Depreciation and its Statutory Background in relation to Business Assets

Table of Content

1. Statutory Background

2. Concept of Depreciation

3. Statutory Background of Section 32(1)(i) – Section 32(1)(i)

4. Statutory Background of Section 32(1)(ii) – Section 32(1)(ii)

5. Ownership of Assets

6.  Used for the purposes of business or profession

Check out Taxmann's Master Guide to Income Tax Rules which covers an in-depth Rule-wise commentary on the Income Tax Rules 1962 in simplified language. The text is supplemented with a statutory background, case laws, illustrations, circulars & notifications, etc. It incorporates all amendments up to Income-tax (Third Amendment) Rules 2023.

1. Statutory Background

1.1 “Assets”, defined [Explanation 3 to section 32(1)]

For the purposes of section 32(1), the expression “assets” shall mean:

(a) Tangible assets – buildings, machinery, plant or furniture;

(b) Intangible assets – know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, not being goodwill of a business or profession.

1.1.1 “Know-How”, defined [Explanation 4 to Section 32(1)]

As per Explanation 4 to section 32(1), the expression “know-how” means any industrial information or technique likely to assist in the manufacture or processing of goods or in the working of a mine, oil-well or other sources of mineral deposits (including searching for discovery or testing of deposits for the winning of access thereto).

1.1.2 Farm-in Expenditure Incurred by Oil Exploration & Production Companies, Clarification

‘Farm-in expenditure’ is incurred when an entity in the line of business of Oil Exploration & Production acquires a participating interest (PI) from another entity(s) in oil/gas block(s) and becomes part of the Production Sharing Agreement entered into with the Central Government. It has been clarified that amount paid for acquiring the participating interest (PI) shall not be treated either as cost for acquiring the share in partnership or investment for acquisition of a member’s interest in an AOPs or BOIs, rather it would be treated as an amount paid to acquire the underlying assets; and the amount paid for acquiring the PI (after reducing component of cost attributable to tangible assets) would be treated as an intangible asset (being a business or commercial right akin to a licence) which is eligible for claim of depreciation—vide Circular No. 20/2019, dated 19-8-2019.

1.1.3 “Goodwill of a Business or Profession”, No Longer an Asset for the Purposes of Depreciation Allowance

‘Goodwill’ denotes the benefit arising from connection and reputation. The original definition by Lord Eldon in Cruttwell v. Lye (1810) 17 Ves 335 that ‘goodwill’ was nothing more than the probability that the old customers resort to the old places was expanded by Wood V.C. in Churton v. Douglas (1859) John 174 to encompass every positive advantage that has been acquired by the old firm in carrying on its business, whether connected with the premises in which the business was previously carried on or with the name of the old firm, or with any other matter carrying with it the benefit of the business. In Trego v. Hunt (1896) AC 7, Lord Herschell described ‘goodwill’ as a connection which tended to become permanent because of habit or otherwise. The benefit to the business varies with the nature of the business and also from one business to another. No business commenced for the first time possesses goodwill from the start. It is generated as the business is carried on and may be augmented with the passage of time – CIT v. B. C. Srinivasa Shetty [1981] 5 Taxman 1 (SC).

In IRC v. Muller & Co.’s Margarine Ltd., (1901) AC 217, although ‘goodwill’ was easy to describe, it was nonetheless difficult to define. In a progressing business, goodwill tends to show progressive increase. And in a failing business, it may begin to wane. Its value may fluctuate from one moment to another depending on changes in the reputation of the business. It is affected by everything relating to the business, the personality and business rectitude of the owners the nature and character of the business, its name and reputation, its location, its impact on the contemporary market, the prevailing socio-economic ecology, introduction to old customers and agreed absence of competition. There can be no account in value of the factors producing it. It is also impossible to predicate the moment of its birth. It comes silently into the world, unheralded and, unproclaimed and its impact may not be visibly felt for an undefined period. Imperceptible at birth it exists enwrapped in a concept, growing or fluctuating with the numerous imponderables pouring into, and affecting, the business.

It has been horticulturally and botanically viewed as ‘a seed sprouting’ or an ‘a corn growing into the mighty oak of goodwill’. It has been geographically described by locality. It has been historically explained as growing and crystallising traditions in the business. It has been described in terms of a magnet as the ‘attracting force’. In terms of comparative dynamics, ‘goodwill’ has been described as the ‘differential return of profit’. Philosophically, it has been held to be intangible. Though immaterial, it is materially valued. Physically and psychologically, it is a ‘habit’ and sociologically, it is a ‘custom’. Biologically, it has been described as Lord Macnaghten in Trego v. Hunt (1896) AC 7 as the ‘sap and life’ of the business. Architecturally, it has been described as the ‘cement’ binding together the business and its assets as a whole and a going and developing concern – CIT v. Chunilal Prabhudas & Co. [1970] 76 ITR 566 (Cal.).

The law laid down in the judgment of CIT v. Smifs Securities Ltd. [2012] 24 taxmann.com 222/210 Taxman 428 (SC), where it has been held that goodwill of a business or profession is a depreciable asset u/s 32 and, hence, the calculation of depreciation should be made in accordance with various other provisions of the 1961 Act [such as in case of amalgamation/succession/demerger, written down value, actual cost, etc.] has been negated and overturned by the Finance Act, 2021 for and from AY 2021-22.

While applying other provisions of the Act, it can be seen in some cases (such as business reorganisation) that there could be no depreciation on account of actual cost being nil whereas in other cases (such as acquisition of goodwill on purchase), there could be legitimate claim of depreciation in accordance with the law laid down by the Hon’ble Apex Court. However, in reality, goodwill is not a depreciable asset and depending upon the running of one’s business, goodwill may see appreciation or alternatively, no actual depreciation to its value. Therefore, there may not be a justification of depreciation of goodwill in the like manner as provided for other intangible assets. Accordingly, the Finance Act, 2021, provides that the goodwill of a business or profession shall not be considered as a depreciable asset (w.e.f. 1-4-2021) and, hence, such goodwill shall not be eligible for depreciation u/s 32. Therefore, one can conclude that goodwill has been equated with land in terms of providing depreciation thereon, i.e., no depreciation.

It has been provided that in a case where goodwill is purchased by an assessee, then such purchase price of that goodwill will continue to be considered as cost of acquisition for the purpose of computation of capital gains u/s 48 subject to the condition that if any depreciation was obtained by the assessee in relation to such goodwill prior to AY 2021-22, then such depreciation shall be reduced from the amount of the purchase price of the goodwill.

Amendment by the Finance Act, 2021 to the effect that no depreciation was allowable on goodwill would take effect from 1-4-2021 and would be applicable for and from AY 2021-22 – I & B Seeds (P.) Ltd. v. DCIT [2022] 142 taxmann.com 274 (Bang. – Trib.).

2. Concept of Depreciation

As per Black’s Law Dictionary, ‘depreciation’ to mean

“a fall in value; reduction of worth. The deterioration, or the loss or lessening in value, arising from age, use, and improvements, due to better methods. A decline in value of property caused by wear or obsolescence and is usually measured by a set formula which reflects these elements over a given period of useful life of property… Consistent, gradual process of estimating and allocating cost of capital investments over estimated useful life of asset in order to match cost against earnings….”.

Allowance for depreciation is to replace the value of an asset to the extent it has depreciated during the period of accounting relevant to the assessment year and as the value has, to that extent, been lost, the corresponding allowance for depreciation takes place – P. K. Badiani v. CIT [1976] 105 ITR 642 (SC).

Depreciation is the monetary equivalent of the wear and tear suffered by a capital asset that is set aside to facilitate its replacement when the asset becomes dysfunctional – I. C. D. S. Ltd. v. CIT [2013] 29 taxmann.com 129/212 Taxman 550 (SC).

Depreciation is an allowance made for wear and tear of tangible assets and the principle factors responsible for reduction in value of a capital asset are:—(1) ordinary wear and tear; (2) unusual damage; (3) inadequacy; and (4) obsolescence. Hence, even by mere passage of time, there could be reduction of value of the assets – CIT v. Punalur Paper Mills Ltd. [2019] 111 taxmann.com 50/[2020] 268 Taxman 47 (Ker.).

The very concept of depreciation suggests that the tax benefit on account of depreciation legitimately belongs to one who has invested in the capital asset, is utilizing the capital asset and thereby loosing gradually investment caused by wear and tear, and would need to replace the same by having lost its value fully over a period of time – Mysore Minerals Ltd. v. CIT [1999] 106 Taxman 166 (SC).

2.1 Depreciation, a Mandatory Deduction [Explanation 5 to Section 32(1)]

With effect from 1-4-2002, it has been explicitly declared that whether or not the assessee has claimed deduction in respect of depreciation (of eligible assets) while computing his total income, such deduction shall be given mandatorily and compulsorily to that assessee. Therefore, depreciation is a mandatory deduction to be given effect to while computing total income and not an optional deduction.

The claim of depreciation does not have a direct, linear or proportionate relationship with capacity utilization. Even without actual utilization of the plant and machinery, depreciation can still be claimed as a deduction.

The depreciation has to be allowed to an assessee under the provisions of the statute, which lays down how profits and gains shall be computed after making the allowances mentioned thereunder, which includes depreciation allowance on specified assets. This therefore is not a matter depending on the genuineness of the books of account – Allahabad Glass Works v. CIT [1961] 42 ITR 439 (All.). The fact that the accounts are defective has nothing to do with the assessee’s claim for depreciation allowance – P. Appavu Pillai v. CIT [1965] 58 ITR 622 (Mad.).

Where the finding was that the assessee has set up his business in the relevant previous year, depreciation could not be disallowed on the ground that the assessee had not commenced commercial production – CIT v. Kanoria General Dealers (P.) Ltd. [1986] 26 Taxman 216 (Cal.).

2.1.1 Depreciation in case of exempted asset/income

Depreciation is to be allowed even on assets, entire expenditure on purchase of which has already been exempted – CIT v. Krishi Upaj Mandi Samiti, Timarni [2013] 34 taxmann.com 277/216 Taxman 172 (Mag.) (MP).

Notional depreciation is to be claimed even for the period during which income wasn’t chargeable to tax – CIT v. U. P. State Warehousing Corporation [2013] 36 taxmann.com 442/217 Taxman 252 (All.).

2.2.2 Depreciation as per Income Tax Act is to be Considered

While assessing income, the assessing authority is required to take into consideration the depreciation as provided under the Income-tax Act, 1961, and not as provided under the Companies Act, 2013 – CIT v. Pushparthy Packs (P.) Ltd. [2014] 42 taxmann.com 106/221 Taxman 403 (Bom.); Karnataka Bank Ltd. v. Asstt. CIT [2013] 34 taxmann.com 150/216 Taxman 192 (Kar.).

2.2.3 Depreciation Calculation to be in Indian Currency

A company may keep its accounts in foreign currency but depreciation will have to be calculated in Indian currency at the point of time of acquisition of the asset – CESC Ltd. v. CIT [1998] 233 ITR 50 (SC).

2.2.4 Law Applicable

Where in rates of depreciation there was amendment raising rate w.e.f. 24-7-1980, the law as amended was not applicable to the AY 1980-81, nor could it be deemed to be retrospective – CIT v. Mirza Ataullaha Baig [1994] 76 Taxman 495 (Bom.); CIT v. S. Palaniswamy [1996] 219 ITR 380 (Mad.).

The Income-tax (Fourth Amendment) Rules, 1983, by which higher rate of depreciation was laid down, came into effect on 2-4-1983. The assessment year 1983-84 began on 1-4-1983. In other words, this new rule was not intended to be made applicable to the assessment year 1983-84. The rates of depreciation laid down in the rules are matters of substantive law. The new rates were intended to apply only from the assessment year 1984-85 since these were not in force on 1-4-1983 on which the assessment year 1983-84 began – S. P. Jaiswal Estates (P.) Ltd. v. CIT [1994] 75 Taxman 298 (Cal.).

3. Statutory Background of Section 32(1)(i) – Section 32(1)(i)

allows deduction in respect of depreciation on tangible or intangible assets owned, wholly or partly by the assessee and used for the purposes of the business in the case of assets of an undertaking engaged in generation or generation and distribution of power. Depreciation shall be allowed at such percentage on the actual cost thereof to the assessee as has been prescribed under Rule 5(1A).

4. Statutory Background of Section 32(1)(ii) – Section 32(1)(ii)

allows deduction in respect of depreciation on tangible or intangible assets owned, wholly or partly by such assessee and used for the purposes of the business or profession in the case of any block of assets. Depreciation shall be allowed at such percentage on the written down value (WDV) as has been prescribed under Rule 5(1).

4.1 Business Need not be Related to Manufacturing Process

In CIT v. Birla Jute & Industries Ltd. [2003] 133 Taxman 337 (Cal.), it was held that the word ‘business’ includes the whole process of the undertaking carried on by the assessee. It begins with the initial process to achieve the end-product and ends with the realisation of the ultimate profit. Whatever means or mode is connected with such process is part of the business. The business may be of manufacturing or trading or otherwise. A business of manufacturing does not begin or end with manufacturing the product. It begins with all the purposes, which are undertaken by the assessee to facilitate the manufacturing. The purpose of manufacturing is to earn profit out of the product manufactured. The profit can be earned by marketing or trading the product. It is one whole cycle of a business or trade, which is comprehended in section 32. If the plant relates to the process of the business of manufacturing, then it is used for the purpose of the business.

4.2 “Block of Assets”, Defined [Section 2(11)]

Unless the context otherwise requires, “block of assets” means a group of assets falling within a class of assets comprising :

(a) tangible assets, being buildings, machinery, plant or furniture;

(b) intangible assets, being know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, not being goodwill of a business or profession),

in respect of which the same percentage of depreciation is prescribed.

4.3 “Written Down Value of the Block of Assets”, Defined [Explanation 2 to Section 32(1)]

The WDV in case of any block of assets [in the below table, block of intangible asset has been used as an illustration] shall be worked out in the following manner :

For and from PY 2023-24, WDV shall be calculated in the same way as has been done for PY 2021-22 or PY 2022-23.

4.4 Deduction in Respect of Depreciation not Allowed in Certain Cases [1st Proviso to Section 32(1)(Ii)]

Depreciation allowance shall not allowed in respect of following assets:—

(a) Any motor car manufactured outside India, where such motor car is acquired by the assessee between 1-3-1975 and 31-3-2001 unless it is used for any of the following purposes:

(i) in a business of running it on hire for tourists; or

(ii) outside India in his business or profession in another country. Also see, CIT v. Punjab Chemi. Plants Ltd. [2012] 20 taxmann.com 58/206 Taxman 60 (Mag.) (P&H); CIT v. Ansal Properties & Industries Ltd. [2013] 35 taxmann.com 212/216 Taxman 103 (Mag.) (Del.).

(b) Any machinery or plant if the actual cost thereof is allowed as a deduction in one or more years under an agreement entered into by the Central Government u/s 42.

With effect from 1-4-2021, depreciation is also not allowable in case of goodwill of a business or profession.

Depreciation is allowable only on capital assets and not on the assets of which the costs have been allowed as a business expenditure or allowed as deduction in full under any other provision – Burrakur Coal Co. Ltd. v. CIT [1981] 7 Taxman 84 (Cal.); CIT v. Sundaram Fasteners Ltd. [1984] 16 Taxman 217 (Mad.); CIT v. Mahindra Sintered Products Ltd. [1986] 24 Taxman 55 (Bom.); Warner Hindustan Ltd. v. CIT [1988] 36 Taxman 106 (AP).

Where transaction of purchase was found to be bogus or could not prove its genuineness, depreciation held not allowable – Avasarala Technologies Ltd. v. JCIT [2016] 66 taxmann.com 377 (SC).

Even if it was held that the expenditure on taking over the gratuity liability was a capital expenditure, yet no depreciation was allowable on the same because such liability taken over by the assessee did not fall under any of the eligible assets specified in section 32—CIT v. Hoogly Mills Co. Ltd. [2006] 157 Taxman 347 (SC); CIT v. Hooghly Mills Ltd. [2015] 62 taxmann.com 227/234 Taxman 625 (Cal.), SLP granted in Hooghly Mills Co. Ltd. v. CIT [2016] 74 taxmann.com 9/242 Taxman 368 (SC).

In CIT v. Luwa India Ltd. [2012] 18 taxmann.com 365/205 Taxman 342 (Kar.), it was held that depreciation is not allowable in respect of machinery which have been discarded due to obsolescence and which have not been used in manufacture of product.

4.4.1 Depreciation on foreign motor cars used by tour operators/travel agents, clarification

Where tour operators or travel agents use certain foreign motor cars owned by them for providing transportation services to tourists, depreciation should be allowed on these cars. The position will not change even where such transportation services are provided as a part of package tour for tourists, which may include a number of other services like boarding and lodging, service of guides, etc. A tourist, who opts for a package tour, agrees to pay for a number of services including use of car provided to him by the tour operator or travel agent. Thus, it can be said that the car has been taken by him on hire from such tour operator or travel agent. Therefore, depreciation on foreign motor cars, owned by him and used for providing transportation services to tourists, whether in a package tour or otherwise, should be allowed. It has also been clarified that ‘motor vans’ are akin to ‘motor lorries’ or ‘motor buses’. However, the higher rate of depreciation, if any available, will not apply if the motor buses, motor lorries, etc., are used in some other non-hiring business of the assessee—vide Circular No. 609, dated 29-7-1991; Circular No. 622, dated 6-1-1992; and Circular No. 652, dated 14-6-1993.

5. Ownership of Assets

5.1 ‘Owned’ Does not Only Mean Owned by the Owner

The term ‘owned’ 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 there from and having right to use and occupy the property and/or to enjoy its usufruct in his own right would be the owner of the buildings though a formal deed of title may not have been executed and registered as contemplated by Transfer of Property Act, Registration Act, etc. – Mysore Minerals Ltd. v. CIT [1999] 106 Taxman 166 (SC); Dalmia Cement (Bharat) Ltd. v. CIT [2001] 247 ITR 267 (SC).

Where the office equipment and motor vehicles owned by the assessee-company were being used by another company which was acting as its sales manager and the assessee used to reimburse all the expenses of the sales manager, it was held that depreciation could not be denied to the assessee on the ground that assets were not used by it, because if the property of the assessee had been used by the sales manager it was still the property of the assessee and the assets were used by them for and on behalf of the assessee and thus depreciation was admissible – CIT v. Associated Cement Co. Ltd. [1968] 68 ITR 478 (Bom.).

5.2 Fractional Ownership

From the assessment year 1997-98, even a fractional owner is entitled to claim depreciation – CIT v. Doongaji & Co. Distillery [2005] 146 Taxman 154 (MP).

5.3 Some Irrelevant Considerations

The term ‘owned by the assessee’, used in section 32(1), does not mean that the assessee should have remained owner of the asset for the entire previous year – A. M. Ponnuranga Mudaliar v. CIT [1996] 88 Taxman 482 (Mad.); CIT v. Geo Tech Construction Corpn. [2000] 112 Taxman 373 (Ker.).

To be treated as ‘owner’, the assessee need not have the right to dispose of the property, so long as he is in a position to enjoy the property in his own right – Gowersons Publishers (P.) Ltd. v. CIT [1999] 107 Taxman 298 (Del. – FB).

Depreciation on cars could not be denied on ground that those cars were parked at residence of shareholders or promotors of the assessee-company when those cars had been shown as fixed assets of the assessee – ACIT v. Claridges Hotels (P.) Ltd. [2021] 124 taxmann.com 601 (Del. – Trib.).

5.4 Registered Deed, Not a Necessity

Where assessee became owner of a hotel by a decree of the Court, decree did not require registration under the Registration Act and assessee having used hotel for business purposes was entitled to depreciation on it – Hotel Skylark & Restaurant (P.) Ltd. v. CIT [1996] 221 ITR 283 (P&H).

For claiming depreciation in respect of a building, it is not obligatory upon assessee to have a registered conveyance deed – CIT v. Guru Nanak Cane Crushing Factory [2005] 149 Taxman 159 (All.); CIT v. Jawahar Kala Kendra [2015] 54 taxmann.com 334/229 Taxman 625 (Raj.).

Mere non-registration of agreement did not imply that benefit otherwise available under section 53A of Transfer of Property Act, 1882 of being entitled to continue in possession in part performance of an agreement to sell, had to be denied to assessee; assessee would be entitled to depreciation on such premises – CIT v. Bhushan Steels & Strips Ltd. [2017] 82 taxmann.com 79 (Del.).

5.5 Ownership in Personal Capacity

Ownership of an asset by director of company in his personal capacity cannot be an asset deemed to be invested ownership or beneficial utility of company. In the instant case, since there was nothing to show that assessee-company had dominion over vehicle and that utility of vehicle was in normal course for benefit of company, assessee would not be entitled for depreciation u/s 32 – M. M. Fisheries (P.) Ltd. v. CIT [2006] 152 Taxman 247 (Del.).

5.6 Registration of Asset in Different Name but Used for Business/Profession

Assessee would not be entitled to depreciation on factory building owned by him which is used by the firm in which he is a partner – Karan Raghav Export (P.) Ltd. v. CIT [2011] 9 taxmann.com 81/196 Taxman 504 (Del.).

Where vehicle in question, though registered in name of director of assessee-company, was used for purpose of business of company, income derived from leasing vehicle was shown as income of company, and entire fund for purchase of vehicle had also gone from coffers of company, assessee was entitled to depreciation on said vehicle – CIT v. Aravali Finlease Ltd. [2012] 21 taxmann.com 147 (Guj.); PCIT v. Asian Mills (P.) Ltd. [2022] 135 taxmann.com 163/285 Taxman 422 (Guj.).

5.7 Leased and Hire-Purchase Assets

Where the effect of an agreement is that the ownership of the subject is, at once, transferred to the lessee, the transaction should be regarded as one of purchase by instalments and no deduction in respect of hire should be made. Depreciation should be allowed to the lessee on the entire purchase price as per the agreement. On the other hand, where the terms of the agreement provide that the equipment shall eventually become the property of the hirer or confer on the hirer an option to purchase the equipment, the transaction should be regarded as one of hire purchase. In such cases the periodical payments made by the hirer should for tax purposes be regarded as made up of consideration for hire (which is to be allowed as deduction in the assessment), and payment on account of purchase to be treated as capital outlay (depreciation being allowed to the lessee on the initial value). The allowance to be made in respect of hire should be the difference between the aggregate amount of the periodical payments under the agreement and the initial value, the amount of this allowance being spread evenly over the term of the agreement—vide Circular No. 9, dated 23-3-1943.

Where assessee engaged in business of hire purchase, leasing, etc., leased out those vehicles to customers, it (lessor) was entitled to claim depreciation in respect of vehicles so leased out – I. C. D. S. Ltd. v. CIT [2013] 29 taxmann.com 129/212 Taxman 550 (SC).

When leasing is business, giving of a vehicle on lease even if it may not be used by lessee on date of agreement but from date of registration of vehicle or thereafter, it would be a use for purpose of leasing business of assessee (lessor) and, therefore, assessee would be entitled to depreciation on such vehicles – Multican Builders Ltd. v. CIT [2005] 147 Taxman 103 (Cal.); CIT v. Kotak Mahindra Finance Ltd. [2010] 191 Taxman 280 (Bom.). As and when leased assets are installed at place of lessee, it could be presumed for purpose of allowance of depreciation that they had been used by lessee; actual date on which such assets were put to use by lessee has no relevance – CIT v. Sundaram Finance Ltd. [2012] 18 taxmann.com 197/205 Taxman 37 (Mad.).

Where the business of the assessee consists of hiring out machinery and/or where the income derived by the assessee from the hiring of such machinery is business income, the assessee must be considered as having used the machinery for the purpose of business—CIT v. Shaan Finance (P.) Ltd. [1998] 97 Taxman 435 (SC).

Where assessee was in the business of hiring out cranes, even if such cranes were also used for personal construction business, the same would not disentitle assessee to claim higher depreciation (if allowable) – Prasad Multi Services (P.) Ltd. v. DCIT [2020] 122 taxmann.com 73 (Guj.).

Where the assessee acquired certain houses under a hire-purchase agreement, the terms of which provided inter alia, (i) that the hirer should hold the said property as a tenant during the hire-purchase period, (ii) that the hirer shall not sell, transfer, assign or otherwise part with the possession of the whole or any portion of the said property without previous consent in writing of the owner which can be refused at the absolute discretion of the owner, and (iii) that the owner had agreed to transfer the property only after the expiry of the hire-purchase period, the assessee could not be said to be the ‘owner’ of the property, and hence was not entitled to depreciation – Atlas Cycle Industries Ltd. v. CIT [2005] 142 Taxman 102 (P&H).

While allowing depreciation in case of assessee engaged in financing of vehicle purchase, the AO has to find true nature and character of agreement and arrangement between financier and vehicle owner and if it is found to be a loan transaction whereunder assessee had only financed purchase of vehicle and borrowers are registered owners, then assessee would not be entitled to depreciation, much less higher depreciation allowable in respect of motor vehicles used in business of running them on hire. However, on other hand, if it is found that vehicles were purchased by assessee and it retained their ownership with registration in its name and vehicles were either given on lease or given under hire purchase agreement giving an option to hirer to purchase same after payment of lease rentals or hire charges during agreed period, then assessee would be entitled to depreciation at higher rate – CIT v. Mannapuram General Finance & Leasing Ltd. [2010] 191 Taxman 313 (Ker.).

The word ‘hire’ used in the entry relating to motor lorries, etc., is only meant to denote that the use of the vehicle is not by the owner himself for his own purposes but it is given to another for use for a limited period of that other for a consideration. For the purpose of this entry, there is no qualitative difference between lease of the vehicle for a specified period for consideration and letting the vehicle on hire for short duration on payment of hire charges. Thus, an assessee leasing out motor lorries owned by him and receiving lease rentals would be entitled to higher rate of depreciation by treating the vehicles as being used in the business of running them on hire – CIT v. Madan & Co. [2003] 128 Taxman 116 (Mad.). For availing higher rate of depreciation, it is not mandatory that vehicles are not only used in business of running on hire but assessee should also use these vehicles himself for same purpose – CIT v. Bansal Credits Ltd. [2003] 126 Taxman 149 (Del.). However, where the assessee leased out vehicles on rent to various industries, depreciation is not admissible at the higher rate on the vehicles, since the vehicles could not be said to have been run by the assessee on hire. Only general rate of depreciation is admissible – Soma Finance & Leasing Co. Ltd. v. CIT [2001] 116 Taxman 173 (Cal.). Also see, Kotak Mahindra Finance Ltd. v. DCIT [2003] 130 Taxman 422 (Bom.).

5.7.1 Operating lease

Assessee had leased out certain plant and machinery to lessee with a specific stipulation in the lease agreement that on termination of lease, leased assets would be returned to assessee in condition in which they were taken, except normal wear and tear. Since it was a case of operating lease and not a finance lease, hence, assessee was entitled to depreciation as owner of said plant and machinery – CIT v. Shree Rajasthan Syntex Ltd. [2009] 178 Taxman 33 (Raj.).

5.7.2 Finance lease

In State Bank of India v. DCIT [2014] 44 taxmann.com 99/148 ITD 71 (Mum. – Trib.), the assessee-bank had entered into an agreement with Railways for leasing out railway tracks comprising of rails, sleepers and associated fitting to KRCL. As per lease agreement, assessee would recover full value of leased asset with interest and not asset in question. All costs regarding loss and obsolescences, repairs, maintenance, insurance, etc., were to be borne by KRCL and risk and reward of ownership of asset would vest in KRCL. Apart from the assessee, asset could not be transferred to any other person. The Tribunal held that since all features and attributes of finance lease were present in case of the assessee, transaction in question was a finance lease and not operating lease and, hence, depreciation on said asset was not admissible to the assessee.

Where assessee-NBFC financed vehicles by way of operating lease and finance lease transactions, since as per finance lease agreement assessee-lessor was absolute owner of leased vehicle and lessee only had right to use vehicles, furthermore, principal component of finance lease rentals therefrom was offered for tax, assessee would be entitled to claim depreciation on assets financed under finance lease agreement – Poonawalla Fincorp Ltd. v. PCIT [2022] 142 taxmann.com 530/197 ITD 590 (Kol. – Trib.).

5.8 Sale and Leaseback Transactions

Where assessee had purchased a boiler from a company and leased out it to that very same company and claimed 100% depreciation on boiler, since rental income from lease transaction was subjected to tax and even after claiming depreciation in one year, assessee was subjecting itself to tax on income arising from that very transaction, transaction could not be said as dubious and, thus, said depreciation was to be allowed – CIT v. Bombay Burmah Trading Corporation Ltd. [2017] 85 taxmann.com 335/250 Taxman 436 (Bom.), SLP dismissed in PCIT v. Bombay Burmah Trading Corporation Ltd. [2018] 95 taxmann.com 141/256 Taxman 393 (SC). Also see, CIT v. SRF Ltd. [2015] 56 taxmann.com 173/230 Taxman 422 (Delhi).

5.9 Amortisation of Construction Cost on Development of Infra-Structure Facility of Roads/Highways Under Built-Operate-Transfer (Bot) Projects, Clarification

Where the assessee incurs expenditure on a project for development of roads/highways, he is entitled to recover cost incurred by him towards development of such facility (comprising of construction cost and other pre-operative expenses) during the construction period. Further, expenditure incurred by the assessee on such Build-Operate-Transfer (BOT) projects brings to it an enduring benefit in the form of right to collect the toll during the period of the agreement. Hon’ble Supreme Court in the case of Madras Industrial Investment Corporation Ltd. v. CIT [1997] 91 Taxman 340/225 ITR 802 allowed spreading over of liability over a number of years on the ground that there was continuing benefit to the company over a period. Therefore, analogously, expenditure incurred on an infrastructure project for development of roads/highways under BOT agreement may be treated as having been made/incurred for the purposes of business or profession of the assessee and same may be allowed to be spread during the tenure of concessionaire agreement. Therefore, the cost of construction on development of infrastructure facility of roads/highways under BOT projects may be amortized and claimed as allowable business expenditure.

The amortization allowable may be computed at the rate which ensures that the whole of the cost incurred in creation of infrastructural facility of road/highway is amortized evenly over the period of concessionaire agreement (after excluding the time taken for creation of such facility). In case where an assessee has claimed any deduction out of initial cost of development of infrastructure facility of roads/highways under BOT projects in earlier years, the total deduction so claimed for the assessment years prior to the assessment year under consideration may be deducted from the initial cost of infrastructure facility of roads/highways and the cost (so reduced) shall be amortized equally over the remaining period of toll concessionaire agreement. It is also clarified that this Circular is applicable only to those infrastructure projects for development of road/highways on BOT basis where ownership is not vested with the assessee under the concessionaire agreement—vide Circular No. 9/2014, dated 23-4-2014.

Where assessee, infrastructure development company, constructed a road on BOT basis on land owned by Government, assessee could not claim depreciation on toll road so constructed and operated – North Karnataka Expressway Ltd. v. CIT [2014] 51 taxmann.com 214/[2015] 228 Taxman 20 (Mag.) (Bom.).

Where assessee, in terms of agreement with NHAI, was constructing and maintaining road on BOT basis against license to collect toll on road facility for specified period, since, as result of developing this project, assessee had acquired a commercial right to collect toll in terms of contract awarded by NHAI, this right definitely fell within meaning of ‘commercial right’ or ‘intangible asset’ – DCIT v. Ashoka Dhankuni Kharagpur Tollway Ltd. [2022] 145 taxmann.com 97 (Pune – Trib.).

6. Used for the purposes of business or profession

6.1 ‘Used’, Different Meanings

The word ‘used’ has been read in some of the pool cases in a wide sense so as to include a passive as well as active user – Liquidators of Pursa Ltd. v. CIT [1954] 25 ITR 265 (SC).

On the contrary, the word ‘used’ denotes actually used and not merely ready for use. The expression ‘used’ means actually used for the purposes of the business – Dineshkumar Gulabchand Agrawal v. CIT [2004] 141 Taxman 62 (Bom.). It cannot be the intention of the Legislature that the word ‘used’ when it is to be interpreted in a wider sense to mean, ‘ready to use’, the same is stretched to the limits of non-user for number of years – CIT v. Oswal Agro Mills Ltd. [2011] 9 taxmann.com 58/197 Taxman 25 (Del.). Thus, depreciation u/s 32 for the plant and machinery installed by the assessee is permissible only in case where it was actually put to use in the year under consideration – CIT v. Malayala Manorama Co. Ltd. [2018] 91 taxmann.com 14 (Ker.).

*Section 32(1).