Depreciation: Companies Act 2013 vs Income Tax Act 2025 — Guide 2026

Depreciation is one of those accounting concepts that seems straightforward until your client asks: "Why does my profit in the financial statements differ from my taxable profit?" The answer, almost always, involves two different depreciation calculations running side by side — one for your statutory books under the Companies Act, 2013, and one for computing income tax liability under the Income Tax Act, 2025 (formerly the Income Tax Act, 1961, repealed with effect from 1 April 2026).

If you maintain only one depreciation schedule, you are either understating your company's book profit or computing your tax liability incorrectly. Getting this right is not optional — it directly feeds into your deferred tax computation under AS-22, your tax audit under Form 3CD, and your final income tax return.

Why Two Depreciation Frameworks Exist

India operates two parallel depreciation systems because the objectives of financial reporting and tax assessment are fundamentally different.

Financial Reporting (Companies Act, 2013): Schedule II of the Companies Act prescribes useful lives for different categories of assets. Depreciation is calculated on the basis of the asset's estimated useful life, ensuring that the profit and loss account reflects a true and fair view of the company's financial performance.

Tax Computation (Income Tax Act, 2025): The Income Tax Act, 2025 (effective 1 April 2026) consolidates provisions from the repealed 1961 Act and prescribes depreciation rates in Schedule VII. The rates use the Written Down Value (WDV) method and operate on a block of assets basis — all assets of the same class are grouped and depreciated together. Accelerated rates in early years function as a capital investment incentive.

Both frameworks exist by law. Both must be computed separately, and neither can substitute for the other.

Companies Act 2013: Schedule II Depreciation

Schedule II of the Companies Act, 2013, bases depreciation on useful life of the asset — not a prescribed rate. You choose between:

Straight Line Method (SLM): Annual depreciation = (Cost – Residual Value) ÷ Useful Life in years

Written Down Value (WDV): Permitted under Companies Act, but the WDV rate is derived from Schedule II useful life, not from any tax rate table.

Key Asset Categories and Useful Lives

Mandatory Residual Value: Schedule II requires 5% of the original cost to remain as residual value at the end of useful life. Depreciation stops at this floor — you cannot write an asset down to zero under the Companies Act.

Practical Example: A laptop purchased for ₹1,20,000. Under Companies Act Schedule II:

• Useful life: 3 years
• Residual value: 5% × ₹1,20,000 = ₹6,000
• Depreciable amount: ₹1,14,000
• Annual SLM depreciation: ₹1,14,000 ÷ 3 = ₹38,000 per year

By end of Year 3, the carrying value equals ₹6,000 (residual). No further depreciation is charged.

Pro-Rata Depreciation for Part-Year Acquisitions

For assets acquired mid-year, Companies Act allows depreciation on a day basis. A machine bought on 15 December 2025 earns 107 days of depreciation in FY 2025-26 (15 December to 31 March 2026), computed as: Annual SLM charge × 107/365. This granularity is one of the key differences from the Income Tax approach described below.

Income Tax Act 2025: Schedule VII Block Depreciation

The Income Tax Act, 2025 continues the Written Down Value block system from the repealed 1961 Act. All assets of the same prescribed class form a single block, and the prescribed WDV rate applies to the block's opening balance plus additions, minus sale proceeds received during the year.

Prescribed WDV Rates — Key Asset Classes

Same Laptop — Tax Depreciation Computation:

• Block: Computers & peripheral equipment — Rate: 40% WDV
• Year 1: Depreciation = ₹1,20,000 × 40% = ₹48,000; Closing block WDV = ₹72,000
• Year 2: ₹72,000 × 40% = ₹28,800; Closing block WDV = ₹43,200
• Year 3: ₹43,200 × 40% = ₹17,280; Closing block WDV = ₹25,920

Under Companies Act, this asset is fully depreciated by Year 3 (to ₹6,000 residual). Under Income Tax, the block carries ₹25,920 forward into Year 4 and continues attracting depreciation indefinitely. This divergence accumulates across every asset the business owns.

The Half-Year Rule — A Critical Compliance Trap

Under the Income Tax Act, assets acquired in the second half of the financial year (1 October onwards) qualify for only 50% of the normal rate in that acquisition year. A laptop bought in January 2026 earns only 20% (half of 40%) in FY 2025-26, regardless of whether it was in use for 90 days or 30 days.

This is a sharp departure from the Companies Act's day-based pro-rata.

Example: Two laptops, each costing ₹1,20,000 — one purchased in May 2025, one in January 2026:

• May purchase (first half of year): full 40% rate = ₹48,000 depreciation in FY 2025-26
• January purchase (second half of year): half rate 20% = ₹24,000 depreciation in FY 2025-26

Claiming the full rate for the January purchase overstates the deduction by ₹24,000 — a common disallowance in scrutiny assessments under Section 143(3) of the Income Tax Act.

Additional Depreciation for Manufacturers

The Income Tax Act, 2025 continues the additional depreciation benefit for manufacturing companies and companies engaged in power generation or distribution. On new plant and machinery (not previously used in India), an additional 20% depreciation is allowed in the year of purchase — stacked on top of the normal WDV rate.

For factories in government-notified backward areas, this additional allowance rises to 35%.

Example: A textile manufacturer buys a new weaving machine for ₹40,00,000 in FY 2026-27:

• Normal WDV depreciation (15%): ₹6,00,000
• Additional depreciation (20%): ₹8,00,000
• Total tax deduction in Year 1: ₹14,00,000

Compare this to the Companies Act charge under SLM over 15 years: (₹40,00,000 × 95%) ÷ 15 = ₹2,53,333.

The timing difference is ₹14,00,000 − ₹2,53,333 = ₹11,46,667. At a 25.17% corporate tax rate (small domestic company), the deferred tax liability on this single asset is ₹2,88,631 — material enough to affect balance sheet presentation and warrant separate disclosure in the notes to accounts.

The Deferred Tax Bridge: AS-22 in Practice

Because Companies Act and Income Tax produce different annual depreciation figures, book profit and taxable profit diverge every year. Accounting Standard 22 (AS-22) — Accounting for Taxes on Income — requires you to recognise this timing difference as a Deferred Tax Liability (DTL) or Deferred Tax Asset (DTA) in the balance sheet.

When a Deferred Tax Liability Arises

When tax depreciation exceeds book depreciation (the typical pattern in early years for most assets), the business pays less tax now than the financial statements imply. This deferred obligation is recorded as a DTL.

Journal Entry for DTL — Year 1, laptop example:

• Book depreciation (SLM): ₹38,000
• Tax depreciation (40% WDV): ₹48,000
• Timing difference: ₹10,000 (tax exceeds book)
• DTL at 25.17%: ₹2,517

Dr. Tax Expense — Deferred Component (P&L)     2,517
    Cr. Deferred Tax Liability (Balance Sheet)  2,517

When a Deferred Tax Asset Arises

In later years — particularly for computers with their 3-year Companies Act life but a tax WDV block that continues to carry a balance — book depreciation will exceed tax depreciation. The business now pays more tax than book profit implies. A DTA is recognised for the future tax recovery.

The DTA arises naturally as the DTL reverses. The net deferred tax position should be disclosed separately in the balance sheet notes and reconciled in the tax audit report under Clause 26 of Form 3CD.

Five Compliance Errors That Trigger Scrutiny

Error 1 — Using the Companies Act WDV rate directly in the income tax return. The WDV rate derived from a 15-year Schedule II useful life is approximately 12.77%, not 15%. Substituting 12.77% understates the allowable tax depreciation and inflates taxable income — you pay more tax than required.

Error 2 — Applying day-based pro-rata instead of the half-year rule. A machine purchased in February earns 7.5% (0.5 × 15%) tax depreciation, not 2.34% (57/365 × 15%). Applying the Companies Act day-basis to the tax return understates the depreciation deduction — opposite error to Error 1 but equally costly.

Error 3 — Incorrect block WDV calculation on asset disposal. Selling one machine from a block does not trigger capital gains on that individual machine. Sale proceeds reduce the block's WDV. Capital gains arise only if total proceeds exceed the entire block's WDV. Computing gains as (sale price − original cost of individual asset) is a fundamental error that either generates phantom gains or misses real ones.

Error 4 — Missing the additional 20% depreciation on eligible machinery. For a ₹1 crore new machine, omitting this claim costs the manufacturer approximately ₹5,03,400 in excess tax (₹20 lakh × 25.17%). The claim requires: (a) the asset is new and not previously used in India, (b) the business is engaged in manufacturing or power generation, and (c) the asset is not office appliances, road transport vehicles, ships, or aircraft.

Error 5 — Failing to disclose useful life deviations in financial statements. If your client's management adopts a useful life different from Schedule II (permissible with justification), the Companies Act mandates a specific note disclosing the deviation and the impact on depreciation for the year. Statutory auditors flag this omission routinely, and it can attract observations in the audit report.

Key Takeaways

• Two separate depreciation computations are mandatory: Companies Act Schedule II for financial statements; Income Tax Act 2025 Schedule VII for the tax return — one cannot substitute for the other.
• The core method difference: Companies Act uses useful-life-based SLM or WDV with a mandatory 5% residual floor; Income Tax uses block WDV at fixed rates with no residual requirement and no individual asset tracking.
• The half-year rule is unique to Income Tax: Assets acquired on or after 1 October get only 50% of the rate in the year of acquisition — regardless of actual days in use.
• Additional 20% depreciation is available to manufacturers on new plant and machinery — often overlooked, and worth lakhs in annual tax savings per eligible asset.
• Every timing difference between the two frameworks generates deferred tax under AS-22, which must appear in your balance sheet at the applicable corporate tax rate.

How corpus Helps

Tracking two parallel depreciation schedules across dozens of assets — with different acquisition dates, half-year rules, block-level sales adjustments, and annual deferred tax postings — is where spreadsheets fail and audit observations accumulate.

corpus's Fixed Asset Register maintains both the Companies Act and Income Tax frameworks simultaneously for every asset your client owns:

• Configures Schedule II useful life and residual value on asset creation
• Assigns the correct Income Tax block category and WDV rate automatically from Schedule VII
• Applies the half-year rule based on the acquisition date — no manual override required
• Posts depreciation entries to both the P&L and Balance Sheet at year-end
• Computes deferred tax adjustments at the entity's applicable tax rate and posts the corresponding AS-22 journal entry
• Generates the block-wise WDV statement in Form 3CD format (Clause 18 — Particulars of Depreciation) for your tax audit, with zero manual reconciliation

For CA firms managing multiple client entities, corpus ensures consistent depreciation treatment across every file. The days of maintaining two separate depreciation registers in Excel — one for the auditor, one for the tax return — are over. Every depreciation figure corpus produces is audit-ready, tax-compliant, and traceable to the original asset record.