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Article Dated 01st January, 2024

Beyond Numbers: Interpreting Actual Cost in Asset Valuation for Taxation

The term "actual cost" in the context of asset acquisition plays a pivotal role in income tax computation, presenting nuances and exceptions that taxpayers and professionals must comprehend. Section 43(1) of the Income Tax Act,1961 delineates the intricacies of determining the actual cost.

"Actual cost" means the actual cost of the assets to the assessee, reduced by that portion of the cost thereof, if any, as has been met directly or indirectly by any other person or authority. This means subsidy has to be reduced in calculating the actual cost.

However, if assessee incurs any expenditure for acquisition of any asset in respect of which a payment or aggregate of payments made to a person in a day, and not made through specified banking channels exceeds Rs.10,000, shall be ignored for the purposes of determination of actual cost.

There are several explanations for this section which provides for various cases, and how actual cost has to be determined in such cases:

1. Explanation 1

Where an asset is used in the business after it ceases to be used for scientific research related to that business, the actual cost of the asset to the assessee shall be the actual cost to the assessee after reducing the actual cost by the amount of any deduction previously allowed under section 35(1)(iv).

Section 35(1)(iv) provides for 100% deduction on capital expenditure i.e., on any capital asset. So, simply, the actual cost of such asset shall be Nil.

2. Explanation 1A

Where a capital asset referred to in clause (via) of section 28 is used for the purposes of business or profession, the actual cost of such asset to the assessee shall be the fair market value which has been taken into account for the purposes of the said clause.

That means if goods which was earlier used as stock-in-trade is converted into capital assets of Business or Profession, the actual cost shall be the fair market value of such goods on the date of conversion.

3. Explanation 2

Where an asset is acquired by the assessee by way of gift or inheritance, the actual cost of the asset to the assessee shall be the actual cost to the previous owner, as reduced by the amount of depreciation actually allowed in respect of any previous year.

So, if asset is acquired by way of gift/will/inheritance, the actual cost shall be actual cost to previous owner less depreciation allowed to him.

4. Explanation 3

Where, before the date of acquisition by the assessee, the assets were at any time used by any other person for the purposes of his business or profession and the Assessing Officer is satisfied that the main purpose of the transfer of such assets, directly or indirectly to the assessee, was the reduction of a liability to income-tax (by claiming depreciation with reference to an enhanced cost), the actual cost to the assessee shall be such an amount as the Assessing Officer may, with the previous approval of the Joint Commissioner, determine having regard to all the circumstances of the case.

For example, if Mr.A buys a capital asset from Mr.B at a higher price to get benefit of excess depreciation, in that case amount determined by Assessing officer after taking prior approval of Joint Commissioner, shall be the actual cost of such capital asset.

5. Explanation 4

Where any asset which had once belonged to the assessee and had been used by him for the purposes of his business or profession and thereafter ceased to be his property by reason of transfer or otherwise, is re-acquired by him, the actual cost to the assessee shall be

  1. the actual cost to him when he first acquired the asset as reduced by amount of depreciation actually allowed in respect of any previous year to him or,

  2. the actual price for which the asset is re-acquired by him,
    whichever is less.

Let us understand this with the help of an example. Suppose Mr. Pranay sold a machinery to Mr. Taran at a price of Rs.2 lakh on 1st May 2023. However, the WDV of such machinery at the time of sale was Rs.1.5 lakh in the books of Mr. Pranay. Now on 1st August 2023, Mr. Pranay bought the machinery back from Mr. Taran at price of Rs.1.80 lakhs. Now the actual cost of machinery to Mr. Pranay will be lower of reacquisition cost or WDV at the time of sale. Therefore, actual cost shall be Rs.1.50 lakh.

6. Explanation 4A

Where before the date of acquisition by the assessee, the assets were at any time used by any other person for the purposes of his business or profession and depreciation allowance has been claimed in respect of such assets and such person acquires on lease, hire or otherwise assets from the first mentioned person, then, notwithstanding anything contained in Explanation 3, the actual cost of the transferred assets, shall be the same as the written down value of the said assets at the time of transfer thereof by the second mentioned person.

Simply, if any person acquires an asset from another person and leaseback such asset to such other person, in that case actual cost for the person who acquired it shall be the WDV of the other person (lessee). For example, Mr. Anurag purchased a machinery from Mr. Vicky at Rs.5 lakhs and leased it back to Mr. Vicky. The WDV as of the date of transfer is Rs.4 lakhs and the same shall be the actual cost.

7. Explanation 5

Where a building was previously the property of the assessee is brought into use for the purpose of the business or profession, the actual cost to the assessee shall be the actual cost of the building to the assessee, as reduced by an amount equal to the depreciation calculated at the rate in force on that date that would have been allowable had the building been used for the aforesaid purposes since the date of its acquisition by the assessee.

In simple words, if a building owned by the assessee was previously used for something else but is now being used for their business or profession, the actual cost would be
the original cost of the building to the taxpayer
xx
(-) notional depreciation till date at current depreciation rate
xx
Actual Cost
xxx

A special point to be noted is that this explanation specifically applies on Building and not on any other capital asset. Also the depreciation shall be applied at the rate which is applicable at the time when building is started to be used for business or profession.

8. Explanation 6

When any capital asset is transferred by a holding company to its subsidiary company or by a subsidiary company to its holding company, then, if the conditions of clause (iv) or, as the case may be, of clause (v) of section 47 are satisfied, the actual cost of the transferred capital asset to the transferee-company shall be taken to be the same as it would have been if the transferor-company had continued to hold the capital asset for the purposes of its business.

9. Explanation 7

Where, in a scheme of amalgamation, any capital asset is transferred by the amalgamating company to the amalgamated company and the amalgamated company is an Indian company, the actual cost of the transferred capital asset to the amalgamated company shall be taken to be the same as it would have been if the amalgamating company had continued to hold the capital asset for the purposes of its own business.

10. Explanation 7A

Where, in a demerger, any capital asset is transferred by the demerged company to the resulting company and the resulting company is an Indian company, the actual cost of the transferred capital asset to the resulting company shall be taken to be the same as it would have been if the demerged company had continued to hold the capital asset for the purpose of its own business :

Provided that such actual cost shall not exceed the written down value of such capital asset in the hands of the demerged company.

Explanation 6, 7 and 7A provides similar kind of conditions. In all the 3 cases the actual cost to transferee shall be WDV of the transferor. In all the three cases, the actual cost of the transferred capital asset to the transferee-company shall be taken to be the same as it would have been if the transferor-company had continued to hold the capital asset for the purposes of its business. Although explanation 7 and 7A lays down the condition that transferee company shall be an Indian Company.

11. Explanation 8

For the removal of doubts, it is hereby declared that where any amount is paid or is payable as interest in connection with the acquisition of an asset, so much of such amount as is relatable to any period after such asset is first put to use shall not be included, and shall be deemed never to have been included, in the actual cost of such asset.

This provision clarifies that when an amount is paid or payable as interest in connection with acquiring an asset, only the portion of the interest related to the period before the asset is first put to use will be considered as part of the actual cost of the asset. Any interest amount attributable to the period after the asset is put to use will be excluded from the actual cost calculation, as if it was never included.

For example, if Mr. A buy a machinery on 1st April 2023 on finance, and put it to use on 30th September 2023, then interest paid for such finance upto September 2023 shall be added to actual cost.

12. Explanation 9

For the removal of doubts, it is hereby declared that where an asset is or has been acquired on or after the 1st day of March, 1994 by an assessee, the actual cost of asset shall be reduced by the amount of duty of excise or the additional duty leviable under section 3 of the Customs Tariff Act, 1975 (51 of 1975) in respect of which a claim of credit has been made and allowed under the Central Excise Rules, 1944.

So, if any asset is purchased and any of the abovementioned duties are levied on it and input for such duty has been claimed, in that case the actual cost shall not include such duty.

For example, Mr. Karthik purchased a machinery for Rs.1,00,000 plus GST @ 18% i.e., Rs.18,000. So, if Mr. Karthik avails the ITC on such machinery, then actual cost of such machinery shall not include GST amount, i.e., actual cost shall be Rs.1,00,000.

13. Explanation 10

Where a portion of the cost of an asset acquired by the assessee has been met directly or indirectly by the Central Government or a State Government or any authority established under any law or by any other person, in the form of a subsidy or grant or reimbursement (by whatever name called), then, so much of the cost as is relatable to such subsidy or grant or reimbursement shall not be included in the actual cost of the asset to the assessee :

Provided that where such subsidy or grant or reimbursement is of such nature that it cannot be directly relatable to the asset acquired, so much of the amount which bears to the total subsidy or reimbursement or grant the same proportion as such asset bears to all the assets in respect of or with reference to which the subsidy or grant or reimbursement is so received, shall not be included in the actual cost of the asset to the assessee.

This provision states that if a portion of the cost of an asset is covered by a subsidy, grant, or reimbursement from the Central Government, State Government, any law-established authority, or any other entity, that specific portion of the cost related to the subsidy or grant should not be included in the actual cost of the asset for the assessee.

The explanation specifies that if the subsidy or grant is not directly linked to the acquired asset, the exclusion from the actual cost should be determined proportionately based on the asset`s value compared to the total value of all assets related to the received subsidy, grant, or reimbursement.

Let’s say the subsidy received for various assets is Rs.1,00,000. A machinery was purchased for Rs.80,000 and all assets for which the whole subsidy is received is Rs.2,00,000. So, now the subsidy amount which has to be excluded from actual cost of machinery shall be:

80,000/200000*100000 = Rs.40,000.

14. Explanation 11

Where an asset which was acquired outside India by an assessee, being a non-resident, is brought by him to India and used for the purposes of his business or profession, the actual cost of the asset to the assessee shall be the actual cost to the assessee, as reduced by an amount equal to the amount of depreciation calculated at the rate in force that would have been allowable had the asset been used in India for the said purposes since the date of its acquisition by the assessee.

In simple terms, if a non-resident individual or entity brings an asset acquired outside India to use it for their business or profession in India, the actual cost of the asset is calculated by subtracting the depreciation amount that would have been allowed if the asset had been used in India since its acquisition. This helps adjust the cost based on the depreciation applicable in India for the period of use.

For example, Mr. Sandip bought a machinery in Dubai at Rs.10 lakhs in April 2021, and brought back to India in April 2023. So the depreciation for 2 years which would have been applicable if machinery was used in India shall be reduced from actual cost in which it was purchased.

15. Explanation 12

Where any capital asset is acquired by the assessee under a scheme for corporatisation of a recognised stock exchange in India, approved by the Securities and Exchange Board of India established under section 3 of the Securities and Exchange Board of India Act, 1992 (15 of 1992), the actual cost of the asset shall be deemed to be the amount which would have been regarded as actual cost had there been no such corporatisation.

In simple terms, if an individual or entity acquires a capital asset under a scheme for the corporatization of a recognized stock exchange in India, approved by the Securities and Exchange Board of India, the actual cost of the asset is considered as if there was no corporatization. This provision helps in determining the actual cost of the asset under specific circumstances related to the corporatization of stock exchanges

16. Explanation 13

The actual cost of any capital asset on which deduction has been allowed or is allowable to the assessee under section 35AD, shall be treated as `nil`,—

(a) in the case of such assessee; and

(b) in any other case if the capital asset is acquired or received,—

  1. by way of gift or will or an irrevocable trust;

  2. on any distribution on liquidation of the company; and

  3. by such mode of transfer as is referred to in clauses (i), (iv), (v), (vi), (vib), (xiii), (xiiib) and

  4. xiv) of section 47:

Provided that where any capital asset in respect of which deduction or part of deduction allowed under section 35AD is deemed to be the income of the assessee in accordance with the provisions of sub-section (7B) of the said section, the actual cost of the asset to the assessee shall be the actual cost to the assessee, as reduced by an amount equal to the amount of depreciation calculated at the rate in force that would have been allowable had the asset been used for the purpose of business since the date of its acquisition;

In simple terms, if a taxpayer has claimed or is eligible to claim a deduction under section 35AD for a capital asset, the actual cost of that asset is treated as `nil` in certain situations. These situations include cases where the asset is acquired through gift, will, or an irrevocable trust, or received through distribution during the liquidation of a company, or transferred in specific ways mentioned in section 47. However, if the asset`s deduction is deemed as income according to the provisions of sub-section (7B) of section 35AD, the actual cost is calculated after reducing an amount equivalent to the depreciation that would have been allowed if the asset had been used for business purposes since its acquisition.

CA Pranay Jain is a young and aspiring Chartered Accountant. He qualified Chartered Accountancy Course in 2021 and has a well-established practice in various fields of taxation and auditing, with his core area of practice being in the field of litigation i.e., handling assessment and appeal-related matters and representing assesses before various tax departments.

He is also socially active on LinkedIn at linkedin.com/in/capranayjain

CA Pranay Jain
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