The Hindu Business Line : Erosion of depreciation

A MAJOR reform in the area of corporate taxation is the steep reduction in depreciation rate on plant and machinery from 25 per cent to 15 per cent. This has been accompanied by the announcement about the reduction in corporate tax rates from 36.59 per cent to 33.66 per cent. It has been pointed out that the steep reduction in deprecation rate will indirectly result in an increase in the corporate tax rate by 3.66 per cent, that is, 33.66 per cent of the reduced depreciation allowance. Does this nullify the reduction in the apparent corporate tax rate? The hardship is mitigated to some extent by the increase in the rate of initial depreciation from 15 per cent to 20 per cent without any precondition of enhancement of installed capacity beyond a minimum level. The amended provision with regard to the increased rate of initial depreciation is significant for the omission of reference to any industrial undertaking.

The Central Board of Direct Taxes (CBDT) has promulgated the Income-Tax (Sixth Amendment) Rules, 2005, which came into force from April 2. Surprisingly, the assets on which 100 per cent depreciation is being allowed will continue to get the same rate. These include buildings acquired on or after September 1, 2002, for installing machinery and plant forming part of water treatment system in the business of providing infrastructure facilities. Air pollution, water pollution and solid waste control equipment will all get 100 per cent depreciation. Purely temporary erections, such as wooden structures, will get 100 per cent. The Expert Group in its report submitted in February 1997 had recommended that the maximum rate of depreciation should be reduced to 50 per cent as against 100 per cent now available in respect of certain specified assets such as energy saving devices, and so on.

It had also suggested that the number of blocks of depreciable assets should be reduced from eight to four. In respect of residual assets, it had suggested a uniform rate of 50 per cent. It had also recommended that items which get 100 per cent depreciation need not figure in Appendix I of the Rules. Such items should be allowed as revenue expenditure. This would be a welcome relief.

The present rate of 15 per cent for plant and machinery will correspond to an equivalent yield at the end of 10 years of 15 per cent at the present level of corporate tax. The Kelkar Task Force had recommended that the rates of depreciation for other blocks of assets must be reviewed along the same lines. This can mean that the depreciation amount charged for tax purposes will be similar to those charged under the Companies Act.

Ultimately, the adequacy of the depreciation rates depends on the period of the useful life of the asset, the mode of granting depreciation, that is, by the diminishing-balance method or the straight-line method, and the past and expected rates of growth of prices of capital goods. Kelkar had assumed a life of 10 years for plant and machinery when he suggested a 15 per cent rate. In practice, though, technological change is rapid and corporate efficiency lies in keeping up with such change.

The Expert Group had interacted with the Group set up for drafting the new Companies Act and the two Groups were not able to align the depreciation rates in the two Acts. Attempting to bridge the gap between the two sets of rates, the Expert Group proposed a rate of 25 per cent as depreciation for both plant and machinery and intangible assets. Kelkar pointed out that the tax treatment under the income-tax law for capital assets took into account returns from capital and enabled the company to recover tax-free the original investment, leaving tax applicable only to the return on the investment.

The divergence in the depreciation schedule between company law and the income-tax law had led to difficulty in re-designing the corporate profit tax so as to align taxable income and the book profit. While it is true that elimination of various tax incentives will not be easy unless a new income-tax law is brought into existence, at least some of the artificial disallowances in the Income-Tax Act, which are neither anti-avoidance in nature nor consistent with accounting practice, need to be reviewed. Only then, the divergence between accounting profits and taxable income would be minimised and corporate profits would bear the full burden of corporate tax.

After the current rate reduction, the income-tax depreciation rate is lower than that under the company law. MAT was thought of as the solution to bridge the difference between book profits and tax profits. A leading consultancy firm has opined that if the depreciation under the company law is higher than that under the tax law, MAT may not have any significant role to play and it will be ideal to scrap MAT.

The Finance Minister is aware of the situation. Rather than scrap MAT, he has chosen the easier route of allowing tax credit for MAT under Section 115JB against tax liability in subsequent years under other provisions of the law.

(The author is a former Chief Commissioner of Income-Tax.)

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