Capital Cost Allowance (CCA) is the means by which Canadian businesses may claim depreciation expense for calculating taxable income under the Income Tax Act (Canada).
Similar allowances are in effect for calculating taxable income for provincial purposes.
Capital property eligible for CCA excludes:[1] CCA is calculated on undepreciated capital cost ("UCC"), which is generally defined as:[2] Where the UCC for a class is negative, a recapture of depreciation is deemed to take place, thus adding to taxable income and bringing the balance of UCC back to zero.
Where UCC for a class is positive, but all assets with respect to that class have been disposed of, a terminal loss is deemed to take place, thus deducting from taxable income and bringing the balance of UCC back to zero.
[3] CCA itself is generally calculated using the following items: For assets subject to the full-year rule:
[5] Under the Income Tax Act:[6] Part XI of the Income Tax Regulations provides for the calculation rules for CCA,[8] and Schedule II outlines the various classes of capital property that are eligible for it.
[9] Special rules are in place to deem certain assets to be in separate classes, thus not becoming part of the general pool for the class.
[10] Certain elections are available to taxpayers to transfer or reclassify assets from one class to another.
[11] Additional allowances are prescribed with respect to specified circumstances.
[12] Specialized calculations for certain classes are also outlined in: Part XVII of the Income Tax Regulations provides for specialized calculation rules for CCA with respect to capital property acquired for use in earning income from farming and fishing.
[21] CCA is calculated under the half-year rule, except where otherwise specified, with respect to the following classes.
(Minimum 5 years and Maximum 40 years) In contrast to the practice followed in the United States for depreciation there is no penalty for failing to claim Capital Cost Allowance.
Where a taxpayer claims less than the amount of CCA to which he is entitled the pool remains intact, and available for claims in future years.
Because assets subject to CCA are generally pooled by class, and CCA is generally calculated on a declining-balance basis, specific techniques have been developed to determine the net present after-tax value of such capital investments.
For standard scenarios under the full-year rule and half-year rule models, the following standard items are employed:[25] More specialized analysis would need to be applied to: Capital cost allowance will be calculated as follows:[26] Therefore, the Tax shield in year n =
As this is an example of a converging series for a geometric progression, this can be simplified further to become:
The net present after-tax value of a capital investment then becomes:
[27] For capital investments where CCA is calculated under the half-year rule, the CCA tax shield calculation is modified as follows:
Therefore, the net present after-tax value of a capital investment is determined to be:
In cases where claims have been contested or disallowed by the Canada Revenue Agency, the Supreme Court of Canada has interpreted the Capital Cost Allowance in a fairly broad manner, allowing deductions on property which was owned for a very brief period of time,[28] and property which is leased back to the vendor from which it originated.
[29] These decisions demonstrate the flexibility of the Capital Cost Allowance as a legal tax reduction strategy.
A notable example of how the Capital Cost Allowance can impact business activity was seen in the Canadian film industry in the 1970s, when the government of Pierre Trudeau introduced new regulations to facilitate the production of Canadian films by increasing the Capital Cost Allowance for film production to 100 per cent in 1974.
[30] While some important and noteworthy films were made under the program, and some film directors who released their first films in this era emerged as among Canada's most important and influential filmmakers of the era, the new regulations also had an entirely unforeseen side effect: a sudden rush of low-budget horror and genre films, intended as pure tax shelters since they were designed not to turn a conventional profit.
[30] Many of the films, in fact, were made by American filmmakers, whose projects had been rejected by the Hollywood studio system as not commercially viable.
[30] The period officially ended in 1982, when the Capital Cost Allowance for film production was reduced to 50 per cent, although films that had entered production under the program continued to be released for another few years afterward.