How Depreciation Affects Your Business Tax Liability

Depreciation as per the Income Tax Act (ITA), 1961, is an annual deduction that allows businesses to account for the wear and tear of assets, such as buildings, machinery and vehicles, as well as certain intangibles, such as patents and trademarks. It directly reduces taxable profit, ensuring tax is paid only on income after factoring in the cost of using these assets.

The rules are primarily governed by Section 32 of the ITA, with depreciation rates prescribed under Appendix I of the Income-tax Rules, 1962.

How depreciation works under the Income Tax Act

The ITA uses the written-down value (WDV) method for most assets, not straight-line depreciation. Each year, the prescribed rate is applied to the asset block's WDV, not its original cost. This results in higher deductions in the initial years, which gradually reduce over time. The key features of this system are:

• Assets are grouped into asset blocks rather than tracked individually. All assets of the same class and rate form one block.
• The depreciation rate is applied to the block's closing WDV, after accounting for additions and disposals during the financial year.
• If an asset is purchased and put to use for less than 180 days in a financial year, only 50% of the applicable depreciation is allowed for that year.
• If the entire block is sold or ceases to exist during the year, no depreciation is allowed; instead, a capital gain or loss is computed.

Which assets qualify for depreciation

Section 32 permits depreciation only on assets owned by the business and used for business or professional purposes. Ownership and usage are both conditions that must be met. The eligible asset classes are set out below.

• Tangible assets
• Intangible assets
• Goodwill of a business was excluded from the definition of intangible assets for Section 32 with effect from financial year (FY) 2021-22, so no depreciation is available on goodwill from that year onwards.

Assets not used for business purposes (for example, a personal vehicle claimed as a business asset) are not eligible and the department may disallow the deduction during scrutiny.

What are the depreciation rates for common asset classes

The rates below are drawn from Appendix I of the Income Tax Rules, 1962. These are indicative rates for the most common asset categories. Businesses should verify the exact rate applicable to their asset type from the official rules before claiming depreciation.

What is additional depreciation for manufacturing and power businesses

Section 32(1)(iia) allows an additional depreciation of 20% of the cost of new plant or machinery in the year of acquisition, over and above the normal WDV depreciation. To qualify, the following conditions must be met:

• The business must be engaged in the manufacture or production of any article or thing, or in the generation, transmission or distribution of power.
• The machinery must be new and must not have been previously used in India or outside India.
• Ships, aircraft, office appliances, road transport vehicles and second-hand machinery do not qualify for additional depreciation.

What happens when depreciation exceeds profit

When depreciation exceeds business income for the year, the excess is called unabsorbed depreciation. It can be carried forward indefinitely until it is fully set off against future profits. Unlike unabsorbed business losses, there is no eight-year limit for carrying forward unabsorbed depreciation. It can also be set off against income under any head (other than salary income) in the year it is adjusted. 

How to claim depreciation on your income tax return

The deduction is not automatic; it must be computed correctly and disclosed in the relevant schedule of your income tax return (ITR). The steps below apply to businesses filing under the regular provisions of the Act:

• Maintain an asset register with purchase dates, cost and accumulated WDV for each block.
• Compute depreciation for the financial year using the applicable rate on the opening WDV, adjusted for additions and disposals, with the 50% rule applied where relevant.
• Report depreciation in Schedule DPM (depreciation on plant and machinery) and Schedule DOA (depreciation on other assets) in your ITR.
• If you are subject to tax audit under Section 44AB, the auditor will verify and certify these computations in Form 3CD.
• Businesses opting for the presumptive tax scheme under Sections 44AD, 44ADA or 44AE cannot separately claim depreciation, as the presumptive rate is deemed to include all deductions, including depreciation.

Conclusion

Incorrect depreciation reporting directly affects tax liability, either by increasing tax outgo due to missed claims or triggering disallowances and interest under Sections 234B and 234C in cases of over-claiming. The key is consistent, year-round maintenance of asset records rather than last-minute adjustments at filing time.

When asset tracking, WDV computation and compliance schedules are handled systematically, the risk of errors is significantly reduced. TallyPrime supports this by recording asset additions and disposals, calculating WDV-based depreciation under the ITA and generating the required schedules for accurate return filing.