002)  Passive vs. Active user. – Whittle Anderson Ltd. vs. CIT (1971) – Capital Bus Service (P) Ltd. vs. CIT (1980) – CIT vs. Pepsu Road Transport Corp. 6 (2002)

Asset must be used for business or Profession Contd.  Assets used partly for business purposes: u/s 32(2) where any business, machinery, plant , or furniture is not exclusively used for business or profession, the deduction shall be restricted to a fair proportionate part thereof.  Other business activity: Waterfall Estates Ltd. Vs. CIT (1981)  Residential Quarters: CIT vs. Delhi Cloth and General Mills Co. Ltd. (1966)  Trial Run: – CIT vs. Ashima Syntax Ltd. (2001) – CIT vs. Union carbide (I) Ltd. (2002)

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Assets must be used during the Relevant Accounting Year  Depreciation allowed only if the asset is used for the purpose of business or profession for atleast sometime in the PY.  The degree of use is immaterial.  But from AY 92-93, assets used for less than 180 days during the PY, then depreciation allowed at rate of 50% of the rate prescribed in respect of block of asset. 8

BUILDINGS  Driveway,Compound,Walls,Fences,Roa ds,bridges,culverts,wells and tube wells, temples and canteen.  All subject to the condition that they are usable for business purposes and are within factory premises.  Indore municipal corp. Earlier roads were not considered to be bldg.- if not connected with bldg. 9

Contd………….  Geetha Hotel: Hotel is considered to be bldg.-toilet fittings are considered as plant.  Building does not include land or site on which the superstructure stands.(CIT vs. London Hotel)  Building constructed on lease land admissible for depreciation. (CIT vs. Y.V Srinivasmurthy) 10

MACHINERY Machinery need not be :  Self contained and may not be capable of being put to use by itself – it may be a part of bigger machinery.  Some examples of machinery as per judicial pronouncements are – Coal bridge used in handling coal, Conveyor, Elevators, Heating boilers , Diesel engines , cold storage rooms etc. 11

PLANTS  Def:43(3)- tests 1.any item used as the means to carry out business and profession. 2.with a degree of durability. (may not last long or may not even contain working parts or plays only passive role.)  Plant includes any ship,vehicles,books,vehicles,surgical equipment,scientific equipments.  Excludes-tea bushes, livestock,furniture & fixtures and 12 bldgs.

Contd………… Important Judgments:  Scientific Engg. House: Earlier Nursing homes-Doctors,Theaters for cinema owners, Hotel Bldg. For restaurant owner were considered as plant. After the judgment bldgs. Cannot be considered as plants.  Karnataka power corp. (tailor made bldgs.) Exceptional case in which bldg. is considered as plant. E.g. bldg. Of 13 transmission house used by power

FURNITURE  All articles of decoration or convenience used for the purpose of furnishing an office or the place of trade or manufacturing would be covered under its definition.  All residual items are also considered as furniture.

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DISSALLOWANCE OF DEPRICIATION  Cars not used in hiring of touristsa. Acquired between 1/4/1967 – 28/2/1975 Depri. Not allowed in excess of actual cost over 25000. b. Acquired between 28/2/1975-1/4/2001 depri. disallowed if car is foreign made. Depreciation allowed in case of foreign cars: 1.Running it on hire for tourists. 2.Acquired > 31/03/2001 used for B/P. 3. Car used outside India for B/P.  When actual cost allowed as deduction in one or more year under agreement – 15 Central govt.u/s 42.

Written Down Value – Sec. 43(6)  Steps for determining WDV: – Step 1: Depreciated value of block of assets at the beginning of the year. – Step 2: Add actual costs of the assets acquired. – Step 3: Deduct moneys received / receivable.  Meaning of “money payable” 16

Value of Scrap  Arises for consideration only when the assets are discarded or demolished.  Immaterial whether the assessee has decided to convert the asset has chosen to convert the value into cash.  When assessee decides to just give away assets having scrap value.

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Computation of WDV on notional basis – Sec 43(6)  Succession in business and profession.  Transfer between holding and subsidiary co.  Transfer in the scheme of amalgamation.  WDV when assets are transferred in the case of demerger.  WDV in the hands of a resulting company. 18

Block of Assets

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Computation of Normal Depreciation Allowance One should find out the following:  WDV of a block of assets.  Rate of depreciation applicable. Result = Normal Depreciation Exceptions to the Rule:  WDV of a block of assets is reduced to zero.  Block of assets ceases to exist.  In the case of imported cars.  In the case of succession, amalgamation and business reorganization.  In the first year where the asset is put to use for less than 180 days. 20

ADDITIONAL DEPRECIATION SEC.32 AMENDED  CONDITION TO CLAIM A.D  Manufacture / production of any article./thing. Not eligible:– cooking food in a hotel – construction of dam, building or contract for civil engg. – cutting and polishing raw diamonds. – hatching of eggs – Pressure piling for building –

Mining of stones

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Additional Depreciation Contd…

New plant & machinery installed and acquired after march 31,2002  Not available in respect of building or furniture  Not available in respect old plant and machinery Reconditioned can be treated as new after - entirely different /substantially new - nature and cost of improvement - date on which machine was manufactured - period it was previously used -latest technical improvements available If acquired before 31 mar.02 and installed after 31 mar.02,then no A.D 22

Eligible plant and machinery  Following assets are not eligible for A.D. – Ships and aircrafts used either within /outside India by any other person. – any office premises or any residential accommodation. – any office appliances or road transport. – actual cost allowed as deduction.

Mobile crane 23

Eligible plant and machinery Contd…

 Certificate from a chartered accountant  Rate of depreciation:– A.D. @15% if used greater than 180 days – A.D. @7.5% if used less than 180 days

 Year in which A.D. is available – in case of new industrial undertaking – in case of industrial undertaking before April 1,2002 24

Installed capacity expansion by

UNABSORBED DEPRECIATION  Set off against any income – not necessary that the same business should continue. – no time limit is fixed.

 Order of priority Is followed in subsequent year – Current depreciation – brought forward business loss – unabsorbed depreciation 25

Actual Cost S-43(1)  Actual cost to the assessee as reduced by the proportion of the cost thereof if any met by any other person or authority.  Cost of Asset: All Expenses directly relatable to the asset – Exp to bring asset to site & install it – Exp to facilitate use of asset – Exp on insurance, power and fuel prior to commencement 26

Interest Different Situtations 1. Business is newely setup Incase of a newly started concern

Stages Tax Treatment Upto the time of Commencement Interestofliability up to the stage of Commercial Production Commencement of production should be capitalized. After the asset is first put to Ituse cannot be capitalised. It may be claimed as deduction under section 36 2. Any existing concerne acquiring Upto the asset is put to use It can be capitalised. It cannot be claimed asset for expanding the same business as deduction as revenue expenditure U/s After the asset is first put to Ituse cannot be capitalised. It may be claimed as deduction under section 36 3.An existing concern acquiring asset to Upto the time of Commencement It can be of capitalised. It cannot be claimed setup a new undertaking relating to theCommercial existing Production as deduction as revenue expenditure U/s business After the asset is first put to Ituse will be allowed as deduction u/s. 36

4.An existing concern acquiring asset to Upto the time of Commencement It should of be capitalized setup a new undertaking not relating toCommercial the Production existing business After the asset is first put to Ituse will be allowed as deduction u/s. 36 27

House Tax, Ground Rent etc.  Kapur Sons & Co. – Assessee capitalised house tax and ground rent – Held they cannot capitalize as these are in relation to the plot and they would have to be paid even if cinema hall not constructed on it.

 Hindustan Times Ltd. – Extra ground rent paid can be capitalised 28

Salaries, Guest House Exp & Staff Training Expenses  Hindustan Polymers Ltd.  Rane (Madras) Ltd. – – – –

Fees to technical staff Salaries Vehicle Exp Guest house exp Incurred at the time of setting up a plant will be part of the cost.

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Pre-production & Exp on test run  Lucas T.V.S. Ltd. – Pre production exp of a new industry can be allocated to cost of various assets

 Karnal Co-op Sugar Mills – Assessee opened L.C. and made F.D.s – Int on such F.D. shall reduce the cost of the asset acquired.

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Actual Cost taken at Notional Figures  Scientific Research Asset Asset acquired by way of Gift or Inheritance Second Hand Assets

Asset that it previously not used for Business Transfer in case of corporatisation of Stock Exchange. 31

Sale and Lease Back of Assets

Mr S.Claims depri u/s 32

Sale

Mr F. Buys and then Lease

Lease Back

 Cost in hand of F = W.D.V. for S at time of transfer 32

Scientific Research Asset Purchase of asset for scientific use

1997

80,000

Deduction allowed U/s 35

80,000

Transferred to business 2004 use

Nil

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Gift or Inheritance  Cost to assessee = Cost to previous owner.  Less: depri actually allowed w.r.t. that asset in respect of the A.Ys up to 1988.  Less: depri that would have been allowed from A.Y. 1988-89 as if that asset was the only asset in the relevant block of assets. 34

Second Hand Assets  Ashwin Vanaspati Industries: – If A.O. satisfied that the transfer is to avoid tax liability – Material that enhanced cost is incurred with the main purpose of claiming higher depri by inflating costs. – Acutal Cost = Amt determined by the A.O. (prior permission of J.C. required)

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Previously not used for B/P  Actual cost = actual cost to assessee – depri @ applicable as if used for B/P. from date of acquisition.

Transfer in case of corporatisation of Stock Exchange. •Cost of asset deemed as if no corporaisation was effected. 36

DEPRECIATION IN CASE OF POWER UNITS  From the assessment year 1998-99, an undertaking engaged in generation or generation and distribution of power can claim depreciation in respect of assts acquired after march 31,1997 , in the case of tangible assets according to any one of the following methods Straight –line method: At the percentage specified in Appendix 1A to the income tax Rules.(depreciation is calculated as a percentage of actual cost of an individual asset). 37

 Written down basis:alternately, such undertaking can claim depreciation at its option according to written down value method like any other assessee on the basis of block of assets.

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The following points should be noted- To claim depreciation on written down basis under the block system, an option has to be exercised before the due date of furnishing the return of income u/s 139(1).  The above option once exercised shall be final and shall apply to all subsequent years.  Additional depreciation is available.  Aggregate amount of depreciation cannot exceed actual cost. 39  Intangible asset are qualified for

The following points should be noted If the asset is put to use for less than 180 days in the first year in which it is acquired then depreciation will be –50% of normal depreciation.  For asset acquired before 1/4/97-a power generating unit does not have any option but to claim depreciation on the basis of written down basis under block of assets system.  If an asset (in respect of which depreciation is claimed on the basis of 40 straight line method) is sold , discarded

TERMINAL DEPRICIATION  When an asset of a power unit on which depreciation has been claimed under section 32(1) is sold , discarded, demolished or destroyed in the previous year terminal depreciation can be claimed.  The terminal depreciation amount will be the amount by which the money payable in respect of such building ,machinery , plant of furniture together with the amount of scrap value,if any,fall short of the written of the written down value thereof .  The following points should be noted When the asset is sold, discarded,etc,in the previous year in which it is first put to use any loss arising there from will not be allowed as terminal depreciation but will be treated as short 41 term capital loss.

Balancing charge  The money payable in respect of such building ,plant , machinery or furniture as the case may be,together with the amount of scrap value, if any , exceeds the written down value ,so much of the excess as does not exceed the difference between the actual cost and the written value shall be chargeable to income tax.  Capital gains-section 50A makes provision for the computation of cost in the case of depreciable assets referred to in section 32(1)(i).  In case of compulsory acquisition it is taxable in the year of receipt of 42 compensation.

Illustration X LTD. Is a power generating unit. On December 20, 2000it purchases a plant for 20 lakhs which is eligible for depreciation @12.77 on SLM. The plant is sold for (a) rs.30,000 (b)rs. 18,72,300 (c)rs.19,00,000 (d)rs 21,500,00 on may 20 2001.

Actual cost 20,00,00 Less depreciation 1,27,700 Written down value on Apr1 2002 -----18,72,300 sale proceeds –written down wdv= surplus Surplus = RS.(a) (-) 18,42,300 (b) NIL ( c) 27,700 43

Solution A Solution B Solution C Solution D Terminal Depr,. Balancing Charge

1842300 Nil Nil Nil

Capital Gains Sale Proceeds less: Cost of Aquiz.

Short Term CG

27700

127700

30000 1872300 1900000 2150000 30000 1872300 1900000 2000000

Nil

Nil

Nil

150000 44