UNIT 4 :TAX DEPRECIATION
Key unit competence: Apply tax depreciation to produce a tax liability
Introductory activity
The main causes of depreciation are the natural wear and tear of fixed
assets through use, which causes the value of fixed assets to decrease
every year, for example, a typewriter is replaced by a computer, an asset
is no longer used due to the change in enterprise size, and some assets
have wastefulness due to the extraction of raw materials from them.
Referring to the section above, answer the following questions:
1) What is depreciation?
2) Using research, outline the assets that are depreciated in a pool
system based on interest rates.
3) With research, the machines were bought in 2015 for FRW
40,000,000. Find the value of the depreciation using the fixed rateaccording to the Income Tax law No. 16/2018.
4.1. Definition, Nature of tax depreciation and its availability
Activity 4.1
If our school spend FRW 25,000,000 on a delivery vehicle, then the truck
is projected to be used for four years. Advise the school administration on
what they can do to ensure that it is replaced at the end of the planned usageperiod.
Depreciation is an accounting word that refers to a way of allocating the cost
of a tangible or physical asset over its useful life. Depreciation is a term used
to describe how much of an asset’s worth has been used. It lets businesses
generate revenue from the assets they possess by paying for them over time
Depreciation of fixed asset is defined as the allocation of the costs of the asset
to the years in which benefits is expected from its use resulting in the loss of
value of the asset due to physical deterioration or obsolescence.
Depreciation is an annual charge against the profits of a company to take
account of the theoretical reduction in value resulting from the use of fixed assets
belonging to the organization. It, therefore, forms deductible expenditure for the
fiscal year under consideration. However, some assets that are not subject to
physical deterioration and associated depreciation, in the same way, are not
allowable. These include in particular land, the works of art, and heritage assets.
a) Definition of tax depreciation
Tax depreciation is a method of accounting for the decrease in the value of an
investment property’s assets over time.
A tax depreciation allowance is available to individuals or corporations who
own depreciable assets at the end of the tax period and use those assets to
generate revenue.
b) Nature of tax depreciation and its availability
Tax depreciation is a form of tax relief given for capital expenditure. It replaces
accounting depreciation because it is given in a standard manner according to
tax legislation.
Accounting depreciation, capital purchases costing over FRW 500,000, and
acquisition costs of fixed assets were all disallowed expenses.
All enterprises can claim tax depreciation on most fixed assets that will be used
for business purposes. If a trader leases rather than owns an asset, the trader
can only claim tax depreciation if the lease is classified as a finance lease (i.e.
the asset is recognized on the trader’s balance sheet). The lessor (the legal
owner) is entitled to claim tax depreciation for operating leases.
Not all forms of capital expenditures are eligible for tax depreciation. The
categories of capital expenditures for which tax depreciation can be claimed
are listed in Article 28 of the income tax law No. 016/2018. Expenditure on the
following items qualifies as a qualifying expense:
– Buildings, heavy industrial equipment, and fixed machinery– the eligible
expenditure includes the costs of acquisition, construction, improvement,
renovation, and reconstruction of such assets
– Purchased intangible assets, including purchased goodwill.
– Information and communication systems – there are different rates of
allowances for these assets depending on whether their estimated useful
life is more than or less than 10 years.– Other qualifying business assets.
Land, Antiques, and Jewelry are examples of assets that do not qualify for tax
depreciation because they are not susceptible to wear and tear or obsolescence.
Internally generated intangible fixed assets, such as customer loyalty, are noteligible for tax depreciation.
Application activity 4.1
Goodwill was purchased by KBM Ltd, a Rwandan resident company, for a
price of FRW 150,000,000.
Which of the following statements is true in relation to the tax relief available
on this purchase?
a) KBM Ltd must have obtained a valid investment certificate in order to
claim 10% tax depreciation.
b) No tax depreciation is available as this is an intangible asset.
c) The tax depreciation rate is 10% on a reducing balance method basis.
d) An investment allowance of FRW 75,000,000 could be available to KBM Ltd.
4.2. Difference between tax depreciation and accounting depreciation
Activity 4.2
Before we talk about accounting depreciation and tax depreciation, what is
initial depreciation itself?
Depreciation is a way of accounting for the decrease in the useful life of tangible
assets owing to obsolescence, wear and tear, and other factors. Accounting
and tax depreciation are frequently different due to two key factors: computation
method and accounting for asset useful life (they are calculated according todifferent procedures and assumptions).
a) What is Accounting Depreciation?
Accounting depreciation (also known as book depreciation) is the cost of a
tangible asset allocated by a company over the useful life of the asset. The
recognition of accounting depreciation is driven by accounting standards and
principles such as GAAP. Remember that depreciation is a non-cash item. In
other words, depreciation expense does not represent an actual cash flow for
a business.
Despite its non-cash nature, depreciation expense still appears on the
company’s financial statements. A company records its depreciation expenses
on the income statement. Thus, this non-cash item ultimately reduces the net
income reported by a company.
In addition, most accounting standards require companies to disclose their
accumulated depreciation on the balance sheet. The accumulated depreciation
reveals the impact of the depreciation on the value of the company’s fixed assets
recorded on the balance sheet.
Accounting depreciation can be calculated in numerous ways. The two most
common ways to determine depreciation are straight-line and accelerated
methods.
The straight-line depreciation is the easiest and most frequently used depreciation
method. It distributes depreciation expenses equally over all periods of the
asset’s useful life.
Conversely, accelerated depreciation methods allow deducting greater
depreciation expenses in the earlier periods of the asset’s useful life and smaller
depreciation expenses in the subsequent periods. One of the examples of theaccelerated depreciation methods is the double declining depreciation method.
b) What is Tax Depreciation?
Tax depreciation is the depreciation expense claimed by a taxpayer on a tax return for a
tax period to compensate for the loss in the value of the tangible assets used in income
generating activities. Similar to accounting depreciation, tax depreciation allocates
depreciation expenses over multiple periods. Thus, the tax values of depreciable assets
gradually decrease over their useful lives. By deducting depreciation, tax authorities
allow individuals and businesses to reduce their taxable income.
A taxpayer cannot claim depreciation for all assets. Only some assets that meet
the specific requirements in the given tax jurisdictions may be eligible for the
depreciation claim. Although the requirements generally vary among the tax
jurisdictions, the most common criteria for depreciable assets are:
• The asset is the property owned by a taxpayer
• A taxpayer uses the asset in the income-generating activities
• The asset possesses a determinable useful life
• The asset’s useful life is more than one year.
Tax authorities treat depreciation expenses as tax deductions. In other words,
taxpayers can claim depreciation expenses for eligible tangible assets to reduce
their taxable income and the tax amount owed.
Therefore, tax depreciation is calculated for the purpose of income tax. The
main purpose of this calculation is to reduce taxable income. This is based on
the Internal Revenue Service’s (IRS) rules. For example, the IRS may state that
a certain asset’s useful life is ten years, hence tax depreciation calculations
should be done for a ten-year period.
The IRS rules also allow a company to accelerate the depreciation expense. This
means charging more depreciation in the first few years and less depreciation in
the later years of the asset’s life. This saves income tax payments in the first few
years of the asset’s life but will result in more taxes in the later years. Companies
that are profitable find accelerated depreciation to be more attractive. Due to
this reason, the company has to maintain two types of records for depreciation:
one for the financial reporting purpose and the other for income tax purposes.
Furthermore, various businesses may have different depreciation policies, and
tax depreciation may be considered differently as a result. For example:
• Full year’s depreciation will be charged in the year of purchase
• No depreciation will be charged for the year if the asset is purchased in
the middle or near the end of the year.
• No depreciation will be charged on the year of disposing of the asset
The key difference between Accounting Depreciation and Tax Depreciation
is that while the accounting depreciation is prepared by the company for
accounting purposes based on accounting principles, the tax depreciation isprepared in accordance with Internal Revenue Service’s rules (IRS).
Application activity 4.2
1. What is Accounting Depreciation?
2. Brainstorm common criteria for depreciable assets.
4.3. Tax depreciation applied to individual assets and to pools of assetsActivity 4.3
Businesses can claim most of their labor costs on their tax returns as they
incur the cost, but typically have to deduct their investment costs over many
years. Due to inflation and the time value of money, the protracted amortization
of capital expenditures is forcing companies to understate their capital
expenditures in present values, thereby overstating their true revenues.
Tax on consumed income or personal expenses would have investment costs
deducted as they are incurred, which is the optimal treatment for achieving
the most economically efficient level of capital formation. Capital costs would
only be amortized if investments lost economic value over time. Economic
depreciation has two problems. First, it is impossible to measure because
similar assets in different uses wear out or become obsolete at different rates.
Second, the concept ignores the cost of locking money into an asset from the
date of its purchase, reducing investment.
Answer the following questions with reference to the section above:With research outline reasons for providing amortization.
4.3.1. Tax depreciation applied to individual assets
The following assets are each treated independently for the calculation of theapplicable tax depreciation, from the types of qualified assets listed in lesson
4.1 above:
• Buildings, heavy industrial equipment, and
• Heavy industrial machinery – these are depreciated annually each
on its own, on the basis of the rate of depreciation equivalent to five
percent (5%) on a straight-line basis, so the relevant cost is multiplied
by 5% and this remains constant until the asset is fully depreciated (20
years) or sold.
• Intangible assets including goodwill that is purchased from a third
party are depreciated annually each on its own, on a straight-line basis,
each on its own, on the basis of the rate of depreciation of ten percent
(10%) of the relevant cost of the asset.
• Information and communication systems with an expected life of over
10 years – are depreciated annually on a straight-line basis of the rate
of depreciation of ten percent (10%) of the relevant cost of the asset.
4.3.2. Tax depreciation applied to pools of assets
The remaining items of qualifying expenditure will be grouped, or ‘pooled’,
and tax depreciation applied to the group of assets rather than to each asset
individually.
The rates applicable are:
• Computers and accessories, and information and communication
systems with a life of no more than 10 years: fifty per cent (50%) on a
reducing balance basis
• Other qualifying business assets (Motor vehicle, Furniture, equipment
and simple machines): twenty-five percent (25%) on a reducing balance basis
Keep in mind that the calculation of the tax depreciation on a pool is on a reducing
balance basis; it is a percentage of the brought forward eligible expenditure
(known as the ‘tax written down value’ (TWDV)) as adjusted for acquisitions anddisposals that have taken place in the year.
Application activity 4.3
a) What rates of tax depreciation, if any, apply to the following items of
expenditure?
A. Production line machinery built into a factory
B. A piece of telephone equipment with an expected life of 15
years, acquired under an operating lease
C. The extension of a residential homeD. The purchase of patent rights
4.4. Computing tax depreciation
Activity 4.4
Analyze the picture above and answer the following question:
With research, the machines were purchased at a cost of FRW 45,000,000.
Find the value of the depreciation using the fixed rate according to the IncomeTax Law No. 16/ 2018
4.4.1. Calculation of tax depreciation on individual assets
The principle of calculating tax depreciation for a single item is straightforward:
simply apply the proper percentage to the asset’s qualifying cost. Remember
that assets that receive straight-line depreciation are treated individually, not
collectively. As a result, each asset’s computation must be prepared separately.
In the tax period in which the asset is acquired, a full year’s worth of tax
depreciation is given (irrespective of when in the period the purchase took
place). There is no tax depreciation available during the time when an asset is sold.
When an asset is sold (disposed of), the sale proceeds are included in the
trader’s taxable income calculation (under Article 5 of Income Tax Law No.
16/2018, items 5 and 6). The asset’s remaining balance must then be writtenoff as a separate deduction in the year of sale.
4.4.2. Calculation of tax depreciation on asset pools
Computers, accessories, and information and communication systems having a
10-year life expectancy, and other qualifying assets, are given tax depreciation
via ‘pools’ of expenditure. The balance of expenditure brought forward is
increased for items purchased during the year (net of the investment allowance
if applicable) and reduced by the proceeds of any relevant items sold. After that,
the remaining balance is multiplied by the appropriate percentage (50 percentor 25 percent for computer equipment and other assets respectively).
Notes
• If either G or H above are negative (due to the sale proceeds on assets
sold in the year being greater than the balance in the pool), a ‘balancing
charge’ arises: the negative balance increases taxable profit for the year
and the pool becomes zero.
Application Example
• If either G or H are a positive value of less than FRW 500,000, the
entire balance is deducted from profits as a balancing allowance (rather
than multiplying by 50% or 25%). Again, the pool will be reset to zero.
The TWDV brought forward on a computer equipment pool at the beginning
of a tax period is FRW 1,000,000. There are no new acquisitions of computer
equipment during the period.
• If computer equipment is sold during the year for FRW 1,200,000 the pool
would stand at a negative balance of FRW (200,000). This FRW 200,000
would be added to taxable profit:
• If computer equipment was sold for FRW 600,000 the pool would stand at
FRW 400,000. Instead of a 50% allowance, the full FRW 400,000 would bededucted from taxable profit.
Application activity 4.4
Nkuvugishe Plc acquired a piece of telecommunication equipment at a cost
of FRW 20,000,000 on July 01st, 2018. The expected life of the equipment
was 20 years. The equipment was then disposed of on March 01st, 2020 for
FRW 9,000,000.
Nkuvugishe Plc did not purchase any other assets in the tax period to
December 31st, 2018.
Calculate the tax depreciation available on this asset for the three years to31st, December 2020.
4.5. Investment allowance and Private use of assets bybusiness owners
Activity 4.5
Analyze the images above and answer the following questions.
a) With research outline the rate of investment allowance4.5.1. Accelerated Depreciation
Rwanda encourages investment by providing a greater rate of tax relief (capitalallowance) during the year of acquisition.
a) Conditions for the Accelerated Depreciation to apply
• For the Accelerated Depreciation to be claimed, the following conditions
need to be met (Law No. 06/2015 relating to investment promotion
and facilitation):
• The taxpayer must have applied for, and hold, a valid investment
certificate issued by the Rwanda Development Board, specifying the
incentives to which the taxpayer is entitled
• The taxpayer has invested at least US$ 50,000 in each new asset or
used asset in the tax period
• Must Operate in at least one of the sectors below and meet therequirements:
i. Export projects;
ii. Manufacturing;
iii. Telecommunications;
iv. Agro processing;
v. Education;
vi. Health
vii. Transport excluding passenger vehicles with less than nine (9)people seating capacity;
viii. Tourism investments worth at least one million eight
hundred thousand United States Dollars (USD 1, 800, 000);
ix. Construction projects worth at least one million eight hundred
thousand United States dollars (USD 1,800,000);
x. Any other sectors provided the investment is worth at least one
hundred thousand United States dollars (USD 100,000);
xi. Any other priority sector as may be determined by an Order of the
Minister in charge of finance;
• The assets must be retained by the business for at least three taxperiods following the period of the claim; and
b) The rate of investment allowanceThe Accelerated depreciation is 50% of the acquisition cost of the asset.
c) The impact on tax depreciation
If the Accelerated depreciation is claimed on an asset, this will reduce the cost
that is eligible for standard tax depreciation. Depending on the type of asset
purchased, the remaining amount of qualifying expenditure will be given tax
depreciation on a straight-line basis or allocated to a pool after computing anddeducting the capital allowance.
d) Assets sold within three years
The investment allowance is revoked if a taxpayer claims the investment allowance
on an asset but then sells it within three years. The reduction in tax obtained
by claiming the investment allowance must be repaid to the tax administration,along with the applicable interest and penalties for the underpayment of tax.
4.5.2. Private use of assets by business owners
Private usage of a business asset by the owner or any employee limits the
amount of tax depreciation that may be claimed.
If an item qualifies for tax depreciation, but the owner uses it for personal
reasons, the tax depreciation deductible from cost is given in full at the usual
rate, depending on the type of asset, while the tax depreciation claimable is
limited to the proportion of business use only.
This arises when an asset is used partly for business and partly for privatepurposes by the trader, or any employee of the trader.
Keep in mind that, where an asset has divided use, then the tax administration
should determine the amount of tax depreciation to be given based on the
proportion of business use of the asset. Tax depreciation should be calculated
in full at an appropriate rate and then the deductible tax depreciation will be
that tax depreciation multiplied by the percentage of business use of theasset. Currently, the assumption is that 20% is for private use.
Application activity 4.5
A building is constructed in Musanze for use in the trade of Mwiza Plc, a
Rwandan resident trading company. The building cost FRW 200,000,000
and was paid for on 30th November 2019. Mwiza Plc has a tax period to 31st
December each year. Mwiza Plc holds a valid investment certificate for this
expenditure.
Which of the following statements is correct concerning the tax relief available
for Mwiza Plc on the cost of the building?
a) The investment allowance will be FRW 100,000,000 and the balance of
FRW 100,000,000 will qualify for straight-line depreciation at 5% per year.
b) The investment allowance will be FRW 100,000,000 and the remaining
FRW 100,000,000 will qualify for straight-line depreciation at 10% per year.
c) The investment allowance will be FRW 100,000,000 and the FRW
200,000,000 will also qualify for straight-line depreciation at 5% per year.
d) The building will only be eligible for standard tax depreciation at 5% per year.
End of unit assessment 4
1. Gasabo Plc, a Rwandan resident company, has the following broughtforward balances on its assets that qualify for tax depreciation:
During the year, the following transactions took place:
Purchases
Office furniture costing FRW 600,000Disposals
Computer equipment – proceeds FRW 3,100,000
Calculate the total tax depreciation available to Gasabo Plc in the tax period.Show clearly the balances to carry forward for each pool or individual asset.
2. Ineza Company purchased a building during the tax period for a
price of FRW 50,000,000. No investment certificate was applied for
by Ineza Company. The building is mainly used as retail premises by
Ineza Company, but there is living accommodation above the shop
which is used by one of the directors. Compute the maximum annual
tax depreciation that can be claimed by Ineza Company in relationto this building.