Cos Act Panel Rules Out Uniform Depreciation Norms

The working group set up to recast the Companies Act, 1956, has recommended that the current distinction in depreciation in the Income Tax Act and Companies Act should be retained. According to the group, any move to align the rates would be detrimental to the share prices of companies and market players including banks, financial institutions and small investors.

This recommendation becomes significant in view of the argument offered by several government officials that the minimum alternate tax is an intermediate measure and would be withdrawn once the Income Tax and Companies Act were aligned to ensure a uniform norm of depreciation.

The depreciation rates under the Companies Act and the Income Tax Act serve very different objectives. The former uses the rates to reflect a true and fair view of the affairs of the company in the interests of shareholders, creditors and other stake-holders. Therefore, its objective is to create long-term corporate value for the shareholders.

The Income Tax Act uses depreciation to calculate net taxable income. Equally importantly, tax depreciation rates are universally recognised as fiscal instruments to promote investment in desirable areas.

The depreciation rates under the Income Tax Act are not just deductions for fall in value of fixed assets due to their productive use and obsolescence. They are also designed to provide funds for replenishment and replacement of assets. As competition increases, the need for such funds will be greater than ever before, said the working group.

The depreciation rates under the Income Tax Act have often been designed to encourage core and priority sector industries, facilitate funding of such projects through appropriate debt-equity ratios, and generate cash flows for timely debt servicing.

This incentive aspect of depreciation is particularly important in the Indian context. Despite living in an age of inflation and technological obsolescence, Indian tax laws do not allow for depreciation of fixed assets on the basis of replacement cost basis, the group argued. The group believes it is logical to maintain a distinction between the two sets of rates, says the groups report. It adds that the issue is not merely one of logic but also deals with reality.

At present, the capital markets are in doldrums. Any increase in depreciation rates under the Companies Act will have the immediate consequence of reducing profits, dividends, and hence, share prices and market capitalisation.