The Hindu Business Line : Problems in depreciation

One area of frequent dispute relates to the interpretation of Section 32 of the Income-Tax Act 1961 concerning depreciation allowance, which is a concession granted by the Government in the computation of income based on factors relevant to a wholesome fiscal administration. It represents diminution in the value of an asset used in business. It is related to the asset and is a notional loss as against actual loss in the sense of outgoings of a business.

The allowance has to be made in computing the profits of the business and does not depend on the genuineness of the books of accounts. Controversies centred around the question of user of the asset in business, the nature of the asset, whether it is plant, machinery or building, and the date from which the rate of allowance is admissible.

The “user” test has been applied by the courts to mean that even passive user will suffice. There is a controversy over this. The Supreme Court had held that the asset must have been used for the purposes of the business during the accounting year.

The applicable law

Depreciation rates are provided for in the Income-Tax Rules.

The Act as it stands amended on April 1 of any financial year applies to the assessment of that year. Amendments to the Act or Rules coming into force after April 1 of a financial year would not apply to the assessment of that year, even if the assessment is actually made after the amendment came into force. This has been the established view of various High Courts.

New interpretation

As far as amendment to the depreciation rules is concerned, the relevant date for coming into force of the rule should be the date on which the amendment was made. A new interpretation has now come on this issue from the Allahabad High Court in the Motor and General Sales Ltd vs CIT (296 ITR 516) case.

A transport company was running vehicles on hire. Its accounting period relevant to the assessment year 1981-82 ended on June 30, 1980. At that time, taxpayers were allowed the option to choose any accounting year. It was not then mandatory that the accounting year should coincide with the financial year.

Depreciation rules were amended by Notification dated July 24, 1980, from the Central Board of Direct Taxes (CBDT) and depreciation on transport vehicles was raised from 30 to 40 per cent. The company had purchased trucks after April 1, 1980, and before July 24, 1980.

In the assessment year 1981-82 (year ending June 30, 1980), the company claimed the higher depreciation at 40 per cent and argued that the law prevailing as on April 1, 1981, allowed a higher rate of 40 per cent.

It did not matter that the vehicles were purchased on dates prior to the coming into force of the new depreciation Rules. The Revenue resisted this claim.

The Allahabad High Court held that the law prevailing on the first day of the assessment year must be applied. The court rejected the Revenue’s argument that the higher rate of depreciation became applicable from a period after the end of the accounting period.

It also referred to the charging Section 4 of the Act holding that the income of the previous year is brought to tax at the rate of tax applicable and in force in the assessment year in question. The law in force on the first day of the assessment year must be applied.

It is strange that the assessee gets the benefit of a higher rate of depreciation even though such rate became applicable after the close of the accounting year.

Appendix I under Rule 5 of depreciation rules has been amended w.e.f April 1, 2005, and depreciation for general machinery and plant is reduced from 25 per cent to 15 per cent.

Initial depreciation rate has been raised from 15 per cent to 20 per cent. Industry has been complaining that these changes have not helped.

Company law vs I-T law

Company law allows depreciation at rates higher than the rates fixed under the Income-Tax Act.

The idea is to secure a “true and fair view” of the affairs of the company. The I-T law aims to provide funds for replenishments and replacement of assets.

In an age of fast technological obsolescence, the rates under the I-T law will appear unacceptable to industry. Australia allows depreciation depending on the effective life of the asset, determined either by the assessee or by the tax authorities. Canada allows 30 per cent on plant and machinery used in manufacture.

Chambers of commerce would like to see the law giving option to the companies to claim depreciation in any assessment year and not necessarily in seriatim.

There is also a long-standing clamour for aligning income-tax depreciation rates with the rates prescribed under the company law.

The ensuing Finance Bill will be keenly awaited in this regard.

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

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