Unabsorbed depreciation

A business writes off part of the cost of its assets every year. That write-off is depreciation.

In a bad year there is not enough income to absorb it. What is left over is unabsorbed depreciation.

The Act does not simply fold it into the business loss. While computing business loss, unabsorbed depreciation is treated as a separate item.

That separate treatment is generous in two ways.

First, it can be carried forward for any number of years. An ordinary business loss gets only 8.

Second, it can be set off against any income, with one exception: salary. A carried-forward business loss can only be set against business income.

So of the two things a loss-making business might be left holding, unabsorbed depreciation is by far the more useful.

One restriction survives anyway. Salary income is out of reach, however many years pass.

The rule, section 7.8.2. The workbook states it in a single sentence attached to the business-loss discussion: while computing business loss, unabsorbed depreciation will be treated as a separate item and will be allowed to be carried forward for any number of years and can be set-off against any income except salary.

Where that leaves it in Table 7.4. The workbook's summary of set-off and carry forward names the exclusion in the row heading itself. Row 2 reads Business or Profession (other than speculation/specified business or depreciation) — so the 8-year, business-income-only row is precisely the row depreciation is carved out of.

Read the table and the sentence together and the point is sharp. Every other carried-forward loss in the list is either time-limited or head-limited, and most are both. Unabsorbed depreciation is neither — except for salary.

Where in the computation it acts. Section 7.12 builds Gross Total Income in three steps: add the five heads of income, club the income of other persons, then set off the losses of the current year or earlier years. Unabsorbed depreciation is applied at that third step, before any Chapter VI-A deduction is considered, so it reduces Gross Total Income itself rather than the tax.

The two adjustments available at that step. Section 7.12, step 3, names them: intra-head adjustment, setting off losses from one source against income from another source under the same head, and inter-head adjustment, setting off losses under one head against income taxable under another head. Unabsorbed depreciation's freedom is an inter-head freedom, which is what makes it valuable.

What the workbook does not say. It gives no figure for the rate of depreciation, no asset-block mechanics, and no ordering rule for whether current-year depreciation, brought-forward business loss or brought-forward depreciation is absorbed first. Those are outside this workbook, so a question here will be about the carry-forward period and the heads available, not about computing the depreciation itself.

Illustrative figures; the workbook states the rule in Table 7.4 and section 7.8.2 without a worked example for depreciation.

Mr Kulkarni runs a small printing business and also earns rent and interest. In Year 1 the business has a bad year.

Year 1
  Business income before depreciation        Rs   2,00,000
  Depreciation for the year                  Rs   9,00,000
                                              -------------
  Absorbed against business income           Rs   2,00,000
  UNABSORBED DEPRECIATION carried forward    Rs   7,00,000

Year 2. The business breaks even. He has Rs 4,00,000 of rent from a shop, Rs 1,10,000 of interest and Rs 6,00,000 of salary from a part-time directorship.

Unabsorbed depreciation brought forward      Rs 7,00,000
Set off against house property and interest  Rs 5,10,000
Still carried forward                        Rs 1,90,000  (for any number of years)
Gross Total Income for Year 2                Rs 6,00,000  (the salary, untouched)

The Rs 6,00,000 of salary bears tax even though he is holding Rs 1,90,000 of unused depreciation. That single exception is the trap.

Now compare the same Rs 7,00,000 as an ordinary business loss.

Same rupee amount, same taxpayer, same year — and Rs 5,10,000 of difference in what can be used, purely because of how the Act classifies the two.

And the clock. If Mr Kulkarni's business makes no profit until Year 12, the brought-forward business loss would have expired after 8 years. The Rs 1,90,000 of unabsorbed depreciation would still be alive.

Chapter 7 (Concepts of Taxation), section 7.8.2 on losses under the head profits and gains of business or profession, carries the rule in one sentence, and Table 7.4 — the comprehensive summary of set-off and carry forward of losses — names depreciation in the exclusion to its business-loss row, along with the 8-year, 4-year and cannot-be-carried-forward periods for the other loss types. Section 7.12, step 3, places the set-off inside the computation of Gross Total Income.

Expect a table-based question on carry-forward periods, where unabsorbed depreciation is the one entry with no limit, and a question on which head it cannot be set against — salary.

• Any number of years, not 8. The 8-year limit belongs to ordinary business loss, and Table 7.4's business row expressly excludes depreciation.
• Any income except salary. That is the only bar, and it is absolute — no number of years removes it.
• It is a separate item from business loss, and the workbook says so while computing business loss. Treating the two as one is the root of every wrong answer here.
• A brought-forward business loss can only go against business income. Unabsorbed depreciation can go against house property, capital gains and other sources too. Do not swap the two rules.
• Speculation loss is 4 years, not 8, and only against speculation profit — a common distractor in the same table.
• It acts at step 3 of Gross Total Income, before Chapter VI-A deductions. So it reduces the income, not the tax.
• The workbook gives no depreciation rates and no absorption order. Any question offering a rate of depreciation or an ordering rule is not sourced from this workbook.