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CHAPTER 6:

The Acquisition, Use, and Disposal of Depreciable


Property

Electronic Presentations in Microsoft PowerPoint

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1
The Acquisition, Use, and Disposal of
Depreciable Property
I. A Standardized System for Depreciable
Property.
II. Depreciable Property and Capital Cost
Allowance (CCA).
III. The Treatment of Eligible Capital Property
(ECP).
IV. Accounting Rules vs. Tax Rules.
V. Impact on Management Decisions.

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I. A Standardized System For Depreciable
Property
Depreciation is:
Process of allocating the cost of an asset
Over its useful life
To match its cost against the income it generates.
Process requires estimates of:
Useful life
Salvage value
Contribution to the business in each year

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I. A Standardized System For Depreciable
Property
Process requires judgment,
Similar businesses acquiring similar assets may reach different
estimates
Lead to different incomes each of the years that the asset is
used.
Total cost deducted will be the same,
Maximum deducted cannot exceed the original cost of the
asset.
Because of these differences, accounting
depreciation is disallowed.

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I. A Standardized System For Depreciable
Property
Each company purchases the same asset but the
useful life is determined to be different

Company A Company B
Asset Cost $10,000 Asset Cost $10,000
Est. useful life 4 yrs Est. useful life 6 yrs
Expense per year $2,500 Expense per year $1,667

Company A would receive the total tax benefit 2 years


earlier than Company B as a result of the difference in
Estimated useful life.

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I. A Standardized System For Depreciable
Property
ITA 18(1)(b) - accounting depreciation is disallowed.
Instead:
A uniform and arbitrary system is used to expense
assets cost.
The result all businesses must use the same rate to
expense the cost of capital assets.
similar assets results in similar write-off for each business.

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I. A Standardized System For Depreciable
Property
The system divides capital assets into two general
categories:
1. ITA 13(21), 20(1)(a) - Depreciable capital property
2. ITA 14(5),20(1)(b) - Eligible capital property

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II. Depreciable Property and Capital Cost
Allowance (CCA)
Calculation of the CCA:
1. Start with opening balance (UCC).
2. Add any additional purchases.
3. Deduct any disposals.
4. Apply the appropriate CCA rate to the resulting balance.

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Who Qualifies for CCA?
What Assets?
Individuals and corporations qualify for CCA
Can claim on:
all tangible assets other than land and
some but not all intangible assets.
To be eligible for CCA:
a)The taxpayer must have legal title; and
b)The asset must be available for use for the purpose of earning
income.

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Who Qualifies for CCA?
What Assets?
The total dollar amount available for allocation as CCA is
referred to as the capital cost of the asset.
The capital cost amount consists of:
the original purchase price plus
all costs incurred to bring the asset to working order.

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Rates of Capital Cost Allowance

The Act assigns various types of assets to specific classes.


Each class has a specific rate attached to it.
signifies the maximum deductible in any year.
No requirement to claim this maximum:
can choose to claim any amount up to the maximum.
Unclaimed portions is available for deduction in future
years.

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The Declining Balance Method

CCA system uses the declining balance method.


with some exceptions, i.e. Class 13 & 14.
Applies a constant percentage to the remaining un-
depreciated portion.
Each class of assets has a specific percentage rate
attached.
Reg. 1100(2) - New assets limited by half-year rule.
some exceptions.

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The Declining Balance Method

CCA claim may be limited when a taxation year is less


than 365 days.
Reg. 1100(1) - CCA is prorated by the number of days in
the taxation year divided by 365.

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Common Classes

Class 1
Buildings After 1987
4% Declining Balance
Additional allowance
Class 3
Buildings Before 1988
5% Declining Balance
Class 8
Miscellaneous Tangible (equipment, office furniture etc.)
20% Declining Balance

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Common Classes

Class 10
Vehicles
Movable equipment
30% Declining Balance

Class 10.1
Vehicles With Cost Greater Than $30,000
30% Declining Balance

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Common Classes

Class 12
Small Tools
Computer Software
Dishes
Books
100% Declining Balance

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Common Classes

Class 29
Manufacturing Equipment
Purchased between
March 19, 2007 to December 31, 2013
25% in first year, 50% in second and remainder in third.
Temporary
Class 38
Power-operated and movable equipment
Acquired after 1987
Used for excavating
30% declining balance
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Common Classes

Class 43
Manufacturing Equipment
30% Declining Balance
See new Class 53
Class 43.2
Clean Energy Generation Equipment (i.e. solar panels)
Acquired after march 20, 2013 and before 2020
50% Declining Balance
Class 44
Patents After April 26, 1993
Can Choose To Use Class 14

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Common Classes

Class 45
Computers Acquired After March 23, 2004
45% Declining Balance-purchase b/w Mar 22, 2004-Mar
19,2007
Class 50
55% Declining Balance between Mar 18,2007and January
27,2009 and after January 31, 2011
Class 54
50% declining balance
Manufacturing Equipment acquired after 2015 and before 2026

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Pooling of Assets of the Same Class

Assets of the same class are placed in a common pool,


provided all used in the same business (Reg. 1100(2)).
Pooling result is the asset losing its individual identity.
A purchase will add to that pool of assets.
A sale of an asset will remove it from the pool.

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Pooling of Assets of the Same Class

CCA on the undepreciated capital cost at the beginning


of the year is treated differently from CCA on net
additions (disposals).
The one-half rule applies only on net additions.
If disposals exceed purchases, no one-half rule.
ITA 13(21)(d) - When assets are sold, the CCA pool is
reduced by lower of
Original cost, or
Proceeds of disposition.

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Undepreciated
Cost of Capital
Example Class 8

UCC beginning of year: $70,000


Additions 60,000
Disposals (50,000) 10,000
$80,000
CCA
20% x $70,000 14,000
20% x $10,000 x 1,000 (15,000)
UCC $65,000

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Gains and Losses on Disposal of
Depreciable Property
Gains and losses remain in the pool, and
Are averaged over the life of the pool except
Sale Price > Original Cost
A loss remains in the pool to be deducted in future year.

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Gains and Losses on Disposal of
Depreciable Property
Gains and losses can occur at three points:
1. Terminal Loss (ITA 39(1)(b)(i)):
All assets in pool are disposed off and
Positive balance in the pool.

2. Recapture (ITA 39(1)):


Negative balance left in a pool
regardless of whether there are assets left.

3. Capital Gain
the selling price exceeds the original cost.

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Special Treatment of Passenger Vehicles
luxury
Passenger vehicles costing more than $30,000.
Class 10.1 limits the tax deduction for luxury cars.
Maximum claim is $30,000 regardless of cost (ITA 13(7)(g)).
Assets are not pooled (Reg. 1101(1af)).
No recapture or terminal loss (ITA 13(2))
One-half rule (Reg. 1100(2.5))
Applies in the year of acquisition
One-half of the CCA is claimable in disposal year.

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Special Treatment of Faxes, Photocopiers
and Manufacturing Assets
Equipment subject to rapid obsolescence.
Can elect to set up a separate class for each property
costing more than $1,000 (Reg. 1100(5p).
Enable a taxpayer to recognize terminal losses on
disposal.
If these assets were pooled, the loss would be averaged
with the remaining assets.
Does not apply to Class 45 assets

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Exceptions to the Declining Balance Method

Two exceptions are as follows:


1. Leasehold Improvements
2. Franchises, Concessions, and Licenses

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Leasehold Improvements

Tenant is responsible for the cost of making the rented


space suitable to their needs.
Expenditures are:
tangible improvements to the rental property and,
at the end of the lease, cannot be removed.
Costs qualify as depreciable property (Class 13).
Allocated using the straight-line method over the life of
the lease plus one renewable option period (Reg.
1100(1)(b)).

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Leasehold Improvements

Minimum 5 years; maximum is 40 years.


Additional improvements are allocated over the remaining
term of the lease and one renewal period.
One-half rule applies to class 13.
Inducement payments (ITA 12(1)(x)):
May be recognized as either business income or
reduction of the cost of leasehold improvements.

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Franchises, Concessions, and Licences

Class 14 if have a limited legal life.


CCA is determined separately for each item.
The annual CCA:
straight-line basis based on number of days owned in the year
divided by the total number of days in the life of the asset.
The one-half rule is not applied to class 14 assets.

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Involuntary and Voluntary Dispositions

Recapture requirements is often a burden when


replacement assets are planned but not purchased in
same year.
Requires tax be paid in current year,
Even though replacing asset.
Involuntary disposition often triggers recapture.
Permitted to defer recognition of the recapture if
(ITA13(4)) - Similar use property within 24 months.

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Involuntary and Voluntary Dispositions

Voluntary dispositions can defer if:


(ITA 13(4)(b)) - Repurchased within 12 months, and
Building is used for the purpose of earning business income.
Year of disposition show recapture and pay relating tax.
Year of replacement file amended return to remove
recapture and receive a refund of tax paid.

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Change in Use

From Personal Use to Business Use:


ITA 13(7)(b) - Deemed disposition when occurs :
FMV < Original Cost then
FMV is the Proceeds of Disposition and new cost base
for CCA.
FMV> Original Cost then
Original cost+ taxable capital Gain is new cost base for
CCA.

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Change in Use

From Business Use to Personal Use:


ITA 13(7)(a) -A change in use from business use to personal
use causes a disposition at FMV

ITA 13(7)(e) acquired by related party adjust capital cost for


CCA purposes:
Reduce by of capital gain

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Terminal Loss Restriction

Sales to Affiliated Persons:


Terminal loss on transfer is denied until affiliated person sells
the asset
Affiliated Persons: individuals and spouse and any corporation
controlled by either.

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Cost of a Business Website

Cost normally includes the cost of design and writing


computer code
Can be considered application software
Class 12 - 100% CCA rate but subject to the year rule.
Acquired Computers to host website.
Computer and systems software costs Class 50
CCA rate 55%
Monthly service costs to third party expense.

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III. The Treatment of Eligible Capital
Property
ITA 42(5) - Capital expenditure of an intangible nature.
Some common types of expenditures are:
Goodwill (purchased).
Franchises, licences, and concessions with no legal limited
life.
Trademarks.
Customer lists.
Incorporation costs.

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Basic Rules for Eligible Capital Property

All assets are pooled together.


ITA 14(5) - Additions and disposals, regardless of original
cost, are recorded at 75%.
ITA 20(1)(b) - Annual rate of write-off is 7%.
One-half rule does not apply.
Proration is used for short taxation years.

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Basic Rules for Eligible Capital Property

Negative Pool:
Amount that represents recapture - add business income,
Amount greater than recapture - two-thirds of excess is
business income.
ITA 24 - Positive Pool and business discontinues -
terminal loss.

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IV. Accounting Rules vs. Tax Rules

Cost allocation
GAAP:
Useful life to allocate capital costs
Requirements management estimates.
Tax:
CCA rates predetermined rates
Rates are determined on the basis of the average normal
use of particular types of assets.

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IV. Accounting Rules vs. Tax Rules

Gains and losses Depreciable Property


Accounting:
Gain or loss are recognized.
Tax purposes:
Only capital gains are recognized.
One-half of the capital gain is taxable.

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V. Impact on Management Decisions

The tax treatment of depreciable capital property and


eligible capital property has a significant impact on
management decisions.
1. The way that capital costs are allocated and gains and
losses are treated influences the amount and timing of
income tax, which in turn affects all decisions relating to
capital expansion.
2. The tax method of dealing with depreciable property
influences the rates and method of
amortization/depreciation chosen by Canadian
businesses.

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