There are two different kinds of depreciation: one relates to accounting principles and the other to the tax law. This is the law we must follow when we make your tax declaration, in which a specific set of rules dictate how we calculate depreciation and your taxable income.
Let’s look at these rules in context. If you buy an asset for 100.000 DKK, depreciation is handled in two ways. The first is tax depreciation, which is what we refer to when we talk about what you can deduct from your income before you pay tax. If you have 1.000.000 DKK in revenue, for example, and you buy something for 1.000.000 DKK, your revenue will not be 0 DKK. That’s not the case when we talk about depreciation.
In general, there are three different types of tax depreciation: improvements to leaseholds, buying goodwill and equipment.
Improvements to leaseholds
Improvements to leaseholds (in Danish: indretning af lejede lokaler) relates to making improvements to a rented property, including painting, carpeting, etc. – anything that you would not be able to bring with you if you moved.
When you make these improvements, we’ll first add everything together, including VAT if you’re registered for it. Once we have the sum of all the improvements, tax law allows us to deduct 20% of this sum from your taxable income.
So if, for instance, you had 1.000.000 DKK in revenue, and you made 1.000.000 DKK in qualified improvements to a rented shop or office; we can then take 20% of that total, which would be 200.000 DKK, and deduct that as a cost in the first year. If your revenue was 1.000.000 DKK before you made the improvements, then we’d be able to deduct 200.000 DKK in depreciations. Your revenue would then be 800.000 DKK. In the second year, you deduct 20%, and so on, in a linear depreciation, until the entire depreciation has been deducted by the fifth year.
Because you made 1.000.000 DKK and you spent 1.000.000 DKK in that first year, the cashflow would be 0, but the taxable income would still be 800.000 DKK, meaning that you’d still have to pay quite a bit of tax for that year.
That’s something you must think about when you make big investments: Do you actually have the cashflow to make the investment? Dania Accounting can help you draft a cashflow budget, if you’d like to see how it actually works with the tax.
The next type of tax depreciation is buying goodwill. Goodwill is something you typically buy if you purchase a shop, restaurant or consulting business, etc., where a portfolio of clients comes with the shop. The word “goodwill” relates to the goodwill of the clients; it means that when you buy this shop, restaurant, etc., there is already a built-in base of loyal customers who were happy with the previous owner’s service or product. That happiness is valued at a price, which is called goodwill.
When we calculate your taxable income, we look at how much you paid for the goodwill shop or restaurant. From this amount, we’re allowed to deduct a seventh of the price that you paid for goodwill in the first year. In the second year, we’re also allowed to deduct a seventh, and so on, in a linear depreciation over the first seven years that you run the shop. After the seventh year, all the goodwill has been deducted.
The last type of tax depreciation is for equipment. Equipment runs the gamut from tables and chairs to kitchen equipment, cars, computer systems, software, etc. To calculate the depreciation, we sum up the purchases throughout the year, and from this sum, we’re allowed to deduct 25% of the balance.
Unlike the first two depreciations, this is not a linear depreciation; instead, we must depreciate 25% of the balance, which is called a declining balance depreciation. For example, if you buy a car for 100.000 DKK, when we deduct the tax in the first year, we’re allowed to deduct 25% of 100.000 DKK, which would be 25.000 DKK in depreciation. 75.000 DKK will be the balance left over, which will be an asset and won’t be deducted as a cost. When we deduct the tax in the second year, we’re allowed to deduct 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.
For this example, it will take nine years to deduct the total depreciation. Because it takes so long to receive your tax deductions for equipment in a declining balance depreciation, you must pay attention to your cashflow when making big investments.
You don’t have to follow the 25% deduction regarding equipment if you have a minimum balance of 13.500 DKK + VAT (2018 rate). If your total equipment balance is below this amount, you can deduct everything at once as a cost in the year that you buy the equipment. Any more than this minimum balance, and you must follow the declining balance depreciation rule, until the balance drops below 13.500 DKK (2018 rate), then you can deduct the remaining amount in total.
If you buy equipment that’s mixed-use – like a computer or car that you use for 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.
The last thing is relevant mainly for restaurants, shops and cafes – businesses where you might take a mortgage from the seller when you buy it. For example, you might buy a shop for 1.000.000 DKK, paying 100.000 DKK in cash, while the seller offers to give you a mortgage on the remaining 900.000 DKK as a loan. If you make such a transaction, we must account for the amount you paid in cash when calculating depreciation and make a cash conversion of these mortgages.
If you buy a shop for 1.000.000 DKK and you pay partially in cash and get the rest as a mortgage, please ask us how much you can depreciate before you create a budget, because a certain amount must be deducted, and this amount is dependent upon the rate the mortgage was issued to you.