Karachi, September 4, 2024 – The Federal Board of Revenue (FBR) has provided a comprehensive explanation on the deduction of depreciation against tax liability for the tax year 2024-25, a critical aspect for businesses managing their assets and tax obligations.
This clarification, as per the updated Income Tax Ordinance, 2001, effective until June 30, 2024, outlines the intricacies of Section 22, which governs the depreciation deductions.
Understanding Section 22 of the Income Tax Ordinance
Section 22 of the Income Tax Ordinance delineates the conditions and methodology for claiming depreciation on depreciable assets. These assets, which are used in a taxpayer’s business during the tax year, are eligible for depreciation deductions, helping to reduce the taxable income.
1. Eligibility and Calculation of Depreciation: According to the FBR, depreciation is allowed on assets that are used in a business during the tax year. The depreciation deduction is calculated by applying the specified rate from Part I of the Third Schedule to the written down value (WDV) of the asset at the beginning of the year. This WDV is adjusted based on the asset’s cost and previous depreciation deductions.
2. Partial Business Use: If an asset is used partially for business and partially for other purposes, the depreciation deduction is limited to the portion attributable to business use. This ensures that only the business-related depreciation impacts the taxable income.
3. Written Down Value Adjustments: The WDV of an asset at the beginning of the tax year is crucial. For newly acquired assets, the WDV is the cost reduced by any initial allowance under Section 23. For older assets, it’s the cost reduced by all prior depreciation deductions. This calculation maintains the accuracy of asset valuation over time.
Special Considerations and Provisions
1. Assets Used in Exempt Businesses: Depreciation is considered to have been allowed even if the business was exempt from tax in previous years. Post-exemption, the WDV is recalculated by reducing the total depreciation, ensuring consistency in the asset’s valuation.
2. Disposition of Assets: When a depreciable asset is disposed of during a tax year, depreciation for that year is not allowed. If the sale price exceeds the WDV, the excess is taxable as business income. Conversely, if the sale price is less, the shortfall is deductible, reducing the taxable income.
3. Depreciation Limits and Leasing Considerations: The cumulative depreciation allowed cannot exceed the asset’s cost. Special rules apply to leasing companies, investment banks, and similar entities, where depreciation is only deductible against lease income, ensuring that depreciation benefits align with business operations.
4. Passenger Transport Vehicles and Immovable Property: For passenger vehicles not used for hire, the depreciation cost is capped at PKR 7.5 million. The cost of immovable property excludes land, focusing only on structural improvements, which depreciate over time.
5. Export and Transfer of Assets: Assets exported or transferred out of Pakistan are treated as disposed of at their cost, effectively ceasing further depreciation deductions in Pakistan.
Defining Depreciable Assets
The FBR defines a depreciable asset as any tangible movable or immovable property, excluding unimproved land, with a useful life exceeding one year, that depreciates through normal wear and tear or obsolescence, and is used to generate taxable business income. This definition clarifies the types of assets eligible for depreciation, aiding businesses in tax planning.
Conclusion
Understanding and applying the rules of depreciation under the Income Tax Ordinance is essential for businesses to maximize their tax benefits. The detailed provisions in Section 22 offer a clear pathway for businesses to manage their depreciable assets effectively, ensuring compliance and optimal tax outcomes for the tax year 2024-25.
