The Depreciation Scenario

The Finance Bill 1996 provided for a number of changes concerning grant of depreciation in computing the taxable income of taxpayers. Some of it was to liberalise the grant of depreciation and some to check the misuse of this benefit specially by under takings engaged in the business of leasing.

It is now well established that depreciation i.e diminution in the value of an asset consequent to user is as valid a charge against the profits of a company for tax purposes as any other expenditure like rent, electricity, salaries and wages etc. However, over the years, the provisions for depreciation concerning income tax have been liberalised to compensate an assessee not only for the loss in asset value, but also as an incentive guided by tax policy considerations. This has caused complications and has tempted people to use depreciation as a tax shelter to avoid or lessen the burden. The leasing companies, it is felt, have misused this benefit to unintended limits.

 

The Finance Bill proposed four-fold changes concerning depreciation as under:

The benefit of depreciation is to be extended to limited/fractional owners also. The SC had held in the case of Seth Banarsi Dass Gupta vs CIT (1987) 166 ITR 783 (followed in B V K Seshavataram vs CIT (1994) 210 ITR 633 (AP) that depreciation under Section 32 of the Act would not be admissible to limited/fractional owner of assets. To overcome the effect of this decision in the context of the modern trend of joint financing of big capital intensive projects by a consortium of financiers having fractional shares in the assets, Section 32 (1) was proposed to be amended to the effect that the assets should be owned wholly or partly by the assessee.

This is obviously a beneficial provision keeping with the changes in the IT Act.

A new explanation (4A) has been added to Section 43(1) of the IT Act defining the meaning of the phrase actual cost, to provide that where before the date of acquisition by the assessee the assets were at any time used by any other person and depreciation has been claimed in respect of such assets, and these are later transferred by way of lease, hire or otherwise, then the actual cost of these assets shall be the same as the written down value at the time of first transfer.

This change has been made to check the misuse of the claim in leasing business.

In cases of amalgamation and succession in business, the law has been changed to check excessive claim for depreciation by restricting it to the amount of the aggregate depreciation in the ratio of number of days for which the assets were used by the predecessors/amalgamating/amalgamated companies so that depreciation claim in its entirety does not exceed 100 per cent of the claim in a year.

The most opposed amendment proposed in the Finance Bill was that which restricted the benefit of carry-forward and set off of unabsorbed depreciation to a limited period of six years so as to bring it at par with carry-forward and set off business losses. Under Section 32(2), as interpreted by courts, unabsorbed depreciation can be set off against income under any other head for the same year, and can also be carried forward and set off against the income for the succeeding years ad infinitum.

The proposed amendment in the Bill put a curb on such set off by providing that if depreciation allowance relating to a particular business cannot be fully set off against the profits of that business, or if there are no profits from that business for that year, the unabsorbed portion could be set off against the profits of any other business for the same year (but not against income under any other head). If any portion still remained unabsorbed, it could be carried forward to the succeeding assessment years (not exceeding eight such years), provided that the business for which the allowance was originally computed continued to exist during the relevant previous years. According to the finance minister, the restrictions proposed were meant to promote efficiency in industry.

On taxpayers demands, there had been some softening of the provisions as under:

The amendment concerning set off of unabsorbed depreciation in only eight years in future is prospective in nature. The cumulative unabsorbed depreciation brought forward as on April 1, 1997 can be set off against taxable business profits or income under any other head for assessment year 1997-98 and seven subsequent assessment years. Therefore, the proposed change will have effect only after eight years and there is no cause for immediate concern about its likely impact on industry.

Eight years is a period long enough for industry to adjust itself to the new dispensation and provide for depreciation accordingly. This time limit shall not apply to sick companies, during the period when they are treated as sick under the Sick Industrial Companies (special provisions) Act, 1985.

The depreciation for the year can be set off not only against business income but also against income under any other head, as is the case with the set off of business losses.

Thus the rigour concerning carry-forward and set off has been considerably diluted.

The provision to limit the set off to eight years is logical. An undertaking which cannot absorb its claim of depreciation even in eight years is not fit to get the tax benefit indefinitely. A tax benefit cannot be availed of for an indefinite period irrespective of the inefficiency in running the enterprise.