Impact of reduced Accelerated Depreciation (AD) in Solar Power Project

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In order to accelerate the growth of solar sector in India, the government has allowed an incentive that can be used by any profitable organization to lower their tax outgo. Known as accelerated depreciation, it is a method of depreciation used for accounting or income tax purposes that allows greater deductions in the earlier years of the life of an asset. By increasing the deductions taken during the first few years of business, one can lower the overall tax burden. As per Section 32 of the Income Tax Act, 1961, if an asset is put to use for less than 6 months, only the 50 % of the prescribed rate of depreciation is allowed to be deducted from the profits of business in that year. It means if the asset is put to use for more than 6 months, even for a single day more than 6 months, then 100 % of the prescribed rate of depreciation will be allowed to be deducted from the profits of the business. The following link (second proviso to section 32(1)(i)) clearly specifies that depreciation has to be restricted to 50% of the prescribed percentage where an asset was used for a period of less than 180 days in a previous year: http://law.incometaxindia.gov.in/dittaxmann/incometaxacts/2005itact/section32.htm In normal course, depreciation is 15% on plant and machinery for any business, but as an incentive measure, the government had prescribed 80% as rate of depreciation for solar power projects: http://law.incometaxindia.gov.in/DIT/File_opener.aspx?page=ITRU&schT=rul&csId=4a23cee1-1818-45d6-ab19-f155e08ed789&rNo=&sch=&title=Taxmann%20-%20Direct%20Tax%20Laws However, starting from 1 April 2017, AD has been capped at 40%, down from 80%, by the federal government, as clarified by the budget web portal of the government: http://indiabudget.nic.in/ub2016-17/bh/bh1.pdf It is, therefore, a meaningful exercise to understand the impact of this reduction on the profitability of the solar power developers, since this axe will certainly trim the trunk of benefits for them. The following example should help clear the mud over the issue, wherein we show a comparative assessment of the accelerated depreciation in September 2016 and September 2017: Suppose that the total project cost is Rs. 500 lacs. If a solar power generation plant costs Rs. 500 lacs, then the company setting up that plant can claim 80% depreciation in the first year itself. Depreciation of 80 % was allowed on plant and machinery of the solar power plant. 80 % of Rs 500 lacs is Rs 400 lacs. This value can be expensed in the very first year itself, which entails the name Accelerated Depreciation, since a large value of assets is shown to have depreciated in the very beginning. (depreciating 80% in one year instead of 15%). Now, 33.99% (Income Tax Rate) of Rs 400 lacs is about Rs 135.96 lacs. Hence this is the saved tax. Consequently, for a solar power project worth Rs 500 lacs, a tax saving of Rs 135.96 lacs was expected with 80% accelerated depreciation during the first year.

Impact of reduced Accelerated Depreciation (AD) in Solar Power Project

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Notably, since AD benefit in year one was Rs 135.96 lacs, the effective project cost of solar power project for a company eligible to claim AD benefits would have roughly been Rs 364 lacs. In addition, AD benefits roll over to subsequent years as, the project developers could depreciate 80% of the written down value of the project till the time it becomes nil. The table below will clarify the concept further:

Years 1 2 3 4

Opening % 100% 20% 4% 1%

Rs Lakh 500.00 100.00 20.00 5.00

Allowed during the year (80% of the opening)

% 80% 16% 3.20% 0.64%

Rs Lakh 400.00 80.00 16.00 3.20

Closing % 20.00% 4.00% 0.80% 0.16%

Rs Lakh 100.00 20.00 4.00 0.80

Accelerated Depreciation Rs Lakh 400.00 80.00 16.00 3.20

Tax Benefit Rs Lakh 135.96 27.19 5.44 1.09

Let us see how the above table would look like for September 2017 with 40% AD benefit:

Years Unit 1 2 3 4

Opening % 100% 20% 4% 1%

Rs Lakh 500 100 20 5

Allowed during the year (40% of the opening)

% 40.00% 24.00% 14.40% 8.64%

Rs Lakh 200 120 72 43.2

Closing % 60.00% 36.00% 21.60% 12.96%

Rs Lakh 300.00 180.00 108.00 64.80

Accelerated Depreciation Rs Lakh 200 120 72 43.2

Tax Benefit Rs Lakh 67.98 40.79 24.47 14.68

The tax benefit reduces by 50% due to new scenario of 40% accelerated depreciation benefit instead of 80%, thus reducing the IRR for solar projects.