In the December continuation of our article, we will show you the basic principles governing capital improvements of intangible assets and leased property.
Capital improvements of intangible assets
The Income Tax Act has the following to say in its definition of capital improvements of intangible assets: A capital improvement of an intangible asset is understood to mean expenses toward a complete expansion of the features or use value of the said intangible asset, or an intervention which results in a change of the intended purpose of the intangible asset, as long as these expenses do not exceed CZK 40,000 upon completion in the case of each individual intangible asset.
As we can see, the limit for entering intangible assets in the books (CZK 60,000) is different from that for capital improvement of such assets (CZK 40,000). The taxpayer will continue to amortize such assets after their capital improvement, based on the increased input value (minus previously made write-offs), for the remaining time period set out in the amortization schedule but in any case for at least
- 9 months, in the case of audiovisual works
- 18 months, in the case of software and intangible work product of research and development
- 36 months, for other intangible assets, or
- until the end of the contractually agreed term (in the case of a fixed-term agreement).
If the remaining amortization period for the improved intangible asset is shorter than the time period listed above, it shall be extended to accommodate the longer of the two periods. If capital improvement takes place with respect to intangible assets which have already been fully written off, then the improvement is being amortized independently.
In many cases, small deviations and proper definitions play an important role in determining whether a given asset has received capital improvement or was merely repaired. For instance, we often encounter software updates or software upgrades in our day-to-day practice. These two terms need to be strictly differentiated! An update makes a given piece of software current again (including modifications that are needed to make it operational in the then current environment), i.e., the software itself is not being expanded. This means that updates do not represent a capital improvement. By contrast, an upgrade improves the software, and may result in added features and functionalities.
Capital improvement of leased assets
If capital improvements of leased assets or of assets acquired under an hire-purchase scheme are to be tax-deductible on the part of the lessee, and be eligible for tax depreciation / amortization on the part of the lessee, all of the following conditions must be fulfilled:
- the capital improvement is being paid for by the lessee,
- the lessee has obtained written consent from the owner with the depreciation of the capital improvement,
- the owner must not increase the input value (acquisition price) of tangible assets by the value of the capital improvement that was performed, and
- the lessee has categorized the capital improvement in the same deprecation class in which the owner accounts for the leased assets.
The depreciation of capital improvements on leased assets is limited by the term of the lease. If and when the lease ends (be it because the term of the lease has expired or because one of the parties has cancelled the lease), one of two possibilities arise in terms of the tax deductibility of the residual value of the capital improvement:
1. If the lessor pays the residual value of the capital improvement upon termination of the lease, then the lessee may deduct the residual value as a tax deductible expense (up to the amount paid by the lessor);
2. If the lessor does not pay the residual value to the lessee, then the residual value is a non-deductible expense on the part of the lessee.
Upon termination of the lease, the lessor shall increase the input value of the asset by the residual value of the capital improvement and may then continue depreciation (irrespective of whether or not they paid the residual value of the capital improvement to the lessee or not).
Income Tax Act (Act No. 586/1992 Coll.)