1. Concept and Role of Depreciation in Income Tax
Depreciation under the Income Tax Act, 1961 is a statutory allowance granted to assessees on tangible and intangible assets used for the purposes of business or profession. It represents the measured recognition of wear and tear, physical deterioration, technological obsolescence and gradual exhaustion of assets over time.
Unlike accounting depreciation, which may be based on useful life estimates and varied methods depending on accounting standards, tax depreciation is strictly governed by prescribed rates and statutory rules. The law allows a portion of an asset’s cost to be claimed each year as a deduction from business income, ensuring that taxable profit reflects a more realistic measure of net earnings after recognising the decline in value of capital assets.
2. Block of Assets System and Written Down Value Method
2.1 Block of Assets – The Core Structural Idea
A block of assets is a group of assets falling within a class and carrying the same prescribed rate of depreciation. For example, all general-purpose plant and machinery eligible for a standard rate form one block; furniture and fittings eligible for a specific rate form another block. Depreciation is computed on the value of the block as a whole, not asset-by-asset.
This block approach simplifies computation and administration. Additions and disposals during the year are adjusted within the block’s written down value (WDV), and the same rate is applied to the aggregate WDV, irrespective of individual asset identities. Once an asset enters a block, it usually loses its separate identity for tax depreciation purposes.
2.2 Written Down Value (WDV) Method
Almost all business assets for income tax purposes are depreciated on the written down value method. The opening WDV of a block is reduced by depreciation of earlier years, adjusted for sales and additions, and the balance is used to compute current-year depreciation at the prescribed rate.
WDV ensures higher depreciation in the earlier years of an asset’s life and gradually lower claims later. This broadly mirrors economic reality – assets generally deliver higher efficiency and benefit when new and slowly decline in productivity as they age. The method also naturally prevents over-depreciation because the base keeps shrinking each year.
3. Broad Categories of Assets and Depreciation Rates
The Income Tax Rules classify assets into broad categories, each attracting specific depreciation rates according to the nature, intensity of use and expected life of the asset. Understanding these categories is crucial for correct classification and accurate claims.
3.1 Buildings
For tax purposes, “buildings” include residential houses, office premises, factory buildings, godowns, warehouses and similar structures used for business or professional purposes. Within this category:
- Residential buildings used for employees generally attract a lower rate.
- Non-residential buildings such as offices and factories carry a higher rate to reflect more intensive use.
- Temporary constructions, such as structures made of tin, wood or other temporary materials, are eligible for higher rates due to their short useful life.
Correct categorisation of a building into residential, non-residential or temporary directly influences the applicable rate and therefore the quantum of annual deduction.
3.2 Furniture and Fittings
Furniture and fittings include chairs, tables, shelves, cabinets, storage units and electrical fittings such as lights and fans. These assets usually enjoy a standard, moderate rate of depreciation, consistent with their relatively long physical life but steady wear and tear through usage.
For offices, shops and service establishments, furniture and fixtures often represent a significant initial capital outlay. Depreciation spreads this cost over time and reduces the effective tax burden on the entrepreneur or professional.
3.3 Plant and Machinery
Plant and machinery is the most critical block for industrial and many service businesses. It broadly covers mechanical and electrical equipment, production lines, tools, devices, testing equipment and specialised installations used in manufacturing, processing or provision of services.
Within the plant and machinery head, different sub-categories may attract different rates, for example:
- General plant and machinery at a standard rate.
- Motor cars used in business, with a separate prescribed rate.
- Commercial vehicles such as buses, lorries and taxis purchased under specified conditions.
- Energy-saving devices, pollution control equipment and other environmentally friendly machinery, often eligible for relatively higher rates or additional depreciation.
These differentiated rates are designed to acknowledge heavier use, faster obsolescence or policy priorities in certain types of equipment.
3.4 Intangible Assets – A Separate Class
Tax depreciation is also allowed on specified intangible assets such as know-how, patents, copyrights, trademarks, licenses, franchises and other business or commercial rights of similar nature. These assets are often subject to a uniform higher rate, reflecting their finite commercial life and rapid obsolescence in dynamic markets.
4. Methodology of Computing Depreciation
Depreciation computation under the Income Tax Act involves applying the prescribed rate to the adjusted WDV of the relevant block, with special rules for assets acquired or put to use during the year.
4.1 Normal Depreciation on WDV
Normal depreciation is calculated on the opening WDV of the block after adjusting for additions and reductions. New assets acquired during the previous year are added to the block at actual cost, provided they are put to use for business or profession.
If an asset is used for at least a specified minimum period during the financial year, full depreciation at the prescribed rate is allowed. If it is used for less than that threshold, only a portion (commonly half of the normal rate) is allowable, reflecting partial use in the first year.
4.2 Additional or Accelerated Depreciation
In specified cases, particularly for new plant and machinery used in manufacturing or certain notified activities, the law permits additional depreciation over and above the normal rate. This extra allowance is meant to promote capital investment, technological upgradation and industrial growth.
Additional depreciation is generally allowed in the year of acquisition and installation, subject to conditions such as the asset being new and used for eligible purposes. Where the asset is used for less than the minimum period during that year, a proportion of additional depreciation may be allowed with the balance sometimes claimable in a subsequent year.
5. Special Rules Affecting Effective Depreciation
5.1 Assets Used for Less Than the Threshold Period
When an asset is acquired during the year and used for less than a prescribed minimum number of days, only half of the normal rate is effectively applied for that year – often referred to informally as the “half-year” depreciation restriction.
From the following year onwards, the asset forms part of the block in the ordinary way and is eligible for full depreciation at the applicable rate on the reduced WDV.
5.2 Sale, Discarding or Demolition Within a Block
If any asset in a block is sold, discarded, demolished or destroyed, the money payable in respect of that asset (such as sale consideration or insurance receipt) is reduced from the block’s WDV. The prescribed rate of depreciation remains unchanged, but the base to which it is applied is modified.
If, after such reduction, there is no asset left in the block and the WDV becomes nil, no further depreciation is allowed on that block. If the money payable exceeds the block’s WDV, the surplus is generally treated as short-term capital gain for tax purposes.
5.3 Assets Not Used for Business
Depreciation is allowable only on assets that are owned and used for the purposes of business or profession. Mere ownership without actual business use (or at least readiness for use) does not qualify. Where an asset is kept idle for non-business reasons during a year, the depreciation claim may be denied for that period.
6. Strategic Implications of Depreciation for Tax Planning
Depreciation is more than a mechanical deduction; it is a powerful planning tool that affects cash flow, investment timing, financing choices and reported profits.
6.1 Impact on Tax Cash Outflow
Depreciation is a non-cash expense that reduces taxable income. A higher depreciation claim in the initial years of an asset’s life lowers current tax outflow and improves post-tax cash flows, leaving more funds available for reinvestment or working capital.
Businesses can plan the timing of major capital investments—such as machinery purchases or office expansion—keeping in mind the availability of higher rates or additional depreciation, thereby smoothing their tax profile over multiple years.
6.2 Asset Selection and Policy Incentives
Different rates for different classes of assets influence asset selection. For example, higher depreciation for energy-efficient equipment or pollution control devices encourages investment in such assets, aligning business strategy with policy objectives and long-term cost savings.
By deliberately choosing asset types that enjoy better depreciation treatment where commercially viable, businesses can enhance their overall tax efficiency without compromising operational performance.
6.3 Interaction with Accounting Depreciation and Book Profits
Accounting depreciation, based on company law or accounting standards, may significantly differ from tax depreciation. This creates a gap between “book profit” and “taxable profit”. While tax laws govern actual tax liability, book figures affect investor perception, dividend policy and loan covenants.
Understanding the prescribed tax rates helps management anticipate these differences, manage deferred tax implications and communicate performance more accurately to stakeholders.
7. Depreciation on Intangible Assets and Commercial Rights
Modern business value often lies in intangible rights; tax depreciation recognises this economic reality. The inclusion of intangible assets such as know-how, patents, copyrights, trademarks, licenses and franchises within the depreciation framework acknowledges that these rights directly contribute to income generation.
Cost incurred to acquire such rights is not treated as an immediate expense but is spread over time through depreciation, similar to tangible assets. Given the rapid pace of technological and commercial change, the rate prescribed for intangibles is typically higher than that for many physical assets, consistent with the expectation that intangible advantages will lose their value faster due to competition, innovation and legal or regulatory shifts.
8. Compliance, Documentation and Asset Tracking
Accurate depreciation claims depend on strong asset records and clear mapping to tax blocks. Poor documentation not only risks disallowance but also complicates internal decision-making.
8.1 Fixed Asset Register and Supporting Records
Although depreciation is computed block-wise, it is vital to maintain a detailed fixed asset register, capturing acquisition date, cost, location, identification number and nature of each asset. This register supports the computation of WDV, helps identify assets eligible for special rates or additional depreciation, and is indispensable in case of assessment or scrutiny.
8.2 Correct Classification into Blocks and Rates
Misclassification of assets—such as treating a temporary structure as a permanent building or mixing commercial vehicles with private cars—can lead to under- or over-claim of depreciation, with potential tax adjustments and interest. Careful mapping of each asset to the correct schedule entry and rate is therefore a core compliance requirement.
9. Evolution and Policy Direction of Depreciation Rates
Depreciation rates have evolved with economic conditions, technology and policy priorities. Over time, the rate structure has been rationalised: extremely high rates for some assets have been moderated, categories have been consolidated, and special reliefs have been targeted to priority areas like energy efficiency, infrastructure and manufacturing.
Depreciation thus functions as a policy lever. By tuning rates, the law can encourage or discourage certain investment behaviours, promote modernisation and respond to changing technological realities without altering the underlying structure of income taxation.
10. Conclusion
The rates of depreciation prescribed under the Income Tax Act, 1961, combined with the block of assets system and WDV method, provide a coherent, predictable and administratively manageable framework for recognising the gradual loss in value of business assets. They ensure that capital expenditure is recovered over time through systematic tax deductions, aligning tax computation with economic reality.
For businesses of all sizes, especially small and medium enterprises, understanding how different asset categories are treated, how rates operate, and how special provisions like additional depreciation work is essential for effective tax planning. When integrated with broader decisions on financing, technology, capacity expansion and risk management, depreciation becomes more than a statutory allowance—it becomes a strategic instrument in shaping long-term business growth and post-tax returns.