Depreciation Differentials

Real profits from a business cannot be ascertained without accounting for depreciation on the assets used in earning the income. The word depreciation means a decrease in the value of an asset or property as a result of wear and tear or deterioration through use or obsolescence. The cost of this wear and tear is denoted through depreciation and the reduction in value, and is a legitimate charge to the profits.

This concept has been incorporated both under the Income-tax Act and the Companies Act. Section 32 of the Income Tax Act provides for deduction of depreciation at the prescribed rates on actual cost or written down value on buildings, machinery, plant or furniture owned and used by an assessee for the purpose of his business or profession. The rates of depreciation have been prescribed in Appendix I of the income tax rules.

 

Considerable case law has also developed in this regard. These relate to ownership of ass-ets, their user, periods for which claims are admissible, applicable rates, written down value etc.

The Companies Act 1956 does not have any separate sections dealing with depreciation. However, a few sections do make a reference to depreciation. This indicates the importance of the subject in company law.

The Institute of Chartered Accountants of India has also issued a detailed standard (AS6) and guidance notes on accounting for depreciation.

The broad differences between the income tax law and Companies Act in the matter of claim of depreciation are as under:

The income tax law recognises only one method of providing depreciation i.e the written down value method, while the Companies Act permits charging depreciation both by written down value and straight line methods. Accordingly, schedule XIV to the Companies Act provides two sets of rates for charging depreciation.

The rates of depreciation under income tax law are higher than those under the Companies Act.

While the Companies Act permits depreciation for double and triple shifts on the plant and machinery, the income tax law has given up this method.

The Income Tax Act currently provides depreciation on the block of assets whereas the Companies Act provides it on an individual asset basis.

Until 1988, the latter allowed depreciation as per the schedule rates prevailing under the income tax rules. However, when the income tax rates were enhanced, this relationship got terminated and a new schedule XIV was incorporated through the Companies (Amendment) Act 1988.

A few changes have also been proposed in the Companies Bill 1997. Clause 155 stipulates that managerial remuneration must be computed in the manner outlined in Clause 252. However, the new Clause 160 provides that before declaring or paying dividends for any year, a company will have to provide for depreciation to the extent not provided for in ten previous financial years. Schedule III specifies the rate at which depreciation must be calculated. It contains a simplified table for single/multiple shift, both for written down value and straight line methods.

The maximum rate of depreciation has been reduced to 50 per cent as against 100 per cent for certain assets in the income tax bill. The number of blocks of depreciable assets which is eight at present will be reduced to four. However, assets which have a short-life and have to be replaced every year, will not be listed in the income tax rules and would be allowed as revenue expenditure.

It is rather unfortunate that an identical set of rates under both the Acts could not be worked out. The two groups associated with drafting the individual bills did not make serious attempts to arrive at an agreement on the issue.

In this regard, the Income Tax Expert Groups remark that it was found that it may not be possible to fully align the depreciation rates in the two Acts sounds unconvincing as no clear reasons have been given for this view.

As of now a company must consider two methods of writing off depreciation. First, in its account books to be maintained under the provisions of the Companies Act; and second, for calculating income under the Income-tax Act. There is no justification for this double exercise.

A company which provides depreciation as per the Companies Act shows a lower quantum of depreciation but claims a higher amount under the IT Act. As a result the book profit as per the accounts under the Companies Act is higher than that computed under the income tax law.

At times, the liability under the income tax law becomes nil because of the high rates of depreciation under the Act. This leads to the enactment of provisions like Sections 155J, 115JJ, 115JJA, which results in unnecessary litigation and waste of time and energy.

This difference in treatment has no justification. Therefore, attempts should be made to bring in uniform rates of depreciation and adopt the same method for working out the depreciation in both the Companies Act and the Income Tax Act.

Provision Subject Clauses in the New Bill

Sec.198 Determination of profits for calculating 155

ceiling on maximum managerial remuneration

Depreciation is to be deducted for arriving

Sec.205 Payment of dividend to be only out of profits 160 arrived at after providing for depreciation as per section 205(2)

Sec.349 Depreciation to the extent specified in section 252 350 shall be deducted for the purpose of arriving at net profits of the company {Section 349(4)(k)}

Sec.350 Ascertainment of depreciation 253

Schedule VI Disclosure requirements as to depreciation Sch.I

Schedule XIV Rates of depreciation Sch.III