Tax depreciation and initial allowance: the two-books problem

Every business that owns equipment, vehicles, machinery or buildings has to deal with depreciation twice: once for the accounts, and again, differently, for tax. The two rarely agree, and that divergence is not a mistake — it is how the law is designed. Tax depreciation runs on statutory rates and a reducing-balance method, sweetened by a one-off initial allowance when an asset first enters use. This guide explains the tax method, how it differs from the accounting figure, and why a separate tax fixed-asset register is not optional.

The two-books problem

Accounting depreciation and tax depreciation answer different questions. The accounts try to reflect how an asset genuinely wears out over its useful life, using management's estimates of life and residual value. Tax law is not interested in that judgement; it prescribes its own rates and its own method, applied uniformly, to decide how much relief a business gets each year.

The consequence shows up on the return. The accounting profit already has accounting depreciation deducted, so the tax computation adds it back and then deducts the tax depreciation instead. The two figures legitimately differ, and they differ every year. Anyone reconciling accounting profit to taxable business income has to make this swap, and it is one of the most routine adjustments in the whole computation. Expecting the two to match is the first misconception to drop.

How reducing-balance depreciation works

Tax depreciation uses the reducing-balance (or written-down-value) method. The statutory rate is applied each year not to the original cost but to the written-down value — the cost less all depreciation already allowed. That single feature drives the whole shape of the relief:

• The deduction is largest early and shrinks over time. Because each year's rate applies to a smaller base, the allowance falls year after year.
• The asset never reaches zero on this method. Applying a percentage to an ever-smaller balance always leaves a residual; the asset is fully cleared from the register only on disposal.
• Each asset class has its own rate. Buildings, plant and machinery, vehicles and other classes carry different statutory rates, so one blended rate across all assets is wrong.

A short illustration on a Rs 1,000,000 asset at a 15% reducing-balance rate shows the pattern:

The rate here is illustrative; the actual class rates are set in the Ordinance and should be taken from the enacted schedule. The mechanic — rate on written-down value, deduction shrinking each year — is what matters.

Initial allowance: the one-off boost

On top of the normal depreciation, the Ordinance grants an initial allowance in the year an eligible asset is first put to use. This is a one-off extra deduction, given only once and only in that first year, designed to front-load relief and encourage investment in productive assets.

Two conditions govern it. First, not every asset qualifies — the categories eligible for initial allowance are defined in the Ordinance, and some asset types are excluded. Second, the allowance is tied to the year of first use, not merely purchase. Both the eligibility and the rate have been adjusted in past Finance Acts, so they should be confirmed for the specific year an asset entered use rather than assumed from an older position.

The rules sit in sections 22 and 23 of the Income Tax Ordinance 2001 — section 22 for normal depreciation and section 23 for the initial allowance — with the rates specified in the Third Schedule. Two features of that structure drive everything below: depreciation is computed on the written down value of a block rather than asset by asset, and the initial allowance is available only in the year an eligible asset is first used.

Timing and part-year assets

When an asset is bought late in the year, the natural question is whether a full year's depreciation is available. The rule turns on when the asset was put to use rather than the purchase date, and the treatment of assets brought into use partway through a year is set by the Ordinance and has changed over time. Because a part-year convention versus a full-year allowance materially changes the first year's deduction, this is a point to confirm against the current-year rule rather than guess — particularly for a significant asset acquired close to the year end.

What happens on disposal

The register earns its keep at disposal. Selling a depreciated asset triggers a balancing adjustment built entirely around the tax written-down value at the date of sale:

1. Proceeds above written-down value. The excess, up to the depreciation previously allowed, is generally brought back as income — in effect clawing back relief that the sale price shows was not needed.
2. Proceeds below written-down value. A further deduction may arise, recognising that the asset lost more value than the depreciation allowed.

Neither adjustment can be computed without an accurate written-down value carried forward for the asset, which is the whole reason the tax register has to track every asset year by year, separately from the accounts.

Keeping a tax fixed-asset register

Everything above depends on one discipline: a tax fixed-asset register kept separately from the accounting one. For each asset it records the cost, the year of first use, the initial allowance claimed, the depreciation each year, and the written-down value carried forward. Without it, the reducing-balance calculation drifts, initial allowance gets claimed in the wrong year or twice, and the disposal adjustment cannot be worked at all. This is the same contemporaneous-records instinct that underpins bookkeeping for compliance generally, and it pairs naturally with getting the inadmissible-expense add-backs right — together, the depreciation swap and the expense add-backs are most of what turns accounting profit into a defensible taxable figure.

Sources

This guide is written against the official and clearly labelled professional references below. Rates, thresholds and portal procedures change between reviews, so open the primary source before relying on a figure.

• Income Tax Basics (FBR)
• Finance Act 2026 (FBR)
• File an Income Tax Return (FBR)

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