There are two different kinds of depreciation to consider: one relates to the tax rules and the other to the accounting rules.
When we speak about tax rules, we are referring to the amount you can deduct from your taxable income before you pay income tax.
If you have a 1.000.000 DKK taxable profit, for example, and you buy an asset for 100.000 DKK, your taxable profit will not be 900.000 DKK.
The reason for this is, that the assets we buy are not deducted fully as costs in the year of purchase.
Instead, the assets are divided into smaller costs over a period of years.
This division of costs over a period of years into smaller costs we call depreciation.
Here we will cover the three most common types of tax depreciation:
– Improvements to leaseholds;
Improvements to leaseholds
Improvements to leaseholds relate to improvements made to a rental property, including painting the walls, carpeting floors – any improvements you do that you will not be able to physically bring with you when you move out at the end of the leasehold.
When you have made improvements to a leasehold during a year, we start by adding all the costs for the year together, since improvements often will consist of many smaller costs (receipts and invoices from different shops).
Once we have the sum of costs for all the improvements done, the tax rules allow us to deduct 20% of this sum from your taxable income in the year of purchase.
If your taxable profit is 1.000.000 DKK, as an example, and you made improvements to a leasehold of 100.000 DKK (f.ex. a rented shop or office), we can depreciate 20% of the total improvement costs during the first year.
If your taxable profit is 1.000.000 DKK before you made the improvements and we then depreciate 20% of the total improvement costs, which is 20.000 DKK, your taxable profit will be 980.000 DKK in the first year.
In the second year, you can depreciate another 20% of the remaining amount as a linear depreciation, until the entire improvement costs have been depreciated by the fifth year.
So during a 5-year period, you depreciate 20.000 DKK each year which adds up to the 100.000 DKK improvement costs from year 1.
The next type of tax depreciation is when you buy goodwill.
Goodwill is something you typically buy if you purchase a shop, restaurant or consulting business that includes a portfolio of customers.
The word “goodwill” relates to the goodwill of the customers; it means there is a built-in base of loyal and returning customers who are happy with the previous owner’s service or product.
That loyalty and happiness are valued at a price, which is called goodwill.
When we calculate your taxable income, we look at how much you paid for the goodwill.
From your taxable income, we are allowed to depreciate a seventh (1/7) of the price that you paid for goodwill in the first year.
In the second year, we are also allowed to depreciate a seventh, and so on, as linear depreciation over seven years.
After the seventh year, all the goodwill has been depreciated in your taxable income.
The last type of tax depreciation we cover here is for equipment.
Equipment can be anything from tables, chairs, kitchen equipment, cars, computers etc.
In general, we consider items which last more than 1 year to be equipment.
To calculate the tax depreciation, we sum up the purchases throughout the year, and from this sum, we’re allowed to deduct 25%.
Unlike the first two depreciations, this is not a linear depreciation; instead, we depreciate 25% of the sum.
For example, if you buy a car for 100.000 DKK, we can depreciate 25% of 100.000 DKK, which would be 25.000 DKK.
In the second year, we are allowed to depreciate 25% of the remaining 75.000 DKK (18.750 DKK), and 25% of the remaining 56.250 DKK in the third year, and so on, until the full 100.000 DKK has been depreciated.
If an item cost 31.000 DKK or less (this is the 2022 rate excl. VAT, in 2021 the rate was 30.700 DKK excl. VAT) you are allowed to depreciate the cost fully in the year of purchase from your taxable income.
If you buy equipment that is mixed-use – like a computer or car that you use for both business and private purposes – you must split the depreciation between what is deductible as a cost in the company and what is to be considered private.
Cash conversion of the tax base
The last thing is relevant mainly for restaurants, shops and cafés – businesses where you might take a mortgage from the seller when you buy.
For example, if you buy a shop with 1.000.000 DKK in goodwill, and you only pay 100.000 DKK in cash because the seller offered to give you a mortgage on the remaining 900.000 DKK, then we must account for the amount you paid in cash when calculating depreciation since it will lower the base of the tax depreciation.
If you buy a car for 100.000 DKK and that car is expected to drive for 10 years, then using accounting rules you will depreciate the cost over a duration of 10 years linear.
The main difference between tax rules and accounting rules is that tax rules follow certain fixed percentages and amounts whereas accounting rules follow expected years of usage.
(Last update of the blog: 28.3.2022)