When dealing with your company’s income tax, asset depreciation is an important consideration. All assets lose value over time, something that’s often referred to as “wear and tear”, throughout their “useful life”.
Assets have a cost price and a set period of depreciation. For example, a delivery vehicle is written off over a period of four years and computer equipment over three years. SARS provides a schedule of write-off periods for various qualifying assets, which you can access here.
It’s important to note that the asset for which you are claiming a tax deduction must have been used in the production of income, i.e., you can claim a deduction for the van you use to make deliveries, but not for the sportscar you drive on weekends.
If you used the van for both personal and business purposes, then you need to apportion the deduction before you work out the allowance (i.e., divide it into portions: 60% business use, 40% personal use, for example).
Also, important to note is that you cannot claim a deduction on buildings or any other assets that are permanent structures.
Methods for determining the asset depreciation allowance
There are two main methods for determining the allowance:
Straight-line method
The most common asset-depreciation method used is the straight-line method. This is a SARS-prescribed rate applied to the cost price of the asset. It allows for a portion of the cost price to be written off as a deduction on your income statement and in your income tax calculation.
Under this method, you can claim the allowance in equal instalments over the prescribed useful life of the asset. For example, you’d claim R25,000 a year for four years on your delivery van.
Diminishing value method
With the diminishing value method, the allowance for a given year is based on how much the asset is still worth (i.e., the cost of the asset, less an allowance for the previous years of assessment).
This means that the amount you can claim every year will change in line with the asset’s value in that particular year.
How to treat small assets
Any asset that costs less than R7,000 may be written off in the year that you bought it.
SARS defines a small asset as one that:
- normally functions in its own right,
- does not form part of a set,
- and costs less than R7,000.
Tools and computers, for example, are considered small items. A table and six chairs do not.
Small business exceptions
Some small businesses will qualify for various accelerated depreciation allowances.
Small Business Corporation
Qualifying small businesses may opt for an accelerated depreciation rate of 50-30-20.
This means you can claim:
- 50% of the allowance in the year you buy the asset,
- 30% the following year, and
- 20% in the third year.
This can be a huge tax break for start-up businesses.
To qualify, a company must meet several requirements:
- Turnover of less than R20 million a year
- May not be a personal services provider (unless employing three or more non–connected employees)
- Shareholder must hold shares in his / her personal capacity
- Shareholder may not hold shares in any other private company or close corporation
10 Critical Facts You Need to Know about Depreciation
Depreciation is not the same as Amortization. Depreciation is the terminology used for fixed assets. Amortization is the terminology used for intangible assets.
Depreciation is the systematic allocation of the cost of a tangible asset over time, as the asset gets consumed in the process of generating income. It is a requirement of the matching principle of accounting under both GAAP and IFRS.
Depreciation can be expensed in the Profit & Loss statement, or it can be accrued as part of the cost of another asset such as inventory or a building, according to the applicable accounting rules.
In manufacturing operations, manufacturing depreciation is part of Cost of Goods Sold, while operating depreciation is part of operating expenses. Both make up the depreciation expense for the period.
Depreciation expense is a function of several management assumptions, namely asset residual value, salvage value and useful life. As those get revised so will the depreciation expense, but not EBITDA and all ratios based on EBITDA.
The annual depreciation expense is often used as a proxy for maintenance CAPEX investments. If the company’s ongoing investment in fixed assets isn’t that least matching the annual depreciation expense, that could jeopardize future asset values and the company’s long term ability to generate income from the use of those assets.
The choice of depreciation method should reflect the pattern of consumption for each fixed asset. There are several other options than the traditional straight line or declining balance methods, including the units of production method which can actually calculate a depreciation expense of 0% when the asset is sitting idle.
The depreciation of an asset starts when the asset is available for use in the location and condition necessary to be capable of operating in the manner intended by management, not when the asset is actually put into use.
Accumulated depreciation is a contra account on the balance sheet which reduces the fixed asset balance by the sum of recorded depreciation expense up until that point in time.
Tax depreciation and accounting depreciation can be different at various points in time, resulting in temporary deferred tax assets or liabilities on the company’s balance sheet.
Asset depreciation is an easy way to reduce your tax bill.
Remember, you need to keep all records relating to your asset (e.g., receipts and purchase agreements) for at least five years, and until the day that you dispose of the asset.
Please note: These are just guidelines and the facts may change. Please contact us to keep up to date.
