Depreciation is a crucial accounting concept that reflects the reduction in value of a fixed asset over time due to usage, wear and tear, or obsolescence. Both the Companies Act, 2013 and the Income Tax Act, 1961 address depreciation, but they differ significantly in terms of methods, rates, and applicability. This blog will compare depreciation as per the Companies Act, 2013 and the Income Tax Act, 1961, providing an in-depth understanding of their differences and implications.
1.Depreciation Under the Companies Act, 2013 :
The Companies Act, 2013 mandates the accounting treatment for depreciation for companies in India. Depreciation is accounted for as per the provisions laid down in Schedule II of the Companies Act, which outlines the rates, methods, and other criteria for depreciation on various fixed assets.
Key Features of Depreciation as per the Companies Act, 2013:
a) Method of Depreciation:
- The Companies Act allows two methods of depreciation: the Straight-Line Method (SLM) and the Written Down Value (WDV) Method.
- SLM is used where the asset’s benefit is expected to be uniform over its useful life.
- WDV is used when the asset’s usage or benefit decreases over time at a higher rate in the earlier years.
b) Useful Life of Assets:
- Schedule II provides specific useful lives for different classes of assets, which companies must adhere to while calculating depreciation.
- The useful life may be reviewed periodically, and adjustments can be made if required.
c) Residual Value:
- A residual value is considered in calculating depreciation, and the minimum residual value is generally taken as 5% of the original cost of the asset.
- The residual value should not exceed the asset’s cost, unless specifically indicated.
d) Depreciation on Revalued Assets:
- If an asset is revalued, depreciation must be calculated based on the revalued amount, with the accumulated depreciation adjusted accordingly.
- Revaluation surplus may be credited to a revaluation reserve
e) Transition to New Provisions :
- For assets existing as of April 1, 2014, companies were required to adopt the provisions of Schedule II for depreciation calculation, considering the remaining useful life of assets.
Rates of Depreciation :
- The rates for depreciation are provided for various categories of assets under Part C of Schedule II of the Companies Act, 2013. For example:
- Buildings: 5% (SLM) or 10% (WDV)
- Furniture & Fixtures: 10% (SLM) or 20% (WDV)
- Machinery: 15% (SLM) or 25% (WDV)
2. Depreciation Under the Income Tax Act, 1961 :
Depreciation under the Income Tax Act, 1961 is governed by Section 32 of the Act. The Income Tax Act provides specific rates of depreciation on assets used for business or professional purposes, primarily to calculate taxable income.
Key Features of Depreciation as per the Income Tax Act, 1961:
1. Method of Depreciation:
- The Income Tax Act mandates the Written Down Value (WDV) method for calculating depreciation.
- SLM is not allowed for tax purposes. Depreciation is deducted from the WDV of the asset each year.
2. Rates of Depreciation:
- The Income Tax Act specifies different rates for various categories of assets, which are subject to change through Finance Acts.
- These rates are typically higher compared to the Companies Act to encourage investment.
Example of depreciation rates under the Income Tax Act:
- Buildings: 10% (if used for business or office)
- Furniture and Fittings: 10%
- Machinery and Plant: 15% (general category), 40% (computers and related equipment)
3. Accelerated Depreciation:
- The Income Tax Act offers higher depreciation rates on certain assets (e.g., computers, windmills, and solar power systems) to incentivize businesses to invest in specific assets.
- This is designed to promote capital investment and growth in sectors like technology and renewable energy.
4. Depreciation on Revalued Assets:
Revaluation of assets does not affect depreciation for tax purposes. Depreciation is calculated on the original cost of the asset, irrespective of any revaluation.
5. Additional Depreciation:
- A business can claim additional depreciation of 20% on new machinery and plant (excluding office buildings) in the first year of purchase, subject to certain conditions.
6. Block of Assets:
- Depreciation is calculated on a block of assets, where assets of similar nature are grouped together. The block is depreciated at a prescribed rate on the aggregate cost of the block rather than individual asset cost.
Key Differences Between Depreciation under the Companies Act, 2013 and the Income Tax Act, 1961 :
| Aspect | Companies Act, 2013 | Income Tax Act, 1961 |
| Method of Depreciation | Straight Line Method (SLM) and Written Down Value (WDV) | Only Written Down Value (WDV) |
| Rate of Depreciation | As per Schedule II of the Companies Act (specific rates) | Prescribed under Income Tax Act (usually higher rates) |
| Asset Classification | Specific life for each class of asset (Schedule II) | Assets grouped into blocks (e.g., machinery, building) |
| Revaluation | Depreciation is recalculated based on revalued amount | Depreciation is based on original cost, even if assets are revalued |
| Additional Depreciation | Not available | Available for new machinery (20% in the first year) |
| Treatment of Residual Value | Minimum residual value of 5% is considered | No specific residual value; depreciation is calculated on WDV |
Conclusion :
Both the Companies Act, 2013 and the Income Tax Act, 1961 provide mechanisms for calculating depreciation, but with different objectives. The Companies Act governs the accounting of depreciation for financial reporting, while the Income Tax Act focuses on providing tax benefits to businesses. For businesses, it is essential to understand both frameworks to ensure compliance with financial reporting standards and optimize tax planning. In most cases, the depreciation calculated under the Income Tax Act will differ from the depreciation under the Companies Act due to differences in rates, methods, and criteria
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