Each year you incur many expenditures while running your business. Certain expenditures may be claimed as expenses in the current year, but others are required to be capitalized as assets depending on their nature. Capitalized assets may be expensed on your income tax return over time by recording annual depreciation known as Capital Cost Allowance (CCA).
Capital expenditures are not defined in the Income Tax Act. There are no clearly stated rules, such as a dollar threshold, to classify your expenditures as current or capital. Each purchase needs to be assessed on its own. The primary consideration is whether the item provides an enduring benefit to your business; will it be used for more than one year? We typically expect an item such as a printer to last longer than one year and therefore would capitalize it, but the paper and ink will be deducted as current expenses.
Assets typically require a certain degree of upkeep to keep them operational and maximize their useful lives. This brings us to another key consideration; are you performing routine maintenance or making a capital improvement? Expenditures incurred to restore an item to its original condition, such as replacing a light bulb, are routine maintenance and can be expensed in the current year. Expenditures incurred to improve an asset, such as installing a new energy efficient lighting system, will be capital in nature. Improvements are significantly different than the original asset and typically provide some form of increased productivity or efficiency. The purchase price and whether it increases the market value of the asset is not a determining factor on its own. You can spend a significant amount to complete repairs all at once that would have been considered maintenance expenses if completed over time.
Once it is decided that an expenditure must be capitalized, we must determine how it will be recorded on your tax return. Capital assets that qualify as depreciable property are recorded to CCA classes. Depreciable property is acquired to gain or produce income over time, such as a building to operate your business out of, office furniture or a computer. Land is specifically excluded from depreciable property as it is not expected to decline in value. The other main exclusion from depreciable property is inventory; an item can not be depreciated if you purchase it with the intention to sell it as part of your business rather than use it in your business.
All purchases of depreciable property that are similar in nature are typically grouped together in a certain class. For example, one of the most common CCA classes is Class 8. This class includes items such as furniture, appliances, tools, and equipment that are not specifically included in another class. Other common CCA classes are used in respect of buildings, vehicles, computer equipment, computer software, machinery and equipment, and intangible assets such as patents or goodwill. Some assets such as certain buildings or vehicles may be recorded in their own CCA class.
At any point in time, the balance of assets in each class is referred to as the Undepreciated Cost of Capital (UCC). Each year, the UCC of each class may be depreciated on a declining-balance basis at the prescribed rate for that class. For Class 8, the prescribed rate is 20%. A half-year rule applies in the year of purchase to account for the fact that you did not own the asset for the full year. Therefore, you would only receive a 10% deduction of your Class 8 additions in the year of purchase, but 20% on the opening UCC of the class. There may be accelerated deductions available in the year of purchase depending on the date the property becomes available and the class it is recorded in. The prescribed rate is intended to approximate the useful life of the asset. The typical rate for a building is 4% due to the expected lengthy period of use, while certain software is eligible for a rate of 100%. Leasehold improvements, such as shelving installed in leased warehouse, are depreciated on a straight-line basis over the term of the lease as this is a more reasonable approximation of the useful life than the typical declining-balance basis.
Assets must be available for use to claim CCA. This is particularly important for assets that are constructed or developed over time. Whether it is a building, a piece of machinery or software, all costs of construction or development should be recorded as a non-depreciable asset until the point in time that it can be used to gain or produce income. This may include soft costs such as interest on loans taken out to fund the construction or development. The total cost will be reflected as an addition to the applicable CCA class in the year the asset becomes available for use.
When assets are sold, the lesser of the original cost or proceeds of sale is recorded as a reduction to the UCC. This reduces the balance available to depreciate in the future without requiring you to specifically track and remove the UCC of each individual asset in the class. Due to the declining-balance basis of depreciation, it is common for frequently used classes such as Class 8 to continue indefinitely and never depreciate to zero. However, occasionally you may run into one of two scenarios after recording a disposal of an asset: the UCC of the class has a positive balance but there are no more assets remaining in the class, or the class has a negative balance. In the first scenario, you can reduce the class to zero by claiming a current expense known as a terminal loss. In the second scenario, you must increase the class to zero by taking the amount into taxable income. This income inclusion is known as recapture. Recapture is intended to account for the fact that your prior CCA deductions exceeded the net expenditures in respect of this asset.
The rules with respect to CCA are complex and constantly changing. There are many additional rules that we have not discussed in detail today such as the construction or demolition of assets, elections to report certain assets in separate classes and non-arm’s length transactions. Furthermore, CCA rates are often revised to reflect technological changes that impact useful lives or to incentivize certain behaviors, such as providing higher prescribed rates for energy-efficient assets or electric vehicles.
For more information, please contact firstname.lastname@example.org or 1 844-GYTD-CPA