Know what is depreciation, and how depreciation is calculated under income tax act.
What Is Depreciation in Income Tax? Depreciation is a tax-saving tool that helps businesses reduce taxable income. It refers to the deduction allowed under Section 32 of the Income Tax Act, 1961, for the wear and tear of business assets. Depreciation is calculated using the Written Down Value (WDV) method, with rates varying by asset type (e.g., 15%, 30%, 40%). Additional depreciation benefits apply in certain cases. If not fully utilized, unabsorbed depreciation can be carried forward indefinitely, reducing future tax liability. Understanding depreciation ensures better tax planning and compliance.
What is Depreciation in Income Tax?
Depreciation as per Income Tax Act refers to the reduction in an asset’s value over time due to wear and tear. It allows businesses to claim tax deductions on asset costs, lowering taxable income. Depreciation is calculated using prescribed rates and methods, primarily the Written Down Value (WDV) method. Section 32 of the Act governs depreciation, covering tangible and intangible assets. Unused depreciation can be carried forward indefinitely, reducing future tax liability.
Depreciation as per Income Tax Act – Importance and Key Concepts
Depreciation as per Income Tax Act refers to the decline in asset value over time due to wear and tear. It allows businesses to claim tax deductions based on an asset’s useful life, reducing taxable income and supporting reinvestment.
Concepts of Depreciation
- Reduces Taxable Income: Deducting depreciation lowers a company’s taxable profit.
- Encourages Reinvestment: Businesses can reinvest tax savings into new assets.
- Applicable to Tangible & Intangible Assets: Covers buildings, machinery, patents, etc.
- Methods of Calculation: Mainly Written Down Value (WDV) method, except for power companies using Straight Line Method (SLM).
- Depreciation Rates: Varies by asset type, typically 15%, 30%, 40%, etc.
- Unabsorbed Depreciation: Can be carried forward indefinitely.
Importance of Depreciation
- Tax Saving: Reduces taxable income, lowering tax liability.
- Encourages Investment: Helps businesses invest in new machinery, vehicles, and infrastructure.
- Regulatory Compliance: Ensures fair valuation of business assets, aligning with financial reporting norms.
Types of Depreciation as Per Income Tax Act
Depreciation under the Income Tax Act, 1961, is categorized into different types based on how it is calculated and applied.
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Straight-Line Method (SLM)
- Depreciation is charged equally each year over the asset’s useful life.
- Common in sectors where predictable asset usage is expected, such as power generation.
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Written Down Value (WDV) Method
- Higher depreciation in initial years, reducing over time.
- Encourages businesses to invest in new assets frequently.
- Most commonly used method under income tax provisions.
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Additional Depreciation
- Extra 20% deduction on new machinery for the manufacturing sector.
- Applicable only in the first year of purchase.
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Unabsorbed Depreciation
- Unused depreciation carried forward indefinitely.
- Can be set off against any income (except salary) under the Income Tax Act.
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Terminal Depreciation
- Claimed when an asset is sold or scrapped before its useful life ends.
- Helps adjust loss on disposal of assets against taxable income.
| Depreciation Type | Calculation Method | Feature | Applicability |
| SLM | Equal annual depreciation | Predictable asset usage | Power, infrastructure |
| WDV | Higher in early years | Encourages reinvestment | General business assets |
| Additional Depreciation | Extra 20% in first year | Boosts manufacturing | New plant & machinery |
| Unabsorbed Depreciation | Carry forward losses | Reduces future tax | Any business sector |
| Terminal Depreciation | Adjusts disposal loss | Helps in tax planning | Asset sale/scrap |
Depreciation Rate & Calculation Methods
Depreciation rate under the Income Tax Act, 1961, varies based on the asset type and method applied. The income tax depreciation rates are prescribed under the Income Tax Rules, 1962, primarily following the Written Down Value (WDV) method.
Depreciation Rates (WDV Method)
| Asset Type | Depreciation Rate (%) |
| Buildings (Factory, non-residential) | 10% |
| Plant & Machinery | 15% |
| Computers & IT Equipment | 40% |
| Furniture & Fixtures | 10% |
| Motor Vehicles (Commercial use) | 30% |
| Motor Vehicles (Personal use) | 15% |
Higher depreciation rates apply to specific categories, such as public transport vehicles, which qualify for higher depreciation (30%-40%).
Depreciation Calculation Methods
- Written Down Value (WDV) Method
- Depreciation is calculated on the reducing balance each year.
- Commonly used for tax purposes under income tax laws.
- Straight-Line Method (SLM)
- Depreciation is charged equally over the asset’s useful life.
- Used mainly for power generation companies.
Understanding income tax depreciation rates ensures businesses claim the correct deductions, reducing tax liability effectively. Let me know if you need further refinements!
Depreciation Formula & Example:
- Straight-Line Method (SLM)
- Formula: (Cost of Asset ÷ Useful Life in Years)
- Example: If a machine costs ₹5,00,000 with a useful life of 10 years, annual depreciation is ₹50,000.
- Written Down Value (WDV) Method
- Formula: (Cost of Asset – Depreciation) × Rate
- Example: If a machine costs ₹5,00,000 with a depreciation rate of 15%, first-year depreciation is ₹75,000.
Suggested to include a step-by-step example with a tax-saving comparison between SLM and WDV methods.
Claiming Depreciation as Per Income Tax Act
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Eligibility
- Only businesses and professionals can claim depreciation.
- The asset must be owned and used for business purposes.
- If used for less than 180 days in a financial year, only 50% depreciation is allowed.
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How to Claim Depreciation?
- Include in ITR: Report in ITR-3 or ITR-4 (for businesses and professionals).
- Maintain Records: Keep asset details, invoices, and usage proof.
- Apply Correct Rate: Use prescribed income tax depreciation rates as per asset type.
- Calculate Using WDV Method: Compute depreciation based on Written Down Value (WDV) method.
- Adjust in Books: Depreciation should be recorded in financial statements.
Depreciation & Tax Planning Strategies
Maximize Tax Savings
- Opt for the WDV Method for higher deductions in early years, reducing taxable income.
- Use Additional Depreciation to claim an extra 20% if engaged in manufacturing.
- Plan Asset Purchases before September 30 to claim full-year depreciation instead of 50%.
- Leverage Unabsorbed Depreciation by carrying it forward to offset future income.
- Maintain Proper Documentation, including invoices and records, to support tax claims.
Quick Tax Planning Checklist
- Choose WDV method for higher early-year deductions
- Buy assets before September 30 for full-year benefits
- Claim additional depreciation for manufacturing units
- Maintain proper invoices and records
- Carry forward unabsorbed depreciation to reduce future tax liability
These strategies ensure efficient tax planning and compliance. Let me know if you need modifications.
Need More Clarification on Depreciation?
Understanding depreciation can be challenging, especially when optimizing tax savings and ensuring compliance with the Income Tax Act. Many businesses struggle with calculating the correct depreciation rate, choosing between WDV and SLM methods, and maximizing additional depreciation benefits.
Our expert tax advisory services help businesses navigate complex depreciation rules, ensuring maximum deductions while staying compliant. Whether you’re a small business owner or a large enterprise, we provide tailored solutions to simplify tax planning.
FAQS
What is unabsorbed depreciation in income tax?
Unabsorbed depreciation refers to the portion of depreciation that cannot be fully deducted in the current year due to insufficient profits. It can be carried forward indefinitely and set off against any income (except salary) in future years under the Income Tax Act, 1961.
What is additional depreciation in income tax?
Additional depreciation is an extra 20% deduction available on new plant and machinery acquired by manufacturing businesses. It applies only in the first year of asset use, provided the asset is used for at least 180 days in that financial year.
What is the depreciation for software?
Depreciation on software is classified as an intangible asset under the Income Tax Act and is eligible for a 25% depreciation rate under the Written Down Value (WDV) method.
How is depreciation deducted in tax?
Depreciation is deducted as a business expense under Section 32 of the Income Tax Act, 1961. It is applied annually using the WDV method, except for power-generating units that can opt for the Straight-Line Method (SLM).
How does depreciation in income tax affect taxable income?
Depreciation reduces taxable income by allowing businesses to deduct the cost of asset wear and tear over time. Lower taxable income results in reduced tax liability, helping businesses save on taxes while maintaining compliance.
