The Capital Cost Allowance System
Israel Mida and Kathleen Stewart*
P RÉCIS
Cet article comporte un historique et une analyse du régime canadien de
déduction pour amortissement, qui sert de base pour l’établissement de
l’amortissement d’immobilisations à l’égard de l’impôt. Les auteurs
résument les éléments clés du régime actuel, y compris les genres de
biens admissibles à la déduction pour amortissement, la méthode de
calcul des demandes de déduction pour amortissement et les principales
dispositions qui ont été adoptées au fil des ans afin de restreindre les
demandes de déduction pour amortissement. Les auteurs évalue ensuite
l’équité, la simplicité, l’à-propos et la compétitivité du régime, et ils
examinent les facteurs qui influenceront les modifications qui y seront
apportées.
ABSTRACT
This article presents a review and analysis of the Canadian capital cost
allowance system, which establishes the basis for the depreciation of
capital property for tax purposes. The authors summarize the key
elements of the current system, including the types of property that are
eligible for capital cost allowance, the method of calculating capital cost
allowance claims, and the major provisions that have been introduced
over the years to restrict capital cost allowance claims. The authors then
assess the fairness, simplicity, adequacy, and competitiveness of the
system and consider the factors that will influence future changes to it.
INTRODUCTION
This article presents a review and analysis of the Canadian capital cost
allowance ( CCA) system. For many taxpayers, capital expenditures represent the most significant cost of doing business. Paragraph 18(1)(b) of the
Income Tax Act 1 prohibits the deduction of capital expenditures; however, paragraph 20(1)(a) allows a taxpayer to deduct an amount with
respect to the capital cost of property to the extent allowed by the Income
Tax Regulations. The regulations contain a multitude of detailed rules
that make up the CCA system.
* Of Coopers & Lybrand, Toronto.
1 RSC 1985, c. 1 (5th Supp.), as amended (herein referred to as “the Act”). Unless
otherwise stated, statutory references in this article are to the Act.
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The first section of the article summarizes the depreciation system
under the Income War Tax Act of 1917 (IWTA) and then the basic CCA
system. As the current CCA system has evolved over a period of nearly 50
years, the article deals with only the highlights of the amendments made
during that time. Table 1 provides a chronological summary of the key
amendments, excluding rate changes. The second section of this article
provides an assessment of the CCA system. The final section considers
the future of the system.
BACKGROUND: THE SYSTEM BEFORE 19492
The CCA system was designed, in large part, to address the many concerns that taxpayers had with its predecessor, the depreciation system
introduced as part of the IWTA. The IWTA gave the minister of national
revenue absolute discretion in determining how much depreciation, if
any, would be allowed to a particular taxpayer for tax purposes.3 Over
time, an informal set of rules developed as the maximum rates that were
generally allowed by the minister for various types of assets became
known within the business community. However, since rates for particular taxpayers could still be negotiated, there was no assurance that the
minister would always be consistent and treat taxpayers equally.
Once depreciation rates were set for a taxpayer, they had to be strictly
adhered to unless otherwise allowed by the minister. Even in a loss year,
the minister required that a taxpayer claim a minimum of 50 percent of its
usual tax depreciation allowance. If a taxpayer claimed a low rate of
depreciation in a given year owing to poor profitability, there was no
opportunity to amend the claim subsequently if profitability was higher in
a later year.
The system was designed to recognize the wear and tear of property used
to earn income. Depreciation was generally calculated on a straightline
basis over what the minister estimated to be the useful life of the property. The effect of obsolescence on the loss in value of the property was
not recognized in the setting of the rates. If property was sold or scrapped
before it was fully depreciated, no further depreciation was allowed, and
any resulting loss was considered capital in nature and thus not recognized
for tax purposes. (Capital gains and losses were “nothings” until 1972.)
In 1940, the legislation was amended to provide that tax depreciation
could not be claimed in excess of the depreciation that was booked for
accounting purposes. The result was that taxpayers established accounting policies for depreciation that would allow for the maximum tax
2 For further discussion of the predecessor system, see Canada, Department of Finance,
1976 Budget, Budget Paper C, “Capital Cost Allowances,” May 25, 1976; Robert W.
Davis, Capital Cost Allowance, Studies of the Royal Commission on Taxation no. 21
(Ottawa: Queen’s Printer, 1966); and Lancelot J. Smith, “Twelve Years of Capital Cost
Allowances,” in Corporate Management Conference 1961, Canadian Tax Paper no. 24
(Toronto: Canadian Tax Foundation, 1961), 15-32.
3 The Income War Tax Act, RSC 1927, c. 97, section 5(a).
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THE CAPITAL COST ALLOWANCE SYSTEM
Table 1
1247
Canadian Tax Depreciation Systems: Summary of Milestones
Year
Milestone
1917 . . . . . .
1940 . . . . . .
Introduction of depreciation system in Income War Tax Act
Introduction of requirement that tax depreciation not exceed accounting
depreciation
Introduction of accelerated depreciation and a limited form of recapture of
accelerated depreciation
Introduction of capital cost allowance system
Repeal of requirement that tax depreciation not exceed accounting depreciation
Restrictions on CCA claims for rental properties
Restrictions on CCA claims for leasing properties
Introduction of half-year rule
Available-for-use rules
Restrictions of CCA for passenger vehicles
Specified leasing property rules
Revision of rules governing non-arm’s-length transfers of assets
1949
1954
1972
1976
1981
1987
......
......
......
......
......
......
1989 . . . . . .
1995 . . . . . .
writeoff, whether or not the method was appropriate for accounting purposes. When the government abandoned this limitation in 1954, a number
of taxpayers restated their accounting depreciation for financial statement
purposes for prior years.4
Beginning in 1940, accelerated depreciation was permitted in order to
encourage the expansion of wartime production facilities. A limited form
of recapture also was introduced in that year. In 1944, a further legislative amendment provided for double depreciation on up to 80 percent of
the cost of new investment. This change was designed to facilitate the
transition to peace and to stimulate the economy. These measures appear
to be the first attempts by the federal government to use depreciation as a
fiscal tool.
Although the system from 1917 to 1948 permitted an allowance that
closely approximated that provided by business in financial statements,
concerns of business about the proper exercise of ministerial discretion
and the lack of recognition of obsolescence made changes necessary.5
These concerns ultimately led to the introduction of the CCA system.
CAPITAL COST ALLOWANCE SYSTEM
Overview
The CCA system became effective January 1, 1949. It was designed to be
simpler and more equitable than its predecessor. Although many modifications have been made over the years, the basic structure of the original
CCA system remains intact today. The system gives taxpayers the statutory right to make a discretionary claim in respect of an eligible capital
acquisition equal to any amount up to the maximum allowed under the
4 Davis,
5 Ibid.,
supra footnote 2, at 61.
at 1.
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regulations. CCA is generally calculated on a declining balance basis at
the prescribed rate on the undepreciated capital cost (UCC) of depreciable
property grouped in prescribed classes. The myriad of factors to be considered in determining a CCA claim are discussed below under three major
headings:
1) eligibility for inclusion in CCA classes,
2) calculation of CCA, and
3) restrictions on CCA claims.
Eligibility for Inclusion in CCA Classes
As noted above, the CCA system applies to capital expenditures. Jurisprudence has established a number of criteria that may be considered in
determining whether an expenditure is capital in nature. For example,
capital expenditures generally produce an enduring benefit, while expenditures of a current nature produce an immediate benefit but have
little or no long-term effect.6
Property must be included in the regulations in order to be eligible for
CCA. 7 The regulations apply to tangible depreciable assets such as buildings, equipment, and furniture and fixtures, and to intangibles such as
patents, franchises, and leasehold improvements.8 No depreciation is allowed for land.9 Goodwill and other intangibles are entitled to a tax writeoff
as eligible capital expenditures.10 This tax writeoff is not discussed here
but has been covered thoroughly elsewhere. 11
Regulation 1102 specifically excludes from the CCA classes certain
property including the cost of property that is deductible in computing
income, inventory, property that was not acquired for the purpose of
gaining or producing income, property acquired that qualifies for a deduction under section 37 of the Act, land, and property owned by a
non-resident person that is situated outside Canada. In addition, class 8
provides a number of other exclusions.12
6 British Insulated and Helsby Cables v. Atherton, [1926] AC 205 (HL). Other criteria
that may be considered in determining whether an expenditure is of a current or capital
nature are summarized in Interpretation Bulletin IT-128R, “Capital Cost Allowance—
Depreciable Property,” May 21, 1985.
7 Paragraph 20(1)(a).
8 Assets included in CCA classes are summarized in regulation schedules II to VI.
9 Regulation 1102(2).
10 Defined in subsection 14(5).
11 See, for example, Ronald W. Larter, “Capital Cost Allowance and Eligible Capital Property: Tax Reform Implications,” in Report of Proceedings of the Fortieth Tax Conference,
1988 Conference Report (Toronto: Canadian Tax Foundation, 1989), 27:1-27; and Joseph A.
Stainsby, “Recent Developments in Capital Cost Allowance and Eligible Capital Expenditures,” in Current Developments in Measuring Business Income for Tax Purposes, 1981
Corporate Management Tax Conference (Toronto: Canadian Tax Foundation, 1982), 167-207.
12 Regulation schedule II, class 8.
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THE CAPITAL COST ALLOWANCE SYSTEM
1249
Ownership
An asset can generally be included in a CCA class only when the taxpayer
has acquired a capital property or a leasehold interest in capital property
for the purpose of gaining or producing income.13 The taxpayer will generally be considered to have acquired a depreciable property at the earlier
of the day on which the taxpayer obtains title to it and the date on which
the taxpayer has all the incidents of title, such as possession, use, and
risk. A number of court cases have considered the issue of ownership,
particularly in the context of lease arrangements.14
Available-for-Use Rules
The timing of the inclusion of an asset in the UCC of a class is also affected by the “available-for-use rules,” which were introduced as part of
the 1987 tax reform. These rules, contained in subsections 13(26) to (32),
prevent the taxpayer from claiming CCA until the time the property is
“available for use.” The time at which property is available for use is
defined in subsection 13(27) for property other than buildings and in subsection 13(28) for buildings. Each of these provisions includes a two-year
rolling start rule, providing that property that has not otherwise become
available for use is deemed to be available for use in the second taxation
year following the year in which the cost was incurred by the taxpayer.
The application of the available-for-use rules may be limited in the
third and subsequent years of a long-term project if the taxpayer elects
under subsection 13(29) to use the “long-term project rule.” The taxpayer
may make the election in the first taxation year that begins more than 357
days after the end of the taxation year in which the taxpayer first incurred
expenditures in respect of the project. When this election is made, only
expenditures in excess of certain threshold amounts in the third and subsequent years will be subject to the available-for-use rules.15
Calculation of CCA
For purposes of calculating CCA, assets are grouped in prescribed classes.
CCA is generally calculated by applying the prescribed CCA rate to the
UCC of each class at the end of a taxation year. 16 Table 2 lists the classes
13 See the definitions of “depreciable property” and “undepreciated capital cost” in
subsection 13(21).
14 See, for example, MNR v. Wardean Drilling Ltd., 69 DTC 5194 (Ex. Ct.); and The
Queen v. Henuset Bros. Ltd. [No. 1], 77 DTC 5169 (FCTD). Additional cases are summarized in Thomas S. Gillespie, “Lease Financing,” in Income Tax and Goods and Services
Tax Considerations in Corporate Financing, 1992 Corporate Management Tax Conference
(Toronto: Canadian Tax Foundation, 1993), 7:1-43.
15 An example of the long-term project rule is provided in the technical notes to Bill
C-18: Canada, Department of Finance, Explanatory Notes to Legislation Relating to Income Tax (Ottawa: the department, May 1991), 186-89. For further discussion of the
available-for-use rules, see Bruce R. Sinclair, “Depreciable Property: A Review of Recent
Legislative Developments,” in Report of Proceedings of the Forty-Third Tax Conference,
1991 Conference Report (Toronto: Canadian Tax Foundation, 1992), 26:1-20.
16 Regulation 1100(1)(a).
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Table 2
Canadian CCA Rates as of 1995
Asset category
Class for tax purposes
Building . . . . . . . . . . . . . . . . . . . . .
Manufacturing machinery
and equipment . . . . . . . . . . . . . . .
Passenger vehicles . . . . . . . . . . . . .
Automobiles and trucks . . . . . . . . .
R & D assets . . . . . . . . . . . . . . . . . .
Furniture and fixtures . . . . . . . . . . .
Computer hardware . . . . . . . . . . . .
Computer software . . . . . . . . . . . . .
Leasehold improvements . . . . . . . .
Patents . . . . . . . . . . . . . . . . . . . . . .
1
43
10.l
10
na
8
10
10
12
13
14
44
Method and rate applied
4% DB
30% DB
30% DB
30% DB
100%a
20% DB
30% DB
30% DB
100%
SL over longer of 5 years and
lease term plus first renewal
term
SL over life
25% DB
DB: declining balance
SL: straightline
a 100% deductible in the year incurred pursuant to paragraph 37(1)(b).
and the current prescribed rates that apply to the most common depreciable
property.17 Although CCA is calculated on a declining balance basis for
most classes, the straightline method is prescribed for some classes.18 As
noted above, CCA is a discretionary deduction, and the taxpayer may
claim any amount up to the maximum prescribed by the regulations. Importantly, Revenue Canada does permit the revision of previous CCA claims
in some circumstances.19
UCC, on which the CCA for a particular class is calculated at any time,
is determined in accordance with a formula set out in subsection 13(21)
of the Act. The issues relevant to the calculation of UCC are discussed
below under the following headings:
• additions to UCC,
• deductions from UCC,
• adjustments to capital cost,
17 Schedules
II to VI contain detailed lists of the asset classifications and the applicable
rates.
18 For example, regulation 1100(1)(c) provides that class 14 assets (licences or franchises) are calculated on a straightline basis over the life of the asset. A straightline
formula is provided in schedule III of the regulations for class 13 assets (leasehold
improvements).
19 Revisions to claims in taxable years are generally permitted only where the revisions
cause no change to assessed tax for taxable years unless the period for filing a notice of
objection has not expired. Revisions to claims in non-taxable years are generally permitted
provided that there is no change to the tax payable for the year or any other year filed.
Revenue Canada’s policy is summarized in Information Circular 84-1, “Revision of Capital Cost Allowance Claims and Other Permissive Deductions,” July 9, 1984.
(1995), Vol. 43, No. 5 / no 5
THE CAPITAL COST ALLOWANCE SYSTEM
1251
• recapture,
• terminal losses, and
• separate classes.
Additions to UCC
The following amounts must be added to UCC:
• The capital cost to the taxpayer of depreciable property of a class
acquired by the taxpayer. Capital cost of a property is generally the purchase price plus any other related costs that must be incurred in order to
make the asset operational (for example, installation and delivery
charges).20 There are a number of provisions that may affect the amount
included in respect of the capital cost of a property. These are discussed
below under the heading “Adjustments to Capital Cost.”
• All amounts included in income as recapture of CCA claimed in a
previous taxation year. The recapture provisions are discussed below.
• Repayments of assistance, inducements, or reimbursements received
in respect of depreciable property of the class occurring after the disposition of the asset.
Deductions from UCC
The calculation of UCC includes the following deductions:
• Total depreciation previously allowed to the taxpayer for property of
the class. Total depreciation is defined to be all CCA claimed plus any
terminal losses previously allowed under subsection 20(16).21 Terminal
losses are discussed in detail below.
• The lesser of proceeds of disposition and the original capital cost of
the disposed of property. The terms “disposition of property” and “proceeds of disposition” are defined in subsection 13(21). A disposition of
property includes any transaction or event that entitles a taxpayer to proceeds of disposition of property. Proceeds of disposition include the sale
price of property that has been sold, compensation for property unlawfully taken, and compensation for property damaged or destroyed.
• Investment tax credits claimed after the related property is sold.
• Certain assistance received in respect of a property subsequent to
the disposition of that property.
Adjustments to Capital Cost
The Act provides for the following adjustments to the capital cost otherwise included in a UCC pool of property:
20 The term “capital cost” is not defined in the Act. Revenue Canada has summarized
its definition in paragraph 8 of Interpretation Bulletin IT-285R2, “Capital Cost Allowance—General Comments,” March 31, 1994.
21 Subsection 13(21).
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• Where a property has been acquired pursuant to a section 85 election, the capital cost of the property will be the “elected amount.”22
• Where a depreciable property has been acquired from a non-arm’slength party, subsection 85(5.1) applies to override subsection 85(1) if
the transferor has an inherent terminal loss with respect to the property. It
deems the capital cost of the property to the transferee to be the lesser of
the transferor’s cost and the UCC attributed to the particular property.
Subsection 85(5.1) is to be repealed with effect after April 26, 1995 as a
result of the introduction of proposed subsection 13(21.2),23 which limits
the capital cost to the transferee to the FMV of the asset. Proposed subsection 13(21.2) is discussed further below under the heading “Terminal
Losses.”
• Where a property has been acquired from a non-arm’s-length transferee, paragraph 13(7)(e) may apply to reduce its capital cost where the
transferor has recognized a capital gain on the disposition.
• Where a taxpayer has acquired anything from a person with whom the
taxpayer was not dealing at arm’s length for an amount in excess of FMV,
the taxpayer is deemed by paragraph 69(1)(a) to have acquired it at FMV.
• Where an amount has been paid in respect of the acquisition of
property or services, section 68 permits the minister to reallocate the proceeds between the various assets or services if some or all of the values
specified are considered unreasonable.24
• Immediately before an acquisition of control, a taxpayer may elect to
have a deemed disposition and reacquisition of each capital property at an
amount between the adjusted cost base and the FMV of the property. 25 For
purposes of calculating CCA, the capital cost of the reacquired property is
deemed by paragraph 13(7)(f ) to equal the original capital cost plus
three-quarters of the realized gain.
• Where government assistance (such as a grant, subsidy, or forgivable
loan) or an investment tax credit has been received in respect of the
22 There are a number of provisions that apply to limit the “elected amount.” Paragraph
85(1)(e) provides that the elected amount cannot be less than the least of the UCC of the
class, the cost to the taxpayer of the property, and the fair market value (FMV) of the
property. Paragraph 85(1)(b) deems the elected amount to equal the FMV of non-share
consideration where the agreed amount is less than the FMV of non-share consideration.
Paragraph 85(1)(c) restricts the elected amount to an amount no greater than the FMV of
the property disposed of.
23 Included in Canada, Department of Finance, Draft Amendments to the Income Tax
Act, the Income Tax Application Rules, the Canada Pension Plan, the Children’s Special
Allowances Act, the Customs Act, the Old Age Security Act, the Unemployment Insurance
Act and a Related Act, April 26, 1995.
24 For a discussion of the application of section 68, see David Forster, “The Purchase
and Sale of Assets of a Business: Selected Tax Aspects,” in Selected Income Tax and
Goods and Services Tax Aspects of the Purchase and Sale of a Business, 1990 Corporate
Management Tax Conference (Toronto: Canadian Tax Foundation, 1991), 2:1-36.
25 Paragraph 111(4)(e).
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THE CAPITAL COST ALLOWANCE SYSTEM
1253
acquisition of a depreciable property, subsection 13(7.1) applies to reduce
the capital cost of the property by the amount received. Where a portion
of the government assistance is repaid before the disposition of the property, the repaid amount is added to the capital cost of the property.
• Where an inducement or reimbursement is received in relation to the
acquisition of a depreciable property, an election under subsection 13(7.4)
can be made to reduce the capital cost of the related property provided
that it was acquired in the year, one of the immediately three preceding
years, or the immediately following year. In the absence of this election,
the amount received would be included in income pursuant to paragraph
12(1)(x). Where a portion of an inducement or reimbursement in respect
of which an election has been made has been repaid before the disposition of the related property, the repaid amount is added to the capital cost
of the property.
• Where a taxpayer has acquired property as a replacement for certain
involuntary dispositions or in respect of the disposition of a former business property, the taxpayer may, in some circumstances, elect to defer the
recognition of the recapture of CCA. Where such an election is made, the
capital cost of the replacement property is reduced by the amount of the
deferred recapture.26
• Where a property that was acquired for some other purpose begins to
be used for the purpose of gaining or producing income, the taxpayer is
deemed to have disposed of and reacquired the property at the time of the
change in use. The capital cost of the reacquired property will be the
FMV of the property at that time unless the FMV exceeds its original cost.
In that case, the capital cost will be limited to its original cost plus
three-quarters of the realized gain on the deemed disposition.27 Similarly,
where a property has been partially used for business and partially used
for other purposes and the proportion of business use changes, there will
be a deemed acquisition or disposition.28
• For passenger vehicles acquired after June 17, 1987, paragraph
13(7)(g) restricts the capital cost to a prescribed amount. The prescribed
amount is currently $24,000 plus the applicable federal and provincial
sales tax on $24,000.29
• Under proposed legislation,30 the capital cost of a film or videotape
acquired after February 22, 1994 is reduced by the amount of any outstanding loan that is convertible into an interest in the film or videotape
or the partnership that owns the film or videotape.
26 Subsections
13(4) and (4.1).
13(7)(b).
28 Paragraph 13(7)(a).
29 Regulation 7307.
30 Draft regulation 1100(21)(e) was released on September 27, 1994. See Canada, Department of Finance, Release, no. 94-084, September 27, 1994.
27 Paragraph
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Recapture
Proceeds of disposition of a depreciable property up to its cost reduce the
applicable CCA class balance. If, as a result of this and other adjustments,
a negative UCC balance in a class arises at the end of a taxation year, it
must be added to the taxpayer’s income for the year as recaptured depreciation.31 In effect, recaptured depreciation can apply only to capital cost
allowance previously claimed and not to a realization of an amount in
excess of the original cost of the property. Any proceeds of disposition in
excess of the original cost of a property are treated as a capital gain.32
Terminal Losses
Where all of the assets of a particular class have been disposed of, subsection 20(16) provides for a mandatory deduction equal to the remaining
UCC balance, referred to as a terminal loss. There are a number of provisions that may affect the recognition of a terminal loss:
• Subsection 13(21.1) may apply in the case of a sale of land and
building to reduce any terminal loss on the building.33
• Each passenger vehicle having a cost in excess of the prescribed
amount must be included in a separate class (10.1). A terminal loss will
be denied by subsection 20(16.1) when the vehicle is sold.34
• Under existing legislation, subsection 85(5.1) denies a terminal loss
that would otherwise be realized on disposition of an asset to a non-arm’slength party. The terminal loss is deferred and realized by the transferee
on sale of the asset. Under proposed subsection 13(21.2), where there has
been an asset transfer to an affiliated party after April 26, 1995 (defined
in proposed section 251.1),35 the portion of the UCC in excess of the FMV
of the asset will remain with the transferor, who will continue to claim
CCA until such time as the loss asset is sold outside the affiliated group.
At that time, a terminal loss could be available to the original transferor.
• Subsection 111(5.1) provides for the recognition of any inherent terminal loss immediately before an acquisition of control by requiring a
taxpayer to deduct as CCA claimed in the year, an amount equal to the
excess of the UCC of the particular class over the FMV of the property in
the particular class.
31 Subsection
13(1).
39(1)(a).
33 Subsection 13(21.1) requires the use of a rather involved calculation. See the explanation in paragraphs 9 to 16 of Interpretation Bulletin IT-220R2, “Capital Cost
Allowance—Proceeds of Disposition of Depreciable Property,” May 25, 1990.
34 However, where an automobile included in class 10.1 at the beginning of the year is
sold, the taxpayer is allowed by regulation 1100(2.5) to claim CCA at the rate of 15
percent rate on the vehicle.
35 Included in the April 26, 1995 draft amendments, supra footnote 23.
32 Paragraph
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THE CAPITAL COST ALLOWANCE SYSTEM
1255
Separate Classes
The establishment of a separate class for a property or a group of properties affects the timing of the recognition of terminal losses and recapture.
There are a number of circumstances in which separate classes are required or in which a taxpayer can elect to use separate classes. Separate
classes are required by regulation 1101 where the taxpayer is carrying on
separate businesses, for rental properties acquired after 1972 with a cost
in excess of $50,000, passenger vehicles costing in excess of a prescribed
amount, certified productions, and specified leasing properties. A taxpayer may also elect to have separate classes for certain properties,
including properties that are exempt properties for the purposes of the
specified leasing property rules (regulation 1101(5o)), outdoor advertising signs (regulation 1101(5l)), and rapidly depreciating electronic
equipment (regulation 1101(5q)).
Restrictions on CCA Claims
The amount of the CCA claim allowed is subject to a number of restrictions, discussed below.
Short Taxation Years
Regulation 1100(3) limits the CCA allowed for short taxation years to the
prorated portion (based on number of days in the taxation year divided by
365) of the CCA otherwise calculated in accordance with the regulations.
Half-Year Rule
The “half-year rule” in regulation 1100(2), effective from November 13,
1981, restricts the CCA claim allowed on net acquisitions (consisting of
additions for the year less the lesser of original cost and proceeds of
disposition for the year) in the year to one-half of the normal claim.
Before the introduction of this rule, depreciable property could be acquired at or near the end of the year and a full year’s claim made. The
half-year rule has the effect of arbitrarily fixing the date of all acquisitions at the middle of the taxation year.
There are a number of exclusions from the half-year rule, including
specified leasing property (described below), certain class 10 and 12 assets, and assets in classes 13, 14, 15, 23, 24, 27, 29, and 34. Regulation
1100(2.2) also excludes from the half-year rule depreciable property acquired in certain non-arm’s-length transactions and corporate reorganizations, provided that the transferred property was originally acquired by
the transferor at least 364 days before the end of the taxation year of the
taxpayer acquiring the property. 36
36 For further discussion of the half-year rule, see “An Analysis of the November 1981
Budget Proposals and Draft Regulations Relating to Depreciable Property,” in Report of
Proceedings of the Thirty-Fourth Tax Conference, 1982 Conference Report (Toronto: Canadian Tax Foundation, 1983), 247-67.
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Rental Property
Regulation 1100(11) was introduced to limit the CCA claimed on a “rental
property” to the amount of rental income earned by the taxpayer either
directly or indirectly through a partnership. Where a taxpayer owns more
than one rental property, the restrictions are not applied to each individual
rental property but to the aggregate of the CCA claims on all rental properties. A “rental property” is defined in regulation 1100(14) to be, in
general terms, a building or leasehold interest used for the purposes of
gaining or producing gross revenue that is rent. These rules were introduced
to prevent taxpayers who owned rental properties from sheltering nonrental income by using CCA to create or increase a loss on a rental property.
Regulation 1100(12) provides that regulation 1100(11) will not apply
if the taxpayer is, throughout the year, a life insurance corporation or a
corporation whose principal business was the leasing, rental, development, or sale, or any combination thereof, of real property owned by it. It
also excludes a partnership, if every partner is a corporation fitting this
description.37
Leasing Property
The restrictions on CCA in respect of “leasing property” were introduced
to apply to acquisitions of property after May 25, 1976. These rules,
which are summarized in regulations 1100(15) to (19), provide that the
total CCA claim made by the lessor in respect of all leasing property
cannot exceed the lessor’s total leasing income. “Leasing property” is
defined in regulation 1100(16) to be, in general, depreciable property
other than rental property that is used principally for the purpose of earning rent, royalty, or leasing income. These rules were introduced to prevent
taxpayers who were in a non-tax-paying position from structuring asset
acquisitions as leasing arrangements and trading off the CCA claims to
the lessor in exchange for lower financing costs.38
An exception is provided in regulation 1100(16) for corporations whose
principal business is the renting or leasing of leasing property, either on
its own or in combination with the selling or servicing of that type of
property, provided that the gross revenue from that principal business is
at least 90 percent of the gross revenue of the corporation. The exclusion
also applies to partnerships where each member of the partnership is a
corporation that fits the same description.39
37 The rental property restrictions are discussed in detail in Interpretation Bulletin
IT-195R4, “Rental Property—Capital Cost Allowance Restrictions,” September 6, 1991;
and Interpretation Bulletin IT-371, “Rental Property—Meaning of Principal Business,”
April 25, 1977.
38 1976 Budget, Budget Paper C, supra footnote 2, at 25.
39 The restrictions on leasing property are discussed further in Interpretation Bulletin
IT-443, “Leasing Property—Capital Cost Allowance Restrictions,” March 14, 1980.
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THE CAPITAL COST ALLOWANCE SYSTEM
1257
Specified Leasing Property
Despite the introduction of the 1976 limitation in respect of leasing property, the Department of Finance was of the view that further restrictions
were required.40 The rules contained in regulations 1100(1.1) and (1.2)
are effective for leases entered into after April 26, 1989. The rules limit
the CCA claim to the amount that would have been a repayment of principal had the lease been a loan and had the lease payments been blended
payments, consisting of principal and interest. The notional principal repayment is determined by first calculating the notional interest in
accordance with regulation 4302. The lessee is not affected by these regulations. Each specified leasing property is required to be placed in a
separate class.
The rules are not intended to apply to property that is commonly leased
for operational purposes and for which CCA reasonably approximates
actual depreciation.41 Excluded from the definition of “specified leasing
property”42 are “exempt property”43 (consisting of computers, office equipment, and furniture, having a value of up to $1 million each, buildings,
automobiles, and light trucks), short-term leases of one year or less, and
leases of property with an FMV of less than $25,000.
Also introduced was an election that could be made by the lessee.
Pursuant to section 16.1, the lessee can elect to deduct CCA and interest
instead of the lease payments. Although a joint election is required, there
is no effect on the lessor. As a result, it is possible for both the lessee and
the lessor to be claiming CCA on the same asset.44
ASSESSMENT OF THE CURRENT CCA SYSTEM
What are the strengths and weaknesses of the current CCA system? While
there are many possible ways to consider this question, the following four
issues are perhaps the most significant:
1) Is the system fair?
2) Is the system simple?
3) Are the rates adequate?
4) Is our system competitive with that of other countries?
40 See Canada, Department of Finance, 1989 Budget, Budget Papers, April 27, 1989,
44-46.
41 Ibid.
42 Regulation 1100(1.11).
43 Regulation 1100(1.13).
44 The specified leasing property rules have been reviewed in detail in Thomas S.
Gillespie, “Lease Financing: An Update,” in Report of Proceedings of the Forty-First Tax
Conference, 1989 Conference Report (Toronto: Canadian Tax Foundation, 1990), 24:1-35;
and Gillespie, supra footnote 14.
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Fairness
In order to be fair, a tax system should, to the extent possible, treat all
taxpayers equally without giving any particular taxpayer or group of taxpayers an unfair advantage. It is important that taxpayers believe that the
system is fair. The perceived inequity of the depreciation system under
the IWTA was a key reason for the establishment of the CCA system.
As the government adjusted CCA rates over the years to aid in the
achievement of certain fiscal goals and to create an incentive for business
to make new investments (through, for example, an accelerated writeoff
for manufacturing assets and Canadian certified feature films), tax preferences were created which gave some industries advantages over others.
Many of the changes to the CCA system since its introduction (see table
1) were intended to make the system fairer for all taxpayers. For example, under the 1987 tax reform, the Department of Finance attempted to
level the tax playing field by broadening the tax base and eliminating tax
preferences such as accelerated writeoffs for certain assets that favoured
one particular industry over another.
As well as unintended advantages, the tax system for depreciable asset
purchases and sales has, in some circumstances, created unintended hardship for some taxpayers. The government has attempted to alleviate
hardship by making certain elections available under the Act, including
the following:
• An election under subsection 13(4) to designate a property as a replacement property for another property (former property) that has been
disposed of in order to defer certain gains on the disposition of the former
property.
• Elections for assets to be included in separate classes. These have
been discussed above under the heading “Separate Classes.”
• An election to transfer assets from one class to another. As a result
of the many changes in the prescribed classes for a given type of property, it is possible that upon disposition of an asset in an old class, recapture
could occur because a newly acquired property was included in a different class. In order to alleviate this burden, regulation 1103(2)(d) allows
the taxpayer to elect, in the year of disposition of the former property, to
transfer the former property to the same class as the new property just
before the disposition of the property. In this way, recapture can be deferred. In addition, regulation 1103 provides for a number of other specific
transfers between classes under various circumstances.
Simplicity
Ideally, a tax system should be simple, straightforward, and easy to administer by both the taxpayer and the tax authorities. The basic method of
calculating CCA remains straightforward. The familiar T2S(8) schedule
attached to corporate tax returns, and similar schedules for individuals
and trusts, have not required substantial change over the years. However,
(1995), Vol. 43, No. 5 / no 5
THE CAPITAL COST ALLOWANCE SYSTEM
1259
the system changes and the myriad of different classes and rates have
resulted in a system that is considerably more complicated than the one
introduced in 1949. As in other areas of the Act, there has been a tradeoff
between fairness and simplicity. It can be argued, however, that fairness
within the tax system, which is the more important goal, has required
increasing complexity throughout the Act and that the CCA system is a
major example (and rightly so) of this. Therefore, it is quite acceptable
that, in an effort to make the system fairer to and among taxpayers, to
deal with the increasing complexity of business itself, and to stop any
inappropriate drain on tax revenues, some of the original simplicity of the
system has had to be sacrificed.
Adequacy of the Rates
A comparison of accounting depreciation and tax depreciation provides a
good initial indicator of the adequacy of the CCA rates. The purpose of
accounting depreciation is to allocate the cost of a capital asset to those
accounting periods that benefit from its use in order to provide a matching of revenues and expenses. The method and rate of accounting
depreciation chosen generally reflect the expectations for the asset regarding factors such as its estimated economic life, the decline in its use
and operating efficiency, obsolescence, and changes in revenue-producing
ability. Therefore, as long as the annual CCA allowed to a taxpayer is at
least equal to the annual accounting depreciation, one could perhaps conclude that the CCA system is at least adequate to allow the taxpayer to
recognize the cost of property over its useful life.
While there are a number of different accounting depreciation methods
(straightline, declining balance, sum of the year’s digits), the straightline
method, which allocates the estimated cost less salvage value of the asset
over the estimated years of useful life, is the most common method used
by most large corporations. For smaller companies, the declining balance
method is often used, so that accounting depreciation and tax depreciation are the same.45
Before the 1987 tax reform, CCA rates were, in many cases, far in
excess of accounting depreciation rates. At that time, the government
estimated that the cost of allowing for CCA rates in excess of accounting
depreciation was $2.3 billion in 1980 alone.46 One of the goals of the
1987 tax reform was to reduce the accelerated CCA rates so that they
would be closer to accounting rates.
A comparison between tax and accounting rates is complicated by the
fact that accounting rates for the same property can vary among different
businesses, depending on the particular fact situation. The example in
table 3 compares the tax and accounting depreciation for manufacturing
45 1976
Budget, Budget Paper C, supra footnote 2, at 8.
Department of Finance, 1985 Budget, The Corporation Income Tax System:
A Direction for Change, May 23, 1985, 9.
46 Canada,
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Table 3
Comparison of Tax and Accounting Depreciation on
Manufacturing and Processing Equipmenta
Year
1
2
3
4
5
6
7
8
9
Original cost . . . . . . . . . . . . . . . . . . . .
Depreciation . . . . . . . . . . . . . . . . . . . .
Undepreciated cost . . . . . . . . . . . . . . .
Depreciation . . . . . . . . . . . . . . . . . . . .
Undepreciated cost . . . . . . . . . . . . . . .
Depreciation . . . . . . . . . . . . . . . . . . . .
Undepreciated cost . . . . . . . . . . . . . . .
Depreciation . . . . . . . . . . . . . . . . . . . .
Undepreciated cost . . . . . . . . . . . . . . .
Depreciation . . . . . . . . . . . . . . . . . . . .
Undepreciated cost . . . . . . . . . . . . . . .
Depreciation . . . . . . . . . . . . . . . . . . . .
Undepreciated cost . . . . . . . . . . . . . . .
Depreciation . . . . . . . . . . . . . . . . . . . .
Undepreciated cost . . . . . . . . . . . . . . .
Depreciation . . . . . . . . . . . . . . . . . . . .
Undepreciated cost . . . . . . . . . . . . . . .
Depreciation . . . . . . . . . . . . . . . . . . . .
Undepreciated cost . . . . . . . . . . . . . . .
Taxb
Accountingc
Difference
10,000
(1,500)
8,500
(2,550)
5,950
(1,785)
4,165
(1,250)
2,915
(875)
2,040
(612)
1,428
(428)
1,000
(300)
700
(210)
490
10,000
(625)
9,375
(1,250)
8,125
(1,250)
6,875
(1,250)
5,625
(1,250)
4,375
(1,250)
3,125
(1,250)
1,875
(1,250)
625
(625)
0
0
875
875
1,300
2,175
535
2,710
0
2,710
(375)
2,335
(638)
1,697
(822)
875
(950)
(75)
(415)
490
a Manufacturing and processing equipment acquired in 1995 half-way through the year,
at a cost of $10,000. b Assumed to be included in class 43 with a CCA rate of 30%.
c Assumed to be depreciated on a straightline basis over eight years.
and processing equipment with a cost of $10,000. The example illustrates
that CCA is generally higher in the early years of an asset’s life, owing to
the use of the declining balance method, and that accounting depreciation
is higher in the later years. The straightline method allows for the full
depreciation of the asset over its estimated useful life, whereas the declining balance method extends depreciation over a longer period. In this
situation, the “annual crossover point” (the point at which annual accounting depreciation exceeds annual CCA) is in year 5 and the “cumulative
crossover point” (the point at which total accounting depreciation exceeds total CCA) is in year 8.
Table 4 shows this comparison for manufacturing and other major
depreciable assets. In all five categories, annual CCA claims exceed accounting depreciation for the initial years, and cumulative CCA does not
exceed cumulative accounting depreciation until the later part of the asset’s estimated useful life. This implies that the tax system still contains a
reasonable incentive for taxpayers to make capital expenditures.
(1995), Vol. 43, No. 5 / no 5
THE CAPITAL COST ALLOWANCE SYSTEM
Table 4
1261
Summary of Crossover Points for Tax and
Accounting Depreciation
Asset category
Manufacturing assets . . . . .
Buildings . . . . . . . . . . . . . .
Furniture . . . . . . . . . . . . . . .
Computer software . . . . . . .
Automobiles . . . . . . . . . . . .
CCA
rate
Accounting
depreciation
ratea
Annual
crossover
yearb
Cumulative
crossover
yearc
30% DB
4% DB
20% DB
100%
30% DB
8 years SL
40 years SL
7 years SL
3 years SL
5 years SL
year 5
year 13
year 4
year 3
year 3
year 8
year 27
year 5
year 4d
year 5
DB: declining balance
SL: straightline
a Assumed to be a typical accounting depreciation rate. Actual rates for each asset
category will vary among different businesses. b The annual crossover year is the year in
which the annual accounting depreciation exceeds annual CCA. c The cumulative crossover year is the year in which cumulative accounting depreciations exceed cumulative CCA
claims. d Accounting depreciation is prorated in the year of acquisition. Since it is assumed that the asset is acquired halfway through year 1, the property will not be fully
depreciated until year 4.
Competitiveness
The competitiveness of Canada’s tax system is an increasingly important
issue, given the trend toward a global economy with few trade barriers.
As the competition to Canadian business most often comes from the United
States, the tax depreciation systems of the two countries should be
compared.
The modified accelerated cost recovery system ( MACRS) is the method
of depreciation used in the United States for most tangible property placed
in service after 1986. Under MACRS, the cost of eligible property is
recovered over a period of 3, 5, 7, 10, 15, 20, 27.5, 31.5, or 39 years,
depending upon the type of property (see table 5 for examples).47
MACRS depreciation tables may be used to compute depreciation over
the recovery period.48 These tables incorporate the appropriate recovery
period and the switch from the declining balance method (generally 200
percent) to the straightline method in the year in which the straightline
method provides a depreciation allowance equal to, or greater than, the
declining balance method. This ensures that the full cost is depreciated
over the recovery period, rather than an indefinite declining depreciation
amount as under the Canadian system. Similar to the CCA system in
Canada, tax depreciation is limited to one-half normal depreciation in the
first year of service.
A comparison with the UK system also is of interest. In the United
Kingdom, the method of calculation is quite similar to that used in Canada:
47 Rev.
48 Rev.
proc. 87-56, 1987-2 CB 674; and Rev. proc. 88-22, 1988-1 CB 785.
proc. 87-57, 1987-2 CB 687; and Rev. proc. 89-15, 1989-1 CB 816.
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Table 5
Summary of Canadian, US, and UK Depreciation Rates
Asset category
Commercial buildings . . . . . . . .
Manufacturing assets . . . . . . . . .
Autos and light trucks . . . . . . . .
R & D equipment . . . . . . . . . . . .
Furniture and fixtures . . . . . . . . .
Computer hardware . . . . . . . . . .
Patents . . . . . . . . . . . . . . . . . . . .
Computer software . . . . . . . . . . .
Canadaa
4% DB
30% DB
30% DB
100%
20% DB
30% DB
SL over life
or 25% DB
30% DB
or 100%
Depreciation rates
USa
UKb
39 years SL
5, 7, or 10 years c DDB
5 years DDB
5, 7, or 10 years DDBe
7 years DDB
5 years DDB
15 years SL
4% SL
25% DB
25% DBd
100%
25% DB
25% DB
25% DB
3 years SL
25% DB
DB: declining balance
DDB: double declining balance
SL: straightline
a Claim in year of acquisition generally limited to 50%. b No half-year rule in year of
acquisition. c Writeoff rate is determined by type of business. d Where the cost of the
property exceeds £12,000, the capital allowance is limited to £3,000/year until tax writtendown value falls below £12,000. e Writeoff rate is determined by type of equipment.
capital allowances are calculated using either the declining balance or the
straightline method. The United Kingdom does not have a half-year rule
and has fewer asset classifications. Examples of the current UK rates are
summarized in table 5.49
The data presented in table 5 may suggest some preliminary conclusions about the relative competitiveness of Canada’s CCA system. The US
rates generally are more generous than the Canadian rates since, for many
assets, the United States uses the double declining balance basis of calculating depreciation; the Canadian rates, in turn, are for the most part a
little more generous than the UK rates. However, a comparison of rates
alone is not a particularly useful approach. Meaningful comparisons of
tax depreciation systems in different countries cannot be made without
consideration of other key factors as well, such as tax rates and time
value discount rates. One possible approach is to approximate the present
value of the “tax shield” (tax saved from depreciation writeoffs) for the
same property in each jurisdiction. Table 6 presents a comparison of the
tax shield provided by the tax depreciation systems in Canada, the United
States, and the United Kingdom for selected types of assets, each with an
assumed cost of $10,000. This calculation, which assumes a discount rate
of 8 percent, takes into consideration both the writeoff rates and the
corporate tax rates. The table includes the tax shield for both a manufacturer and a non-manufacturer since the Canadian tax rates applicable to
each differ significantly.
49 Capital
Allowances Act 1990, Public General Acts of 1990, c. 1.
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THE CAPITAL COST ALLOWANCE SYSTEM
1263
Table 6 Comparison of Present Value of Tax Shield Provided by
the Canadian, US, and UK Tax Depreciation Systems
Present value of tax shield:a manufacturer
USc
UKd
Asset
Canadab
Manufacturing assets . . . . . . . . . . .
Commercial building . . . . . . . . . . .
Furniture . . . . . . . . . . . . . . . . . . . . .
Computer software . . . . . . . . . . . . .
Automobiles . . . . . . . . . . . . . . . . . .
2,705
2,816e
2,500
1,142
1,124
1,409
2,447
2,612
2,500
3,172
3,061
2,500
2,705
3,002
2,500
Present value of tax shield:a non-manufacturer
Canadaf
USc
UKd
Commercial building . . . . . . . . . . .
Furniture . . . . . . . . . . . . . . . . . . . . .
Computer software . . . . . . . . . . . . .
Automobiles . . . . . . . . . . . . . . . . . .
1,431
3,066
3,975
3,389
1,124
2,612
3,061
3,002
1,409
2,500
2,500
2,500
a Calculated on an asset with a cost of $10,000 using a discount rate of 8%. Assumes
that the taxpayer is in a taxable position in all years. b Assumed tax rate of 35.58%.
c Assumed tax rate of 37%. d Assumed tax rate of 33%. e Average of present value for
manufacturing assets eligible for 5-year, 7-year, and 10-year writeoffs. f Assumed tax rate
of 44.58%.
While it is still difficult to draw firm conclusions from such broad-based
data, it appears that the Canadian CCA system measures up well to the
depreciation systems in the United States and the United Kingdom in
terms of tax relief provided for new capital expenditures. However, this is
because Canadian tax rates are higher than the rates for the United States
and the United Kingdom, particularly for non-manufacturers. If tax rates
are ignored, the depreciation rates under the Canadian system are generally less favourable than the US rates and comparable to those in the
United Kingdom.
The detailed results in table 6 show that, in the case of the manufacturer, the tax shields for the United States and Canada are quite similar.
The tax shield in the United States is marginally higher than the tax
shield in Canada for assets other than computer software and buildings.
The tax shield provided by the UK writeoff is lower than that in Canada
for all assets other than buildings and furniture.
In the case of the non-manufacturer, the present value of the tax shield
provided by the Canadian system is higher than both the US and the UK
tax shields in all cases. This is a result of the high effective tax rate
(44.58 percent) for a Canadian taxpayer that is not eligible for the small
business deduction or the reduced manufacturing tax rates.
The CCA system is, of course, only one factor in determining the competitiveness of Canada’s tax system for capital asset acquisitions. Other
factors include the effective tax rate, the availability of investment tax
credits, tax-free holiday periods, the treatment of tax losses, corporate
minimum taxes, and capital taxes. For this reason, studies undertaken to
compare various tax systems have generally considered a number of these
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factors together and not just CCA rates in isolation. These studies have
concluded that Canada’s tax depreciation system is less generous than
that of the United States.50
THE FUTURE OF THE CCA SYSTEM
Overall, the CCA system in place today seems to be operating well, although some would debate whether the rates of writeoff take full account
of obsolescence rates caused by the rapidly accelerating changes in business in the 1990s. The basic system introduced in 1949 has survived a
number of tax reforms, but it has become significantly more complex.
The main changes, other than changes in rates, have been the restriction
of claims in certain circumstances, so as to improve the fairness of the
system, and the elimination of improper results and perceived abuses.
What lies ahead? We are unlikely to see dramatic changes to the current CCA system, since the government is likely to follow the maxim “If
it ain’t broke, don’t fix it.” With this in mind, business and government
should work to ensure that the CCA system, and particularly the rates, are
subject to regular review. This review is essential to help keep Canada’s
tax system competitive in the increasingly globalized, freer trading
economy and to ensure that changes to actual obsolescence rates are recognized by the CCA system in a timely manner. Against this objective, it
is recognized that, while accelerated CCA writeoffs were often used as a
fiscal policy tool in past decades, the current debt and deficit burdens of
the federal and provincial governments make it probable that policy makers will be reluctant to apply this approach for the remainder of the 1990s
and well into the first decade of the 21st century.
50 See, for example, Jack M. Mintz and Thomas Tsiopoulos, “Contrasting Corporate
Tax Policies: Canada and Taiwan” (1992), vol. 40, no. 4 Canadian Tax Journal 902-17,
which compares the competitiveness of the Canadian tax system using the cost of capital.
The cost of capital is defined to be the minimum rate of return that an investment must
earn to cover the operating costs associated with that investment. The cost of capital takes
into account the corporate tax rate, the present value of depreciation allowances for tax,
the valuation of inventory, and the deductibility of interest. Also see Jack M. Mintz,
“Competitiveness and Tax Policy: How Does Canada Play the Game?” in the 1991 Conference Report, supra footnote 15, 5:1-14. In the latter study, the author calculates the effective
tax rate on capital invested in a marginal project, taking into account federal and provincial corporate and capital taxes.
(1995), Vol. 43, No. 5 / no 5