For certain assets the tax laws in Canada do not allow you to fully deduct the purchase cost in the year of acquisition. The Income Tax Act refers to these expenditures as capital outlays and classifies them as capital assets. Capital assets would include computers, automobiles, furniture, buildings etc. Expenses incurred for capital assets differ in nature from operating expenses such as advertising, supplies and rent because capital assets are generally held and used over longer periods. An automobile, for instance, would likely be used in your business over several years.
For this reason the tax laws in Canada allow you to claim a deduction for a prescribed portion of the cost of the asset each year it is used in your business. This deduction is called depreciation, or for income tax purposes, capital cost allowance (CCA). Each asset is added to a class and CCA is calculated on a declining basis based on the percentage assigned to that class and the undepreciated cost of the asset in that year. For instance an automobile purchased for $20,000 would be included in Class 10 at a rate of 30%. In year 1 and 2, $6,000 and $4,200 would be deducted, respectively [Year 1 20,000 X 30% = $6,000, Y2 (20,000 - $6,000) X 30% = $4,200]. The remaining undepreciated cost of $9,800 (20,000 – 6,000 – 4,200) would be deducted until it is reduced to zero or the asset is disposed of.
Tax Tip: In the first year the asset is acquired, only ? of the CCA can be claimed. If you plan on purchasing assets early in the next business year, you should consider expediting the purchase before the year end in order to claim ? of the CCA in the current year and the full CCA deduction in the next year.
Tax Tip: CCA is a permissive deduction meaning you can claim any amount up to the maximum prescribed limit for the year. If you have non-capital losses it may be advantageous to not claim CCA until all non-capital losses have been claimed. The reason is because non-capital losses expire after a defined carry-forward period whereas CCA has no such limitation and can be carried forward indefinitely.
Tax Tip: In general, on disposition of the asset, a deductible loss (terminal loss) would occur if the undepreciated cost exceeds the disposition value. If the disposition value exceeds the undepreciated cost a taxable gain (recapture) would be recognized. In certain circumstances where you expect the asset to appreciate in value and may consider selling that asset in the near-term it may beneficial to not claim CCA in order to avoid the gain on recapture which would be 100% taxable. In this situation the appreciation in value over original purchase price at the time of sale would be a capital gain and would only be taxed at 50%
As Chartered Accountants in Toronto and Mississauga we can help you with your taxes in Canada when purchasing assets for your business. Contact a Chartered Accountant for more income tax tips by email at info@srjca.com or call us at 647-725-2537 for consultation.
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