How Depreciation Affects Your Business Taxes
Depreciation is a fundamental concept in accounting and taxation, allowing businesses to spread the cost of their capital assets over their useful life. In New Zealand, understanding how depreciation works and how it affects your business taxes is crucial for effective financial management. This article explores the intricacies of depreciation, its impact on business taxes, and the specific rules and regulations in the New Zealand context.
What is Depreciation?
Depreciation is the process of allocating the cost of a tangible fixed asset over its useful life. As assets like machinery, vehicles, and buildings lose value over time due to wear and tear, businesses can claim this loss in value as a tax deduction. This deduction helps businesses reduce their taxable income, thereby lowering their tax liability.
Key Concepts in Depreciation
- Depreciable Assets Not all assets are depreciable. Depreciable assets typically include tangible fixed assets used in the business, such as machinery, office equipment, vehicles, and buildings. According to Inland Revenue (IRD), you can claim depreciation on assets you own, lease, or buy under a hire purchase agreement and use, or intend to use, in your business.
- Non-Depreciable Assets Certain assets do not qualify for depreciation. These include land, trading stock, franchise fees, and intangible assets like goodwill. It’s important to distinguish between depreciable and non-depreciable assets to ensure accurate tax reporting.
- Depreciation Methods In New Zealand, there are two primary methods to calculate depreciation:
- Diminishing Value Method (DV): This method applies a constant percentage to the adjusted tax value of the asset each year, resulting in higher depreciation expenses in the early years and lower expenses in later years.
- Straight Line Method (SL): This method spreads the depreciation expense evenly over the asset’s useful life, resulting in a consistent annual expense. Businesses can choose the method that best suits their financial strategy and switch methods at the end of each year, using the adjusted tax value to calculate the new depreciation.
Calculating Depreciation
To calculate depreciation, you need to know the asset’s cost, its useful life, and the applicable depreciation rate. The IRD provides a tool to find the depreciation rate and calculate depreciation for business assets. For GST-registered businesses, depreciation is calculated on the GST-exclusive price of the asset, while non-GST-registered businesses use the GST-inclusive price.
Depreciation Rates and Pooling
Depreciation rates vary based on the type of asset and its useful life. The IRD sets these rates, and businesses must use the prescribed rates or apply for a special depreciation rate if necessary. Additionally, businesses can pool low-value assets (those costing below a certain threshold) and depreciate them as a group using the diminishing value method.
Impact on Business Taxes
- Tax Deductions Depreciation allows businesses to claim a deduction for the loss in value of their capital assets, reducing taxable income and, consequently, the tax payable. This deduction is claimed annually as part of the end-of-year accounts.
- Immediate Deductions for Low-Value Assets For assets below a certain value, businesses can claim an immediate tax deduction instead of spreading the cost over the asset’s life. The threshold for low-value assets has varied over time, with recent changes allowing higher immediate deductions to support businesses during the COVID-19 pandemic.
- Depreciation Recovery When a depreciated asset is sold, businesses must account for depreciation recovery, which can affect taxable income. The recovery amount is the difference between the sale price and the asset’s adjusted tax value, and it is taxable in the year of sale.
Depreciation on Buildings
Depreciation rules for buildings have changed over the years. From the 2012 to 2020 income years, depreciation on buildings with an estimated life of more than 50 years was set at 0%. However, recent changes have reintroduced depreciation deductions for non-residential buildings for the 2021 to 2024 income years, with the rate returning to 0% from the 2025 income year.
Depreciation is a vital tool for managing business taxes in New Zealand. By understanding the rules and methods for claiming depreciation, businesses can optimise their tax position and ensure compliance with IRD regulations. Whether you are a small business owner or a large corporation, leveraging depreciation effectively can lead to significant tax savings and improved financial health. For detailed guidance and specific calculations, businesses should consult with a tax professional or refer to resources provided by Inland Revenue.