“TAX PLANNING REGARDING DEPRECIATION” Submitted to: Mr. Varun Dhingra Submitted by:- (GROUP – IV) 04. Brahmbhatt Ankita 07. Desai Deep 14. Jindani Soyeb 21. Magodra Anirudh 58. Vaghani Viral

1.Introduction As a general rule, the Income Tax Act charges tax on the profits or income without making any allowance for deduction in respect of the exhaustion or dimunition in the value of capital. However, an exception is found under Section 32 of the Income Tax Act which provides for the deduction of allowance in respect of depreciation of certain types of assets.

2.Which assets are entitled to normal depreciation allowance? The normal depreciation allowance is not granted on every type of asset as it is confined only to building, machinery, plant and furniture. “building” refers to both factory and non – factory buildings, including the one used for store, office, godown, employees’ quarters, sports, pavilion and works godown. “Buildings” however, does not include the land under it but word “building” would include a part of the building also.

Cont…. “Machinery”, for the purpose of depreciation allowance, need not be a self – contained unit. ‘machinery’ does not mean a mere collection of tools. ‘plant’ as defined under Section 43(3) of the Income Tax Act, includes ships, vehicles, books, scientific apparatus and surgical equipments, used for the purpose of the business or profession. The expression ‘plant’ does not include an animal or the human body. It also does not include loose implements or tools of trade.

Cont… The following articles or items satisfy the functional test laid down by the courts and would be ‘plant’- Technical know – how embodied in patterns, designs, drawings and technical data. Well for manufacturing business Fencing around refinery Light fittings, ceilings and pedestal fans in a hotel Cold storage buildings

3.Depreciation is normally admissible on assets which are owned by the company? One of the conditions for grant of normal depreciation allowance is that the building, machinery, plant or furniture should be fully or partly owned by the company. In the case of leased out assets, the lessor and not the lessee would be entitled to claim depreciation on the assets the assessee, a lessee of a building, constructed a third floor of a building and was running hotel business and as he had to remove the addition before handing back the possession of the building at the end of the lease, it was held that the assessee was the owner of the building and was therefore, entitled to depreciation on the third floor.

Where the business or profession of the company is carried on in a building not owned by the company but in respect of which it holds a lease or other right of occupancy, and if any capital expenditure is incurred by the company for the purposes of the business or profession on the construction of any structure or doing any work in or in relation to any work by way of renovation or extension of, improvement to the building, then the provisions of depreciation rates would apply as if the said structure or work is a building owned by the company as provided by the Explanation 1 to Section 32 (1).

4. The building, machinery, etc 4.The building, machinery, etc. should be used for the purpose of business or profession in the relevant previous year? the depreciation allowance is granted in respect of the aforesaid four types of assets which are used for the purposes of the assessee’s business or profession The aforesaid assets, Viz., the building, machinery, plant or furniture may be used either passively or actively. Depreciation is also admissible on the stand – by plant meant to provide against a breakdown or unforeseen circumstances, even when it is not actually used during the previous year. the asset issued is used for less than 180 days in a year, depreciation is allowed at 50 % of the normal rate.

5.Particulars may be furnished regarding depreciation? It is not obligatory now on the part of an assessee as per Section 32 to furnish the prescribed particulars as contained in the form of return of income in respect of his claim for depreciation on the various assets used in the previous year foer the purposes of business or profession. But from a practical tax planning point of view it is advisable to do so. requirement of Section 34 (1) has now been omitted with effect from 1-4-88, but it is better to submit proper particulars regarding depreciation with the I.T. Retun.

6. When depreciation allowance can be refused or partly allowed: In some cases, the company is not entitled to any depreciation even where the aforesaid conditions are fulfilled. In some other cases the depreciation allowance admissible to a company is disallowed in part, on the fulfillment of certain conditions as per section 38. Where an asset is used for personal purposes of the proprietor, a part of the depreciation allowance is disallowed. This normally happens in the case of a motor car or any other conveyance which is used by the proprietor or partner of a firm partly for the purposes of business and partly for personal purposes. But such cases are rare in the case of a company. A conveyance allowed by a company for both personal and official purposes by an employee or director is treated as one used for company’s business.

7. When 100 percent depreciation is admissible in respect of any machinery or plant? Ordinary, normal depreciation is admissible in the case of plant or machinery or building or furniture at the rates prescribed by the income tax rules. However, up to the A.Y. 1995 – 96, it has been provided that in respect of any machinery or plant the actual cost of the plant or machinery is admissible as a deduction by way of depreciation in the year in which such plant or machinery is bought For such item of plant & machinery up to Rs. 5,000 (only up to A.Y. 1995 – 96), it is not necessary that it must be used for 180 days. There are certain items of plant and machinery in which 100% depreciation is allowed as per the I. T. Rules, like energy saving devices, books for professional use, etc.

8. New income tax provisions regarding depreciation: In the past, normal depreciation was allowed on different types of assets at varying rates of depreciation applicable to different asset as per appendix I to Income Tax Rules. Besides, other depreciation allowances like extra shift allowance, additional depreciation, initial depreciation balancing allowance at the time of sale or discard of an asset, etc. were also allow owed year 1987 – 88, required the maintenance of detailed records by every taxpayer for each type of asset including records of the original cost of the asset, the amount of depreciation allowed in any particular year in respect of the sale of a part of that machinery, etc. all this involved a lot of as the income tax department as was also mentioned by the economic administration reforms commission in para 20 0f its report no. 12. Hence, the new system has been devised to dispense with the maintenance of individual records of plant and machinery or other assets W.e.f. the assessment year 1988 – 89.

9. What is ‘block of assets’: From the assessment year 1988-89 depreciation is not calculated for each individual asset separately but is calculated in respect of a “block of assets.” According to the new section 2(11) of the income tax act, 1961, the expression “block of assets” means a group of assets falling within a class of assets, such as building, machinery, plant or furniture in respect of which the same percentage of depreciation is prescribed as per the latest appendix I to the income tax rules, 1962. To illustrate, there are certain items of plant and machinery like air and motor taxies used for hiring which would be entitled to the increased depreciation of 40%.

10. New rates of depreciation: Under the revised appendix I to the Income Tax Rules, the various assets I.e, the block of assests have been classified under the following 4 categories, namely- 1. Building; 2. Furniture and Fittings; 3. Machinery and Plants; and 4. Ships.

Cont… FOR BUILDING:- office and factory buildings would generally be entitled to a depreciation of 10%. under the new income tax depreciation rules, hotel buildings and residential buildings for low income employees who are provided with a dwelling unit of plinth area up to 80 sq. meters would now be entitled to a depreciation of 20% as against the general rate of normal depreciation of 5% which is applicable to all other residential buildings.

Cont… FOR FURNITURE & FIXTURES:- depreciation as allowed in the past @ 10% continues However, for furniture and fittings used in hospitals, restaurant, boarding houses, school, colleges, libraries, educational institution, cinema houses, theatres, meeting halls, and the furniture and fittings used on the depreciation would be 15%. The general waters and speed boats would become entitled to 10%.

Cont… FOR MACHINERY & PLANT:- plant and machinery have further been divided into 3 Block of Assets which are entitled to 3 different rates of depreciation namely, 25%, 40% and 100%. %. For motor cars purchased on or after 1- 4- 1990, however, the rate of depreciation is 20% only The rate of depreciation of 40% would be applicable to such item of plant and machinery like aero planes, motor buses, motor Lorries and motor taxies used in business for running them on hire, moulds used in rubber and plastic factories, certain specified air pollution, water pollution and solid waste control equipment systems pollution control equipment and other specified equipments and books for professional purpose dated 24.5.96 depreciation @ 25%. The new rates of depreciation are applicable now. Thus, electric fans, electric fittings, scooters, mopeds, etc. would all be entitled to depreciation at general rate of 25%.

11. What is written-down value of assets? The definition of “written-down value” has been amended in keeping with the new system of depreciation which is calculated on the block of assets separately.

Rs. Aggregate of the written-sown value of all the Assets falling within that block of assets as at The beginning of the previous year relavant to The assessment year 1988-89. Add: The actual cost of all assets falling within that Block acquired during the previous year. _______________ Gross Written -Down Value. Deduct: Moneys payable in respect of any assets within That block which is sold, discarded, etc. during that previous year ______________ Final written-down value on which depreciation Would be allowed.

12. Short-term Capital gains on sale of assets:- If any extra amount is received on sale of any asset over and above the written down value thereof, no income tax would be charged in the year of sale of the asset but it would indirectly affect the computation of the total depreciation because the entire sale proceeds would be deducted while computing the written-down value of the value of the Block of Assets on which depreciation has to be calculated. However, sometimes it so happens that the sale proceeds of any asset or of the assets of a particular Block of assets is more than the written-down value. In that case, the different between the sale value and the written-down value of Block of assets would be deemed to be short-term capital gains

13. Unabsorbed depreciation carried forward 8 years only:- The finance (no.2), Act 1996 has w.e.f. the A.Y. 1997-98 amended Section-32 to provide that the unabsorbed depreciation would be allowed to be carried forward only if the earlier business continues to exist and that too only for a period of 8 years. The limitation of unabsorbed depreciation for the purpose of carry forward is prospective. Thus, the unabsorbed depreciation as on 1-4-97 would be set of against taxable business profit or income under any head of assessment year 1997-98 and 7 subsequent assessment years. Further the time limit of 8 year shall not apply to sick companies during the period the company treat as a sick company. Under the sick industrial companies Act.1995. It has also been clarified that the depreciation for the year can be set of not only against the profit and gains of any business carried on by the assesses but also against income any other head as is case with the set off of business loss.

Illustration An industrial company owns certain plant and machinery like typewriters, office equipments, etc., the written-down value of which at the end of the previous year relevant for the assessment year 1997-98 is, say Rs. 10 lakh. Depreciation on these items allowed at 25%. It has purchased new office equipment on 28-05-1997 at a cost of Rs. 6 lakh and has sold on 3-5-1997 for Rs. 4 lakh some of the old office equipment which had cost Rs. 1,60,000 seven years ago. The written down value and the depreciation to be allowed for the assessment year 1998-99 would be calculated by taking the different items of plants and machinery which would be entitled to the increased general rate of depreciation at 25% on Block of Assets as shown below:

Rs Written-down value of assets entitled to depreciation at 25% As on 1-4-1997 10, 00,000 Add. Actual cost of new assets purchased on 28-4-1997 6, 00,000 ---------------- Gross written-Down Value 16, 00,000 Less: Sale proceeds of assets on 3-5-97 4, 00,000 __________ Written-down value of depreciation 12, 00,000 Depreciation at 25% for the assessment year 1998-99 3, 00,000 ___________ Written-down value as on 1-4-1998 9, 00,000

14. Conclusion The company must go in greater details to have a glance at the rates of depreciation as mention in the appendix in the I.T. rules, 1962 for claiming correct depreciation as per rates. Likewise, a company can adopt proper tax planning by buying additional plant and machinery if there is any deemed capital gain under section 50 in any year as explained in para 12 above and thus save a good deal of income tax.

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