Capital Cost Allowances and

Cumulative Eligible Capital

How Tax Addresses Depreciable Property

Concepts of Depreciation:Tax Versus Accounting

• There is a wide range of generally accepted amortization methods in accounting, with ambiguous estimates of an asset’s useful life and salvage value

• As a result, accounting measures of depreciation are too subjective for tax purposes

• Furthermore, there is too much potential for abuse if a taxpayer is permitted to self-assess depreciation

• As a result ... – Par. 18(1)(b) prohibits the deduction of any

amounts related to capital costs, including depreciation, and

– Par. 20(1)(a) specifically permits the deduction of Capital Cost Allowance (CCA)

• The CCA system is strict, leaving no alternative choices for the computation of the economic decline in the value of an asset

Accounting & Tax Terminology

Accounting Term Analogous Tax TermAcquisition cost Capital Cost

Amortization/Depreciation Capital Cost Allowance (CCA)

Net Book Value Undepreciated Capital Cost (UCC)

Capital Cost Allowance (CCA)

• CCA is the tax term for a concept analogous to accounting’s depreciation and amortization

• CCA establishes specified rates using either diminishing balance or straight line depreciation

• This ensures equity among taxpayers and eliminates subjectivity and the potential for abuse

• CCA provides the maximum deduction available• However, taxpayer has discretion in selecting any

amount within that range from zero to the maximum – which allows the taxpayer to do some tax planning

• For example, a company has a active Net Income of $20,000 before taking CCA and the maximum CCA available on all its assets is $30,500

• The company has the following options available:1. Take no CCA and pay tax on the NIFTP of $20,0002. Take enough CCA to equal $20,000 and pay no tax3. Take the full $30,500 of CCA and create a $10,500 loss

Three General Categories

• The CCA system separates capital property into three general categories:

Non-Depreciable

PropertyDepreciable

Property Eligible Capital

Property

Non-Depreciable Property

• Generally, this property is not used up or worn out over time, and therefore, is not eligible for capital cost allowance, e.g.

• inventory• receivables• land• investments

Eligible Capital Property• This category includes intangible assets

such as:• goodwill• patents• unlimited franchises• incorporation costs

• Par. 20(1)(b) specifically permits a deduction for eligible capital property

• This category will be discussed later

Depreciable Property• S.13(21) defines depreciable property as

property acquired by the taxpayer where CCA has been or will be allowed

• Par. 20(1)(a) permits a deduction from net income to reflect the wear and tear on assets used in the income-earning process

• Upon disposition of depreciable property, a capital gain may arise, however, a capital loss can never occur, as we will see later

Treatment of Assets• In accounting, assets are generally

depreciated on an individual basis, except in a few cases

• In tax, assets are broadly defined as belonging to a group or ‘class of assets’ – Similar assets are pooled into the same

class (For example: Vehicles)– The total balance in the class is

depreciated at the rate prescribed for that class

• There are over 50 classes of assets, each with its own rate of CCA

Total Balance X 30% = Max. CCA

Some Common Classes of AssetsClass Rate Description of Property1 4% Bridges, Dams, Buildings & its components (plumbing,

electrical, etc.) acquired after 19873 5% Buildings (and its components), acquired before 1988, docks,

windmills, telephone poles8 20% Furniture, fixtures, and machinery or equipment such as

photocopiers, telephone equipment purchased for >$1,00010 30% Vehicles (including Automobiles), trailers, TV converters &

decoders, mining & logging equipment10.1 30% Passenger vehicle with a cost in excess of the prescribed limits

12 100% Dental & Medical instruments, kitchen utensils costing <$500, uniforms & costumes, linens, motion picture films/videotape

13 S.L. Leasehold improvements to leased property

14 S.L. Franchises, concession or license for a limited period

45 45% Computer hardware & systems software acquired after March 22/04

The CCA System is Progressive• CCA Class 42 was introduced to

allow for the depreciation of fibre optic cables

• CCA Class 43.1, on renewable energy & energy efficient equipment, was modified to included assets used in new types of energy efficient projects

The CCA System as Fiscal Policy

• CCA classes and rates provide the government with a means of implementing fiscal policy:– Computer hardware & software systems were moved

from Class 10 (30%) to Class 45 (45%) in March/04, and to class 50 (55%) in 2007 and in 2009 to class 52 (100% )

– In 2007, buildings used 90% or more for manufacturing or processing will qualify for an additional 6% CCA for a total rate of 10% and buildings used 90% or more for non-residential purposes receive an additional 2% (total = 6%)

The Addition of A New Asset to a Class

• Only capital assets, not inventory, are to be added to a class:

• This may be different for different taxpayers• For example, consider:

– a car for a dealership (inventory) versus a delivery service (capital asset)

– A building for a retailer (capital asset) versus a residential leasing company (inventory)

Cost is calculated in the same manner as for accounting:– Cost includes freight, installation costs, tariff

duties, sales taxes (except refundable GST), legal/accounting fees, engineering, etc.

– Any government assistance, including grants, subsidies, forgivable loans, ITCs and refundable GST/HST are deducted from the cost of the asset

– interest on borrowed funds can be deducted as incurred and any resulting loss, i.e. non-capital loss created, can be carried forward, or the taxpayer may choose to capitalize interest costs [ssec.21(1)] if their earnings are/have been insufficient to take advantage of the interest deduction

Non-Arms’ Length Acquisitions• The tax authorities are concerned that parties

not dealing at arms’ length may collude to reduce their tax liability

• The concern is that transfers of depreciable property between persons not dealing at arms’ length may not be made at fair market value – a price which could also impact the CCA deduction

• S. 69 (General Anti Avoidance Rule – GAAR) is used by the tax authorities to impose values on these transactions

Available-for-Use Rules• Available-for-Use Rules: A taxpayer

may not begin claiming capital cost allowance until the property has become “Available for Use”

• A property is available for use when delivered and capable of performing the function for which it was acquired

This means:• When the asset is first used for the purpose of earning

income• For buildings, when 90% or more of the building is

being used for the purpose it was acquired• At the beginning of the second taxation year following

acquisition of the property (This deferral is also referred to as the “rolling start” rule.)

• For public companies, the year in which amortization is first recorded on the property for F/S purposes

• In the case of motor vehicles and other transportation equipment that require certificates or licences, when such certificates or licences are obtained

The Basic CCA System

The Basic CCA Formula

Undepreciated Capital cost at the Beginning of the year $XXAdd: Purchases during the year $ XDeduct Dispositions during the year: Lesser of:

(a) capital cost $ XX(b) proceeds of disposition $XXX (XX) X

Undepreciated Capital Cost Base before Adjustment $XXDeduct 1/2 of net additions ( X)Undepreciated Capital Cost Before CCA $XXDeduct CCA for the year ( X)Add back 1/2 net Amount XUndepreciated Capital Cost at end of year $ X

Half Year Rule

• Is the asset NEW to the taxpayer?• At one point in time, the taxpayer was permitted to

take full CCA even when assets were acquired as late in the year as the last working day – this privilege was abused

• As a result, now in the first year of acquisition, only half of the CCA is permitted as a deduction

• Specifically, one-half of the excess of additions over dispositions is eligible for CCA

Short Fiscal Year

• Is the business operating a full 365 days in the current tax year?

• Short fiscal years occur when the first or last year of a business’s life are less than 365 days in duration

• CCA must be prorated based on the actual days out of 365 that the business is in operation [Regulation 1100(3)]

An Example• A business commences its first year of operations

April 30th by purchasing a $6,000 class 8 (20%) :1. Use the first year rule on the new $6,000 asset:

(only ½ of the regular CCA rate applies)AND

2. Prorate that deduction by the number of days during the year that the company was in operation

[$6,000](20%)[1/2 year rule](274/365) = $450 CCA

Is the asset new?

Yes= ½ Yr. rule

How many days during the year has the business

been in operation?365/365 or less?

Separate Classes

• Generally, similar assets are pooled or aggregated into the same class, but certain assets must be allocated to their own class

• An asset allocated to its own separate class effectively compels the taxpayer to recognize the full tax consequences upon disposition of the asset

Treatment of Assets and ClassesPooled Separated

Office Furniture Rental Property costing more than $50,000

Manufacturing Equipment Luxury Cars

China, Cutlery and Tableware at a Restaurant

Computers, Software, Photocopiers

Rental Property• Each rental property acquired after 1971 at a cost

of $50,000 or more must be placed into its own separate class

• For example, if an investor purchases 5 rental properties, each at a cost greater than $50,000, there will be 5 separate Class 1 CCA pools, each being depreciated at 4%

• Upon disposition of one of these rental properties, the class will have no further assets and full tax consequences must be realized

Luxury Cars

• Passenger vehicles with a cost in excess of the prescribed amount, must be placed into separate Class 10.1 pools

• While CCA is deductible, it is limited to the prescribed limit of $30,000 (+ HST)

• In the year of disposition, the taxpayer may deduct half of the regular CCA, i.e. 15% instead of 30%

• Terminal losses upon disposal are disallowed

Electronic Office Equipment• This type of equipment becomes obsolete

quickly, therefore the actual useful life of the asset may be shorter than the time provided to realize the full CCA deduction

• As a result, the taxpayer is permitted to choose whether to pool the assets into a single class or to place an asset into its own class

The specified electronic properties are:• Class 10 (30%): computer equipment and software• Class 8 (20%): photocopiers, electronic

communications equipment costing in excess of $1,000 such as facsimile transmission device or telephone equipment

• Class 43 (30%): manufacturing equipment with a cost in excess of $1,000

• After 4 years, any undepreciated amounts in Class 10 or 8 must be transferred back to the main class [Reg.1103(2g)] and after 5 years for class 43 [Reg. 1103(29)]

Separate BusinessesIf a taxpayer owns more than one business, each business must maintain its own portfolio of CCA classes

Factory

Apartment Building

Shopping Mall