Tax Deductions and Capitalization: International Comparison

Tax Deductions: An International Comparison

Income Tax Imposition

Income tax is imposed on gross income minus deductible expenditures. Generally, you cannot use expenses from one category of income to offset profits belonging to another. Expenses related to business activity may have specific deductions, while employment income often has standard deductions. Personal expenditures are generally not deductible. Mixed business and personal expenses are generally not deductible unless specific rules apply. For example, the UK does not allow deductions for mixed expenses. However, some countries like Australia, Sweden, and France allow deductions upon apportionment.

Specific Deductible Expenses

Commuting Expenses

Travel from and to work is generally non-deductible in the US, the Netherlands, and the UK. However, Germany and France allow deductions for commuting expenses.

Moving Expenses

Normally, employees pay moving expenses. In non-Commonwealth systems, moving expenses are deductible in Germany, the US, and France.

Clothing

Clothing is generally non-deductible in Canada and Sweden. However, the US allows deductions for specific items like wigs, and Germany allows deductions even if the clothing is worn outside of work.

Business Travel

Business travel is deductible in the US (unless the travel lasts more than one year) and Sweden.

Child Care

Child care is generally considered a personal expense and is non-deductible in most countries. Limited deductions are available in the US, Germany, and Italy. France does not allow deductions but offers an annual tax credit of 50%.

Hobby Losses

Profits from activities are taxable.

Education Expenses

Education expenses are deductible if they improve your current skills. Basic education is generally non-deductible.

Interest Expenses

Interest expenses related to income-earning activities are deductible.

Medical Expenses

Medical expenses are deductible in the US but not in Sweden.

Charitable Donations

Charitable donations are deductible in most countries except Sweden.

Deductions vs. Credits

Deductions reduce taxable income, while credits reduce the tax due.

Capitalization

Capitalization refers to how an asset's value is adjusted when cash flow changes due to an increase or decrease in tax liability.

Capitalized Costs

Capitalized costs are not currently deductible but are capitalized. They create a benefit in the future and can be recovered over a longer period or not at all. This includes the creation of separate assets, such as the acquisition of machinery.

Tax Adjustments

Tax adjustments are made every year through tax depreciation. Depreciation for financial accounting may differ from tax accounting. These differences are compensated by upward or downward tax adjustments. Upward adjustments are made until the accounting value in the financial statements is recovered, followed by downward adjustments.

Capital Recovery Systems

Money is recovered over the years. The straight-line method applies the same depreciation rate every year. After a set number of years, the asset can be fully deducted.

Three Aspects of Capital Recovery

• Income Measurement: Straight-line and declining balance methods.
• Practicability: Classes of assets, de minimis rules for small assets.
• Regulatory: Accelerated depreciation, boosted depreciation (Italy), full immediate deduction (US).

Loss Compensation

Financial and tax losses are considered from the taxpayer's perspective. Most countries allow taxpayers to carry over their losses.

Inter-periodical Loss Compensation

This concerns corporations that generate business income. Net operating losses (NOLs) are deductible from positive income in later years. You can carry forward the losses. There are quantitative limitations to carrying over losses.