Discuss the provisions relating to the depreciation and set off and carry forward of losses under income tax act. What is the relevance of such provisions in case of a new project?

Ans. Provisions relating to depreciation

According to Section 31 (1) of the Income Tax Act, depreciation at prescribed rates on the actual cost (as determined in the manner stated in the preceding heading) in respect of (i) buildings, plant and machinery and furniture and fittings being tangible assets and (ii) know-how, patents,copyrights, trademarks, licences, franchises or other business other business or commercial rights being intangible assets used for business/professional purposes is a tax deductible expenses. For claiming the depreciation allowance, the assets should be owned and used for the purpose of business by the assessee. When a capital asset is imported, by incurring a liability in foreign exchange and the rupee equivalent of such liability is outstanding at the end of each year or at the time of repayment increases/decreases due to fluctuation in rates of exchange then such increases/decreases are adjusted against the actual cost (Section 43 A).The actual cost so adjusted at the end of each year is treated as if it was the actual cost from the date of acquisition of the asset. This necessitates adjustment toward depreciation in each year in respect of earlier years.Depreciation is charged on blocks of assets, which represent a group of assets,within the broad class of assets, of buildings, plant, machinery, and furniture, for which a common rate of depreciation is applicable. Depreciation will be calculated by applying the prescribed rate (which varies between 5% and 100%) on the written down value (WDV) of the entire block. When an asset is sold the amount realized from the sale of such asset (after deducting expense on sales) will simply be deducted from the WDV of that block. If the amount realized is greater than the WDV of the block, the difference will be treated as short term capital gain. In a case where all the assets in the block are disposed off and there is still a balance in the account of the block, such amount will be treated as short-term capital loss.

To illustrate the above provisions, let us consider an example. A block of assets consisting of 10 items acquired during 2000 to 2005 has a written down value of Rs.3 million as on 1st April 2005. During 2004-2005, the assessee sells an asset for Rs.2 million (on which an expense of Rs.0.1 million is incurred on sale) and acquires an asset for Rs.0.5 million.

The net block of assets for depreciation purposes at the end of 2004-2005 will be:

Opening WDV                                                                             Rs.2 million

Value of addition during the year                                           Rs0.5 million

                                                                                                      Rs 2.5million

.

Less

Sale proceeds (after deducting selling expense)                     Rs. 1.9

For the asset sold

Net block for purposes of depreciation                                   Rs.0.6 million

In the above example, if the sale proceeds (after deducting selling expense) had been Rs.5 million, the difference between this amount and Rs.2.5 million should be treated as short-term capital gain and the net block for purposes of depreciation will be zero. Suppose, all the assets in the block (including the assets acquired during the year) are sold for Rs.2.2 million (after deducting selling expense), the balance of Rs.0.3 million remaining in the block amount will be treated as short term capital loss.In may be noted that when any asset is acquired and put to use during the previous year for a period less than 180 days then depreciation will be allowed only to the extent of 50 percent of the prescribed rate for that asset in respect of the year of acquisition.

Set off, carry forward, and order of deduction for computing income from business

Various deductions and allowances are considered in computing the income from business as discussed in the previous section. If the result after providing for such deductions and allowances is a negative figure in any year, this is allowed to beset off against income from other heads and the remaining unabsorbed amount, if any, can be carried forward to the next year and set off against the income of that year and so on. The provisions relating to set off negative income and aggregation and the order of deduction for computing income from business are as follows:

• The first step in the aggregation process is the determination of income under       each head by setting off losses against incomes under different sources. The rules for such set off are as follows:

(a) Losses from any source under a given ‘head of income’ can be set off only against income from any other source under the same ‘head of income’ with exceptions noted in

 (b) below,(b) Losses from speculation business (which falls under the head of income ‘profits and gains of business or profession’) can be set off only against profits from speculation business. Likewise, losses from owning and maintaining racehorses can be set off against profits from similar activity.

• Setting off losses does aggregation of income from all heads of income from one head of income against income from other head/s. The rules regarding set off and carry forward are as follows:

(a) Subject to (i) above losses under any head of income other than the head capital gains can be set off against the income under any other head of income. Losses under the head house property to the extent it relates to the interest on loan taken for construction, purchase or repair of such property can be set off against income from any other head. In the subsequent year, the carried forward loss should be set off against income from house property and the balance loss can be carried forward for a period of eight subsequent years from the year in which the loss was first computed.

(b) Losses that remain under the head capital gains can be carried forward and set off against income under the head capital gains of subsequent years and so on. Such carry forward can be done for a period of eight subsequent years from the year in which the loss was computed.

(c) Unabsorbed business loss (other than speculation business loss) of any year can be carried forward and set off against income under the head of business of subsequent years. Such carry forward can be done for eight subsequent years from the year in which the loss was computed.

(d) Unabsorbed loss from speculation business can be carried forward and set off against income from speculation business. Such carry forward can be done for eight subsequent years.

• Unabsorbed depreciation can be carried forward and set off against the income from any other head of subsequent years without any limitation as to the number of years.

• Capital expenditure on scientific research, which is not absorbed by available current profits, is treated in the same way as unabsorbed depreciation.

Order of Deduction for Computing Income from Business For the purposes of carry forward and set off, the unabsorbed benefits from an earlier year are divided into various categories and are considered for set off, along with certain current allowances, in the order given below in computing the income from business of the current year:

• Current scientific research capital expenditure

• Current depreciation

• Carried forward business loss

• Unabsorbed depreciation and Unabsorbed capital expenditure on scientific research A loss cannot be carried forward unless the return of Income Tax is filed within the time allowed under Section 139 (1) of the Act.