S.

32 Understanding Deprecation with latest case laws

Depreciation a non-cash expenditure allowed under Income Tax Act, 1961

following block concept. Under the block concept, all the assets falling within the
same class and subject to same rate of depreciation are clubbed together and
considered as single asset. Any alterations to the value of the block have to be
strictly in accordance with the provisions of Chapter IV D of Income Tax Act,
1961.
As per section 32 of Income Tax Act, 1961, a assessee is entitled to claim
depreciation on fixed assets only if the following conditions are satisfied:
1. Assessee must be owner of the asset registered owner need not be
necessary.
2. The asset must be used for the purposes of business or profession.
3. The asset must be used during the previous year.
The use of the asset during the previous year may be active use or passive [ie.,
kept ready for use]. I shall elaborate this topic at later part of this article
Now let us go through the recent Judicial decisions in respect of
deprecation.
In the recent case of CIT v. Star Resorts (P) Ltd . (P&H) 335 ITR 587 it was held
that Depreciation cannot be determined on the basis of estimate.
Assessee obtained delivery of the new aircraft purchased by it in the later half of
the relevant previous year and got the same insured, it was held that the aircraft
was made ready to use in business , hence depreciation was allowable.(Asst year
1996-97) . Refer CIT v E.I.H. Ltd. 54 DTR 249
Kochi ITAT decided that when assessee, a charitable body, has already claimed
deduction for acquisition of capital assets by application of money, a further
claim of depreciation on same assets would amount to double benefits .
Depreciation under section 32 was allowable to the assessee company on the
assets which were purchased in the name of the managing director of the
assessee company and his wife but, used exclusively for the assessees business.
(A. Y. 2004-05). Refer, CIT vs. Metalman Auto P. Ltd. 52 DTR 385.
It was held by Honble Mumbai Tribunal that where cost of fixed assets was
adopted by assessee on basis of registered valuers report and there was no
evidence of transaction a collusive one, or to reduce tax liability and there being
no clause for payment of goodwill, the assessee was entitled to depreciation on
actual cost shown in the books of accounts. (A. Y. 2000-01). Refer, Dy. CIT vs.
Lafarge India Ltd. 9 ITR 118 (Mum.)(Trib.).

Hirer of an asset under hire purchase agreement is entitled to depreciation in

view of the CBDT Circular No. 9 dt 23-3-1943 (C & P Vol. 10. P. 537 -538 4th
Edition). (A. Y. 1995-96). Refer, IT vs. Kaveri Engineering Industries 53 DTR 102
(Mad.)(High Court).
In the case of Chowgule & Company v ACIT, it was held that mere accounting
entries do not give right to assessee to claim depreciation on goodwill.
An assessee should not be deprived of benefit of depreciation u/s 32 for not
running its factory due to adverse law and order situation. Refer, CIT v Norplex
Oak India 10 Taxmann.com 163.
After the amandment of sec 32, depreciation is to be allowed on tangible &
intangible assets irrespective of fact that there is no erosion in value of these
assets. Refer Eypore Sugar Company Limited v ACIT 9 Taxmann.com 122.
Assessee is entitled to claim depreciation on plant and machinery even if it is
used during the year for trial production. Refer, CIT vs. Mentha & Allied Products
47 DTR 284 (All). Again , Depreciation is allowable even where trialrun
production takes place. Refer, Finolex Cables Ltd 29 SOT 595
If the assessee have merely financed the vehicles and borrowers are registered
owners of such vehicles it would be a loan transaction and in such case the
assessee will not be entitled to depreciation on such vehicles, on the other hand,
if the vehicles are purchased by the assessee and retained their ownership with
registration in their name and the vehicles were either given on lease or given
under hire purchase agreement giving an option to the hirer to purchase if after
the payment of lease rentals or hire charges during the agreed period, then the
assessee will be entitled to depreciation, matter remanded for consideration.
Refer , CIT vs. Manappuram Central Finance & Leasing Ltd. (2010) 46 DTR 323
(Ker.).
Actual user of the machinery was not required with respect of discarded
machinery and condition for eligibility for depreciation that the machinery being
used for the purpose of the business would mean that the discarded machinery
was used for the purpose of the business in the earlier years for which
depreciation has been allowed. Refer, CIT vs. Yamaha Motor India Pvt. Ltd (2010)
328 ITR 297 (Delhi).
In the case of CIT v Paliwal Glass Works 326 ITR 407 it was decided that Subsidy
received from State government for specific purpose of purchase of generator
set. Subsidy to be deducted in computing actual cost
In case of expenditure on leased premises in order to make it fit for assessees
business, if any extra facility was created by way of brick works and connected
expenditure, the same would be a capital expenditure eligible for depreciation
under explanation 1 to s. 32(1) and if not, the expenditure would be revenue in
nature covered by s. 30(a)(ii). Refer, EDS Electronic Data Systems (India) (P)
Ltd. (2009) 23 DTR 10 (Del)(Trib).

Scrap value of the assets which have been written off during the year is to be
reduced from the WDV of the block of assets for the purpose of allowing
depreciation and not of the individual assets. Refer, Xerox India Ltd. (2010) 127
TTJ 84 (Del).
Defective machineries found during trial run Whether depreciation is allowable
on machineries which were brought for business purpose and found to be
defective after the trial installation. Held, Yes. The defective machineries cannot
be said that they were not for business purposes. Hence, the claim is allowable.
Sri Chamundeshwari Sugar Ltd. 223 CTR 423.
In the case of G R Shipping 309 ITR 125 it was decided that The assessee,
engaged in shipping business, owned a barge which was included in the block of
assets. The barge met with an accident and sank on 6.3.2000 (AY 2000-01). As
efforts to retrieve the barge were uneconomical, the barge was sold on as-iswhere-is in May 2001 (AY 2002-03). As the barge was non-operational and not
used for business at all in AY 2001-02, the AO denied depreciation. On appeal by
the assessee, the Tribunal took the view that after the insertion of the concept of
block of assets by the T.L. (A) Act, 1988 w.e.f. 1.4.1988 individual assets had
lost their identity and only the block of assets had to be considered. It was held
that the test of user had to be applied upon the block of assets as a whole and
not on individual assets. On appeal by the Revenue, the High Court dismissed
the appeal holding that the issue was squarely covered in favour of the assessee
by its earlier judgments in Whittle Anderson 79 ITR 613 and G. N. Agrawal 217
ITR 250.
As per s. 32(1) the asset is to be owned and used for the purpose of business
or profession, the expression used for the purpose of business when applied to
block asset would mean use of block asset and not any specific items in the said
block as individual assets have lost their identity after becoming inseparable part
of the block asset. Refer, Bharat Aluminium.
The Supreme Court held that in case of manufacturer of tea, by virtue of rule 8D,
only 40% of the income is taxed and consequently in deciding liability only
proportionate depreciation is required to be taken in to account as that is the
depreciation actually allowed. Refer, Doom Dooma India Ltd. 310 ITR 392 (SC).
Assessee having sold the machinery and then acquired the same on lease and
lease rental was also paid, it could not be said that transaction was sham or a
device, and therefore depreciation was allowable. Refer, Punjab State Electricity
Board. 30 DTR 153.

The expenses incurred by Assessee towards training fees of its personnel before
setting up of plant were to be capitalized as part of plant and machinery and
depreciation was to be allowed in respect of the same. Refer, Gujarat Guardian
Ltd.

In case of block of assets, in order to allow assessees claim under section 32(1),
use of individual asset for purpose of its business can be examined only in first
year when asset is purchased and subsequent years use of block of assets is to
be examined. Existence of an individual asset in block of assets itself amounts to
use for purpose of business and therefore, depreciation is allowable on it, even
though saidasset is not actually used in course of business during relevant
assessment year. Refer, Swati Synthetics Ltd. vs. ITO 38 SOT 208 (Mum.).
Assessee company having not acquired any special rights of business or
commercial nature in the course of amalgamation of three group companies with
it, the goodwill appearing in its books of account as a balancing figure for the
assets acquired and the price paid is goodwill simpliciter and therefore, it is not
eligible for depreciation. Refer, Borker Packaging (P) Ltd. vs. ACIT 40 DTR 29
(Panaji) (Trib.).
Finance company cannot claim depreciation as they are not the owner. Refer, CIT
v Manappuram General Finance & Leasing Ltd. 5 Taxmam.com 74 Ker.
Assessee is not entitled to depreciation on a plant which is not operation since its
capitilsation. Refer, Sponge Oron India Ltd V DCIT 5 taxmann.co, 58 Hyd ITAT.
However, in the case of CIT v Premier Industries Limited 323 ITR 672 MP. It was
held that even idle machine is entitled for depreciation.
Assessee would be entitled to depreciation and investment allowance on
increased cost of Plant & Machinery resulting from increase in liability to repay
forign currency loand taken for purchase of such plant & Machinery. Refer,
Century Enka Limited V ACIT 188 Taxmann 382 Cal. Again in the case of DDIT V
Staubil A.G. India Taxmann.com 49 Mum -ITAI -2010 it was held that Depreciation
on assets acquired out of foreign currenncy loans: Depreciation on account of
enhanced cost due to fluctuation in forighn rate is an allowable claim.
Original cost of Machine include AMC cost for 10 Years Allow to be capitilsed.
Refer, CIT V D.D. Industries Limited 323 ITR 596.
Assessee not claiming depreciation change of law w.e.f 1.4-2002 deduction in
respect of depreciation will be granted automatically Dr. Mrs. Sudha S. Trivedi Vs
ITO 318 ITR 356.
Unabsorbed Depreciation:
The High Court of Himachal Pradesh in the case of CIT v Kriti Resorts Pvt Ltd
decided that Unabsorbed depreciation for and up to AY 19961997 could be
carried forward and set-off against income chargeable under any head of income
in any subsequent year
Assessee being entitled to deduction under section 10B upto A.Y. 2005-06,
provisions of section 10B (6) are not applicable in the relevant A.Y. ie 2004-05
and therefore unabsorbed depreciation brought forward from assessment years
prior to A.Y. 2000-01 can be set off against business income or against any other

head of income including income from other sources.(Asst year 2004-05). Refer,
Dy CIT v Akay Falvours & Aromatics (P) Ltd 55 DTR 1.
Unabsorbed depreciation of earlier year in which no deduction was claimed u/s
10B is available for set off against other taxable income of subsequent A/Y. Refer,
Patspin India Limited v DCIT 9 Taxmann.com 140.
In case of Acquisation of Fixed Assets, Actual cost of same to be considered for
purpose of section 32 should be actual cost paid by Assessee. Refer, DCIT v
Lafarge India Limited 9 Taxmann.com 40
Assessee company was entitled depreciation in respect of gas sweetening plant
which was kept ready for use but could not be actually used due to lack of
availability of raw material during relevant assessment years. Refer, ACIT v
Chennai Petroleum Corporation (2010) 125 ITD 396 (Chennai).
Once it is found that assets are used for business, it is not necessary that all the
items falling within the block of assets have to be simultaneously used for being
entitled to depreciation. Refer, CIT v. Sonal Gum Industries (2010) 42 DTR (Guj)
159.
Unabsorbed depreciation relating to assessment year 1997-98 to 1999-2000,
cannot be set off in 2003-04 and 2004-05 against income from other sources.
Refer, Dy. CIT vs. Times Guaranty Ltd 4 ITR 210 (Mum.) (Trib.) (SB).
Unabsorbed depreciation could be set off against income from house property till
the provision was amended w.e.f. 1st April, 2002. Refer, CIT vs. SPIC Ltd 37 DTR
177.
The unabsorbed depreciation brought forward as on April 1, 1997 could be set off
against the taxable business profit or income under any other head for the Asst.
Year 1997-98 and even subsequent years. Short term capital gains for the Asst.
Year 1999-2000 can be set off against unabsorbed depreciation brought forward
as on April 1, 1997. CIT vs. Rpil Signalling Systems Ltd (2010) 328 ITR 283
(Mad.).
Unabsorbed depreciation of amalgamated company cannot be deducted while
taking written down value of asset taken over of amalgamated company. Refer,
CIT v Silical Metallurgic LTd 324 ITR 29.
Additional Depreciation :
The ITAT Ahemdabad decided that Whether when Directors report admits that
there is no change in installed capacity of company, a contrary CA report cannot
contradict same to claim additional depreciation. Hence, Assessees appeal
dismissed
In the case of Anurena Tristar v ITO 330 ITR 168 it was decided that No addl
depreciation in case machine was not new.

Production of ready mixed concrete amounts to manufacture or production of

goods and the assessee is entitled to claim additional depreciation under section
32 (1)(iia) on RMC machinery. Refer, YFC Projects (P) Ltd. vs. Dy. CIT (2010) 46
DTR 496 (Delhi)(Trib.).
Windmills installed for electricity generation which did not increase plant
capacity and which was not the core business, additional depreciation is
allowable. Refer, CIT vs. Texmo Precision Castings (2010) Taxation 468 (Mad.).
Additional depreciation disallowed for failure to file audit report in Form 3AA
along with original return Revised return filed within time Technical ground
Disallowance not proper. Refer, CIT Vs Sharda Motor Industrial Limited 319 ITR
109.
Classification of Assets.
Assessee engaged in printing business, used certain hardware for execution of
printing process, said hardware could not be categorized as computer and
would not be eligible for higher depreciation. It is only where machine is being
used essentially and predominantly for computing capability and where it is not
being harnessed for other specialized industrial uses, be it mechanical, electric
or electronic (or a composite thereof) activity that it could be called as a
computer.(A.Y. 2005-06). Refer, S. T. Reddiar & Sons vs. Dy. CIT 129 ITD 475 / 135
TTJ 480 / 49 DTR 326 (Cochin)(Trib.).
Approach road constructed by the assessee inside its factory premises should be
treated as part of building as such, depreciation has to be allowed on the same.
Refer, CIT vs. Sunshine Glass Indus P. Ltd. 49 DTR 31 (Raj.)(High Court).
In view of the amendment of Appendix I w.e.f. Asst. Year 2003-04 allowing
depreciation @ 60 percent on software, depreciation is allowable on expenditure
for development of website @ 60 percent. (A.Y. 2003-04 & 05). Refer, Dy. CIT vs.
C. M. Y. K. Printech Ltd. 53 DTR 59 (Delhi)(Trib.).
Generator is to be depreciate @ 15% not 20%. Refer, CIT v P Glass Works 333 ITR
355.
Depreciation is allowable on specified intangible assets like, license or any other
business or commercial rights of similar nature and not on Goodwil. Refer, Osram
India (P) Ltd. vs. Dy. CIT 51 DTR 297 (Delhi)(Trib).
Purchase of hospital as going concern along with goodwill Assesse entitled for
depreciation. Refer B Raveendran Pillai v CIT 332 ITR 549.
Hardware like danippon screen, electronic plate processor & K rite 510 involved
in execution of prionting Processing by assessee does not qualify to be
categorized as computers and thus not eligible for a highrer rate of depreciation.
Refer, S T Reddia & Sons v DCIT 9 Taxmann.com 133.
Goodwill is entitled for depreciation . Refer CIT v Hindustan Coco Cola Beverages
(P) Limited 331 ITR 192.

Where assessee company received brand name under a scheme of arrangement

under section 391 to 394 of Companies Act 1956, assessee was eligible for
deppreciation in respect of brand name under section 32(1)(ii) of the Income Tax
Act. Refer, KEC International Ltd. vs. Addl. CIT (2010) 41 SOT 43 (Mum.).
Depreciation is admissible on foreign cars used at foreign sites for assessees
business. Refer, CIT v Punjab Chemi.Plants Ltd (2010) 43 DTR (P&H) 322.
Designs and interior decoration work carried out in its office by the assessee
carrying on the business of interior designing for the purpose of demonstrating
its work to the prospective clients and exhibition purpose cannot partake the
character of furniture and fittings but is Plant and is entitled to depreciation
applicable to plant. Refer, Asst CIT v Eskay Agencies (2010) 42 DTR (Chennai)
(Trib) 366.
Routers & Switches are to be included in Block of Computer entitled to
depreciation @ 60% Refer, DCIT v Datacraft India Limited 6 taxmann.com 85
Mum ITAT / 40 SOT 295.
Though JCB has been categorized as an excavator and its main function is
removing soil or earth, yet at the same time, JCBs another function is to carry or
transport removed soil and dump it at another site to discharge function like
transshipment and loading into another vehicle and therefore, for the purpose of
depreciation, JCB can be treated as a motor lorry and it would be eligible for
higher depreciation at 40 percent. Refer, Gaylord Constructions (2008) 175
Taxman 99 (Magz) (Cochin).
Goodwill is not an intangible asset within the meaning of s. 32(1)(11) hence
acquisition cost of goodwill is not entitled to depreciation. Refer, R.G. Keswani
116 ITD 133.
License granted by State Government for collection of toll on a road which
constructed and maintained by the assessee on build, operate and transfer basis
in terms of agreement with the State Government for a fixed period of 16 years
and 9 months is an intangible asset eligible for depreciation as prescribed u/s.
2(1)(ii). Refer, Asoka Info (P) Ltd. 129 TTJ 77 (Pune) (Trib). However, in the case of
Tamil Nadu Road Development Company Ltd. 24 DTR 618 it was held that Road is
not plant but after asst year 1988-89 is included in the category of building for
depreciation as such.
Commercial rights of exploration of mineral oils acquired by assessee by entering
in to production sharing agreement with the Russian Government fall under the
expression any other business or commercial rights of similar nature same
being akin to licence as stipulated in s. 32(I)(ii) and therefore .they are in the
nature of intangible assets eligible for depreciation. Refer, ONGC Videsh Ltd. 33
DTR 22 (Del)(Trib).
Non compete right acquired by the assessee company is eligible for Depreciation
under cl (ii) of s. 32(1) as intangible asset being of the same nature as

business/commercial right of a patent etc mentioned in that clause .Refer,

Medicorp Technologies India Ltd. 21 DTR 69.
Assets purchased and leased back to same person. Assessee entitled to
depreciation. Refer, ICICI Limited 307 ITR 262 (AT)(Mum).
Lease of machinery before end of accounting year, Lessee installing machinery
after end of accounting year is not relevant. The assessee is entitled to
depreciation. Refer, Kotak Mahindra Finance Ltd. 317 ITR 236.
Where the assessee is engaged in the business of leasing out motor trucks and
lorries, is entitled to claim depreciation at the rate of 40 per cent on such leased
out vehicles. Refer, Agarwal Finance Co. (P) Ltd. 28 DTR 102 (Cal).
Membership card of stock exchange would be entitled to claim depreciation on
the WDV of the membership right of the stock exchange. Refer, Kotak Securities
Ltd 24 DTR 214.
Higher rate of depreciation is also admissible when motor lorry is used by
assessee in his own business of transportation of goods on hire. Refer, S.C.
Thakur & Bros. 180 Taxman 348.
Depreciation is allowable on spares which are not actually used but are kept
ready for use. The expression used for the purpose of business includes ready
for use. The spares which are specific to a particular machine may become
useless once the machine is discarded even if not actually used but kept ready
for use. Refer, Insilco 20 DTR 65.
Workers quarters having been leased out as a part of the plant and income
derived as assessed as business income, the assessee was entitled to
depreciation @ 40 percent u/s. 32(1)(iv) in respect of workers quarters. Refer,
Rieta Biscuit Co. (P) Ltd. 31 DTR 89. Similar decision was given in the case of CIT
vs. Bajaj Auto Ltd 322 ITR 29 where it was held that Canteen for workers inside
factory premises, constitutes factory building. Entitled to higher rate of
depreciation.
In order to apply expln. 3 to s. 43(I), AO has to determine the actual cost of the
assets to the assessee which can only mean arms length value or real value or
worth of assets transferred .Burden is on AO to establish that actual cost is not
proper. Refer, Chitra Publicity Company (P) Ltd. 127 TTJ 1(Ahd)(TM).
Goodwill is a bundle of rights which include, inter alia, patents trade marks,
licences franchises, etc and they assume importance in commercial world as
they represent a particular benefit or advantages or reputation built by a
person / company / business house over a period of time and customers
associate themselves with such assets hence depreciation would be allowable on
same. Refer, Kotak Forex Brokerage Ltd. 33 SOT 237.
Depreciation cannot be allowed on Membership card on Stock Exchange. Refer,
Madhur Shares & Stock (P) Limited v ACIT 2010 5 taxmann.com 118 AHD ITAT.

It is impossible to preseume that expression Licence provided in section 32(1)ii)

is an endless expression and even a tenancy right can be brought under it. Refer,
ACIT v malayala Manorama Co Limited 5 taxmann.com 79 Cochin.
Finding that flat fitted with amenties & ready for use and also used for office use,
entitled for depreciation. Refer, CIT V Panacea Biotech Limited 324 ITR 311.
Concept of Block of Assets :
As per the provisions of section 43(6) of the Income Tax Act, the WDV of block of
assets as at start of the year has to be adjusted as follows so as to arrive at
closing WDV:
- It has to be increased by actual cost [as per section 43(1)] of any asset falling
within in the block acquired during the previous year.
- Thereafter, It shall be reduced by moneys payable in respect of asset
sold/discarded/demolished or destroyed during the previous year.
It has been held in Ashok Betelnut Case [ mad. ] that moneys payable represents
gross sale consideration where as the contrary has been held in the case of Essar
Shipping Limited case.
No deletion is permitted from the value of the block except when the asset is
sold, discarded, demolished or destroyed. e.g., in case of theft of an asset, no
deletion is permitted from the block of asset since the asset is neither sold nor
demolished nor destroyed nor discarded.
- Further, scrap value, if any of any asset has to be reduced.
The question of deduction of scrap value from the block arises only when the
asset is not sold.
Now lets analyse a interesting concept arising in relation to claiming of
depreciation. In earlier part of this article, I have laid down the essential for
claiming depreciation. One of the requirements was that asset must be used
during the previous year. For the purposes of Income Tax Act, a previous year is a
distinct unit. In case an asset is discarded by the business but not sold, section
43(6) permits the scrap value of the asset to be reduced from the block in the
previous year in which such asset is discarded. The assessee is entitled to claim
depreciation on the residual value of such discarded asset [ie., Opening WDV of
such asset less scrap value] even though such discarded asset is not used for the
purposes of business or profession in such year and subsequent years.
In case of CIT v. Yamaha Motor India Private Limited (2009) 226 CTR (Del) 304,
the assessee claimed depreciation on discarded assets which were written off
during the previous year. The AO disallowed the claim on the ground that the
assets were not used for the purposes of business during the previous year. It
was held that that the term used appearing in section 32(1) comprise of both
active use and passive use. Further, the expression used for the purposes of
business used in section 32(1) has to be read harmoniously with the term

discarded meaning thereby that the assessee is entitled to claim depreciation

as far as discarded asset is concerned if the asset has been used for the
purposes of business in earlier years. Adopting a realistic approach and
harmonious construction, the expression used for the purposes of business
appearing in section 32 when used in respect of discarded asset would mean
that the use in the business need not necessarily be in the relevant previous year
but in earlier previous years. Any other interpretation would lead to an
incongruous situation because on the one hand the depreciation is allowed on
discarded asset after allowing inter alia adjustment for scrap value, yet, on the
other hand use would be required of the discarded machinery which use is not
possible.
To conclude, the decision of the delhi high court is logical considering the existing
provisions of the Act as regards allowability of depreciation on discarded asset.
Either the Act must permit the residual value of the discarded asset to be written
off completely in the year in which the asset is discarded or the interpretation
adopted in the aforesaid judgement has to be accepted
Depreciation on leasing? An ageing puzzle
Under the Income Tax law, two most important conditions for tax depreciation
claim pertain to ownership and usage of the asset. As is the case on any other
contentious matter, history is replete with judicial pronouncements by courts on
this subject. Though the condition on usage is more or less a settled
issue,ownership condition still continues to keep the judiciary engaged
particularly as new models of businesses are evolving. Entitlement of
depreciation in a lease transaction has witnessed the maximum debate in recent
times. The moot question being who shall be eligible to claim depreciation in a
lease transaction whether the lessor (person who hires or leases the asset for
a consideration) or the lessee (who hires for business use).Before we dwell on
leasing transactions, I must add that the issue on hire purchase is a law which
has been settled way back in 1943. An administrative circular clarifies that where
the terms of agreement provide that the asset shall eventually become the
property of the hirer or confer on the hirer an option to buy the asset,the
transaction shall be regarded as one of hire-purchase and he would be entitled to
depreciation. The administrative guideline was predominantly dealing with a
situation of a movable asset, though, without any specific reference. On the
other hand, a land mark Supreme Court judgement in 1999 in the case of Mysore
Minerals clarified that the condition of ownership must be assigned a wider
meaning any one in possession of property in his own title exercising such
dominion over the property as would enable others being excluded and having
right would be the owner. The fact that a formal deed was not executed and
registered under the law would not be of relevance. In one stroke, the apex court
diluted the definition of ownership and took a liberal view.
Of course, the law was subsequently amended to provide that insofar as the
condition for legal ownership of an immovable property is concerned. In common
parlance, a lease is understood as hiring of an asset for a periodic payment;

parties involved in the transaction are classified as lessor and lessee whilst the
periodic payment to be made by lessee is termed as lease rental. From an
accounting standpoint, simplistically, lease can be classified in three forms
finance lease, operating lease and hire purchase. A lease is classified as a
finance lease if it is for the entire economic life of the asset and under the lease
arrangement all risks and rewards incidental to the ownership of the asset is
transferred to the lessee.
The International Accounting Standards Committee defines finance lease as an
arrangement where all the risks and rewards incident to ownership of an asset
are with the lessee. Any lease other than a finance lease is operating lease. On
the other hand, if under the lease agreement, the lessee/hirer has an option to
acquire the asset at the end of the identified lease period, such arrangement
shall classify as hire purchase.
Interestingly, the last part of definition is in conformity with the 1943 Board
guideline, thereby suggesting the wisdom of the Indian
administration.Admittedly, the line of distinction between a finance lease and a
hire purchase is blurred and leaves a lot to interpretation. Interestingly, the
interpretation of various forms of lease has been ratified and applied by different
courts from time to time; the determination of whether a lease is a finance lease
or operating lease or is in the nature of a hire purchase arrangement depends on
the facts and substance of the transaction rather than the form of such
arrangement. Indian Accounting Standard 19 on Leases provide that in case of
an operating lease, the lessor shall be eligible to claim depreciation in respect of
leased asset; whereas in an finance lease the lessee becomes the economic
owner of the asset and, therefore, should be entitled to claim depreciation on the
leased asset.Under the Income tax Act, 1961, a tax payer is eligible to claim
depreciation on an asset provided the asset is owned by such person and is
being used for the purpose of his business. There is plethora of precedents where
the claim of depreciation has been denied by tax authorities in case either or
both of these tests are not met.The twin tests of ownership and use for
claiming depreciation become even more critical in lease transactions, wherein
the owner of the assets foregoes the possession and use of the asset; whilst the
assets is used by lessee for his business.
The principles governing eligibility of lessor to claim tax depreciation under the
lease arrangement is enunciated by administrative guidance issued by the CBDT
in circulars 9/1943 and 2/2001. These circulars do not distinguish between the
two kinds of lease arrangements and provides that in a lease, other than a hire
purchase, the lessor is eligible to claim depreciation, provided the tests of
ownership and use of the asset are satisfied. The circulars indirectly shows the
thumbs down to accounting treatment of lease by providing that classification of
asset in accordance with Accounting Standard 19 will not have implications on
the allowance of depreciation to the lessor under the income tax laws. After the
issuance of administrative guidance on depreciation in leasing transcations,
there is no ambiguity insofar as depreciation in an operating lease situation is
concerned. On the contrary, in case of finance lease there has been prolonged

controversy over the determination of ownership of the leased asset and

therefore the eligibility of lessor to claim depreciation on the asset leased under
a finance lease arrangement. The principles for claiming tax depreciation
provided unique planning opportunity to taxpayers and throw the issue open for
varying interpretation.Increasingly, finance companies began funding purchase
of asset under a finance lease arrangement. This mechanism enabled the
financing companies to reduce their taxable income base by claiming
depreciation as deduction against the income.
In other instances, the owner of the assets resorted to sale-and-lease back
mechanism with the objective of realising value from tax depreciation on the
asset by enabling the buyer (or lessor) claim depreciation on inflated cost of
asset. However, in most such instances, the courts have held the transaction was
a colourable device to evade taxes and disallowed the deprecation claim. Though
the eligibility of a lessor to claim depreciation in finance lease has been a matter
of debate courts have become increasingly alert on misuse of tax depreciation
shield under the garb of finance lease. In a recent landmark decision of Marico
Industries, a Mumbai Tribunal held that in a finance lease it is the lessee who
becomes the owner of the assets for all economic purposes and therefore the
depreciation on the leased asset shall be available to the lessee and not the
lessor.
The Tribunal applied the principles enunciated by the Apex court in Asea Brown
Boveris case ( though not on a tax related matter ) wherein the court held that a
finance lease is essentially a financing arrangement whereby the lessee assumed
the ownership of the asset in as much as it is the borrower who chooses the
property to be purchased, takes delivery, enjoys the use of occupation of the
property, bears the wear and tear and takes the risk of loss or damage. The
decision of the Tribunal could well prove to be a turning point insofar as the claim
of depreciation in a finance lease in concerned. Though the decision of Tribunal is
not the last word on the question of law; nevertheless the ruling could take away
the heat from long drawn debate over availability of depreciation in a finance
lease Whilst the finality on the issue would need more time, tax payers and tax
advisers would anxiously await the Supreme Courts decision, which is soon
expected to hear a sizeable bundle of appeals arising out of inconsistent High
Court decisions. I would hope that the court would lay down principles, taking
into consideration the inconsistency in the past decisions and align the decision
(to some extent) with definitions under the Indian and International accounting
standards. Of course, the facts of each individual case would be the deciding
factor in each judgment.
Sec 43A of the IT Act Vs. AS 11
Suppose a machine was imported for one lakh US dollars when the exchange
rate was Rs 45 per dollar. Both in the accounting records as well as in the tax
records, the transaction would have been recorded debiting the asset concerned
with Rs 45 lakh. But should the asset be financed by suppliers credit or a
specific borrowing for the purpose, the two records would now start pursuing

divergent courses with any increase in the actual repayment due to devaluation
of the rupee meanwhile vis--vis the dollar, swelling the actual cost of the fixed
asset in the tax records even while leaving the accounting records undisturbed
as it was On the contrary, any appreciation in the rupee vis--visthe dollar would
have the opposite effect in the tax records while leaving the accounting records
undisturbed once again. These then in brief are the respective mandates of
Section 43A of the Income-tax Act, 1961 and Accounting Standard 11 (AS 11). AS
11 does not tinker with non-monetary items which fixed assets are. Instead, any
notional increase or decrease in the rupee liability on the balance sheet date on
the touchstone of the exchange rate prevailing on that date is required to be
recognised with a corresponding debit or credit to the profit and loss
account.Sagacious shift
Prior to the amendment made by the Finance Act, 2002 to Section 43A, a chronic
tinkering was contemplated any increase or decrease in rupee liability in
respect of fixed assets acquired on deferred payment terms or with borrowed
funds on account of fluctuation in the exchange rate between the currency in
which the payment is required to be made vis--vis the rupee, was required to be
added or, as the case may be, subtracted from the actual cost of the fixed asset
each time there was a change in the exchange rate, thus giving rise to the
nightmarish possibility of repeated tinkering with the asset account given the
day-to-day fluctuations witnessed in the currency market, especially if the
currency in which the payment is required to be made happens to be a floating
currency. Mercifully, the amendment made a sagacious shift in favour of
recognising the increase or decrease in such liability only at the time of actual
payment, thus dispensing with the need to chronically tinker with the asset
account for every notional increase or decrease in the rupee liability. To be sure,
the objectives of a fiscal law and accounting standards cannot always be the
same. AS 11 is right on notional increase or decrease in rupee liability being
recognised at the balance-sheet date given the fact that otherwise the balance
sheet would be guilty of under- or over-valuation of a liability. It is also right in
not tinkering with the cost of the fixed asset given the fact that no increase or
decrease in the fair value of the asset accrues merely on the strength of the
gyrations in the currency market.
Cost of asset
One can understand a fiscal law providing for a heightened tax incentive such as
depreciation on fixed asset and pro tanto there would be a divergence between
the written-down value (WDV) of an asset in the tax records vis--vis its
accounting records. While this may be unavoidable, the gulf between the two
sets of records can be bridged by agreeing not to disagree at least on the issue
of the cost of the asset. The I-T Act should allow any increase in the rupee
payment on account of acquisition of a fixed asset as expenditure in one shot
instead of condescending to amortise the same by way of depreciation. And
when there is a reduction in rupee payments, the same should be treated as
income straightaway. AS 11 is not payment fixated like Section 43A. Instead, it
mandates revaluation of all monetary items on the balance sheet date. In other

words, it has a balance sheet fixation which of course is understandable. One

area where the two can converge is the cost of the asset the I-T Act should
emulate AS 11 in not tinkering with it in view of the fact that gyrations in the
currency market by themselves do not add to, or detract from, the value of the
asset.
TAX PLANNING THROUGH DEPRECIATION
DEPRECIATION AS A TOOL FOR TAX PLANNING :
Depreciation can be used as an effective tool for tax planning. According to
section 32 (1), depreciation can be claimed in respect of building, machinery,
plant or furniture and w.e.f. assessment year 1999-2000 depreciation on
intangible assets such as know-how, patent rights, copyrights, trade marks,
licenses, franchises, or any other business or commercial rights acquired on or
after 1.4.98 can also be claimed, which are owned by the assessee and used for
the purposes of business or profession.
It may be noted that for the purpose of depreciation Building includes roads,
bridges, culverts ,wells and tubewells. Likewise, plant and machinery includes
Typewriters, Photocopiers, Telex & Fax Machines, Computers, Tools and Books
(used by the professionals). Depreciation is allowed at prescribed percentage,
which varies between 5% to 100% for various blocks of assets on the written
down value. However, as per second proviso to section 32(1),depreciation shall
be restricted to 50% of the prescribed percentage in respect of such asset which
is acquired by the assessee during the previous year and put to use for the
purpose of business or profession for a period of less than 180 days in that
previous year. Another important point is that the first proviso to section 32(1) ,
which provided for full deduction of the actual cost of any machinery or plant
costing upto Rs.5,000,has been omitted by the Finance Act , 1995 with effect
from Assessment Year 1996 -97. However depreciation on professional books has
been allowed at the rate of 100% with effect from Assessment Year 1996-97.
CLAIMING 100% DEPRECIATION & REDUCING TAX LIABILITY :
Wind mills and other special devices including electric generators and pumps
running on wind energy, bio-gas plant, bio-gas engines, agricultural and
municipal waste conversion devices producing energy and electrically operated
vehicles including battery powered or fuel-cell powered vehicles, solar power
generating systems etc., are some of the items included in machinery and plant
which are eligible for 100% depreciation. An existing industry having
considerable taxable profits may plan diversification in the industries and can
claim 100% depreciation in respect of the new plant and machinery. In the recent
past many companies have successfully done such tax planning, which is
absolutely within the legal frame work and in accordance with the Govt. policy to
promote investments in certain sectors.
IS IT MANDATORY TO CLAIM DEPRECIATION OR IS TAX PLANNING POSSIBLE BY
DEFERRING THE CLAIM ?

In the case of - CIT v. Mahendra Mills and ors. [2000] 243 ITR 56 (SC). Supreme
court has held that the provision for claim of depreciation is for the benefit of the
assessee. If he does not wish to avail of that benefit for some reason, the benefit
cannot be forced upon him. It is for the assessee to see if the claim of
depreciation is to his advantage. Income under the head Profits and gains of
business or profession is chargeable to income-tax under section 28 and income
under section 29 is to be computed in accordance with the provisions contained
in sections 30 to 43A. The argument that since section 32 provides for
depreciation it has to be allowed in computing the income of the assessee
cannot in all circumstances be accepted in view of the bar contained in section
34. If section 34 is not satisfied and the particulars are not furnished by the
assessee his claim for depreciation under section 32 cannot be allowed. Section
29 is thus to be read with reference to other provisions of Act. It is not in itself a
complete code.
If the revised return is a valid return and the assessee has withdrawn the claim of
depreciation it cannot be granted relying on the original return when the
assessment is based on the revised return. Allowance of depreciation is
calculated on the written down value of the assets, which written down value
would be the actual cost of acquisition less the aggregate of all deductions
actually allowed to the assessee for the past years. Actually allowed does not
mean notionally allowed. If the assessee has not claimed deduction of
depreciation in any past year it cannot be said that it was notionally allowed to
him. A thing is allowed when it is claimed. A subtle distinction is there when we
examine the language used in section 16 and sections 34 and 37 of the Act. It is
rightly said a privilege cannot be a disadvantage and an option cannot become
an obligation. The Assessing Officer cannot grant depreciation allowance when
the same is not claimed by the assessee.
NON-CLAIMING OF DEPRECIATION :
Non-claiming of depreciation may at times be more beneficial rather than
claiming it. Accordingly one may plan not to claim depreciation in a particular
year and to claim the same in a subsequent year, in which depreciation can be
claimed at a higher written down value due to non-claiming of depreciation in the
earlier year. In this process the benefit of depreciation is not lost but it is
deferred only.
In the following situations it is advisable not to claim the depreciationi) In case where certain deductions and allowances like brought forward
investment allowance may lapse for insufficiency of profits, in a particular year, if
the depreciation is claimed.
ii) In case of non-corporate assessees expecting higher profit in the subsequent
year or years, if their present income is falling in lower tax bracket, as claim of
depreciation in the subsequent years will help them reducing the taxable profits
and thereby saving tax, which would have been payable at a higher rate
considering the slab rates.

Non-claiming of depreciation may be used for avoiding the provisions of section

50. It may be noted that profit on sale of depreciable asset is treated as Short
Term Capital Gain under section 50. Therefore, if any person desires to hold an
asset for the purpose of re-sale at a future date, particularly in cases where such
asset is retained for such period which may entitle him to claim it as a long term
asset, then it is advisable not to claim depreciation on the same. In such a
process, the profit on sale of the asset will be beyond the mischief of sec. 50 and
shall be treated as Long Term Capital Gain (LTCG). As a result such assessee will
be entitled to the benefit of cost inflation index as well as the concessional rate
of tax on LTCG.
Further w.e.f. assessment year 1997-98 depreciation can be carried forward for 8
assessment years only, as such it has become more important to claim it only in
the year in which taxable profit arises.
CLAIM OF DEPRECIATION ONLY WHEN AN ASSET IS USED FOR BUSINESS :
One of the stipulation for claiming depreciation under section 32(1) is that the
assessee had used the asset for the purpose of business or profession. When an
asset will be considered to have been used, has been a matter of controversy.
Some important Judicial views are as under :Punjab National Bank Ltd. v. CIT 141 ITR 886 (Del.)- That depreciation had to be
allowed in full on the lifts and the air-conditioning plant since they were being
used by the assessee for the purpose of its business, the fact that they might
also be utilised by the tenant of one of the floors or customers or visitors did not
make any difference. Plant or machinery could be said to be used by somebody
else if such other person has control over the same. It is the control which
determines who is using it. User means not only getting benefit, but also
controlling, running, stopping, repairing, replacing, etc.
Whittle Anderson Ltd. v. CIT 79 ITR 613 (Bom.)- The word used should be
understood in a wide sense so as to embrace passive as well as active user ;
when machinery is kept ready for use at any moment in a particular factory
under an express agreement from which taxable profits are earned, the
machinery can be said to be used for the purposes of the business which
earned the profits although it was not actually worked. Western India Vegetable
Products Ltd. v. CIT 26 ITR 151 (Bom.)- When a business is established and is
ready to commence then it can be said of that business that it is set up; but
before it is ready to commence business it is not set up. There may however be
an interval between the setting up of the business and the commencement of
the business and all expenses incurred during that interval would be permissible
deductions.
CWT v. Ramaraju Surgical Cotton Mills Ltd. 63 ITR 478 (SC)- A unit cannot be said
to have been set up unless it is ready to discharge the function for which it is
being set up. It is only when the unit has been put into such a shape that it can
start functioning as a business or a manufacturing organisation that it can be
said that the unit has been set up.

CIT v. Industrial Solvents and Chemicals (P) Ltd. 119 ITR 608 (Bom.)- Even if the
finished product obtained by the assessee could be termed as sub-standard, it
cannot be contended that because the end product then obtained was not of
proper standard, the business of the assessee cannot be said to have been set
up though the plant was being worked.
Grasim Industries Ltd. v. CIT 32 TTJ 329 (Bom-Trib.)- A company need not have
actually commenced production to claim depreciation. It was enough if it was
merely ready to produce. The bench ruled that the plant was ready for
business in fiscal 1992-93, and hence eligible for claiming depreciation.
TREATMENT OF REPAIRS- WHETHER ON REVENUE OR CAPITAL ACCOUNT :
It is more or less an age old tradition to treat only small repairs to an asset as
revenue expenditure. However, there are occasions when heavy repairs are
undertaken and/or one whole item of Plant & Machinery may require
replacement. The taxing authority tends to immediately jump to the conclusion
that the same is on capital account. The assessee also succumbs to the assertion
of the authorities under ignorance of law. The result, no appeal thereby inviting
heavy taxation.
Some situations when repairs/replacement may be treated as Revenue
expenditure and Capital expenditure are given below 1. A factory has got 2 or
3 electric motors. If one of them is worn out and replaced by a new motor of
similar capacity involving a heavy cost, in such case, the expenses would be
treated as revenue expenditure. The entirety of Plant & Machinery in a factory is
to be treated as one unit capable of carrying on the business. If any one part of
that unit, say an electric motor in this instance, is replaced by another motor of
similar capacity, it is a repair to the whole gamut of Plant & Machinery and
therefore allowable as revenue expenditure.
2.If the same factory is reconstructed by replacing the old Plant & Machinery by
new ones of bigger capacity then it will be a clear case of reconstruction and the
cost of new Plant & Machinery will be treated as capital expenditure.
3.If a wall is constructed as covered by the obligation of a tenant as per
conditions of a leasehold property, such cost incurred for reconstruction of the
wall will be treated as revenue expenditure. It is a case similar to the
replacement of a few units of worn out railway track by a company out of its
entire long track, which was held as revenue expenditure by the courts.
4.Cost of replacement of petrol engine of a bus by a diesel engine to continue to
run it will also be treated as revenue expenditure.
5.A fleet owner purchases a second hand car with a view to use its parts to
repair his own other cars. It is a simple case of revenue expenditure as the car
was purchased for using its parts to repair the other cars and not to run it as a
car.

6.A company undertook extensive repairs to its own building by

repairing/replacing some columns and beams and plastering with cement with
the process of guniting which involves heavy expenses. As in such case no
structural alteration was made to the building and the assessee carried out only
those repairs which were absolutely necessary to preserve and maintain the
building, the expenditure was not capital expenditure. The magnitude of the
repair was in consonance with the magnitude of the wear and tear the building
had suffered.
7.A Company doing business in automobile parts takes lease of an old building,
the owner of which is incapable of repairing/reconstructing the same. The lessee
company wants to reconstruct the building at its own cost to run its business. In
such a case, it may be stated that expenditure was incurred to relieve the
assessee from a series of future revenue outgoings and therefore the
expenditure would be on revenue account and therefore allowable as such.
8.Expenses incurred on arrear repairs to restore the property to usable state are
treated as revenue expenditure.
9.In case heavy expenses are incurred for extensive repairs to a lease property
without bringing into existence a new asset, the cost incurred had to be allowed
as general revenue expenditure, even if not as current repairs.
10.In case of a cinema hall premises taken on monthly rent with no long term
lease if expenses are incurred to remove defects in cinema building pursuant to
direction of an order of the District Magistrate in order to get a renewal of the
cinema hall license, the entirety of such expenses partakes the nature of repairs
under a statutory direction. The same are therefore allowable as general revenue
expenditure.
11.Magnitude of an expenditure on repairs is immaterial consideration in
deciding whether it is on a revenue account or capital account. It is the nature of
alteration, renovation, repairs etc. which is relevant.
12.Due to fire in factory and office premises, as also residential quarters of the
Managing Director, if expenses are incurred for repairs and reconstruction, such
expenditure incurred for putting the original building in proper working shape
does not bring into existence a new building. As such the same is considered as
revenue expenditure
13.An assessee manufacturing cars contributed an amount necessary to improve
nearby approach roads belonging to the Government. The money spent was not
to bring about any asset or advantage of enduring benefit to the assessee, but to
run the business effectively and conveniently and hence, in such case the
amount is deductible as revenue expenditure, though it was spent voluntarily by
the assessee in view of business interest.
14.If expenses are incurred by a cotton mill towards remodelling of furniture in its
own retail depots, such expenditure is deductible on revenue account.

15.If an assessee has taken three buildings on a short term lease and effected
improvement to those by construction of partition walls, wall panelling, show
windows etc. the expenses so incurred will be treated on revenue account in
view of the facts that the assessee was not the owner of the premises and there
was no longer term lease in favour of the assessee.
FACTORS RELEVANT TO DETERMINE THE NATURE OF EXPENSES ON REPAIRS :
1.If the repair is not resulting into a new asset or any additional asset, it will be
revenue expenses otherwise it will be capital expenditure.
2.If the expenses are incurred on ground of commercial expediency, the same
may be considered as revenue expenditure.
3.If any expenses are essentially incurred for reconstruction or modification as
per direction of any statutory authority, it may be treated as revenue
expenditure.
4.In determining the nature of expenditure, the nature of assessees business
and overall circumstances have to be considered. No uniform test can be applied
to all situations.
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