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| Taxation Year Less Than 12 Months |
|
Capital Cost Allowance |
| Capital assets, though durable, have a
limited lifetime and at some point will be
replaced. Generally, the capital cost of a
property is what the buyer pays for that
property. Capital cost includes items such
as delivery charges, GST, and PST. The
Income Tax Act permits a deduction of part
of the capital cost of the asset against the
income from the business. Capital cost
allowance (CCA) is the maximum rate set
under the Income Tax Act that the taxpayer
can claim for depreciation. CCA is not a
cash flow issue but rather a matter of
taxation and tax deductible expenses. CCA
acknowledges the existence of depreciation
that is the result of wear and tear over the
life of an asset and the ability to offset
income in relation to the cost of that
asset. |
| |
|
CCA as a Permissive
Deduction |
| The rate of CCA applied to each class is
specified as a maximum rate. A taxpayer may
therefore claim any CCA amount up to the
maximum by multiplying the CCA rate by the
balance in the class at the end of the
taxation year. Only the amount of CCA
actually claimed is deducted from the
balance of the class and the remaining
balance is carried forward and available for
future CCA claims. |
| |
| CCA
Classes |
| The Income Tax Act and Regulations
detail various classes for purposes of CCA
calculation. |
| |
|
Class |
Type of Asset |
1/2 YR-RULE |
RATE & METHOD |
|
1 |
Buildings after 1987 and
axcess
renovations to class 3
buildings |
YES |
4% DB |
|
3 |
Buildings before 1988 and
renovations after 1988 |
YES |
5% DB |
|
6 |
Farm
buildings, fences and oil
and water storage tanks |
YES |
10% DB |
|
8 |
Misc
Capital Property not
included in other classes:
eg: office equipment and
furniture |
YES |
20% DB |
|
10 |
Automobiles or trucks used
for business purposes,
computers and system
software |
YES |
30% DB |
|
12 |
Computer application
software, tools, utensils,
uniforms |
Some
Exceptions |
100% DB |
|
13 |
Leasehold Interest and
Improvements paid by Tenant |
Special
Rules |
SL |
|
14 |
Patent, franchise of limited
life, license |
NO |
Variable |
|
17 |
Roads, sidewalks, parking
areas or storage areas |
YES |
8% DB |
|
|
| |
|
CCA Restrictions - Rental Property |
| Before 1972, no restrictions existed
regarding rental properties. A paper loss
could be incurred if CCA deductions exceeded
net operating income, resulting in tax
savings from other income received by the
taxpayer. Regulation 1100, subsections (11)
to (14.2), now restricts CCA on rental
properties owned by individuals,
partnerships, and certain types of
corporations. Life insurance companies and
principal business corporations (or a
partnership thereof), are excluded. A
principal business corporation is defined as
an entity whose principal business involves
the leasing, rental, development, or sale of
owned real property. Multiple-unit
residential properties (MURBS ) were, at one
time, another important exception. Tax
reforms during 1988 removed most advantages
relating to this investment vehicle. As a
result of Regulation 1100, the maximum
allowable capital cost allowance is now
limited to the total amount of taxable
income before CCA. This requirement
effectively eliminates the possibility of
paper losses from CCA deductions. |
| |
|
CCA Permissive
Deduction |
| The rate of CCA applied to each class is
specified as a maximum rate. A taxpayer may
therefore claim any CCA amount up to the
maximum by multiplying the CCA rate by the
balance in the class at the end of the
taxation year. Only the amount of CCA
actually claimed is deducted from the
balance of the class and the remaining
balance is carried forward and available for
future CCA claims. |
| |
|
Declining Balance Method |
| The most frequently used method to
calculate depreciation. Declining balance
involves the reduction of the capital cost
by a percentage as set out for a particular
class of property with subsequent reductions
always applied to the declining balance
(undepreciated capital cost), within that
class. |
| |
|
Half-Year
Rule |
| The half-year rule (often referred to as
the 50% Rule), was implemented to correct
the fact that assets purchased at the end of
a taxation year would otherwise provide an
amount in a class eligible for the maximum
capital cost allowance in that year. This
rule provides that 50% of purchases during
the year, minus the lesser of capital cost
and proceeds of disposition of assets in the
class during the year, is deducted before
the CCA for the year is calculated. By
effectively reducing the CCA on purchases
(in excess of dispositions), made during the
year, the tax advantage of a late purchase
is reduced. |
| |
| The Regulations limit the amount of
capital cost available for newly acquired
assets to one-half of the normal amount of
CCA for the year of acquisition (1981
revision). For newly acquired properties,
the Regulations were further amended for all
taxation years following 1989. The half-year
rule now applies only to properties that are
available for use, otherwise, capital cost
allowance is deferred to the following
taxation year. Previously, CCA could be
taken for properties under construction and
not technically being used for income
purposes. Now, the property must be used for
generating income and the Regulations set
out requirements in that regard. |
| |
| CCA may be deducted in the year that the
property was first used for generating
income or 358 days following the taxation
year in which the property was acquired.
Regarding the issue of available for use
–special rules, elections by taxpayers, and
relieving rules relating to the term
available for use go beyond the scope of
this publication. Expert advice is required. |
| |
|
Land and Building Allocation |
| As the cost of improvements to property
will normally be categorized under the
capital cost allowance provisions,
allocating the purchase price between land
and improvements is necessary. As a rule,
such allocations must be fair, reasonable,
and defensible. Expert advice is required.
Seller and buyer perspectives on how this
allocation occurs are usually different,
owing to tax implications arising from the
determination. |
| |
| The allocation of purchase price between
land and building is a key negotiating point
in many commercial transactions. The buyer
seeks to maximize building allocation (plus
chattels associated with the sale), to
establish a high capital cost for future CCA
calculations—the seller wants to minimize
the allocation to avoid recapture.
Generally, a reasonable, mutually accepted
allocation, if defensible, would undoubtedly
be sufficient in the agreement/contract .
Occasionally, commercial practitioners use
municipal tax assessment ratios as a
benchmark for the allocation. Alternatively,
an appraiser may be retained to value the
property and provide a supportable
allocation between land and improvements. |
| |
| If property is sold and improvements
have no economic value, the seller may be
able to allocate the full sale price to the
land. The term no economic value generally
means that the cost of demolition exceeds
the building(s) value. From a taxation
perspective, the position taken must be
defensible. As a caution, the fact that the
buyer sees no value in such buildings, owing
to a different planned use for the property,
does not in itself create no economic value. |
| |
|
Recaptured Capital Cost Allowance |
| At the time of property disposition, the
Income Tax Act requires the recapture of
capital cost allowances if the value of the
improvements has been maintained or
increased since originally acquired. The
recapture cannot exceed the capital cost
deductions allowed. As a rule, if the
undepreciated capital cost (UCC) has a
positive balance and no assets remain,
terminal loss can be claimed. If a negative
UCC balance occurs due to asset disposition,
recapture (referred to as income inclusion)
occurs, even if assets remain in that
particular class. Recapture must be declared
as income. Deferral of recapture is possible
in some instances, e.g., a replacement
property is acquired within a specified time
limit. In this instance, an amount equal to
the recapture is applied against the UCC for
new property. |
| |
| Recapture can occur either when
analyzing taxable income from operations
cash flows or sale proceeds at the point of
disposition. An example is provided relating
to the sale of property. As recaptured CCA
will affect sale proceeds and consequently
cash flows after tax, practitioners must be
aware of basic procedures used in
establishing whether a recapture is being
realized. Further, accurate forecasting of
sale proceeds after tax is necessary when
calculating an after tax internal rate of
return (IRR). |
| |
| Example Capital Cost Allowance
–
Recaptured Capital
Cost Allowance |
| Recaptured capital cost allowance for
purposes of a sale involving a typical
investment-grade property is calculated by
establishing the lesser of Improvement
Allocations at Purchase or Improvement
Allocations on Sale and deducting
Undepreciated Capital Cost Improvement
Allocations on Sale. |
| |
|
Acquisition Price |
$1,000,000 |
|
Less: Total Soft Costs |
-0 |
|
Less: Original Land Allocation |
-300,000 |
|
Improvement Allocation at Purchase
|
$700,000 |
Improvement Allocation on Sale
(established at the point of sale) |
$930,000 |
| |
Improvement
Allocation
(lesser of the two allocations) |
$700,000 |
| |
Plus: Capital
Improvements |
+0 |
| |
Less: CCA
Taken |
-77,836 |
|
Underappreciated Improvements at
Sale |
$622,164 |
|
Recaptured Capital Cost Allowance |
$77,836 |
|
| |
|
Straight Line Method |
| Under the straight line approach, the
useful life of the depreciable assets must
be estimated according to the Regulations.
The annual capital cost allowance taken
represents a pro-rated amount based on the
estimate. |
| |
| The calculation of CCA for Class 13
(leasehold improvements paid by the tenant),
uses a straight line as opposed to declining
balance method. An example is provided
regarding entries over a two-year period for
an item with a useful life of ten years. |
| |
| Example
of
Capital Cost Allowance
–
Straight Line Method |
| Assume that the capital cost allowance
for an item is ten years, with a pro-rated
straight line calculation of depreciation.
Following are the entries for the first
two-year period: |
| |
| Capital Cost |
$10,000 |
| |
First Year
Depreciation (1/10th of 10,000) |
- 1,000 |
| |
Remaining
Capital Cost (UCC) |
9,000 |
| |
Second Year
Depreciation (1/10th of 10,000) |
- 1,000 |
| |
Remaining Capital Cost (UCC) |
8,000 |
|
| |
|
Taxation Year Less Than 12 Months |
| In the first or last years of the
operation of a business, or in a year in
which there has been a change in the fiscal
year, it is possible to have a taxation year
of less than 12 full months. In such cases,
CCA must be prorated by the proportion that
the number of days in the taxation year is
to 365 (or 366 in a leap year). |
| |
|
Undepreciated Capital Cost (UCC) |
| Undepreciated capital cost is the
capital cost associated with a specific
improvement under a particular class, less
any capital cost allowance already taken and
less previous disposals in the same class. |
| |
| Example Capital Cost Allowance
–
Undepreciated
Capital Cost (UCC) |
| Assume that the capital cost allowance
for an item is ten years, with a prorated
straight line calculation of depreciation.
Following are the entries for the first
two-year period: |
| |
Capital Cost |
$20,000 |
| |
First Year
Depreciation (1/10th of $20,000) |
-2,000 |
| |
Remaining
Capital Cost (UCC) |
18,000 |
| |
Second Year
Depreciation (1/10th of $20,000) |
-2,000 |
| |
Remaining Capital Cost (UCC) |
$16,000 |
|
