TAX DEPRECIATION, AMORTISATION,

PRE-COMMENCEMENT EXPENDITURE
ICAP F students
From the desk of KP
1) TYPES OF DEPRECIATION

a) Normal depreciation. Normal tax depreciation is allowable on WDV of assets at the

beginning of the tax year at the following rates:

Assets Rate of depreciation

Buildings 10%
Furniture and fittings 15%
Plant and machinery general 15%
Computers and allied items including printer, monitor
and IT related plant and machinery 30%
Technical and professional books 15%
Motor vehicles and ships 15%
Aircrafts and aero engines 30%

Normal depreciation on an asset acquired during a tax year shall be calculated on full
years basis (where the asset is commissioned for use) on the cost of asset as reduced
by initial allowance while no depreciation shall be calculated in the year of disposal.

b) Initial allowance section 23

Initial allowance is allowable @ 50% of the cost of asset if the asset is used for
business purpose in the tax year in which the asset is placed into service or in which
commercial production is commenced whichever is later, other than the following:

o Road transport vehicle not plying for hire [Vehicles given on lease under finance
lease shall be considered as not plying for hire CBR brochure 10]
o Furniture and fittings
o Any plant and machinery that has been used previously in Pakistan
o Assets allowed as tax expense
o Building given on rent along with plant and machinery [plant and machinery is
eligible for initial allowance section 40]

It means that initial allowance is allowable on the following assets:

o Buildings all types
o Plant and machinery not previously used in Pakistan. It means that second hand
imported machinery is eligible for initial allowance.
o Road transport vehicle plying for hire
o Computers and allied items including printer, monitor
o Technical and professional books

Example of Tax Depreciation

Opening tax WDV of plant and machinery Rs.500,000
Purchase of plant during the year eligible for initial allowance Rs.200,000
Tax WDV of disposals during the year Rs.85,000
Answer:
WDV Depreciation
Opening tax WDV 500,000
Less: WDV of disposal during the year 85,000
415,000
Additions net off initial allowance 100,000
Amount eligible for normal depreciation 515,000
Initial allowance @ 50% 100,000
Normal tax depreciation @ 15% 77,250

2. OTHER ASPECTS
a) Depreciable asset means any tangible movable property, immovable property or
structural improvements to immovable property (excluding cost of land) owned by a
person that has a normal useful life exceeding one year.

Structural improvement includes any building, road, driveway, car park, railway line,
pipeline, drainage, bridge, tunnel etc.

CBR brochure 10: Owned means legal ownership in most cases. However, it also
includes real or beneficial ownership in certain cases and therefore tax depreciation
can be claimed e.g.
Where a person can exercise the right of ownership and is entitled to the
use or income thereof without legal title

Where a person enjoys full possession of the property and the entire
consideration paid but formal conveyance deed not yet executed

Building constructed by the person on land not owned e.g. leasehold land

Assets held by members and applied for AOPs business

Benami Transactions
[Benami purchases are purchases in false name of another person, who
does not pay the consideration but merely lends his name. In this case the
beneficial owner is the person who actually purchased and paid the
amount of property.]

b) Cost of an asset shall be the total of the following:

Consideration given or FMV of any consideration given in kind
Expenditure incurred in acquiring and disposing off the asset; and
Amount paid to bring the asset to its present location and condition fit for its
intended use such as incidental expenses incurred in acquiring, transporting,
altering, improving, renewing, installing.

Cost of internally produced assets will also include a fair proportionate part of
factory and admin overheads [CBR brochure 10].

c) Partial use for business. If an asset is used partly for business purpose and partly
for other use in a tax year then normal depreciation for the year shall be allowed

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 proportionately. However, initial allowance shall be calculated in the normal manner
as the provision of proportionate calculation is given in section 22 (for normal
depreciation) and not in section 23 (for initial allowance).

Example: Mr. A purchased a building on 1 July at Rs.800,000 which is used 60%

for his retail shop and 40% for his private residence. Calculate the amount of
depreciation he can claim as tax deductible.

Answer:
Tax Dep
Cost on 1 July 800,000
Initial allowance @ 50% 400,000 400,000
400,000
Depreciation for the year @ 10% 40,000
Normal depreciation allowable 60% of 40,000 24,000
Closing WDV 360,000

d) Gain or loss on disposal of an asset shall be taken into business income and
considered as per tax workings i.e. consideration received less tax WDV. Therefore,
the following adjustments are required while calculating taxable business income:

Accounting gain on disposal of an asset deduction

Tax gain on disposal of an asset add back
Accounting loss on disposal of an asset add back
Tax loss on disposal of an asset deduction

At the time of disposal, tax WDV shall be increased by the amount of depreciation
disallowed on account of non-business use.

Example: Mr. C purchased a computer on 1.7.2005 at Rs.80,000 which is used 80%

for his business and 20% for his private purpose. Mr. C sold this computer on
5.7.2007 for Rs.50,000. Calculate the amount of tax gain or loss under business
income.

Answer:
Depreciation
Allowable
(80% business use)
Tax year 2006
Cost on 1 July 2005 80,000
Initial allowance @ 50% 40,000 40,000
40,000
Depreciation for the year @ 30% 12,000 9,600
Closing WDV 28,000

Tax year 2007

Opening tax WDV 28,000
Depreciation for the year @ 30% 8,400 6,720
Closing WDV 19,600

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 Tax year 2008
Opening tax WDV 19,600
Add: Depreciation disallowed for non-business use
In the tax year 2006 (12,000 9,600) 2,400
In the tax year 2007 (8,400 6,720) 1,680
Total tax WDV 23,680
Less: sale proceed 50,000
Tax gain on disposal 26,320

e) Disposal includes disposal of a part of an asset. A person shall be treated to have

made a disposal when he parts with the ownership of the asset including when the
asset is sold, exchanged, transferred, cancelled, destroyed, lost, expired etc.

f) Application of a business asset wholly to personal use shall be treated as a disposal

of asset at FMV at the time it is so applied. Likewise, application of a personal asset
wholly or partly to business use shall be treated as an acquisition of asset at FMV at
the time it is so applied.

g) Any rebate, commission, grant or subsidy (not being in the nature of loan) from
Government or any other person shall be deducted from the cost of asset.

CBR brochure 10:

o Recoupment of cost shall be deducted from the cost / WDV of asset

o Waiver of debt owed by the taxpayer related to acquisition of an asset shall also
be deducted from the cost / WDV of asset.

o Where a depreciable asset is acquired as a result of waiver of debt owed to the

taxpayer then the cost shall be equal to the debt waived and not the FMV of the
asset.

h) Exchange difference in making payment of liability in foreign currency against an

asset shall be added to or deducted from the cost of asset on accrual basis including
the effect of hedging arrangement relating to the loan.

Example:
Exchange Rate Cost (Rs.)
Cost on 1.1.2002 own investment 1,300,000
- Foreign currency debt $100,000 57.00 5,700,000
Debt outstanding on 30.6.2002 $100,000 57.25 25,000
Cost for the purpose of tax depreciation 7,025,000

First installment paid on 1.1.2003 $10,000 56.95 (3,000)

Debt outstanding on 30.6.2003 $90,000 57.50 22,500
Net increase to be capitalized 19,500

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i) Where the acquisition of an asset is the derivation of an amount chargeable to tax,
the cost of the asset shall be the amount so charged plus any amount paid by the
person for the asset.

Similarly where the acquisition of an asset is the derivation of an amount exempt

from tax, cost of the asset shall be the amount so exempt plus any amount paid by
the person for the asset.

Example: Purchase of a paper cutting machine to be used in printing business

Price actually paid 75,000
Non-cash benefit given
Printed stationery given (taxable income) 15,000
Agricultural produce given (exempt income) 15,000
Cost for tax depreciation purpose 105,000

j) Cars:
o Maximum allowable cost of one car was Rs.1 million up to 30.6.2005. This limit has
now been removed.
o Rate of normal tax depreciation on vehicles was 20% up to the tax year 2005
o If a car, having original cost in excess of maximum allowable cost, is subsequently
disposed off then sale proceed shall also be reduced proportionately as under:

Restricted Cost x sale proceed = Proportionate sale proceed

Original Cost

o Maximum allowable cost of one car before the tax year 2003 was as under:

With effect from Maximum

Assessment year allowable cost
1990-91 250,000
1992-93 600,000
2001.2 750,000

Example: Mr. A purchased a car of Rs.1,400,000 on 1.7.2004 for his business and
sold this car on 31.7.2007 for Rs.900,000. Calculate tax gain or loss on disposal of
car in the tax year 2008.

Answer:
Cost of car on 1 July 2004 Rs.1,400,000
Cost of car for tax purpose 1,000,000
Less: Tax depreciation @ 20% for the tax year 2005 200,000
800,000
Less: Tax depreciation @ 15% for the tax year 2006 120,000
680,000
Less: Tax depreciation @ 15% for the tax year 2007 102,000
Opening tax WDV for the tax year 2008 578,000
Sale proceed (1,000,000 / 1,400,000) x 900,000 642,857
Tax gain on disposal of car in the tax year 2008 64,857

k) Definition of consideration received:

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i) Normal case: Actual sale proceed or FMV whichever is higher.

ii) Consideration received in kind: FMV

iii) Non-arms length transaction: FMV at the time of disposal. The purchaser
shall be treated to have acquired the said asset at the same FMV and not at
the cost paid by him.
CBR brochure 10: Arms length transaction means a transaction between two
parties who are:
Not related
Not on close terms
Not involved in a confidential relationship
Presumed to have roughly equal bargaining powers
Knowledgeable about the deal; and
Willing to undertake the deal

iv) Asset is destroyed or lost: Scrap value along with any compensation,
indemnity or damages received under an insurance policy, agreement,
settlement or judicial decision.

v) Sale of an asset by an approved leasing entity: Residual value on

maturity or on pre-mature termination of lease subject to the condition that
residual value plus other lease amounts are not less than original cost of asset.

After purchase of an asset on maturity or pre-mature termination of lease the

purchaser is entitled to claim tax depreciation on residual value or bargain
purchase price.

vi) Export of asset after use in Pakistan: Original cost of the asset.

In this case gain on disposal shall be equal to depreciation allowed

vii) Sale of immovable property. Consideration received shall be taken at the

lower of Cost of immovable property and consideration received.

Example: Mr. Z purchased a factory building for his business for Rs.800,000
and up to 30.6.2007 he has claimed tax depreciation of Rs.563,804 on the
building. On 31.8.2007 he sold his factory building for Rs.2,800,000. Calculate
tax gain or loss on disposal of the factory building.

Answer:
Cost of factory building 800,000
Tax depreciation up to 30.6.2007 563,804
Tax WDV 236,196
Sale proceed actual sale proceed or original
cost whichever is lower 800,000
Tax gain on disposal 563,804

In this case gain, if any, shall not exceed depreciation allowed and

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 therefore consideration received in excess of original cost shall be exempt.

Illustration 1: From the following data calculate tax depreciation, tax gain or loss on
disposal of assets and taxable income of Z (Pvt) Ltd:

Rs.
(a) Accounting profit before charging accounting depreciation and tax 2,400,000
(b) Accounting depreciation 640,000
(b) Opening tax WDV of assets are:
Plant and machinery 1,500,000
Furniture and fixtures 900,000
Factory Building (Original purchase cost Rs.1,900,000) 692,550
Vehicles 1,400,000
(c) Purchase of assets during the year:
Plant and machinery 420,000
Furniture and fixtures 80,000
One Toyota Car 1,250,000
(d) Disposal of plant and machinery during the year:
Sale proceed 190,000
Tax WDV 145,000
Accounting WDV 205,000
(e) Disposal of factory building during the year:
Sale proceed 3,600,000
Tax WDV 692,550
Accounting WDV 1,330,000

Answer: Taxable income Rs._________

NO GAIN NO LOSS TRANSACTIONS section 79 (i.e. non-recognition rules)

a) No gain or loss shall arise in the following transactions if the transferee is a
resident person at the time of acquisition of asset and the transferee shall be
treated to have acquired the asset at the cost equal to the cost of asset for the
transferor at the time of disposal:

i. Between spouses under an agreement to live apart

ii. Gift
iii. Transmission of an asset on the death of a person
iv. By a company to its shareholders on its liquidation
v. By an AOP to its members on its dissolution where the assets are
distributed to the members in accordance with their interests in the capital
of AOP

b) Where an asset is disposed off on compulsory basis under any law and the
consideration received is reinvested in another asset of a like kind within one year
of disposal then the cost of replacement asset shall be the cost of asset disposed
off + consideration given for replacement asset in excess of consideration received
for the asset disposed off.

Example:
Cost of a particular equipment Y disposed off on

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 1.8.2007 under the law 500,000
Tax depreciation allowed 220,000
Tax WDV of equipment Y 280,000
Sale proceed of equipment Y received 900,000
Another similar equipment Z was acquired on 25.8.2007 980,000

Tax treatment in the tax year 2008:

- Tax WDV of Y shall be deducted from opening tax WDV of plant and machinery
- Cost of equipment Z for tax depreciation purpose shall be 580,000 i.e. 500,000
+ (980,000 900,000).

Certain special cases:

1) Cost of an asset owned by more than one person in the hands of each co-owner is
their cost of acquiring and not the cost of asset itself. In a special case, equal co-
owners may have different costs e.g. cost of office building for Mr. A is Rs.1 million.
After one year Mr. A sold 50% of building to Mr. B for Rs.800,000. Part of an asset
disposed off shall be considered as disposal of asset. Now the cost of 50% for Mr. A is
Rs.500,000 and for Mr. B Rs.800,000.

2) Cost of a depreciable asset acquired with some thing else in a single transaction shall
be restricted to FMV e.g. a photocopy machine having FMV of Rs.70,000 is purchased
at Rs.80,000 due to 6 months service and maintenance contract. In this case,
depreciable amount would be Rs.70,000 and the balance shall be allowed as revenue
expenditure.

3) Cost of two or more assets acquired in a single transaction is apportioned in

proportion to their FMV at the time of acquisition e.g.

Cost of furniture and computer 100,000

FMV at the time of acquisition:
Furniture 70,000
Computer 50,000
Therefore cost for tax depreciation purpose:
Furniture 58,333
Computer 41,667

AMORTIZATION OF INTANGIBLES section 24

a) Intangible means any patent, invention, design, secret formula, copyright, trade
mark, scientific or technical knowledge, computer software, motion picture film,
export quota, franchise licence or like property or right and any expenditure that
provides an advantage for a period of more than one year.

b) Where an intangible is used for business purpose an amortization deduction in a tax

year is allowable as under:
Cost of intangible
Normal useful life in whole years

Where an intangible has a normal useful life of more than 10 years or does not have
an ascertainable useful life then the same shall be treated as 10 years.

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c) If an intangible is used partly for business purpose and partly for other use in a tax
year then amortization deduction shall be allowed proportionately.

Example: Mr. A acquired an intangible asset on 1.7.2007 at a cost of Rs.500,000

which is used 60% for his business and 40% for other use. Useful life of the
intangible is estimated to be 8 years. Calculate amortization deduction allowable for
the tax year 2008.

Answer:
Cost of the intangible as on 1.7.2007 500,000
Amortization for the year (500,000 / 8) 62,500
Closing WDV 437,500

Amortization deduction allowable for the tax year 60% of 62,500 37,500

d) If an intangible is not available for use for the whole tax year then amortization
deduction shall be calculated proportionately based on number of days available
for use divided by number of days in the tax year.

Example: Mr. B acquired an intangible on 1 March at Rs.300,000 with estimated

useful life of 12 years and there was no other use. Calculate the amount of
amortization he can claim as tax deductible for the year ended 30 June.

Answer:
Cost of intangible 300,000
Less: Amortization (300,000 / 10) x (122 / 365) 10,027
Closing WDV 289,973

e) Amortization deduction is not allowed in the year of disposal of intangible. Any gain
or loss on such disposal shall be considered for tax purpose and shall be calculated
by deducting tax WDV from consideration received.

PRE-COMMENCEMENT EXPENDITURES section 25

a) Pre-commencement expenditures that were not allowed as tax expense shall be
amortized @ 20% on straight line basis and amortization shall be allowed as a tax
deduction.

b) Pre-commencement expenditure means any expenditure incurred before the

commencement of business (i.e. before the commencement of commercial
production) exclusively for business purpose including the cost of feasibility studies,
prototypes and trial production activities but excluding cost of land, depreciable
assets and intangibles.