The basis for the depreciations is the acquisition cost.

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1 Memorandum 17 February 2005 Ministry of Finance Sweden Tax and Customs Department Summary of the Swedish rules on depreciations of machinery and equipment According to Swedish tax law tangible assets are divided into four categories: 1. land, 2. land improvements/ground installations, 3. buildings and 4. machinery and equipment. Land may not be depreciated at all. Land improvements/ground installations and buildings are depreciated on an individual basis under the straight-line method. Machinery and equipment are depreciated on a pool basis. This paper will only focus on the rules for machinery and equipment (m&e). Scope The rules are applicable to all kinds of m&e (i.e. everything from typewriters and telephones to airplanes, ships and locomotives). Basically all tangible assets that are not categorized as land, land improvements/ground installations, buildings or inventory are treated according to the rules for m&e. Basis for depreciations The basis for the depreciations is the acquisition cost. Assets that may not be depreciated Art and other assets of such a characteristic that the value does not decrease, may not be depreciated at all.

2 2 Assets qualifying for immediate deduction M&e with an economic life of less than three years or with a low acquisition cost may be immediately depreciated in the year of the acquisition. The Swedish Tax Agency has defined a low acquisition cost as follows: Small companies 5,000 SEK (550 EUR) Medium sized companies 10,000 SEK (1,100 EUR) Large companies 20,000 SEK (2,200 EUR) These rules may only be used if the amount that is written off immediately is not material in relation to the company s result or financial position. Two different methods for depreciations For the m&e with an economic life of three years or longer (art etc. excluded) Swedish tax law provides two different methods for depreciations. For the purpose of this paper they are denoted the main method and the supplementary method. The main method may be used if: 1. the taxpayer prepares an annual financial statement; and 2. the depreciations for tax purposes are equal to the ones in the accounts. Since the main method provides the most favourable rules (for the taxpayer), this method is, by far, the most widely used. In general, the supplementary method is only used by those taxpayers who are not preparing an annual financial statement (i.e. many sole traders) or the ones who want to make smaller depreciations in the accounts than in the tax return. However, within the next year a changed legislation is expected under which everybody who carries out business activities will have to prepare an annual financial statement (a draft proposal for new legislation has been presented). When this legislation has entered into force the supplementary method will be more or less obsolete. Therefore, this method will not be dealt with further in this paper. The main method for depreciations The depreciations are calculated on a pool basis according to two alternative sub-methods: 30% declining balance; or 20% straight-line A verbal description of the two methods is given below. In Appendix I there is a numerical illustration of the system that stretches over a period of five years.

3 3 30% declining balance The base for the depreciations is calculated according to the following formula: Residual value (tax purposes) from the previous year + Acquisition cost of the m&e that has been bought during the present year - Selling price for the m&e that has been disposed of during the present year = Base for depreciation The maximum depreciation allowed is 30% of the base. Another way to express this is to say that the lowest allowable residual value at the end of the financial year is 70% of the base. The starting point for the calculations is the residual value of the entire pool of m&e for the previous financial year. Adding the acquisition cost of the m&e that has been bought during the present financial year (and still is owned by the company) and subtracting the selling price for the m&e that has been disposed of during the present financial year (i.e. the selling price for m&e that was owned at the beginning of the present year) gives the base for depreciation. To fully understand why the selling price is subtracted, some comments on the Swedish system for taxation of disposals of m&e are required. The selling price for m&e is taxable income and, in principle, charged with the normal corporate tax rate. For m&e that has been bought and sold during the same year the taxpayer must calculate a gain or a loss (i.e. the purchase price is deducted from the selling price). However, the pooling system and the combination of the declining balance method and the straight-line method described below, makes it very difficult to trace the residual value of an individual piece of m&e that was bought some years ago. Therefore, the taxpayer does not have to calculate a gain or loss on such items. Instead he can claim a deduction for the entire selling price provided that the basis for depreciation is reduced with the same amount. The effect of this method is that a gain is not subject to immediate taxation (or a loss an immediate deduction). Gains on old m&e are instead taxed in such a way that future depreciations will be lower than they otherwise would have been (and losses deducted in a way that future depreciations will be higher than they otherwise would have been). 20% straight-line Under the declining balance method described above an item will never be fully depreciated. Therefore, an alternative method is available. According to this method the pool as a total may be depreciated over a period of five years according to a straight-line depreciation scheme, i.e. 20 % p.a. The lowest residual value allowed according to this method is calculated according to the following formula:

4 4 M&e that was acquired Acquisition cost Lowest residual value the present financial year 80% the previous financial year 60% the second year before the present financial year 40% the third year before the present financial year 20% Total Hence, the only input into the formula is the acquisition cost of the m&e that still is possessed by the taxpayer, i.e. the acquisition cost of the m&e that has been disposed of is not included. The acquisition cost of all the m&e that was bought a certain year (second column) is multiplied with the applicable percentage given in the third column. The result is entered in the fourth column. The lowest residual value allowed according to this method is given by adding all the numbers in the fourth column. Relationship between the two methods A taxpayer may freely change between the 30%-rule and the 20%-rule from one year to another. However, the same method must be applied for the entire pool. Therefore, a taxpayer who wants to make as large depreciations as possible each year has to make two calculations in order to determine the most favourable alternative, i.e. the lowest allowed residual value according to both methods. The total depreciations must not result in a residual value that is lower than the lowest one according to the two calculations. The taxpayer can, however, freely choose to make smaller depreciations than the allowed maximum. The relationship between the two methods can be illustrated as follows:

5 5 Lowest allowed residual value Residual value % declining balance 20 % straight line Year A taxpayer who only has one piece of m&e over the five-year period (and who wants to make as large depreciations as possible) will chose to apply the 30%-rule for years 1-3 and the 20%-rule for years 4-5. If he, on the other hand, continuously invests in new m&e the most favourable option is normally to apply the 30%-rule for every year. By doing so an individual item may as mentioned before never be fully depreciated. The depreciations for the pool as a total will, however, normally be larger this way. Excess depreciation If the taxpayer can prove that the real value of the pool as a total is lower than the lowest value allowed according to the 30%- and the 20%-rules, an excess depreciation is allowed to ensure that the taxable value of the pool equals the real value. This rule is, however, very seldom applied. First year, year of disposal and financial years other than 12 months A full depreciation is granted for the first year regardless of when the item was purchased. It would be a rather complicated task to adjust the formulas in order to allow for i.e. monthly depreciations for the first year. No depreciation at all is granted for the year of disposal. Gains and losses from disposals may as mentioned above be recognized in such a way that future depreciations are adjusted. Furthermore, if gains and losses from disposals are subject to the same tax rate as other income there is no need for a rule that requires depreciations in the year of disposal. The only effect of such depreciations would be an increased gain or a reduced loss. The net income would, however, be unaffected. For accounting purposes it may be rational to require depreciations even for the year of disposal, if the

6 depreciations and gains/losses are recorded on different levels in the profit and loss account. For tax purposes, however, such a treatment seems pointless (if which is the case for Sweden the same tax rate is applied to all income). If the financial year is longer or shorter than 12 months the depreciationpercentages are adjusted proportionately. Relationship with the accounting rules The Swedish rules are as shown above highly standardized. For m&e with an economic life of less than 5 but more than 3 years, the depreciations will be too small to recognize the actual wear and tear. For m&e with an economic life of more than 5 years the rules, on the other hand, will result in a more rapid depreciation than what would be motivated due to wear and tear. Because of the pooling the disadvantage for the m&e with an economic life of less than 5 years is normally offset by the advantage for the m&e with an economic life in excess of 5 years. One prerequisite for using the 30%- and 20%-rules is, as mentioned above, that the taxpayer makes the same depreciations in the tax return and in the accounts. For accounting purposes the company normally wants to deduct only what is motivated due to wear and tear but the tax rules quite often allow for a more rapid depreciation. This dilemma is solved in such a way that the depreciations that are motivated due to wear and tear are recorded under the operating profit. The extra depreciation that consequently is made only for tax purposes is openly recorded as such at the bottom of the profit and loss account (more or less like an extraordinary item). In the balance sheet the aggregated amount of the tax motivated extra depreciations is recorded as a special reserve. 6 A simple system The Swedish system is very simple to apply, both for the taxpayers and the tax authorities. Consequently, it facilitates the efforts of keeping the compliance costs down. Because of the highly standardized nature of the rules and the pooling system, there is no need for the taxpayer to apply individual depreciation schemes for every piece of m&e with the risk of errors that such a system could lead to. Further, there is no need to calculate gains or losses in connection with disposals or even depreciations in the year of the disposal. There is also very little need for rules regarding excess depreciations if the actual wear and tear is more extensive than what follows from individual depreciation schemes (and therefore no need for taxpayers to make an effort to prove such a decline in value). Basically the only thing that the companies and the tax authorities have to concentrate on is to ensure that the residual value for the entire pool is not too small according to the 30%- and 20%-rules. Two simple calculations are all that is needed.

7 7 Appendix I Numerical example of the depreciation rules In order to illustrate the system the appendix present a numerical example that stretches over a period of five years. The table below shows in what year an item was bought and sold and to what price. The underlying assumption in the example is that the taxpayer wishes to make as large depreciations as possible for every year making use of the 30%- and 20%- rules. No decimals are used in the calculations. Year Machine Purchase price Selling price 1 A B C D E E F A G C 50

8 8 Year 1 Three items were bought for a total of 1 000, none was sold. 30%-rule Residual value from the previous year 0 Purchase price of new m&e Selling price for m&e that has been disposed of - 0 Base for depreciation Lowest allowed residual value (70% of the base) %-rule M&e that was acquired Purchase price the present financial year % 800 the previous financial year 60% the second year before the present financial year 40% the third year before the present financial year 20% Lowest allowed residual value 800 Claimed depreciation The lowest residual value is reached by application of the 30%-rule (700 compared to 800). The total depreciation will be = 300.

9 9 Year 2 One item (D) was bought for a total of 150. It was still possessed by the taxpayer at the end of the financial year. Another item (E) was bought for 300 and sold in the same year for 250. Since it was bought and sold in the same year it will not be included in the calculations of depreciations. The loss of = 50 will be deductible as a normal business expense. 30%-rule Residual value from the previous year 700 Purchase price of new m&e Selling price for m&e that has been disposed of - 0 Base for depreciation 850 Lowest allowed residual value (70% of the base) %-rule M&e that was acquired Purchase price the present financial year % 120 the previous financial year % 600 the second year before the present financial year 40% the third year before the present financial year 20% Lowest allowed residual value 720 Claimed depreciation The lowest residual value is reached by application of the 30%-rule (595 compared to 720). The total depreciation can be calculated by adding the residual value from the previous year and the acquisition cost for the new item and subtracting the residual value for the present year, i.e. ( )- 595=255.

10 Year 3 One item (F) was bought for a total of 100. It was still possessed by the taxpayer at the end of the financial year. Item A (which was bought for 300 in year 1) was sold for 160. Since the taxpayer has claimed full deduction for depreciations according to the 30%-rule for both years 1 and 2 it would, in principle, be possible to calculate the residual value for item A, and hence a gain or a loss. The residual value in such a calculation would be 300 0,7 0,7 = 147 which would lead to a gain of = 13. However, for tax purposes it is not necessary to make such a calculation. Instead, under the 30%-rule the base is reduced with the total selling price and under the 20%- rule the acquisition cost may no longer be included in the calculation. Thus, the gain is taxed in such a way that the base for future depreciations will be 13 lower than otherwise would have been the case. 30%-rule Residual value from the previous year 595 Purchase price of new m&e Selling price for m&e that has been disposed of Base for depreciation 535 Lowest allowed residual value (70% of the base) %-rule M&e that was acquired Purchase price the present financial year % 80 the previous financial year % 90 the second year before the present financial year % 280 the third year before the present financial year 20% Lowest allowed residual value 450 Claimed depreciation The lowest residual value is reached by application of the 30%-rule (375 compared to 450). The total depreciation can be calculated by adding the residual value from the previous year and the acquisition cost for the new item and subtracting the residual value for the present year, i.e. ( )- 375= I.e. the acquisition costs for machines B and C. Since machine A has been disposed of its acquisition cost is no longer included.

11 11 Year 4 No items were bought or sold. 30%-rule Residual value from the previous year 375 Purchase price of new m&e + 0 Selling price for m&e that has been disposed of - 0 Base for depreciation 375 Lowest allowed residual value (70% of the base) %-rule M&e that was acquired Purchase price the present financial year 0 80% 0 the previous financial year % 60 the second year before the present financial year % 60 the third year before the present financial year % 140 Lowest allowed residual value 260 Claimed depreciation The lowest residual value is reached by application of the 20%-rule (260 compared to 262). The taxpayer therefore applies this method for the present year. Since no items were bought or sold the total depreciation can be calculated by subtracting the residual value for the present year from the residual value for the previous year, i.e =115.

12 Year 5 One item (G) was bought for a total of 800. It was still possessed by the taxpayer at the end of the financial year. Item C (which was bought for 200 in year 1) was sold for %-rule Residual value from the previous year 260 Purchase price of new m&e Selling price for m&e that has been disposed of - 50 Base for depreciation Lowest allowed residual value (70% of the base) %-rule M&e that was acquired Purchase price the present financial year % 640 the previous financial year 0 60% 0 the second year before the present financial year % 40 the third year before the present financial year % 30 Lowest allowed residual value 710 Claimed depreciation The lowest residual value is reached by application of the 30%-rule (707 compared to 710). The taxpayer therefore applies this method for the present year. The total depreciation can be calculated by adding the residual value from the previous year and the acquisition cost for the new item and subtracting the residual value for the present year, i.e. ( )-707=

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