Explain Depreciation & Discuss Rules for Depreciation Allowance under Income Tax Ordinance 2001


Rules for Depreciation Allowance under Income Tax Ordinance 2001

A gradual decrease in value of asset due to use or wear and dear is known as depreciation. Generally the term depreciation also includes amortization and depletion.

  • Depreciation of fixed tangible asset such as building, plant and machinery.
  • Amortization of intangible assets such as copy right, patent rights
  • Depletion of wasting assets such as mines.

Depreciation under income tax ordinance
According to section 20(2) of income tax ordinance 2001,
Where a person acquires depreciable assets or intangible assets with a useful life of more than one year or incurs per-commencement expenditure, he must charge depreciation or deplete the asset as per section 22, 23, 24 and 25.
While calculating the income under the head “income from business” depreciation is allowed as deduction if it calculated according to the provisions of 3rd schedule of income tax ordinance 2001.
Accounting depreciation v/s Tax depreciation
Any depreciation charged to profit and loss account without considering the provision of 3rd schedule is known as accounting depreciation. It will be added back in the profit to reach at taxable profit.
Depreciation which is computed considering the provision of 3rd schedule of income tax ordinance is termed as tax depreciation or statutory depreciation.
Kinds of depreciation allowance

  • Initial allowance for depreciation
  • Normal depreciation

Initial of depreciation allowance
Initial allowance for depreciation is allowed only on depreciable assets. It will be allowed when the asset is used for the first time or latter in the tax year in which commercial production is started.
Normal depreciation
Normal depreciation of a depreciable asset is calculated at prescribed rate on its written down value. Following are the rates for normal depreciation.
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Rules / Provision / Conditions for allow ability of Depreciation

Depreciation is an admissible expense of the business. However following provisions must be considered while computing the depreciation.

  1. Asset must be of depreciable nature

According to see 22 (15). The asset must be of depreciable nature, depreciable assets means “assets which are eligible for depreciation allowance it includes,

  • Tangible moveable property……plant, vehicles, aircraft etc.
  • Immoveable property………factory hotel, hospitals etc.
  • Structural improvement…….. Factory, bridges airport etc.
  1. Uses for business or profession

Depreciation is allowed on such assets, which are only used for business purpose. Assets that are in personal use of the owner are not entitled for depreciation.

  1. Assets must be owned by the taxpayer

The depreciable asset must be owned by assesses. Depreciation would be allowable to the owner even the asset are worked or utilized by another person.

  1. Rate of depreciation

According to sec (2292) depreciation is allowed in accordance to the rates, prescribed in part 1 of 3rd schedule of income tax ordinance 2001.

  1. Determination of written down value

Depreciation will be charged on written down value of the asset. It will be calculated as fallows,

  • Newly purchased assets

Written down value = Cost of asset – initial allowance

  • In other cases

Written down value = Cost of asset – Total depreciation and deductions

  1. Assets partial used for business and partial private purpose

According to sec 22(3) when depreciation asset used partial for business purpose and partial for private purpose, the depreciation will be allowed proportionally.

  1. Depreciation of asset of leasing company

Where asset owned by a leasing company, investment bank, Modaraba or schedule bank etc. leased assets of such entities will be treated as used by them for their own business. However depreciation will be allowed against income from leasing only.

  1. Immovable property and depreciation

Depreciation is only allowed on cost of immovable property excluding cost of land, or depreciation allowance is restricted only to cost of immovable property or up to the cost of structural improvement.

  1. Asset not used for the whole year

According to sec 22(2) if an asset is not used for the whole of the tax year, depreciation on such assets is also shall not be charged for the whole year. We can say, fully depreciation is not charged in the year of acquisition assets.

  1. Allowance should not exceeding from original cost

According to sec 22(7) total depreciation allowance of asset should not exceeding the originally cost of such asset.

  1. Used in income year

For allow ability of deduction it is necessary that the asset must be used in business or profession during the tax year. No depreciation allowance will be allowed in year in which asset is not used.

  1. Disposal of assets and depreciation

When depreciable asset is disposed off, then no depreciation is allowed in the year in which asset is disposed off.

  1. Gain or loss on disposal of asset

If the asset is sold at more than written down value then the gain on disposal of asset is income of that year, if it is sold less than the written down value the loss is expense of that year.

  1. Particulars of assets

Depreciation is allowed only if the assesse has provided all prescribed particular of the depreciable asset at the time of filling the return of income.

  1. Asset with useful life up to one year

When an asset has useful life up to one year then no depreciation is allowed on such asset; however renewal replacement cost of such assets will be allowed as revenue expenditure.

  1. Depreciation of business exempt from tax

No depreciation is allowed if business income is completely exempt from tax. If business’s income is exempted up to a specific period the depreciation will be allowed after the expiry of that period.

  1. Amortization of intangible

Intangible asset mean asset, which have no physical existence. For example Good will, Copyright, patents rights trade mark, models, formulas etc. income tax law also allows deduction as amortization on such assets.

  1. Depletion of Natural Resources

Depletion means the exhaustion of natural resources; the depletion of natural resources is also treated as an admissible expense and as deduction from income like depreciation and amortization.

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