Unabsorbed Depreciation Under Section 32(2) Of The Income Tax Act
In a financial year, it is possible that an assessee does not have sufficient profits to cover the depreciation expenses. In this case, we refer to the amount of unutilised depreciation as unabsorbed depreciation.
According to guidelines set by the Income Tax Act of 1961, one can set off any unabsorbed depreciation against any other heads of income. Furthermore, one can also carry forward the remaining balance to subsequent financial years.
So if you have insufficient profits in your profit & loss account, keep reading to learn more about rules and restrictions regarding the adjustment of unabsorbed depreciation.
What does Unabsorbed Depreciation Mean?
For taxation purposes, every taxpayer maintains a book of accounts. Unabsorbed depreciation takes place when one is unable to absorb a portion of depreciation in their book of accounts. Such a situation can take place when one’s profits are not enough to balance depreciation.
However, the Income Tax Department allows assessees to carry forward this portion of depreciation so that they can absorb this amount against any future profits. Moreover, the difference between business loss and unabsorbed depreciation is that one can carry forward the latter for an infinite number of years. Meanwhile, for business loss, the time limit is up to 8 years.
Actual Cost of Assets
In simple terms, actual cost refers to the actual expenditure incurred to acquire an asset. Meanwhile, Section 43 of the Income Tax Act defines actual cost as the cost incurred on assets to an assessee, decreased by that part of the cost thereof, if any, as met indirectly/directly by a person or authority.”
In 2018, the Central Board of Direct Taxes made amendments to the calculation of actual costs of assets. Now, if an assessee uses a cheque, bank draft, or electronic clearing system to pay for expenses more than Rs. 10,000 to acquire an asset, then one does not include the expenses while calculating the actual costs of assets.
Here is a list of actual costs of assets under different circumstances:
| Assets | Actual Costs |
| Used for scientific research | Cost of assets after deduction claimed under Section 35 |
| Gained through gift or inheritance | Cost of assets incurred by the previous owner after deduction claimed by them |
| Sold and re-acquired | Actual cost of the asset incurred when first acquired after deduction or cost of re-acquiring asset, whichever is lower |
| Building used for personal purpose | Cost of assets after deduction (the deduction amount is what would be allowed if the building was used for business.) |
| Acquired from holding or subsidiary business | Net cost of depreciation if both companies are Indian |
| Acquired on amalgamation | Net cost of depreciation if the amalgamated company is Indian. |
| Acquired by demerger | Net cost of depreciation if the resulting company is Indian |
| Interest paid on asset acquisition | 1. If interest gets paid before the asset is put to use: Interest is added to the actual cost of assets 2. If interest gets paid after the asset is put to use: Interest charged to the P&L account |
| Subsidy received on an asset | The subsidised part of an asset will not be a part of the actual cost |
| Asset eligible for deduction under Section 35AD | Nil |
Provisions to Set off Unabsorbed Depreciation
When an assessee faces unabsorbed depreciation, the first thing to do in the current year is to adjust it against the income head “Profits and Gains of Business and Profession”. Then, if business income is not sufficient, set off any remaining balance against other income heads for that assessment year. Other income heads can be:
- Income from Salaries
- Capital gains
- Income from House Property
- Income from other sources
However, it is possible that after making all the adjustments in the current year, an assessee still has an unabsorbed depreciation balance. In this situation, one can carry forward the balance and consider it as the following year’s deprecation. Thus, the assesse will be able to set it off against future profits.
Order Followed to Set off Unabsorbed Depreciation
For ITR purposes, it is necessary to follow this order while setting off the unabsorbed depreciation balance:
- First: Adjust current year depreciation and expenses incurred from scientific research and family planning.
- Second: Adjust brought forward business loss (time limit to make these adjustments is eight years).
- Third: Adjust the remaining unabsorbed depreciation.
Provisions to Carry Forward Unabsorbed Depreciation in case of Delayed Returns
The guidelines on set-off and carry forward of depreciation are set under Section 32(2) of the Income Tax Act and not Section 80. Thus, an assessee’s delay in filing income tax returns does not affect the carrying forward of unabsorbed depreciation.
Irrespective of missing the ITR due date, one can set off this depreciation allowance against the taxable income of subsequent years. Nonetheless, assessees do need to follow the provisions mentioned under the Act.
Final Word
Many times assessees or taxpayers are unable to make enough profits from their profession/business. In these cases, it is possible for them to have insufficient gains to set off any depreciation in the current year.
Fortunately, the Government of India allows assessees to set off and carry forward this unabsorbed depreciation to the subsequent years. However, assessees should pay close attention to the rules and restrictions mentioned under Section 32(2) of the Income Tax Act.
FAQs
Ans: According to Section 32 of the Income Tax Act, an assessee can carry forward depreciation to the next financial year. Thus, the income you earn in the future can be utilised to set off any depreciation you incurred in the past.
Ans: Yes, it is possible to set off unabsorbed depreciation against capital gains after adjusting them against profits from the business. These capital gains can be short term or long term, arising from various sources, like the sale of business assets.
Ans: The closing down or discontinuation of a business does not impact the carrying forward of unabsorbed depreciation. Thus, one can continue to set off or carry forward the depreciation balance for an indefinite period.
Ans: Carrying forward of depreciation can only take place when the assessee remains the same during the adjustment period. Thus, it is not possible for different assessees to set off the same unabsorbed depreciation. Nonetheless, there are some exceptions, like amalgamation, demerger, etc.
Ans: The Income Tax Act has set up time restrictions on carrying forward various depreciations. For example, one can set off a business loss till a maximum of eight years. However, there is no time limit in the case of unabsorbed depreciation.
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This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
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