Which deductions are allowed while calculating PGBP?

Table of Contents:

1. Rent, Rates, Taxes, Repairs and Insurance premium of Buildings: [Sec. 30]

2. Repairs and Insurance premium of Machinery, Plant and Furniture: [Sec. 31]

3. Depreciation : [Sec. 32]

4. Conditions for Claiming Depreciation

5. WDV for charging ‘Depreciation’: [Sec. 43(6)]

6. ‘Actual cost’ means : [Sec. 43(1)]

7. Rates of Depreciation for WDV: [Rule 5, Appendix I to Income-tax Rules, 1962]

8. Depreciation on Intangible Assets

9. Depreciation restricted to 50% of the normal depreciation

10. Additional Depreciation on NEW Plant or Machinery: [Sec. 32(1)(iia)]

11. SLM Depreciation for assessees engaged in Power Sector: [Sec. 32(1)(i)]

12. Terminal depreciation: [Sec. 32(1)(iii)]

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1. Rent, Rates, Taxes, Repairs and Insurance premium of Buildings: [Sec. 30]

In respect of rent, rates, taxes, repairs and insurance for premises used for the purposes of the business or profession, the following deductions shall be allowed:

(a) Where the premises are occupied by the assessee

(i) as a tenant – the rent paid for such premises; and further if he has undertaken to bear the cost of repairs to the premises, the amount of such repairs;

(ii) otherwise than as a tenant – the amount paid on account of current repairs of the premises;

(b) Any sum paid on account of land revenue, local rates or municipal taxes, subject to provision of section 43B, whether as tenant or as an owner,

(c) Any insurance premium paid in respect of insurance against risk of damage or destruction of the premises, whether as tenant or as an owner.

Explanation: Current repairs as referred above shall not include any expenditure in the nature of capital expenditure.

2. Repairs and Insurance premium of Machinery, Plant and Furniture: [Sec. 31]

In respect of repairs and insurance of the plant, machinery or furniture used for the purposes of the business or profession, the following deductions shall be allowed-

(a) the amount paid on account of current repairs,

(b) the amount of premium paid in respect of insurance against risk of damage or destruction of the plant, machinery or furniture.

Explanation: Current repairs shall not include any expenditure in the nature of capital expenditure.

3. Depreciation : [Sec. 32]

In respect of –

• • Building, plant, machinery or furniture, being tangible assets;
  • Know-how, patents, trademarks, copyrights, franchises, licences or any other business or commercial rights of similar nature, being intangible assets not being goodwill of a business or profession;

owned, wholly or partly, by the assessee and used for the purposes of the business or profession, depreciation shall be allowed on the Written Down Value (WDV) of the BLOCK OF ASSETS at the prescribed percentage.

[Amended by Finance Act, 2021 w.e.f. A.Y. 2021-22]

Block of Asset means a group of assets falling within a class of asset comprising:

• • Tangible assets, being building, plant, machinery or furniture;
  • Intangible assets, being know-how, patents, trademarks, copyrights, franchises, licences or any other business or commercial rights of similar nature, not being goodwill of a business or  profession.

for which same percentage of depreciation is prescribed.

[Amended by Finance Act, 2021 w.e.f. A.Y. 2021-22]

Reason for Amendment: It is seen that Goodwill of a business or a profession has not been specifically provided as an asset either in the definition u/s 2(11) or in section 32. The question whether goodwill of a business is an asset within the meaning of section 32 and whether depreciation on goodwill is allowable, is an issue which came up before Hon’ble Supreme Court in the case of Smif Securities Limited (2012) where it was held that the Goodwill of a business or profession is a depreciable asset u/s 32.

Now, it is seen that Goodwill, in general, is not a depreciable asset and in fact depending upon how the business runs; goodwill may see appreciation or in the alternative no depreciation to its value. Therefore, there may not be a justification or very little justification for depreciation on goodwill.

Accordingly, the Finance Act, 2021 has provided that Goodwill of a business or profession will not be considered as a depreciable asset and no depreciation will be provided on Goodwill of business or profession in any situation. Instead, capital gains shall arise on transfer of the Goodwill of business or profession.

3.1 Depreciation is mandatory: Explanation 5 to Sec. 32(1)

Depreciation shall be allowed to the assessee, whether or not the assessee has claimed deduction for depreciation while computing PGBP.

4. Conditions for Claiming Depreciation

4.1 Assessee must be the owner of the asset

4.1.1 Owner need not be a Registered Owner

Apex Court held in case of Mysore Minerals Ltd. v. CIT (1999) 239 ITR 775 (SC) that Sec. 32 is a beneficial section. Depreciation is allowable if possession has been acquired by the assessee and used for the purpose of his business or profession, even though assets were not transferred in the name of the assessee, i.e. for claiming depreciation registered ownership is not compulsory.

4.1.2 Depreciation on Leased assets

CBDT Circular: Irrespective of accounting treatment prescribed by the Accounting Standard, the LESSOR shall be entitled to claim depreciation on LEASED ASSETS (whether the lease is an operating lease or a financial lease).

Explanation 1 to Sec. 32: Depreciation can be claimed on the Capital Expenditure incurred on a Building; even though the building is not owned by the assessee but in respect of which he holds a lease or any other right of occupancy. Such capital expenditure will be deemed as the building owned by the assessee.

4.1.3 Jointly owned assets

Depreciation on jointly owned asset shall be allowed to the extent of assessee’s share in the asset.

Judicial Decisions

CIT v. Smt. A. Sivakami and Another (2010) 322 ITR 64 (Mad.)

Beneficial ownership of asset is sufficient for claiming depreciation under section 32.

Facts: The assessee, proprietor of a concern, claimed depreciation on three buses, even though she was not the registered owner of the same. However, in order to establish that she was the beneficial owner, she furnished documents of loan obtained for the purchase of buses, repayment of such loans out of collections from running the buses. She had also obtained an undertaking from the persons who held the legal title to the vehicles as well as the permits, for plying buses in the name of her proprietary concern. The buses in dispute were also shown as assets in the balance sheet of the proprietorship concern.

Decision: The Supreme Court, in CIT v. Podar Cement (P.) Ltd. (1997), observed that the owner need not necessarily be the lawful owner. Since, in this case, the assessee has made available all the documents and established before the authorities that she is the beneficial owner, she is entitled to claim depreciation even though she is not the legal owner of the buses.

4.2 Asset must be USED for the business or profession of the assessee

• • As per Sec. 32, an assessee can claim depreciation on asset owned, wholly or partly, by him and used for the purpose of business or profession. However, the word ‘USED’ in above section has been subject to many controversies regarding whether it denotes a wide connotation of ‘assets ready for use’ as well as ‘actually put to use’ or only those assets which are actually put to use. In other words, whether ‘use’ here includes both, active and passive, or only active use of asset. There are many conflicting judgments of various High Courts regarding this issue.

Following are the cases which are in favour to allow depreciation even when asset is ready for use:

• • The Bombay High Court in the case of Whittle Anderson Ltd. v. CIT 79 ITR 613, held that when the machinery was kept in working condition and ready for use, it was entitled to claim depreciation allowance, even though it is kept idle. The High Court also noted that the word ‘used’ should be understood in a wide sense so as to include passive as well as active use.
  • In the case of CIT v. Refrigeration and Allied Industries Ltd. 247 ITR 12, the Delhi High Court observed that the words ‘used for the purpose of business’ are capable of a larger and narrower interpretation. If the expression used is construed strictly, it could be taken as connoting or requiring the active employment or the actual working of the machinery, plant or building in the business. On the other hand, the wider meaning would include not only the cases where the machinery or plant are actively employed but also cases where there is passive use of the same in business. In such a situation, an asset could be said to be in use when it is kept ready for use. The Delhi High Court held that the assessee was entitled to depreciation allowance on asset though it was not actually put to use.

Following are the cases which are against to claim depreciation when asset is kept ready to use:

• • The Karnataka High Court in the case of CIT v. Yellamma Dassappa Hospital (2006) 290 ITR 353, held that kept ready theory is not available to the assessee for the purpose of claiming depreciation when the Legislature has chosen to use the word ‘used’. It is necessary to give a commercial meaning to it and avoid reading something not intended by the Legislature. If the machinery is not used, section 32 is not applicable.
  • The Calcutta High Court in the case of CIT v. Oriental Coal Co. Ltd. (1994) 206 ITR 682, held that no depreciation can be allowed on plant and machinery where the factory of the assessee remained under lock-out throughout the relevant previous year and the plant and machinery had not been actually used for the purpose of business even for a single day during that year.
  • If asset is partly used for business/profession and partly for private purpose, then proportionate depreciation shall be allowed.

Judicial Decisions

I.C.D.S. Ltd. v. CIT (2013) 231 ITR 308 (SC)

Depreciation on leased vehicles cannot be denied to the lessor on the grounds that the vehicles are registered in the name of the lessee and that the lessor is not the actual user of the vehicles.

Facts: The assessee, a non-banking finance company, engaged in the business of leasing and hire purchase, purchased vehicles directly from the manufacturers. Now, the assessee leased out these vehicles to its customers, after which the physical possession of the vehicles was with the lessee. Further, the lessees were registered as the owners of the vehicles in the certificate of registration issued under the Motor Vehicles Act, 1988. The assessee-lessor claimed depreciation on such vehicles.

The Assessing Officer disallowed the depreciation claim on the ground that the assessee’s use of these vehicles was only by way of leasing or hiring out the vehicles to others and not as an actual user and secondly, the vehicles were registered in the name of the lessee and not the assessee-lessor.

Decision: The Supreme Court observed that for claiming depreciation under section 32, as far as usage of the asset is concerned, the section requires that the asset must be used in the course of business. It does not mandate actual usage by the assessee itself. Hence, this requirement of section 32 has been fulfilled, notwithstanding the fact that the assessee was not the actual user of the vehicles.

Further, no inference could be drawn from the registration certificate as to the ownership of the legal title of the vehicles, since registration in the name of the lessee during the period of lease is mandatory as per the Motor Vehicles Act, 1988. If the lessee was in fact the legal owner, he would have claimed depreciation on the vehicles which was not the case.

The Apex Court held as long as the assessee-lessor has a right to retain the legal title against the rest of the world, he would be the owner of the asset in the eyes of law. In this regard, the following provisions of the lease agreement are noteworthy:

• • The assessee is the exclusive owner of the vehicle at all points of time;
  • The assessee is empowered to repossess the vehicle, in case the lessee committed a default;
  • At the end of the lease period, the lessee was obliged to return the vehicle to the assessee;
  • The assessee had a right of inspection of the vehicle at all times.

It can be seen that the proof of ownership lies in the lease agreement itself, which clearly points in favour of the assessee.

The Supreme Court, therefore, held that assessee was entitled to claim depreciation in respect of vehicles leased out since it had satisfied both the requirements of section 32, namely, ownership of the vehicles and its usage in the course of business.

CIT v. Yamaha Motor India Pvt. Ltd. (2010) 206 ITR 682 (Delhi)

The phrase ‘used for purpose of business’ in respect of discarded machine includes use of such asset even in the earlier years for claiming depreciation under section 32.

The discarded machine may not be actually used in the relevant previous year but depreciation can be claimed as long as it was used for the purpose of business in the earlier years provided the block continues to exist in the relevant previous year.

5. WDV for charging ‘Depreciation’: [Sec. 43(6)]

Concept of Block of assets has been introduced w.e.f. A.Y. 1988-89. Earlier to that, the concept of individual asset was relevant and depreciation was allowed on each asset separately.

5.1 WDV of the block of asset shall be calculated as under

WDV of the block at the beginning of the Previous Year	XX
Add: Actual Cost of the assets acquired during the previous year within this block.	XX
Less: Moneys payable in respect of assets of this block which are sold, discarded, demolished or destroyed during the previous year and the scrap value.	XX
Less: Actual cost of the assets falling within that block transferred by way of slump sale referred to in section 50B as reduced by	XX
depreciation actually allowed upto A.Y. 1987-88 in respect of the asset transferred, and depreciation that would have been allowable for A.Y. 1988-89 and further A.Y. as if the assets were the only assets in the block of assets, but it shall be limited to the WDV of Block of assets. [Sec. 43(6)(c)(i)]
Less: Actual cost of the goodwill falling within that block as decreased by	XX
depreciation actually allowed upto A.Y. 1987-88 for such goodwill and
depreciation that would have been allowable for A.Y. 1988-89 and further A.Y. as if the goodwill was the only asset in the block of assets,
but it shall be limited to the WDV of Block of assets. [Sec. 43(6)(c)(i)]
WDV of block for charging depreciation	XX

[Amended by Finance Act, 2021 w.e.f. A.Y. 2021-22]

Reason for Amendment: The Finance Act, 2021 has provided that no depreciation shall be allowed on goodwill w.e.f. A.Y. 2021-22 and it will be treated as non-depreciable capital asset chargeable to capital gains at the time of sale.

Accordingly, the Finance Act, 2021 has amended Sec. 43(6) to provide that, in a case, where the goodwill was a part of any block of assets upto A.Y. 2020-21 and on which depreciation was obtained by the assessee for the immediate preceding previous year, the WDV of the goodwill included such block of assets shall be reduced from the opening WDV of such block of assets. Also, the actual cost of goodwill acquired during the previous year shall not be added to the opening WDV of the block of asset.

5.2 Depreciation shall be allowed only if the block does not cease to exist

Block of Asset ceases to exist in following two situations:

1. 1. When all assets of the block are transferred or
   2. When money payable for any asset of the block exceeds the WDV of the block.

Points to Note:

1. ‘Moneys payable’ here means the sale price of the assets and is to be reduced from the block only to the extent of the WDV becoming NIL.
2. The word ‘money’ has to be interpreted only as actual money or cash and not any other benefit, even though such benefit could be evaluated in terms of money.

CIT v. Kasturi & Sons Ltd. (1999) 119 ITR 431 (SC)

3. Where the block does not cease to exist, the expenditure incurred wholly and exclusively for transfer of the asset of the block shall be allowable as revenue expenditure u/s 37(1) and shall not be adjusted from the WDV of the block of assets. Only the gross sale price of the asset shall be deducted from the WDV of the block of asset. But, where the block ceases to exist, section 50 is attracted and then while calculating Capital gains/loss on such block of assets, the expense of transfer is deductible from the sale consideration.

Practical Question: A company transferred its Steel Division under the slump sale for ` 25,00,000 on 01.04.2021. The WDV of the Block of Plant & Machinery as on 1.4.2021 is ` 12,00,000. During the year, the new machinery has been acquired by the company for ` 2,50,000 on 05.07.2021 and one of the machine was sold for ` 9,25,000 on 31.12.2021.

From the accounting records maintained by the company, it was found that the actual cost of the machines transferred under the slump sale was ` 11,50,000 and as per Income-tax Act, the depreciation on machines transferred in slump sale is as under:

Actual Depreciation upto A.Y. 1987-88	` 2,25,000
Depreciation from A.Y. 1988-89 to A.Y. 2021-22 assuming that these machines are the only assets in the block of assets.	` 2,85,000

Calculate the WDV of Block of Machinery for A.Y. 2022-23.

What will be the situation, if the machinery was sold for ` 15,50,000 instead of ` 9,25,000.

Solution:

Calculation of WDV of Block of Machinery for A.Y. 2022-23			`
Opening WDV as on 1.4.2021			12,00,000
Add: Actual cost of Assets acquired during the previous year.			2,50,000
Less: Moneys payable in respect of the assets sold during the previous year.			9,25,000
Less: Assets transferred in slump sale:
Actual Cost	11,50,000
Less: Depreciation upto A.Y. 1987-88	2,25,000
Less: Depreciation from A.Y. 1988-89 to A.Y. 2021-22	2,85,000	6,40,000
Restricted to			5,25,000
WDV			NIL

If the machinery was sold for ` 15,50,000 instead of ` 9,25,000:

Calculation of WDV of Block of Machinery for A.Y. 2022-23	`
Opening WDV as on 1.4.2021	12,00,000
Add: Actual cost of Assets acquired during the previous year.	2,50,000
Less: Moneys payable in respect of assets sold during the previous year.	14,50,000
Less: Assets Transferred in slump sale ` 6,40,000 restricted to	NIL
WDV	NIL

STCG under section 50 = ` 15,50,000 – ` 14,50,000 = ` 1,00,000.

6. ‘Actual cost’ means : [Sec. 43(1)]

• • the actual cost of the assets to the assessee,
  • reduced by that portion of the cost thereof, if any, as has been met directly or indirectly by any other person or authority:

Provided that where the assessee incurs any expenditure for acquisition of any asset or part thereof in respect of which a payment or aggregate of payments made to a person in a day, otherwise than by an account payee cheque drawn on a bank or an account payee bank draft or use of Electronic Clearing system (ECS) through a bank account or through such other electronic mode as may be prescribed, exceeds ` 10,000, such expenditure shall be ignored for the purposes of determination of actual cost.

As per the ICDS V—Tangible Fixed Assets:

• expenses which are specifically attributable to construction of a project or to the acquisition of a tangible fixed asset or bringing it to its working condition, shall be included as part of the cost of the project or as part of the cost of the tangible fixed asset. All other administration and other general overhead expenses are to be excluded, unless they relate to a specific tangible fixed asset.
• expenditure incurred on start‐up and commissioning of the project, including test runs and experimental production, shall be capitalised. The expenditure incurred after the plant has begun commercial production, that is, production intended for sale or captive consumption, shall be treated as revenue expenditure.

Example:

1. 1. A Ltd. takes a loan of ` 10 crores from an individual, Mr. B for meeting its cost of plant and machinery. Subsequently, due to financial crunch in A Ltd., Mr. B allowed A Ltd. a waiver of ` 2 crores loan. This will be considered as meeting of a portion of the actual cost of the asset of A Ltd. by Mr. B. Therefore, this waiver of loan shall be reduced from the actual cost of the plant and machinery as provided by section 43(1). This would not be covered u/s 2(24)(xviii) as it is not received from by Central Government/State Government/authority/body/agency.
   2. X Ltd., engaged in steel industry, takes a loan of ` 20 crores from the Government of India under the Steel Development Fund to meet the cost of its plant and machinery. In the previous year 2021-22, X Ltd. gets a waiver of ` 12 crores (out of total loan of ` 20 crores). This waiver of loan is in the nature of assistance received from the Government and will be taxable u/s 2(24)(xviii). It shall, then, not be reduced from the actual cost of the asset as per section 43(1) for calculating depreciation.

7. Rates of Depreciation for WDV: [Rule 5, Appendix I to Income-tax Rules, 1962]

	Part A  — Tangible Assets
I. Buildings:
Block 1	Buildings mainly used for residential purpose except hotels & boarding houses	5%
Block 2	Buildings, other than above, i.e. general building	10%
Block 3	Temporary Erections such as Wooden Structures	40%
Note: Buildings include roads, bridges, culverts, wells and tube-wells.
II. Furniture & Fittings including electrical fitting		10%
III. Plant & Machinery:
Block 1	(a) Plant and Machinery (General)	15%
	(b) Motor cars (other than used in business of running them on hire) except those covered in Block 2 (a) below
	(c) Oil Wells [vide Notification No. 13/2016 dated 03-03-2016]
Block 2	(a) Motor cars (other than used in business of running them on hire) acquired between 23.08.2019 to 31.03.2020 and put to use on or before 31.03.2020 (b) Motor Cars, buses and motor tax is used for running them on Hire other than those covered in Block 4 below	30%
	(c) Moulds used in rubber and plastic goods factories
Block 3	(a) Aeroplanes
	(b) Specified life saving medical equipment	40%
	(c) Containers made of glass or plastic used as refills
	(d) Machinery and plant, used in weaving, processing and garment sector of textile industry, which is purchased under TUFS on or after 1.4.2001 but before 1.4.2004 and is put to use before 1.4.2004
	(e) Computers including computer software
	(f) Books owned by assessee carrying on a profession (other than books (i) being annual publications, or (ii) books owned by assessee carrying on business in running lending libraries)
	(g) Rollers used in flour mills, Rolling mill used in iron and steel industry, Rollers used in sugar works, Energy saving devices, and Renewable energy devices (e.g. Wind mills)
	(h) Books owned by assessees carrying on profession, being annual publication
	(i) Books owned by assessees carrying on business in running lending libraries
	(j) Air Pollution/Water Pollution Control Equipments, Solid waste Control Equipments, Solid waste recycling and resource recovery systems
Block 4	(a) Motor Cars, buses and motor taxis used for running them on Hire which is acquired between 23.08.2019 to 31.03.2020 and put to use on or before 31.03.2020	45%
IV. Ships
Ocean going ships, vessels operating on inland waters including speed boats		20%
Part B — Intangible Assets
Know-how, patents, trademarks, copyrights, franchises, licenses or any other business or commercial rights of similar nature		25%

It can be inferred from the above that there are two parts of asset with total 5 Classes of assets. Further with different rates of depreciation there are 9 blocks of assets.

Part A

• • Buildings 3 blocks (5%, 10% and 40%)
  • Furniture & fittings 1 block (10%)
  • Plant and machinery 4 blocks (15%, 30%, 40%, 45%)
  • Ships 1 block (20%)

Part B

• • Intangible assets 1 block (25%)

For example: Building is one class of assets having three rates of depreciation and so there will be 3 blocks of buildings. Similar groupings shall be made for the blocks of plant and machinery. However, for intangible assets, furniture-fittings and ships there will be only one block of asset for each of these classes.

Note: Section 43(3) defines ‘Plant’ to include ships, vehicles, book, scientific apparatus, and surgical equipment used for the purpose of the business or profession but does not include tea bushes, livestocks, buildings or furniture and fittings.

Therefore, Theater Buildings and Hotel Building, though specially equipped for business purpose are still building and cannot be treated as plant for claiming depreciation.

Notification No. 82/2020 dated 01.10.2020

In the following cases, where the depreciation on any block of assets is more than 40%, it shall be restricted to 40% on the WDV of such block of assets:

(i) a domestic company which has exercised option u/s 115BA or 115BAA or 115BAB; or

(ii) an individual or HUF which has exercised option u/s 115BAC; or

(iii) a co-operative society resident in India which has exercised option u/s 115BAD:

For the purposes of section 115BAA, if the following conditions are satisfied:

(i) option under sub-section (5) thereof is exercised for a previous year relevant to the assessment year A.Y. 2020-21 and onwards;

(ii) there is a depreciation allowance, in respect of a block of asset, from any earlier assessment year or allowance of unabsorbed depreciation deemed so u/s 72A, which is attributable to the provisions in Sec. 32(1)(iia); and

(iii) such depreciation or allowance for unabsorbed depreciation is not allowed to be set off,

the WDV of the block of asset as on 1st day of April, 2019 shall be increased by such depreciation or allowance for unabsorbed depreciation not allowed to be set off:

For the purposes of section 115BAC and section 115BAD, if the following conditions are satisfied:

(i) the option under sub-section (5) of the respective section is exercised for a previous year relevant to the assessment year beginning on the 1st day of April, 2021;

(ii) there is a depreciation allowance, in respect of a block of asset, from any earlier assessment year which is attributable to the provisions in clause (iia) of sub-section (1) of section 32; and

(iii) such depreciation is not allowed to be set off under sub-clause (a) of clause (ii) of sub-section (2) of section 115BAC or clause (ii) of sub-section (2) of section 115BAD,

the WDV of the block of asset as on 1st day of April, 2020 shall be increased by such depreciation not allowed to be set off.

Judicial Decisions

CIT v. BSES Yamuna Powers Ltd (2013) 358 ITR 47 (Delhi)

Computer accessories and peripherals such as printers, scanners and server etc. form an integral part of the computer system and they cannot be used without the computer. Consequently, the High Court held that since they are part of the computer system, they would be eligible for depreciation at the higher rate of 40% applicable to computers including computer software.

The Delhi High Court, in CIT v. Orient Ceramics and Industries Ltd. [2013], following its own judgment given in the above case, held that depreciation on UPS is allowable @ 40%, being the eligible rate of depreciation on computers including computer software, and not @ 15%.

Federal Bank Ltd. v. ACIT (2011) 332 ITR 318 (Kerala)

EPABX and mobile phones cannot be treated as computers for higher depreciation at 40%.

The High Court held that the rate of depreciation of 40% is available to computers and there is no ground to treat the communication equipment as computers. Hence, EPABX and mobile phones are not computers and therefore, are not entitled to higher depreciation at 40%.

8. Depreciation on Intangible Assets

Income tax Act defines ‘Intangible Assets’ as any know-how, patents, copyrights, trademark, licenses, franchises or any other business or commercial right of similar nature.

Note: As computer software is not covered hereunder, it shall not be treated as an Intangible
Asset, although Schedule III to Companies Act, 2013 classifies computer software in Intangible Assets. Therefore, computer software shall be covered under the block of computers and 40% depreciation shall be allowed on it.

Clarification regarding treatment of expenditure incurred on purchase of Participating Interest by the Oil Exploration and Production (E&P) Companies [Circular No. 20/2019, dated 19.08.2019]

Over the lifecycle of an Oil & Gas block, Oil Exploration and Production (E&P) companies generally buy (‘Farm in’) and sell (‘Farm out’) their Participating Interests (PI) in the ‘Production Sharing Agreement’ (PSC). ‘Farm-in’ expenditure is incurred when an entity in this line of business acquires a PI from another entity(s) in oil/gas block(s) and becomes part of the PSC entered into with the Central Government.

It is common international practice for the upstream companies to buy (farm-in) and sale (farm-out) their PI in the PSC or similar contracts with the Government and thereby to share risk, bring new and niche expertise and technologies. In such transactions, PI are treated as interests in rights, licences and obligation under the PSC. Such farm-in purchase price is accounted as an asset as per guidance note issued by the Institute of Chartered Accountants of India.

Earlier vide Notification No. G.S.R. 117(E), dated 08.03.1996, the Central Government had laid down that the persons with whom it enters into agreement for the association or participation in any business consisting of the prospecting for or extraction or production of mineral oils on or after 01.04.1992:

(a) shall not be assessed on the income as AOP or BOI of such persons; but

(b) each of the persons referred to above be assessed in respect of his or its share of income, in the same status in which the person enters into the agreement with the Central Government.

In view of the above legal position, it is hereby clarified that:

(i) amount paid for acquiring the ‘Participating Interest’ shall not be treated either as cost for acquiring the share in partnership or investment for’ acquisition of a member’s interest in an association of persons or body of individuals, rather it would be treated as an amount paid to acquire the underlying assets; and

(ii) the amount paid for acquiring the ‘Participating Interest’, after reducing component of cost attributable to tangible assets for purposes of section 32(1)(i), would be treated as an ‘intangible asset’ (being a business or commercial right akin to a licence), eligible for claim of depreciation for purposes of section 32(1)(ii).

9. Depreciation restricted to 50% of the normal depreciation

• • Where any capital asset forming part of the block of asset is acquired during the previous year; and
  • has been put to use for a period of less than 180 days during the previous year;
  • the actual cost of such asset (to the extent of the WDV of the block) would be eligible to only half of the normal depreciation.

Practical Question: Rajan Ltd. has two machines namely S & M in the block as on 01.04.2021, WDV of which is ` 3,00,000. Machine L was acquired on 12.11.2021 for ` 1,50,000 and put to use on the same date. The same Machine L is sold on 24.03.2022 for ` 2,00,000.

(a) Compute the depreciation allowable under section 32 for the A.Y. 2022-23 on the block.

(b) What will be the amount of depreciation allowed, if machine S is sold instead of machine L.

(c) What will be the amount of depreciation allowed if both S and M machines are sold instead of machine L.

(d) What will be the amount of depreciation allowed, if machine S is sold at ` 3,20,000 instead of machine L.

Solution:

(a)	`
WDV of the block as on 01.04.2021	3,00,000
Add: Actual cost of Machine L (acquired and put to use for less than 180 days)	1,50,000
	4,50,000
Less: Sale consideration of machine L (sold in this same year)	2,00,000
WDV as on 31.03.2022	2,50,000
Depreciation on ` 2,50,000 @ 15%	37,500
WDV as on 01.04.2022	2,12,500

Depreciation @ 15% has been charged on the total WDV, as the machine L which was put to use for less than 180 days during the year, ceases to exist on 31.03.2021 and as such depreciation shall not be charged at the rate of 50% of the normal rate.

(b)		`
WDV of the block as on 01.04.2021		3,00,000
Add: Actual cost of Machine L (acquired and put to use for less than 180 days)		1,50,000
		4,50,000
Less: Sale consideration of machine S sold during the year		2,00,000
WDV as on 31.03.2022		2,50,000
Depreciation on ` 1,50,000 @ 7.5% (half of normal depreciation)	11,250
` 1,00,000 @ 15%	15,000	26,250
WDV as on 01.04.2022		2,23,750

As machine L is in the block as on the last day of the previous year, so the actual cost of Machine L to the extent of the WDV of the block would be eligible to only half of the normal depreciation.

(c)		`
WDV of the block as on 01.04.2021		3,00,000
Add: Actual cost of Machine L (acquired and put to use for less than 180 days)		1,50,000
		4,50,000
Less: Sale consideration of machine S & M		2,00,000
WDV as on 31.03.2022		2,50,000
Depreciation on ` 1,50,000 @ 7.5% (half of normal depreciation)	11,250
` 1,00,000* @ 15%	15,000	26,250
WDV as on 01.04.2022		2,23,750

* Although only one asset L is left in the block whose cost is ` 1,50,000, still depreciation will be allowed on the balance amount ` 1,00,000 @ 15% as the block has not ceased to exist.

(d)	`
WDV of the block as on 01.04.2021	3,00,000
Add: Actual cost of Machine L (acquired and put to use for less than 180 days)	1,50,000
	4,50,000
Less: Sale consideration of machine S	3,20,000
WDV as on 31.03.2022	1,30,000
Depreciation on ` 1,30,000 @ 7.5%	9,750
WDV as on 01.04.2022	1,20,250

As machine L is in the block as on the last day of the previous year, the actual cost of Machine L to the extent of the WDV of the block would be eligible to only half of the normal depreciation, as the machine L was put to use for less than 180 days during the year.

Practical Question: Subhash Ltd. has 3 machines at the beginning of the previous year 2021-22, forming part of a block of assets carrying depreciation @ 15%, WDV of which is ` 10,00,000. The following 4 machines of the same block were purchased and put to use:

Machines	Date of Purchase	Date when put to use	Cost (` )
A	10.01.2021	20.01.2022	1,00,000
B	01.04.2021	12.06.2021	2,00,000
C	18.05.2021	25.01.2022	4,00,000
D	25.11.2021	15.03.2022	3,00,000

Two machines of this block (other than those which were acquired and put to use for less than 180 days) were sold for ` 8,00,000.

(a) Compute the depreciation for the A.Y. 2022-23.

(b) What will be the answer if the two machines were sold for ` 14,00,000 instead of ` 8,00,000?

Solution:

(a)	`	`
WDV as on 1.4.2021		10,00,000
Add: Actual cost of machines acquired in the same block
Machine A* acquired last year but put to use this year (although put to use for less than 180 days; the depreciation shall be allowed in full as half depreciation is allowed only if the asset is acquired during the same year in which it is put to use for less than 180 days.)	1,00,000
Machine B acquired and put to use for 180 days or more.	2,00,000
Machine C acquired during the year, but put to use for less than 180 days.	4,00,000
Machine D acquired during the year, but put to use for less than 180 days.	3,00,000	10,00,000
Less: Assets sold during the year		(8,00,000)
WDV on which depreciation is to be charged		12,00,000
Depreciation:
On Machine C and D ` 7,00,000 @ 7.5%	52,500
On remaining balance of WDV ` 5,00,000 @ 15%	75,000	(1,27,500)
Opening WDV for next year		10,72,500
(b)	`	`
WDV as on 1.4.2021		10,00,000
Add: Actual cost of machines acquired in the same block
Machine A* acquired last year but put to use this year (although put to use for less than 180 days; the depreciation shall be allowed in full as half depreciation is allowed only if the asset is acquired during the same year in which it is put to use for less than 180 days.)	1,00,000
Machine B acquired and put to use for 180 days or more.	2,00,000
Machine C acquired during the year, but put to use for less than 180 days.	4,00,000
Machine D acquired during the year, but put to use for less than 180 days.	3,00,000	10,00,000
Less: Assets sold during the year		(14,00,000)
WDV on which depreciation is to be charged		6,00,000
Depreciation on ` 6,00,000 @ 7.5% as WDV is less than cost of machines which were put to use for less than 180 days		45,000
Opening WDV for next year		5,55,000

* It is assumed that the Machine A, although acquired during the previous year 2020-21, but was not installed in that year and so it was not added to the block of asset during the year 2020-21.

Practical Question: Raghu Ltd. has a block of assets (15% rate of depreciation) consisting of asset A, B, C, and D on 01-04-2021.

Opening WDV of the block	` 10,00,000
Asset ‘E’ was acquired on 05-07-2021 for	` 3,00,000
Asset ‘A’ was destroyed by fire on 06-11-2021
Insurance compensation payable	` 6,00,000

The Insurance compensation was determined on 30-03-2021 but received on 30-11-2022.

(a) Calculate the depreciation for the A.Y. 2022-23.

(b) What will be the answer if Insurance compensation received was ` 15,00,000 instead of ` 6,00,000?

Solution:

(a) A.Y. 2022-23	`
WDV as on 1.4.2021	10,00,000
Add: Actual cost of assets acquired	3,00,000
Less : Moneys payable in respect of assets destroyed during the year	(6,00,000)
WDV on which depreciation is to be charged	7,00,000
Less: Depreciation @ 15%	(1,05,000)
Opening WDV for next year	5,95,000

Note: No short term capital gain arises u/s 45(1A) as section 50 is not attracted since the block is in existence.

(b) A.Y. 2022-23	`
WDV as on 1.4.2021	10,00,000
Add: Actual cost of assets acquired	3,00,000
Less: Moneys payable in respect of assets destroyed during the year restricted to the WDV of the block i.e. ` 13,00,000	(13,00,000)
WDV on which depreciation is to be charged	Nil

Note: As the block of asset has ceased to exist, section 50 shall be attracted and short term capital gain shall arise. As per section 45(1A) the capital gains shall be taxable in the year in which the insurance compensation is received i.e., here A.Y. 2023-24 as the compensation was received in the financial year 2022-23.

A.Y. 2023-24

Short Term Capital Gain under section 50:	`
Insurance Compensation Received	15,00,000
Less: Opening WDV as on 01-04-2021	10,00,000
Less: Assets acquired during the P.Y.	3,00,000
Short Term Capital Gain	2,00,000

10. Additional Depreciation on NEW Plant or Machinery: [Sec. 32(1)(iia)]

Any assessee who is engaged

• • in an industrial undertaking (i.e. in business of manufacture or production of any article or thing), or;
  • in the business of generation, transmission or distribution of power;

shall be eligible for additional depreciation on any NEW plant or machinery, other than ships and aircrafts, which have been acquired and installed by the assessee after 31.3.2005.

10.1 Rate of Additional Depreciation

20% of the actual cost of the eligible asset in the previous year in which such asset is acquired and installed.

However, the above rate shall be 35%, if the industrial undertaking is set-up in the notified backward areas in the State of Bihar, West Bengal, Andhra Pradesh or Telangana (if acquired and installed from 01-04-2015 to 31-03-2020).

Note: This enhanced rate of 35% is not available in the business of generation, transmission or distribution of power, even if set-up in the notified backward areas in the above States.

10.2 Additional depreciation shall NOT be allowed for following assets

1. 1. plant or machinery which, before its installation by the assessee, was used either within or outside India by any other person;
   2. plant or machinery installed in any office premises or residential accommodation, including accommodation in the nature of a guest house;
   3. office appliances or road transport vehicles;
   4. plant or machinery, the whole actual cost of which is allowed as deduction (whether by depreciation or otherwise) under the head ‘Profits and gains of business or profession’ of any previous year.

Points to Note:

• • • Additional depreciation, as normal depreciation shall be reduced from the block of asset.
    • Where the asset is acquired and put to use for less than 180 days in the previous year, then the deduction for the additional depreciation shall be half of 20% i.e. 10% during the previous year. Balance 50% of the Additional depreciation shall be allowed in the subsequent year.
    • Additional depreciation allowed in the year when ‘installation’ is completed.
    • Business of printing or printing and publishing amounts to manufacture or production of any article or thing and is, therefore, eligible for additional depreciation. (CBDT Circular)
    • Additional depreciation is available only when depreciation is claimed u/s 32(1)(ii) on the basis of WDV of block of assets. Thus, a power generating unit claiming depreciation on SLM basis u/s 32(1)(i) cannot claim additional depreciation in respect of investments in new plant and machinery.

Practical Question: Rama Ltd. has started a new business of manufacturing paints on 01.04.2021. The company has purchased the following assets during the financial year 2021-22:

Asset	Actual cost of acquisition (` )	Date of Purchase	Rate of Depreciation	Date when asset is put to use
Furniture	6,00,000	20.04.2021	10%	20.04.2021
Air-Conditioner installed in office	3,00,000	10.06.2021	15%	22.06.2021
Motor Car	24,00,000	15.07.2021	15%	16.07.2021
Plant A	1,50,00,000	22.04.2021	15%	25.04.2021
Plant B	60,00,000	14.09.2021	15%	14.11.2021
Plant C	2,40,000	05.08.2021	40%	18.09.2021
Computer installed in office	3,00,000	09.07.2021	40%	09.07.2021
Computer for factory	4,50,000	08.07.2021	40%	12.07.2021

Compute the total depreciation, i.e. normal and additional depreciation allowable for A.Y. 2022-23 to Rama Ltd.

Solution:

Computation of normal and additional depreciation A.Y. 2022-23			Amount in `
Asset	Furniture (10%)	Plant (40%)		Plant & Car (15%)
Opening WDV as on 01.04.2021	Nil	Nil		Nil
Add: Actual cost of assets acquired during the year	6,00,000	9,90,000		2,37,00,000
WDV as on 31.03.2022	6,00,000	9,90,000		2,37,00,000
Less: Normal Depreciation	60,000	3,96,000		31,05,000
		(Note 2)		(Note 3)
Less: Additional Depreciation	Nil	1,38,000		36,00,000
	(Note 1)	(Note 2)		(Note 3)
WDV as on 01.04.2022	5,40,000	4,56,000		1,69,95,000

Note 1: Additional depreciation is not available on furniture as the same is not covered u/s 32(1)(iia).

Note 2: Block of Plant also consists of computer. But computer installed in office is not eligible for additional depreciation.

Normal depreciation @ 40% on ` 9,90,000	` 3,96,000
Additional Depreciation @ 20% on ` 6,90,000	` 1,38,000

Note 3: Normal Depreciation on Plant (inclusive of Motor Car) has been calculated as under:

Depreciation @ 15% on ` 1,77,00,000	` 26,55,000
Depreciation @ 7.5% on ` 60,00,000 (as put to use for less than 180 days)	` 4,50,000
	` 31,05,000

Additional Depreciation has been calculated as under:

Asset	Plant A	Plant B
Actual cost	` 1,50,00,000	` 60,00,000
Rate of Additional Depreciation	20%	10%
Additional Depreciation	` 30,00,000	` 6,00,000

As per third proviso to sec. 32(1)(iia), the balance of additional depreciation of ` 6,00,000 being 50% of ` 12,00,000 (20% of ` 60,00,000) would be allowed as deduction in the A.Y. 2023-24.

11. SLM Depreciation for assessees engaged in Power Sector: [Sec. 32(1)(i)]

Where an assessee is engaged in the:

• • generation, or
  • generation and distribution of power,

depreciation shall be allowed on the actual cost of the asset (i.e. Straight Line Method SLM) at the percentage specified in the Appendix 1A of the Income Tax Rules, 1962 as per Rule 5(1A).

The aggregate depreciation shall not exceed the actual cost of the asset.

Points to Note:

• However, the assessee may claim depreciation as per WDV method (i.e. the Block of asset) and this option is to be exercised by the assessee on or before the due date of filing return of income. Option once exercised shall be final and apply to all subsequent years.
• Even in SLM, depreciation shall be restricted to half of normal depreciation if the asset is acquired and put to use for less than 180 days.
• Where assets were acquired by the power sector units before 1.4.97, depreciation should be provided by following only Written Down Value (WDV) method.

12. Terminal depreciation: [Sec. 32(1)(iii)]

If the assets on which SLM basis depreciation has been claimed and allowed to the Power Sector Units is transferred, then the sale consideration falling short of the written down value of such asset shall be allowed as depreciation (generally termed as terminal depreciation), provided such deficiency is written-off in the books of assessee.

Dive Deeper:
Method of Accounting: How far relevant for computing Business Income (PGBP)