Introduction
Depreciation is a valuable deduction under the Income Tax Act, 1961, allowing taxpayers to account for the wear and tear of assets used in their business or profession. However, in some cases, the depreciation allowable exceeds the taxable income, resulting in unabsorbed depreciation. Understanding how to carry forward and utilize unabsorbed depreciation is crucial for efficient tax planning. This blog will explain the concept, legal provisions, and practical treatment of unabsorbed depreciation.
What is Unabsorbed Depreciation?
Unabsorbed depreciation refers to the portion of depreciation that cannot be deducted due to insufficient taxable income in a given financial year. This excess depreciation does not lapse; instead, it is carried forward for future adjustments.
Example:
If the taxable income of a business is ₹2,00,000 and the depreciation allowable is ₹3,00,000, the excess ₹1,00,000 is considered unabsorbed depreciation.
Legal Provisions for Unabsorbed Depreciation
1. Section 32(2)
Under Section 32(2) of the Income Tax Act, unabsorbed depreciation can be carried forward and adjusted against any income in subsequent years.
2. Unlimited Carry Forward
Unlike business losses, which can be carried forward for only 8 assessment years, unabsorbed depreciation can be carried forward indefinitely.
Set-Off of Unabsorbed Depreciation
The unabsorbed depreciation can be set off against:
- Income from Business or Profession: Priority is given to set it off against income under this head.
- Income from Other Heads: If no income is available under “Profits and Gains of Business or Profession,” it can be set off against income from other heads (except salary).
Example:
- Year 1: A business has unabsorbed depreciation of ₹1,00,000.
- Year 2: The business earns ₹50,000 from house property and ₹30,000 from other business activities.
- ₹30,000 of unabsorbed depreciation is set off against business income.
- ₹50,000 is set off against house property income.
Priority of Set-Off
When unabsorbed depreciation and other losses (e.g., business losses) are carried forward:
- Current depreciation is adjusted first.
- Brought-forward business losses are adjusted next.
- Unabsorbed depreciation is adjusted last.
Examples of Unabsorbed Depreciation Treatment
Example 1: Set-Off Against Business Income
- Year 1:
- Business income: ₹2,00,000
- Depreciation allowable: ₹3,00,000
- Unabsorbed depreciation: ₹1,00,000 carried forward.
- Year 2:
- Business income: ₹1,50,000
- Unabsorbed depreciation: ₹1,00,000
- Taxable income after set-off: ₹50,000
Example 2: Set-Off Against Other Income
- Year 1:
- Depreciation allowable: ₹4,00,000
- Business income: ₹2,00,000
- Unabsorbed depreciation: ₹2,00,000 carried forward.
- Year 2:
- Business income: ₹0
- Income from house property: ₹1,50,000
- ₹1,50,000 of unabsorbed depreciation is set off against house property income.
Special Cases
1. In Case of Business Discontinuation
Unabsorbed depreciation can still be carried forward and set off against other income, even if the business generating it is discontinued.
2. In Case of Tax Holidays
If a business is in a tax holiday period (e.g., SEZ units), the unabsorbed depreciation can be carried forward to post-holiday years for set-off.
3. For Companies Under MAT (Minimum Alternate Tax)
Companies paying MAT can carry forward unabsorbed depreciation for set-off against regular income in subsequent years.
FAQs
1. Is unabsorbed depreciation treated differently from business losses?
Yes, unabsorbed depreciation has an unlimited carry-forward period, while business losses can be carried forward only for 8 assessment years.
2. Can unabsorbed depreciation be adjusted against salary income?
No, unabsorbed depreciation cannot be set off against salary income.
3. What happens to unabsorbed depreciation in case of amalgamation?
In case of amalgamation, the unabsorbed depreciation of the amalgamating company can be carried forward by the amalgamated company, subject to conditions under Section 72A.
4. Does the carry forward of unabsorbed depreciation require a tax audit?
Yes, businesses must ensure proper compliance with tax audit requirements for carrying forward unabsorbed depreciation.
5. Can unabsorbed depreciation be claimed by individuals?
Yes, individuals carrying on business or profession can claim unabsorbed depreciation under the same provisions as companies or firms.
Conclusion
Unabsorbed depreciation is a valuable tax relief that ensures businesses can maximize their deductions over time, even when profits are insufficient in a particular year. Its unlimited carry-forward feature provides flexibility for businesses to manage their tax liabilities efficiently. By understanding and applying these provisions, taxpayers can optimize their tax planning and ensure compliance with the Income Tax Act.
Additional Resources
Learn more about Tax Provisions on the official Income Tax India website.
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