Depreciation under the Income Tax Act, 1961 made easy

Depreciation under the Income Tax Act, 1961, allows taxpayers to claim a deduction for the wear and tear of tangible and certain intangible assets used in their business or profession. This deduction reduces the taxable income of the taxpayer, reflecting the reduction in the value of these assets over time.

Key Features of Depreciation under the Income Tax Act, 1961:

  1. Block of Assets Concept:
    • Assets are grouped into “blocks” based on their type and depreciation rate.
    • A block of assets consists of a group of assets falling within a class of assets with the same depreciation rate.
  2. Rates of Depreciation:
    • Depreciation rates are specified under the Income Tax Rules, 1962, and vary depending on the type of asset.
    • Common depreciation rates include 5%, 10%, 15%, 40%, and 60%, depending on the asset type (e.g., buildings, machinery, furniture, vehicles, etc.).
  3. Methods of Depreciation:
    • Written Down Value (WDV) Method: The most commonly used method under the Income Tax Act, where depreciation is calculated on the reduced value of the asset after accounting for depreciation in the previous year.
    • Straight Line Method (SLM): This method is generally not applicable under the Income Tax Act but is used under the Companies Act for calculating depreciation for accounting purposes.
  4. Depreciation on New Assets:
    • Depreciation on new assets is allowed for the full year if the asset is put to use for more than 180 days in the financial year.
    • If the asset is put to use for less than 180 days, depreciation is allowed at 50% of the applicable rate for that financial year.
  5. Additional Depreciation:
    • Certain manufacturing companies are eligible for additional depreciation at 20% on the cost of new machinery or plant acquired and installed after 31st March 2005.
    • If the asset is used for less than 180 days, 10% additional depreciation is allowed.
  6. Depreciation on Intangible Assets:
    • Intangible assets such as know-how, patents, copyrights, trademarks, licenses, and franchises are eligible for depreciation at a flat rate of 25%.
  7. Set-Off and Carry Forward:
    • Unabsorbed depreciation (depreciation that cannot be fully set off against the income of the current year) can be carried forward indefinitely and set off against income in subsequent years.
  8. Special Considerations:
    • No depreciation is allowed on land.
    • Depreciation is mandatory to claim under the Income Tax Act and must be claimed even if not shown in the books of accounts.
    • For entities claiming 100% deductions (like those under Section 80IA), depreciation must be deducted even if no income is chargeable to tax.
  9. Changes in Rates and Provisions:
    • Depreciation rates and provisions may be updated periodically by the government, so taxpayers must ensure they are using the most current rates.

Compliance and Documentation:

  • Proper records must be maintained for the assets, including their acquisition cost, date of purchase, and the rate of depreciation.
  • Depreciation must be claimed while filing the income tax return, and it should be reflected in the financial statements as per the prescribed rates and rules.

Importance in Tax Planning:

  • Depreciation can significantly reduce the taxable income of a business, making it a vital aspect of tax planning.
  • Proper understanding and application of depreciation rules help ensure compliance and optimize tax liabilities.

LedgerFusion assists in calculating depreciation as per the Income Tax Act by automating the process based on the user’s data and configurations. Here’s how it works:

  1. Automatic Calculation Based on Data from Tally:
  • Additions and Deletions: LedgerFusion automatically calculates depreciation on the additions and deletions of assets by capturing the amount and date of each transaction from Tally data.
  • Block of Assets: The system uses a predefined configuration to determine the block of assets. This includes the categorization of assets and the applicable depreciation rates as per the Income Tax Act.
  • Additional Depreciation: If applicable, additional depreciation rates are applied based on the configuration set up by the user.
  1. Handling Schedule III and Non-Schedule III Formats:
  • Schedule III Format:
    • Since companies typically calculate depreciation as per the Companies Act, 2013, the user must provide the opening Written Down Value (WDV) from the previous year’s depreciation note.
    • LedgerFusion then calculates depreciation under the Income Tax Act using this opening WDV and updates based on the additions and deletions during the year.
  • Non-Schedule III Formats:
    • For other balance sheet formats, LedgerFusion directly pulls data from Tally to calculate depreciation.
    • The process is guided by the user-defined configuration, ensuring that the correct rates and categorization are applied.
  1. Compliance with Income Tax Act:
  • LedgerFusion ensures that all depreciation calculations comply with the regulations set out in the Income Tax Act, using the Written Down Value (WDV) method.
  • This automated approach reduces the chances of errors and ensures accurate financial reporting.

Overall, LedgerFusion simplifies the complex process of depreciation calculation, making it easier for businesses to stay compliant with tax regulations.