Terminal Depreciation is essentially the final depreciation deduction that a taxpayer can claim on a fixed asset in the year it is disposed of or written off. It helps ensure that the entire cost of the asset is eventually written off for tax purposes.

How It Works:

• Final Year Adjustment:
  When an asset is sold or otherwise disposed of before the end of its useful life, the usual depreciation calculation may leave a remaining balance (the written down value). Terminal depreciation is the pro-rata depreciation claimed in the year of disposal based on the number of days the asset was in use.

• Pro-Rata Calculation:
  In the disposal year, depreciation is calculated on a pro-rata basis. This means if the asset was used for part of the year, you claim a proportionate deduction for that period. This final adjustment is what we call terminal depreciation.

• Purpose:
  The idea is to fully account for the cost of the asset in your tax computations. Without terminal depreciation, there might be an unabsorbed cost remaining in the books when the asset is disposed of.

Key Point:

• Section 32 of the Income Tax Act, 1961 governs the depreciation of assets, including the pro-rata (or terminal) depreciation in the year of disposal. While “terminal depreciation” isn’t mentioned by name in the Act, the concept is inherent in the depreciation calculations applied when an asset is retired.

As per Section 55(2)(b) of the Income Tax Act, 1961, for a capital asset acquired before 1st April 2001, the taxpayer has a special option to calculate the cost of acquisition.

Section 55(2)(b) – Cost of Acquisition for Assets Acquired Before 1st April 2001:

“Where the capital asset became the property of the assessee before the 1st day of April, 2001, the cost of acquisition shall be deemed to be—
(i) the actual cost of acquisition of the asset; or
(ii) the fair market value (FMV) of the asset as on 1st April, 2001,
whichever is higher.”

Explanation in Simple Terms:

If you acquired a capital asset (such as land, a building, or unlisted shares) before 1st April 2001, you don’t have to stick to the original purchase price. Instead, you can choose to take the Fair Market Value (FMV) as on 1st April 2001, which could help reduce your capital gains tax liability.

How to Determine FMV (Fair Market Value) as on 1st April 2001?

1. For Land or Property: FMV can be determined through a registered valuer who assesses the asset’s value as of 1st April 2001.

2. For Listed Shares: FMV is generally taken as the highest price quoted on a recognized stock exchange on 1st April 2001.

3. For Other Assets: FMV can be determined based on market trends, valuation reports, or any government-approved reference rates.