What Is Unabsorbed Depreciation?

Unabsorbed depreciation is the excess amount of unaccounted depreciation that cannot be adjusted in the current year due to lack of profits in the profit and loss account. This unabsorbed amount can be set-off against other heads of income and is carried forward for adjustments in the forthcoming years. It can be carried forward perpetually for any number of years until the excess amount is fully adjusted.

Legal Enforcement Of Unabsorbed Depreciation

Section 32(1) of the Income Tax Act expounds on unabsorbed depreciation and states that the assessee can claim depreciation on assets (tangible and intangible) if the following two criteria are fulfilled:

– The asset is owned (partially or wholly) by the assessee

– The asset is used for purposes of business and profession. Under no circumstance should it be a personal asset for individual

Section 32(2) expounds on ‘unabsorbed’ depreciation and its feature to be carried forward in perpetuity for adjustment purposes.

On reading through the said section it can be gleaned that where full effect cannot be given to depreciation as computed u/s 32(1), in any previous year, owing to fact that the depreciation allowance for said year exceeds the profit or gains for said previous year then subject to section 72(2) & 73(3), the excess of such depreciation shall be added to the depreciation of following previous year and where there exists no depreciation for following previous year, such unabsorbed depreciation shall deemed to be the depreciation for that year.

Application Of Unabsorbed Depreciation

Ideally there is no restriction in the application of unabsorbed depreciation and if there would have been, it would be clearly expounded in section 32(2). However, although no restrictions, there is a set hierarchy in which such depreciation has to be accommodated. The sequence of adjustment is mentioned in section 72(2) which states that where there is a business loss, it must be accounted before the unabsorbed depreciation.1

There is no restrictive time period for the settlement of unabsorbed depreciation because the intent of the legislature had been to conserve sufficient funds to replace plant and machinery.

They have therefore, done away with the 8 year period limitation that earlier existed.2

“Once the unabsorbed carried forward depreciation has become a part of the depreciation of the current year, it is not open to the assessee to bifurcate the two again and claim depreciation for the current year and not claim the unabsorbed depreciation of previous years thereby contending that it cannot be forced upon the assessee”.3

The depreciation is an amalgamation of the depreciation for the current year along with the unabsorbed depreciation and once these have been scrambled together they cannot be unscrambled and differentiated yet once again. This defeats the entire purpose of section 32 and can lead to the assessee misusing this section to escape adjustment of unabsorbed depreciation.

Treatment Of Losses And Unabsorbed Depreciation In A Merger Transaction

Tax law plays a major role when certain restructuring measures like mergers and acquisitions are adopted. When an amalgamation takes place the transferee (amalgamated company) is obligated to carry forward the losses and unabsorbed depreciation of the transferor (amalgamating company). The amalgamated company can only carry forward the losses when certain conditions are fulfilled and compliances are met:

– “The amalgamating company must be owning an ‘industrial undertaking’

– The surviving company must hold atleast 75% of the book value of fixed assets of the amalgamating company for a minimum period of 5 years from the date of amalgamation;

– The surviving company must continue the business of the amalgamating company for a minimum period of 5 years from the date of amalgamation;

– The surviving company shall achieve the level of production of at least 50% of the installed capacity of the undertaking before the end of 4 years from the date of amalgamation.”4

It is however, to be realised that fulfilling all these conditions may pose immense difficulty for a company trying to revive under the IBC. Especially if the revival plan includes a merger then fulfilling these conditions can be extremely challenging because there may be hindrances in achieving the minimum level of production and the amalgamating company may not be owning an ‘industrial unit’ either. This would make the absorption of losses and unabsorbed depreciation in the amalgamated company extremely difficult thereby putting the transferor company in a risky position pre-merger.

Under the SICA regime, the Board for Industrial and Financial Restructuring (‘BIFR’) would more than often exempt sick companies from stringent application of these conditions so that they could get some relief and the obligation of unabsorbed depreciation and losses can be easily transferred to the amalgamated company. However, ever since IBC is being governed under the NCLT no such exemptions have been made for the suffering companies.

Concluding Thoughts

The concept of unabsorbed depreciation provides Companies a ‘sigh of relief’ as they are permitted to carry forward the burden of adjusting it in the coming years. There is no limit to the number of years it can be carried forward. However, in a case where a company is insolvent/ bankrupt and is restructuring through a merger, the conditions required to be fulfilled for carrying forward the unabsorbed depreciation from the amalgamating company to the amalgamated company is extremely stringent. These guidelines should be relaxed and suffering companies should be given some leeway with respect to these conditions.

1 Suresh Industries in ITA No. 5374/Mum/2011

2 General Motors Ltd Case 354 ITR 244 , Bajaj Hindustan Ltd. 394 ITR 73

3 Seshasayee Paper and Board Limited vs DCIT (SC)

4 Law Street India: Tax Policy for Losses of IBC Companies – A Case of Treading in Turbulent Waters?

Author- Rhea Ajmera | BBA LLB (Hons) | O.P. Jindal Global University, Sonipat | Student Placement Representative

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March 2021