What is Capital Cost Allowance?
Capital expenditures are distinct from current expenses. While both may be incurred for the purpose of earning income, only the latter is immediately deductible under the Income Tax Act. The former is only deductible pursuant to an exception under paragraph 20(1)(a), which allows for regulations to determine the amount of a capital expenditure that is deductible in a given tax year. This amount is called the “capital cost allowance” (CCA).
What is Depreciable Property?
The property for which capital cost allowance may be claimed is called “depreciable property”. The idea behind this is that the property may be used year after year, while slightly declining in value.
There are prescribed classes of depreciable property listed in Schedule II to the Income Tax Act, the most common of which are listed here. Examples include motor vehicles, tools, or goodwill.
What is Undepreciated Capital Cost?
Regulation 1100(1) sets out the percentage amount of CCA that applies to the “undepreciated capital cost” (UCC) of a class of depreciable property. UCC can be thought of as the cost that a taxpayer estimates to incur in acquiring and keeping depreciable property, which includes not only the purchase price, but also maintenance, legal, accounting, and/or other similar fees. The legal definition of UCC is found under subsection 13(21).
The CCA system allows for taxpayers to recover UCC by deducting it from their income. For example, a professional carpenter who purchases a new power saw for his business can expect for the saw to have the highest possible UCC at the moment of purchase, but he can expect for its UCC to be increasingly used up as it approaches the end of its life. This is because he has been using the depreciation yearly, which continues to lower the UCC of the saw eventually getting down to zero.
Capital Cost Allowance Calculation
The CCA that may be deducted for a class of depreciable property is calculated as follows under Regulation 1100(1):
CCA = CCA % amount x UCC at the end of the tax year
Capital Cost Allowance – Limitations
CCA deductibility may be limited. For instance, since Regulation 1100(1) mandates a determination of the UCC of a class of property at the end of the tax year, no CCA amount, subject to certain exceptions, may be deducted in a tax year if the class of depreciable property has no UCC left over at the end of that tax year and even if UCC was outstanding prior to the end of that tax year. Similarly, for depreciable property acquired during a tax year, only half of the CCA amount is deductible. This is known as the “half year rule”.
The Sale of Capital Assets
If a depreciable property is sold for more than its UCC, the value of the property according to the price for which it is sold will be greater than the value of the property according to its UCC. Under these circumstances, subsection 13(1) provides for a “recapture” by adding the difference in value to the seller’s income. This means that the provision effectively looks back to prior tax years in which too great a CCA amount was deducted, and then reduces the deduction. This ensures that the seller does not deduct from income any CCA that exceeds the actual decline in value of the property.
If a depreciable property is sold for less than its UCC, the value of the property according to the price for which it is sold will be less than the value of the property according to its UCC. Under these circumstances, subsection 20(16) provides for a “terminal loss” by allowing the seller to deduct from income the difference in value.
The possibility of claiming a “terminal loss” does not mean that taxpayers are free to create losses that shelter income but that do not reflect the economic reality of their circumstances. Rental property investments, for example, may present an attractive means of using the CCA system to shelter income, but the Act’s “stop-loss rules” restrict such use. For our blog post further discussing the relationship between rental properties and the CCA system, click here.
If you have questions regarding the capital cost allowance system, or if you are interested in learning how to use it to your advantage, call us today!
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.