Section 34 of ITA, 1961 : Section 34: Conditions For Depreciation Allowance And Development Rebate

Explanation using Example

Imagine a company in India, XYZ Pvt. Ltd., that specializes in manufacturing textiles. In the financial year 2020-2021, the company decides to upgrade its manufacturing capacity by installing new machinery. The cost of this machinery is INR 10 million. XYZ Pvt. Ltd. is aware that under Section 33 of the Income-tax Act, they can claim a development rebate, which is a deduction from their taxable income, for investing in new plant and machinery.

However, to avail this deduction, Section 34(3)(a) stipulates that XYZ Pvt. Ltd. must debit an amount equal to 75% of the development rebate to its profit and loss account. This means that if the company is eligible for a development rebate of INR 1 million, it must debit INR 750,000 to its profit and loss account and credit the same amount to a reserve account. This reserve account cannot be used for distributing dividends or for creating assets outside India for a period of eight years.

Now, let's say in the financial year 2023-2024, XYZ Pvt. Ltd. is in need of funds and decides to sell the machinery to another company. Since the machinery is being sold within eight years of its installation, according to Section 34(3)(b), the rebate claimed by XYZ Pvt. Ltd. would be deemed to have been wrongly allowed. Therefore, the company must reverse the tax benefit it received unless the machinery is sold to the government, a local authority, or in specific cases like amalgamation or succession.

This example demonstrates how Section 34 of the Income-tax Act, 1961, affects the tax planning of a company and ensures that the benefits of the development rebate are used to further the company's growth, rather than for immediate gains or external investments.