Depreciation of leasing asset is accrued by a lessee - in the event of financial leasing, and by a lessor - in the event of operating leasing.
The Concept of Tax Depreciation
Pursuant to the Law on Profit Tax, fixed assets depreciation means gradually charging expenses related to purchase, manufacture or improvement of fixed assets to the reduction of adjusted gross income of the taxpayer.
Expenses for purchasing fixed assets with the view of their further resale to other persons are not subject to tax depreciation and are fully attributed to gross expenses. On this basis, for tax accounting purposes, leasing companies record the purchase of leasing asset (to be further transferred in financial leasing) as the purchase of goods. In our opinion, a better practice would be to record this transaction under the item “capital investments.”
Classification of Fixed Assets and Tax Depreciation Rates
In accordance with the Law on Profit Tax, fixed assets include tangibles intended for use in the course of taxpayer’s business activity over the period longer than 365 calendar days from the date of their putting into operations, and whose value exceeds UAH 1000 and is reduced gradually due to physical and moral depreciation.
All fixed assets may be classified into four groups, with quarterly depreciation rate for each group being as follows:
Group 1 (2%) – buildings, structures, their structural components and transmission devises;
Group 2 (10%) – transportation vehicles and components (spare parts) thereto; furniture, household electric, optical and mechanical devices and tools, other office equipment, fixtures and fittings thereto;
Group 3 (6%) – any other fixed assets not included in groups 1, 2 and 4;
Group 4 (15%) – computers, other automated data processing equipment, related devices for reading and printing of information, other information systems, computer software, telephones (including cellular), microphones and portable radio sets.
Law permits the taxpayer to apply other depreciation rates not exceeding the above rates.
For Group 1 fixed assets the Law on Profit Tax stipulates tax accounting on both each separate building, structure or structural component or on the group as a whole (as a sum of book value of individual assets in the group).
For fixed assets in Groups 2 – 4, the accounting of aggregate book value of the relevant group of fixed assets is stipulated. Despite the fact that the law does not provide for separate accounting of book value of individual assets in these groups, we believe that there should be individual accounting for leasing assets (relating to each specific leasing asset).
Procedure for Charging Depreciation
The amount of depreciation charges in the reporting period (quarter) is determined by multiplying the relevant quarterly depreciation rate by the book value of fixed assets as of the beginning of such quarter. Depreciation is charged on a straight-line basis based on the residual value of the relevant group of fixed assets.
For fixed assets in Groups 2 – 4, depreciation is charged until the book value of assets reaches zero. For Group 1 fixed assets depreciation is charged until their book value reaches one hundred non-taxable minimal incomes of citizens (presently, it is UAH 1700 = UAH 17 x 100).
The application of current tax law precludes the write-off of Groups 2, 3 and 4 fixed assets (and these assets are the most frequent leasing assets) to the zero level even after ten years. This is demonstrated by the below example (Table 1), showing a calculation of depreciation charges and the book value of leasing assets with the initial value of UAH 100 thousand.
Table 1
Calculation of tax depreciation of different groups of fixed assets
|
Year of leasing asset use |
Group 1 |
Group 2 |
Group 3 |
Group 4 |
|
Annual depreciation (depreciation rate 8% = 2% x 4) |
Book value as of the year-end |
Annual amount of depreciation (depreciation rate 40% = 10% x 4) |
Book value as of the year-end |
Annual amount of depreciation (depreciation rate 24% = 6% õ 4) |
Book value as of the year-end |
Annual amount of depreciation (depreciation rate 60% = 15% õ 4) |
Book value as of the year-end |
|
1 |
8.00 |
92.00 |
40.00 |
60.00 |
24.00 |
76.00 |
60.00 |
40.00 |
|
2 |
7.36 |
84.64 |
24.00 |
36.00 |
18.24 |
57.76 |
24.00 |
16.00 |
|
3 |
6.77 |
77.87 |
14.40 |
21.60 |
13.86 |
43.95 |
9.60 |
6.40 |
|
4 |
6.23 |
71.64 |
8.64 |
12.96 |
10.55 |
33.40 |
3.84 |
2.56 |
|
5 |
5.73 |
65.91 |
5.18 |
7.78 |
8.02 |
25.38 |
1.54 |
1.02 |
|
6 |
5.27 |
60.64 |
3.11 |
4.67 |
6.09 |
19.29 |
0.61 |
0.41 |
|
7 |
4.85 |
55.79 |
1.87 |
2.80 |
4.63 |
14.66 |
0.25 |
0.16 |
|
8 |
4.46 |
51.32 |
1.12 |
1.68 |
3.52 |
11.14 |
0.10 |
0.06 |
|
9 |
4.11 |
47.21 |
0.67 |
1.01 |
2.67 |
8.47 |
0.04 |
0.02 |
|
10 |
3.78 |
43.43 |
0.40 |
0.61 |
2.03 |
6.44 |
0.01 |
0.01 |
Financial Leasing
If before the transfer of leasing asset to a lessee the property was part of lessor’s fixed assets, after the transfer of leasing asset a lessor must decrease the book value of the relevant group of its fixed assets by the value of asset transferred in leasing.
Upon the receipt of leasing asset a lessee increases the book value of the relevant group of its fixed assets by the value of this leasing asset.
Operating Leasing
When providing property for operating leasing, a lessor does not decrease the book value of the relevant group of its fixed assets. A lessor charges depreciation on the assets provided on lease.
Upon the receipt of operating leasing asset a lessee does not increase the book value of its fixed assets.
Expenses Related to the Improvement of Leasing Asset
Financial Leasing
Any expenses related to the improvement of fixed assets(including the expenses for improving fixed assets taken on leasing), if their amount does not exceed 10% of the aggregate book value of all groups of fixed assets as of the beginning of the reporting period, may be attributed by taxpayers to gross expenses during such reporting period.
Expenses exceeding the indicated amount are allocated proportionally to the amounts of taxpayer’s expenses actually incurred for improving fixed assets of Groups 2, 3 and 4 or individual assets of Group 1 and increase the book value of the relevant group of fixed assets or individual assets of Group 1 as of the beginning of the quarter.
Operating Leasing
A lessee is entitled to deduct part of the value of improvements made to the operating leasing asset within the amount not exceeding 10% of the aggregate book value of all groups of its fixed assets as of the beginning of the reporting period.
If operating leasing agreement obliges or permits a lessee to improve leasing asset, a lessee includes part of the value of such improvements that exceeds the above 10% in the book value of:
à) the relevant group of fixed assets – if the group of fixed assets to which such leasing assets belongs is accounted for at the balance sheet of a lessee;
á) the relevant group of fixed assets created by a lessee - if the group of fixed assets to which such leasing assets belongs is not accounted for at the balance sheet of a lessee.
A lessee does not take into account the book value of operating leasing asset at which this asset is recorded in the books of a lessor.
If (1) a lessee returns operating leasing asset to a lessor as a result of expiration of leasing contract or (2) operating leasing asset was destroyed, stolen or ruined,
such lessee:
à) if leasing asset belongs to Group 1 of fixed assets, shall increase its gross expenses by the amount of book value (residual value) of this asset and the value of such leasing asset shall be equal to zero;
á) shall not change the book value of Group 2, 3 and 4 fixed assets.
A lessor shall not change the book value of fixed assets or gross income (expenses) by the amount of expenses incurred by a lessee in connection with the improvement of such leasing asset.