Capitalisation on Capital Goods

Capitaliation on Capital Goods

Prepared By:

CA Pradeep Jain

Mayank Palgauta

The recent budget has made changes in respect of reversal of Cenvat credit on removal of capital goods. Through this piece, we are trying to analysis the same and seeing its impacts.

Amendment in the Budget:-

The second proviso to sub-rule 5 of Rule 3 has been substituted which reads as follows:-

“Provided further that if the capital goods, on which CENVAT Credit has been taken, are removed after being used, the manufacturer or provider of output services shall pay an amount equal to the CENVAT Credit taken on the said capital goods reduced by the percentage points calculated by straight line method (SLM) as specified below for each quarter of a year or part thereof from the date of taking the CENVAT Credit, namely:-

1. for computers and computer peripherals:

for each quarter in the first year @ 10%

for each quarter in the second year @ 8%

for each quarter in the third year @5%

for each quarter in the fourth and fifth year @1%

2. for capital goods, other than computers and computer peripherals @ 2.5% for each quarter.”

Meaning:

From the above amendment in Rule 3 (5) of CENVAT Credit Rules, 2004 it is clarified that those Capital Goods on which credit is taken and are removed after being used by the Manufacturer or service provider then he will liable to pay the proportionate amount of Cenvat Credit which will be decreased by depreciation amount calculated on % basis on each quarter in each year or part thereof. Earlier the depreciation was provided @ 2.5% per quarter. But now the Capital goods have been classified in two categories for this purpose -

I. computers and computer peripherals; and

II. other capital goods

In first category of “computers and computer peripherals” the amount of depreciation will be determined as follows:

	% apply in each quarter	Total *historical cost* of capital goods will reduced by
In first Year	10 %	10 * 4 = 40%
In second Year	8 %	8 * 4 = 32%
In third Year	5 %	5 * 4 = 20%
In fourth Year	1 %	1 * 4 = 4%
In fifth Year	1 %	1 * 4 = 4%
TOTAL % of depreciation		100%

Thus, the assessee will able to get the full amount of depreciation during the first five year due to affect of SLM approach.

For Capital Goods, other than computers and computer peripherals, the benefit of depreciation will be permitted during the period of ten years as rate of depreciation is given in this notification @ 2.5 % per quarter.

Whereas according to provisions of the Income Tax Act, 1961 the amount of depreciation on "Computers and Office Equipments” will be calculated on the basis of Written down Value (WDV) method @ 60 % on carrying amount of such asset in each year and part thereof. This can be understood by the following table: -

PARTICULARS	CALCULATIONS OF DEPRECIATION AMOUNT	CARRYING AMOUNT
	Assumed Cost of Asset	Rs. 100
First Year	100 * 60 % = Rs. 60	(100-60) = Rs. 40
Second Year	40 * 60% = Rs. 24	(40-24) = Rs. 16
Third Year	16 * 60% = Rs. 9.6	(16-9.6) = Rs. 6.4
Fourth Year	6.4 * 60% = Rs. 3.84	(6.4-3.84) = Rs. 2.56
Fifth Year	2.56 * 60% = Rs. 1.54	(2.56-1.54)= Rs. 1.02

Thus, according to Income Tax Act, 1961 the assessee will not be able to get full amount of depreciation on such asset due to affect of WDV approach during first five years.

But while going through per year benefit of depreciation in terms of % as a whole then it appears that benefit of depreciation amount in first year will be more under Income Tax Act whereas in subsequent years benefit will be more under Excise Law. This can be presented in tabular form as follows: -

Particulars	As per Excise Law	As per Income Tax Law	Excess Benefit under excise law
	Benefit of depreciation in % on Original Cost
First Year	40 %	60 %	(-) 20 %
Second Year	32 %	24 %	8 %
Third Year	20 %	9.6 %	10.4 %
Fourth Year	4 %	3.84 %	0.16 %
Fifth Year	4 %	1.54 %	2.46 %
TOTAL	100 %	98.98 %

There should not be different tax rates under Income tax and Central Excise Rules.

The second impact of this amendment clarifies is that the depreciation will be allowed on straight line method. Earlier it was not clearly provided in the rule that the depreciation will be allowed on straight line or written down value method. The audit party has raised paras on the same. But this dispute is settled by this clear amendment. This is a welcome step.

Before parting……..

The cenvat credit on the capital goods falling under Chapter 82, 84, 85, 90 is allowed as per Rule 2(a) of Cenvat Credit Rules, 2004. The computer falls under the above definition. But the other condition is that the same should be used in the factory but does not include the things used in office premises. Most of the computers and peripherals are used in the office premises only. As such the credit will not be allowed on the same. However, the computers and computer peripherals are attached to machines comes along with machine and classified as a whole in that tariff heading. If this part is removed after use then the same will fall under tariff heading of machine. As such, whether the depreciation listed above will be allowed? The department will not agree to the same. But the service provider will definitely get the benefit of the same.

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