Fanshawe College Taxation Chapter 5 PDF

Fanshawe College FINA 3043 - Taxation 1 Wasim A. Ismail THE CAPITAL COST ALLOWANCE (CCA) SYSTEM CCA is depreciation/amortization that is calculated for income tax purposes. This system separates capital proper...

Fanshawe College FINA 3043 - Taxation 1 Wasim A. Ismail THE CAPITAL COST ALLOWANCE (CCA) SYSTEM CCA is depreciation/amortization that is calculated for income tax purposes. This system separates capital property into 3 categories: 1. Non-depreciable property (not defined in the Act): examples are inventory, receivables, investments, personal use property (PUP) and listed personal property (LPP). PUP an LPP are to be discussed in the chapter on capital gains. Other examples include capital expenditures allowed to be deducted in full (e.g., landscaping costs), property not acquired for purpose of earning income, an animal, tree, shrub, herb or similar growing thing. 2. Depreciable property: is defined in subsection 13(21) as property acquired by the taxpayer where CCA has been allowed or will be allowed. This includes both tangible and intangible property.  A capital gain may arise from depreciable property, but a capital loss can never occur (to be discussed). THE “CLASS” SYSTEM  The CCA system is mostly based on a declining balance method, with assets being grouped into classes with specific rates (REG 1100 and Schedule II). Eligibility for CCA 1. Depreciable property – must fit into one of the prescribed classes of CCA described in ITR (Income Tax Regulations) REG 1100 or Schedule II to be depreciable. 2. Employees are restricted – only CCA for motor vehicles (terminal losses not allowed – to be discussed later) and aircraft costs and musical instruments are allowed. Home office or personal computer costs are not depreciable under the CCA system for employees. 3. Businesses – may deduct CCA for capital assets used in the income-earning process. ACCOUNTING TERMS & TAX TERMS Accounting Term Income Tax Term Acquisition Cost Capital Cost Amortization or Depreciation Expense Capital Cost Allowance (CCA) Carrying Value (Net Book Value) Undepreciated Capital Cost (Acquisition Cost minus Accumulated Depreciation/Amortization) (UCC) Chapter 5 1  Fanshawe College FINA 3043 - Taxation 1 Wasim A. Ismail THE BASIC CCA EQUATION UCC stands for Undepreciated Capital Cost UCC (before CCA) = UCC beginning + (additions – **dispositions)  (additions – dispositions) is net additions CCA = UCC (before CCA) X prescribed rate (per class) UCC ending = UCC beginning + net additions – CCA **Dispositions are the lesser of capital cost OR proceeds of disposition (dispositions cannot exceed original capital cost); otherwise the amount above the capital cost is a capital gain. Basically, the maximum that leaves the CCA class is what went in there in the first place. UCC is normally the acquisition cost of the property (for arm’s length transactions) as determined under GAAP (ASPE/IFRS), basically put, the net cash value of the consideration paid to put the asset in use. Cost of improvements or additions to a depreciable property will generally be added to the CCA pool that contains the property. Capital expenditure vs. expenditure of repair and maintenance is outlined in IT-128R (CRA guidelines). CCA can be claimed up to the maximum in a given year. A taxpayer need not claim the entire amount even though a loss can be created from CCA. ITR rules determine maximum available CCA. Once maximum CCA is determined, amount deducted is discretionary. Example 5.1:  UCC beginning = $5,000  Class 8 ~ 20% Calculate CCA and UCC ending Solution: UCC (before CCA) = UCC beginning + net additions UCC (before CCA) = $5,000 + $0 = $5,000 CCA = UCC (before CCA) X prescribed rate (per class) CCA = $5,000 X 20% = $1,000 UCC ending = UCC beginning + net additions – CCA UCC ending = $5,000 + $0 – $1,000 = $4,000 Chapter 5 2  Fanshawe College FINA 3043 - Taxation 1 Wasim A. Ismail Example 5.2: Continue from example 5.1 and calculate CCA and UCC ending for the following year. Solution: UCC (before CCA) = UCC beginning + net additions UCC (before CCA) = $4,000 + $0 = $4,000 CCA = UCC (before CCA) X prescribed rate (per class) CCA = $4,000 X 20% = $800 UCC ending = UCC beginning + net additions – CCA UCC ending = $4,000 + $0 – $800 = $3,200 CCA and Acquisition of New Assets – First-Year Rule (½-Year Rule) REG 11(2) requires that in the first year that an asset is purchased, CCA on the new asset may be claimed on only 50% of the net additions (additions minus dispositions minus any government grants) during the year to the applicable asset class. Net additions must be a positive number for the first-year rule to apply. If it is negative, i.e. dispositions are greater than additions, then the number is subtracted away normally and the half-year rule would not apply. Exceptions to the half-year rule on positive net additions include Class 14 and certain Class 12 items. Example 5.3: Continue from example 5.2 and calculate CCA and UCC ending for the following year given the fact that a new piece of equipment is purchased worth $1,500 Solution: UCC (before CCA) = UCC beginning + net additions UCC (before CCA) = $3,200 + ½($1,500) = $3,950 CCA = UCC (before CCA) X prescribed rate (per class) CCA = $3,950 X 20% = $790 UCC ending = UCC beginning + net additions – CCA UCC ending = $3,200 + $1,500 – $790 = $3,910 Chapter 5 3  Fanshawe College FINA 3043 - Taxation 1 Wasim A. Ismail Example 5.4:  UCC beginning = $5,000  Class 8 ~ 20%  Purchased equipment for $2,000  Sold equipment for $1,000 Calculate CCA and UCC ending for this year and the following year. Solution ~ Net additions = additions – dispositions = $2,000 – $1,000 = $1,000 (positive number). UCC (before CCA) = UCC beginning + net additions UCC (before CCA) = $5,000 + ½($1,000) = $5,500 CCA = UCC (before CCA) X prescribed rate (per class) CCA = $5,500 X 20% = $1,100 UCC ending = UCC beginning + net additions – CCA UCC ending = $5,000 + $1,000 – $1,100 = $4,900 Subsequent year CCA = $4,900 X 20% = $980; UCC ending = $4,900 – $980 = $3,920 Example 5.5:  UCC beginning = $5,000  Class 8 ~ 20%  Purchased equipment for $3,000  Sold equipment for $4,000 Calculate CCA and UCC ending for this year and the following year. Solution ~ Net additions = additions – dispositions = $3,000 – $4,000 = ($1,000) net disposition (negative). UCC (before CCA) = UCC beginning + net additions UCC (before CCA) = $5,000 + ($1,000) = $4,000 CCA = UCC (before CCA) X prescribed rate (per class) CCA = $4,000 X 20% = $800 Chapter 5 4  Fanshawe College FINA 3043 - Taxation 1 Wasim A. Ismail UCC ending = UCC beginning + net additions – CCA UCC ending = $5,000 + ($1,000) – $800 = $3,200 Subsequent year CCA = $3,200 X 20% = $640; UCC ending = $3,200 – $640 = $2,560 CCA – Taxation Year Less than Twelve Months The short year only occurs in the first year of operation; REG 1100(3) requires that CCA be prorated based on the number of days in the year: [# of days in the taxation year/365] Short taxation years, which occur on the final period of business operations, don’t fall under this rule because a terminal loss or recapture of CCA will occur when the assets have been disposed of. Some exceptions to this rule are in the case of an employee using their car for work purposes. In their case, they don’t have to pro-rate the CCA on the vehicle. However, the half-year rule still applies in the first year they purchase the vehicle. Another exception is where depreciable capital property is used by an individual to produce income from property rather than a business, for example, real estate rentals. Example 5.6: A business starts operations on November 25th of the current year. Equipment worth $6,000 is purchased and put to use on November 25th. Calculate CCA and UCC ending. Solution: the number of days left in the year is 37 so CCA will have to be prorated by using 37/365; however, this is the first year for the equipment which means the ½ rule will also apply. UCC (before CCA) = UCC beginning + net additions UCC (before CCA) = $0 + ½($6,000) = $3,000 CCA = UCC (before CCA) X prescribed rate (per class) CCA = $3,000 X 20% X (37/365) = $61 UCC ending = UCC beginning + net additions – CCA UCC ending = $0 + $6,000 – $61 = $5,939 Accelerated Investment Incentive (AccII) – Temporary Replacement of the ½-Year Rule On November 21, 2018 the half-year rule was replaced for most depreciable property with a new temporary incentive that actually allows 150% of the maximum CCA rather than only 50%. This is referred to as the Accelerated Investment Incentive (AccII). The AccII is generally 150% of the net additions to a class of Chapter 5 5  Fanshawe College FINA 3043 - Taxation 1 Wasim A. Ismail depreciable property for purchases from November 21, 2018, to December 31, 2023, but only 125% for purchases made from January 1, 2024, to December 31, 2027. As far as eligibility for the AccII, some classes are excluded, such as class 54 covering zero-emission vehicles. The conditions for eligibility begin with purchases of depreciable property that were done between November 21, 2018 and December 31, 2027. The same property which is purchased cannot be one in which CCA or a terminal loss was claimed by the purchaser and at the same time acquired on a rollover basis or previously owned by the purchaser or a non-arm’s length person. Transactions on a rollover basis mean that an asset is traded at cost, for example, between an owner and a controlled corporation. Non-arm’s length transactions mean situations where the purchaser has some connection to the seller, such as with related persons like family members. Example 5.7: A business with opening UCC of $3,200 in class 8 acquires a new piece of equipment for $1,500. Calculate CCA and UCC ending by applying the Accelerated Investment Incentive (AccII). Solution: UCC (before CCA) = UCC beginning + net additions UCC (before CCA) = $3,200 + 1.5($1,500) = $5,450 CCA = UCC (before CCA) X prescribed rate (per class) CCA = $5,450 X 20% = $1,090 UCC ending = UCC beginning + net additions – CCA UCC ending = $3,200 + $1,500 – $1,090 = $3,610 Example 5.8: A business acquires a class 8 property with a capital cost of $100,000. Calculate CCA and UCC ending under the scenario of the ½-year rule (before the AccII) and after the Investment Incentive (AccII) took effect. Solution: Chapter 5 6  Fanshawe College FINA 3043 - Taxation 1 Wasim A. Ismail Restriction on the ½-Year Rule in the Case of a Rollover The ITR prevents the half-year rule from applying if a taxpayer has purchased depreciable property from a non-arm’s-length person (i.e., a family member or corporation controlled by the taxpayer or family members) and that non-arm’s-length person had owned the depreciable property continuously for at least 364 days before the end of the taxation year of the taxpayer’s purchase. The rationale for the exclusion is that the original individual owner would already have been subjected to the half-year rule, therefore it should not be applied a second time to the corporate purchaser where there is a close connection between the seller and purchaser. The AccII would not have applied to the purchase of this depreciable property, explained next. Chapter 5 7  Fanshawe College FINA 3043 - Taxation 1 Wasim A. Ismail Example 5.9: Indicate in the following if the purchase qualifies for the AccII. 1. Arna Enterprises Ltd., a CCPC, purchases new equipment from an arm’s-length manufacturer on February 10, 2023. The equipment qualifies for the AccII. The flowchart analysis flows from 1, 2, then to 4. The new equipment purchased from the manufacturer would have been inventory of the manufacturer, which would have disqualified a claim for CCA because inventory is not depreciable property. 2. Arna Enterprises Ltd., a CCPC, purchases used equipment from an arm’s-length manufacturer on February 10, 2023. The manufacturer had previously claimed CCA on the equipment. The equipment qualifies for the AccII. The flowchart analysis flows from 1, 2, 3, then to 4. 3. Arna Enterprises Ltd., a CCPC, purchases new equipment from a non-arm’s-length manufacturer on February 10, 2023. The equipment qualifies for the AccII. The flowchart analysis flows from 1, 2, then to 4. The manufacturer could not have claimed CCA since the property would not have been depreciable property because it was inventory of the manufacturer. 4. Arna Enterprises Ltd., a CCPC, purchases used equipment from a non-arm’s-length manufacturer on February 10, 2023. The manufacturer had previously claimed CCA on the equipment in the last two years. The equipment does not qualify for the AccII. The flowchart analysis flows from 1, 2, 3, then to 5. The fact that CCA was previously claimed eliminates the first condition, while the fact that the purchaser and seller are non-arm’s length eliminates the second condition. The half-year rule would not have applied since the seller was non-arm’s length with the purchaser and owned the equipment for Chapter 5 8  Fanshawe College FINA 3043 - Taxation 1 Wasim A. Ismail more than the requisite 364 days. Purchaser can claim full CCA as normal. Example 5.10: UCC in class 8 is $250,000 and new purchases of $40,000 took place in 2023. Calculate CCA and UCC ending under the scenario of the ½-year rule (before the AccII) and after the Accelerated Investment Incentive (AccII) took effect for both 2023 and 2024 Solution: Accll Application – Class 12 Class 12 inherently qualifies for a 100% CCA write-off on items such as medical and dental instruments, uniforms, chinaware, cutlery, or other tableware and tools costing less than $500. Due to this, the Accll does not apply as it would not bring more benefit. Some items in class 12 are subject to the half-year rule, specifically, computer software and certified Canadian films. These continue to be subject to the half-year rule unless the half-year rule did not apply, which would require a non-arm’s-length purchase as a starting point. Straight-Line CCA – Class 13 Class 13 is uses straight-line CCA (same for Class 14). Leasehold improvements in Class13 are calculated on a year-to-year basis as the lesser of:  1/5 of the capital cost of the leasehold interest; and  The capital cost interest divided by the number of 12-month periods from the beginning of the taxation year in which the cost was incurred to the end of the term of the lease plus the first renewal term, not to exceed 40 years (denominator not to exceed 40). Chapter 5 9  Fanshawe College FINA 3043 - Taxation 1 Wasim A. Ismail Example 5.11: Leasehold improvements costing $10,000 are paid at the beginning of a 5-year lease. The lease comes with two options of renewal of 5 years each. Calculate the CCA in the first and second years assuming the ½-year rule applies. Solution: Year 1 – CCA is the lesser of:  $10,000/5 = $2,000; and  $10,000/(5 + 5) = $10,000/10 = $1,000; The lesser is $1,000 and the ½-year rule applies; $500 CCA Year 2 – CCA is the lesser of:  $10,000/5 = $2,000; and  $10,000/(5 + 5) = $10,000/10 = $1,000; The lesser is $1,000 Of course, this will last 11 years because for year 2 until year 10, $1,000 is taken as CCA for each year. For years 1 and 11, $500 of CCA is taken for each year. $500 is taken in year 11 because that is all that remains. The summary is as follows: Year CCA 1 $ 500 2 $ 1,000 3 $ 1,000 4 $ 1,000 5 $ 1,000 6 $ 1,000 7 $ 1,000 8 $ 1,000 9 $ 1,000 10 $ 1,000 11 $ 500 Total $10,000 Chapter 5 10  Fanshawe College FINA 3043 - Taxation 1 Wasim A. Ismail Example 5.12: Leasehold improvements costing $10,000 are paid at the beginning of a 5-year lease. The lease comes with two options of renewal of 5 years each. Calculate the CCA in the first and second years assuming the AccII applies. Solution: Year 1 – CCA is the lesser of:  $10,000/5 = $2,000; and  $10,000/(5 + 5) = $10,000/10 = $1,000; The lesser is $1,000 and with the AccII @ 1.5 it is $1,500 CCA Year 2 – CCA is the lesser of:  $10,000/5 = $2,000; and  $10,000/(5 + 5) = $10,000/10 = $1,000; The lesser is $1,000 This will last for 10 years. For year 1 it is $1,500 and for years 2 to 9 it is $1,000 per year, leaving $500 for year 10. The summary is as follows: Year CCA 1 $ 1,500 2 $ 1,000 3 $ 1,000 4 $ 1,000 5 $ 1,000 6 $ 1,000 7 $ 1,000 8 $ 1,000 9 $ 1,000 10 $ 500 Total $10,000 Chapter 5 11  Fanshawe College FINA 3043 - Taxation 1 Wasim A. Ismail Example 5.13: Leasehold improvements costing $9,000 are paid in the second year of a 5-year lease. The lease term is 5 years with two options of renewal of 5 years each. Calculate the CCA in the first and second years assuming the ½-year rule applies: Solution: Year 1 – CCA is the lesser of:  $9,000/5 = $1,800; and  $9,000/(4 + 5) = $9,000/9 = $1,000; The lesser is $1,000 and the ½-year rule applies; $500 CCA Year 2 – CCA is the lesser of:  $9,000/5 = $1,800; and  $9,000/(4 + 5) = $9,000/9 = $1,000; The lesser is $1,000 Example 5.14: Leasehold improvements costing $9,000 are paid in the second year of a 5-year lease. The lease term is 5 years with two options of renewal of 5 years each. Calculate the CCA in the first and second years assuming the AccII applies: Solution: Year 1 – CCA is the lesser of:  $9,000/5 = $1,800; and  $9,000/(4 + 5) = $9,000/9 = $1,000; lesser is $1,000 and with the AccII @ 1.5 it is $1,500 CCA Year 2 – CCA is the lesser of:  $9,000/5 = $1,800; and  $9,000/(4 + 5) = $9,000/9 = $1,000; The lesser is $1,000 Straight-Line CCA – Class 14 – Accll Application Chapter 5 12  Fanshawe College FINA 3043 - Taxation 1 Wasim A. Ismail Class 14 covers the cost of intangible capital property with a limited life. Specifically identified are patents, franchises, concessions, or licenses. Not subject to the ½-year rule, CCA should be calculated on a reasonable pro rata basis. A reasonable basis would include a determination using the number of days in the taxation year against the total days of the life of the property. While class 14 is similar to class 13 in the sense they both employ a straight-line methodology, class 14 was not subject to the half-year rules as already noted. Class 14, however, will benefit from the 50% AccII adjustment based on additions to the class for qualifying property. Class 53 – Manufacturing and Processing Property Machinery and equipment acquired after 2015 and before 2026 to be used in Canada more than half the time for the purpose of manufacturing or processing goods to be sold or leased is eligible for a 50% CCA rate applied on a declining balance basis. Accll Application – Class 53 Instead of adding 50% to the CCA base for calculating CCA in the year of acquisition, the AccII provisions add 100% of the capital cost of net additions. The purpose of which is to allow a 100% write-off in the year of purchase. Example 5.15: A taxpayer acquires a class 53 property with a capital cost of $200,000. Calculate CCA and UCC ending under the scenario of the ½-year rule (before the AccII) and after the Accelerated Investment Incentive (AccII) took effect. Solution: Recap: CCA – Taxation Year Less than Twelve Months In the first or last year of the carrying on of a business, a fiscal period with less than 365 days may occur. Under these circumstances, the maximum CCA for all of the commonly used CCA classes, with the exception Chapter 5 13  Fanshawe College FINA 3043 - Taxation 1 Wasim A. Ismail of class 14, must be calculated using a proration based on the relationship between the days in the actual short fiscal period and 365 days. Note that it is the length of the fiscal period for the business, not the period of ownership of the property, that determines the proration. The application of both the half-year rule and the short fiscal period rule results in a double reduction in the maximum CCA claim. On the other hand, when the AccII is applied together with a reduction for the short fiscal period rule, it will reduce the impact of the AccII. An exception to the short fiscal period rule is class 14. It is also the situation in which an individual is earning net income from property that is rental income. But for a corporation earning rental income, CCA is prorated. Example 5.16: A corporation begins carrying on a business on November 1, 2023 choosing December 31 as the fiscal period for its business which becomes its taxation year. On November 11, 2023, the company acquires class 8 property with a capital cost of $300,000. Calculate CCA and UCC ending under the scenario of the ½-year rule (before the AccII) and after the Accelerated Investment Incentive (AccII) took effect. Solution: PROCEEDS OF DISPOSITION, RECAPTURE AND TERMINAL LOSS Involuntary and voluntary disposition of capital property create proceeds of disposition or deemed proceeds, and arise from:  The sale or transfer of an asset (voluntary disposition)  The theft, destruction, or expropriation of an asset (involuntary disposition)  A change in the taxpayer’s circumstances – death or becoming a non-resident (deemed disposition)  A change in the use of the asset (deemed disposition) For tax purposes, the taxpayer may end up with any of the following: Chapter 5 14  Fanshawe College FINA 3043 - Taxation 1 Wasim A. Ismail  UCC with assets remaining in the class  UCC with no assets remaining in the class (terminal loss)  A negative UCC (recapture of depreciation) Capital Gain This occurs when the proceeds of disposition exceed the capital cost of the asset. A capital gain falls outside of the CCA accounting. The proceeds of disposition are capped at the capital cost of the asset, and anything above that is a capital gain. There is no such thing as a capital loss on depreciable property, rather a terminal loss (as will be seen below). A capital loss can occur with non-depreciable capital property such as land or public company stocks. Losses on private company stock are business investments losses. UCC with Assets Remaining in the Class CCA continues to be taken on remaining UCC amount in the class after disposal of assets. Example 5.17: Class 8 has in it 3 pieces of equipment and UCC beginning is currently $4,000; the business sells one piece of equipment for $1,000 and the equipment sold had an original cost of $900. Calculate CCA and UCC ending. Solution: First, as mentioned earlier, dispositions are the lesser of capital cost OR proceeds of disposition. In this case, the equipment was originally worth $900 and the proceeds are $1,000 so the lower is $900. The $100 difference is a capital gain which will go into paragraph 3(b) as a $50 taxable capital gain. Again, the maximum that leaves the CCA class is what went in there in the first place, and what went in there is $900 worth of equipment. Net additions = additions – dispositions Net additions = $0 – $900 = ($900) UCC (before CCA) = UCC beginning + net additions UCC (before CCA) = $4,000 – $900 = $3,100 CCA = UCC (before CCA) X prescribed rate (per class) CCA = $3,100 X 20% = $620 UCC ending = UCC beginning + net additions – CCA UCC ending = $4,000 – $900 – $620 = $2,480 Example 5.18: Class 8 has in it 3 pieces of equipment and UCC beginning is currently $4,000; the business sells one piece of equipment for $800 and the equipment sold had an original cost of $900. Calculate CCA and UCC ending. Chapter 5 15  Fanshawe College FINA 3043 - Taxation 1 Wasim A. Ismail Solution: Net additions = additions – dispositions Net additions = $0 – *$800 = ($800); lesser of proceeds of $800 or original cost of $900 is $800 UCC (before CCA) = UCC beginning + net additions UCC (before CCA) = $4,000 – $800 = $3,200 CCA = UCC (before CCA) X prescribed rate (per class) CCA = $3,200 X 20% = $640 UCC ending = UCC beginning + net additions – CCA UCC ending = $4,000 – $800 – $640 = $2,560 UCC with No Assets Remaining in the Class – Terminal Loss When all assets in a class are disposed of, and a positive amount in the UCC (before CCA) remains, this amount is a terminal loss and 100% deductible against business or property income; it is not discretionary but a must. An employee cannot claim a terminal loss against employment income even though they may have assets that are allowed CCA (such as vehicle CCA as allowed under paragraph 8(1)(j)). Example 5.19: Class 8 has in it 3 pieces of equipment and UCC beginning is currently $4,000; the business sells all 3 of them below the original costs and receives a total of $3,600. Calculate CCA and UCC ending. Solution: Net additions = additions – dispositions Net additions = $0 – $3,600 = ($3,600) UCC (before CCA) = UCC beginning + net additions UCC (before CCA) = $4,000 – $3,600 = $400; note that there are no assets left in the class. The entire $400 is taken as a terminal loss and deducted entirely against business income. UCC ending = $0 Another way of thinking about this is that this is a loss on disposal of the asset. In accounting, if proceeds are less than the book value of an asset, then this is recorded as a loss on disposal. The equivalent of a terminal loss in accounting terms is a loss on the disposition of an asset. The accounting scenario would be assets having a net book value of $4,000 which are sold for only $3,600. Assume that the original cost of these assets was $10,000 and their accumulated depreciation (A/D) $6,000: Assets $10,000 Less: A/D ($6,000) Chapter 5 16  Fanshawe College FINA 3043 - Taxation 1 Wasim A. Ismail Net Book Value $ 4,000 The journal entry to show the sale of these assets for $3,600 cash would be as follows: DR. Loss on Disposition $ 400 DR. Cash $ 3,600 DR. A/D $ 6,000 CR. Assets $10,000 Recaptured Depreciation When proceeds of disposition exceed UCC beginning, UCC (before CCA) becomes negative. This results in a recapture of depreciation. This is the opposite of a terminal loss and can occur even if there are assets left in the given class. Such a recapture may be avoided if assets in the same class are purchased in the same year. Example 5.19: Class 8 has in it 3 pieces of equipment and UCC beginning is currently $2,000; the business sells 1 of them below its original cost for proceeds of $2,500. Calculate CCA and UCC ending. Solution: Net additions = additions – dispositions Net additions = $0 – $2,500 = ($2,500) UCC (before CCA) = UCC beginning + net additions UCC (before CCA) = $2,000 – $2,500 = ($500) The negative amount indicates that there was a gain on disposal, but not a capital gain because the proceeds of disposition are not greater than the original cost as indicated above. The $500 is depreciation recapture and it is added to income. UCC ending = $0 which means that if any other equipment is sold then it will all become depreciation recapture. The answer to the above question would be the same whether it was three pieces of equipment or one piece of equipment which was sold. In accounting terms, depreciation recapture would be the equivalent of a gain on disposition of an asset. Assume that it is one piece of equipment which originally cost $10,000 with accumulated depreciation (A/D) of $8,000: Chapter 5 17  Fanshawe College FINA 3043 - Taxation 1 Wasim A. Ismail Assets $10,000 Less: A/D ($8,000) Net Book Value $ 2,000 The journal entry to show the sale of the asset for $2,500 cash would be as follows: DR. Cash $ 2,500 DR. A/D $ 8,000 CR. Assets $10,000 CR. Gain on Disposition $ 500 Separate Class Election The default for most depreciable property is to pool assets together in one class. This means that acquisitions and dispositions are blended together. This may not be in the best interest of the taxpayer because an acquisition adds to the CCA pool, while a disposition subtracts away from it. The disposition might be one in which there is a terminal loss. A terminal loss allows the taxpayer to write off the entire UCC of the asset. This write-off would not be as effective if such an asset is pooled with other assets. There are few exceptions regarding pooling assets together, such as the rule that requires each rental property with a capital cost in excess of $50,000 to be included in a separate class and the separate class concept of Class 10.1 (luxury vehicles); both of these exceptions are not optional. On the other hand, elective options are available on a selective basis to include certain types of depreciable property in separate classes. For example, high tech or electronic products that are normally included in class 8 have actual service lives that are significantly shorter than the 20% class 8 CCA rate. ITR 1101(5p) lists the following specific types of class 8 properties that are eligible for separate class treatment, provided they have a capital cost of $1,000 or more:  Photocopiers  Electronic communications equipment, such as telephone equipment  Computer software (only if included in class 8 rather than class 12 or 50) Example 5.20: A $25,000 photocopier in Class 8 is in its third year of CCA as follows: Chapter 5 18  Fanshawe College FINA 3043 - Taxation 1 Wasim A. Ismail Capital cost $25,000 CCA year 1 including Accll adjustment = [(20%)(150%)($25,000) ($7,500) CCA year 2 = [(20%)($25,000 – $7,500)] ($3,500) UCC beginning for year 3 $14,000 If this photocopier becomes obsolete, the entire $14,000 could potentially be written off as a terminal loss, less any amount received for the disposition, for example $5,000. In this case, a $9,000 terminal loss is claimed. On the other hand, if a new photocopier costing $15,000 is purchased in the same year while the old photocopier is disposed of for $5,000 and both are pooled in the same class, the outcome for year 3 would be as follows: UCC beginning for year 3 $14,000 Net Additions = $15,000 – $5,000 = $10,000 CCA = [(20%)($14,000 + (150%)($10,000)] ($5,800) UCC beginning for year 4 $ 8,200 In the case when they are not pooled together, the terminal loss for the old one would be $9,000 and the CCA in a new class for the new one would be [(20%)(150%)($15,000)] = $4,500; the total deduction is $9,000 terminal loss + $4,500 CCA = $13,500 as compared with CCA of $5,800 when they are pooled together. Class 1 – Building (4%, 6%, or 10%) In general, class 1 is a 4% declining balance class that applies to buildings acquired after 1987. This class also includes bridges, canals, culverts, subways, tunnels, and certain railway roadbeds. If an election is made to place new non-residential buildings acquired after March 18, 2007, in a separate class 1, the CCA rate will increase from the basic 4% to the following rates, as follows:  10% if the building is used 90% or more for manufacturing and processing; the CRA considers that any supporting activities to a manufacturing operation, such as administrative offices, cafeterias, washrooms, and so on, would be considered as manufacturing and processing space.  6% if the building is used 90% or more for business purposes but that use is not manufacturing and processing. This could occur where only part of the business is manufacturing and processing or there is no manufacturing or processing at all in the business. Generally the 90% test is based on the use of the square footage of the building.  This leaves 4% for other buildings, which would be residential rentals for example. Zero-Emission Vehicles (ZEV) and Zero-Emission Passenger Vehicles (ZEPV) These are covered in classes 54 (30%), 55 (40%), and 56 (30%) and have certain incentives regarding CCA.  Class 54 for those new ZEVs that would otherwise have been included in classes 10 or 10.1  Class 55 for those new ZEVs that would otherwise have been included in Class 16 (i.e., taxis)  Class 56 (30%) for zero-emission automotive equipment (other than motor vehicles) that are fully electric or powered by hydrogen. The automotive equipment that qualifies includes aircraft, watercraft, trolley buses, and railway locomotives. Costs to convert automotive equipment such as gas-powered Chapter 5 19  Fanshawe College FINA 3043 - Taxation 1 Wasim A. Ismail equipment to zero-emission equipment would also qualify and be considered available for use once no emissions are produced. Class 56 also requires meeting the conditions to qualify for the AccII In the case of class 54, the amount of deductible CCA will, for vehicles purchased on or after January 1, 2023, be limited to $61,000 if the ZEV qualifies as a “zero-emission passenger vehicle” (ZEPV). This is identical to the rules dealing with passenger vehicles under class 10.1 which is also limited to $36,000 The three categories of zero-emission property are technically excluded from the AccII provisions because the intention was to allow 100% of the cost of the property in each of the three categories to be claimed as CCA in the year of purchase rather than to allow an additional 50% in first-year CCA. The CCA rate for classes 54 and 56 is 30%, requiring an adjustment of 2 1/3, and the class 55 rate is 40%, requiring an adjustment of 1½ Class 14.1 – Goodwill and other Intangible Property or Capital Expenditures The CCA rate for this class is 5% applied on a declining balance method basis. AccII generally applies. No terminal loss in this class can be claimed until the business has ceased to be carried on by the taxpayer. On the other hand, CCA can continue to be claimed on the UCC balance even though there are no properties remaining in the class. Goodwill is intangible property that represents the excess of the purchase price over the FMV of identifiable property acquired on the purchase of a business. Goodwill attaches to a business and obtains value as a business grows. This is often referred to as internally generated goodwill. The ITA, however, only recognizes goodwill for income tax purposes when there is an actual cost to that goodwill. This can only happen if an existing business is purchased for an amount that is greater than the FMV of the identifiable property of the business that is acquired. In recognition of internally generated goodwill, a business is deemed to own goodwill that has a cost of nil. Other Intangible Property or Capital Expenditures - this generally includes intangible properties with unlimited lives. Intangible property with limited lives are included in class 14 or, in the case of patents, class 44. Examples of properties or capital expenditures that are included in class 14.1 are trademarks, patents, licenses, and franchises with unlimited lives, expenses of incorporation to the extent they exceed $3,000 where the first $3,000 of incorporation expenses are allowed to be fully deducted. Immediate Expensing for Individuals, CCPCs, and Certain Partnerships Chapter 5 20  Fanshawe College FINA 3043 - Taxation 1 Wasim A. Ismail The immediate expensing incentive was added by the 2021 federal budget and it overrides both the half-year rule and the AccII, but it is temporary in nature, applying only until either December 31, 2023, or December 31, 2024, depending on the nature of the taxpayer. Such businesses are allowed to expense up to $1.5 million per year in capital expenditures for most types of depreciable property. They are:  CCPCs – private corporations that are resident in Canada (i.e., incorporated in Canada) and that are controlled by residents of Canada. Controlled generally means that residents of Canada own the majority of the issued voting shares of the company.  Canadian Resident Individuals  Canadian Partnerships – a partnership where the partners are resident in Canada. There are three variations of qualifying Canadian partnerships, which depends on the composition of the partners: i. where all partners are individuals resident in Canada; ii. where all partners are CCPCs; and iii. where partners are a combination of individuals resident in Canada and CCPCs. Partnerships with another partnership as a partner (i.e., tiered partnerships) do not qualify for the incentive regardless of the composition of the partners of that other partnership. The immediate expensing incentive has two separate application periods depending on the identity of the eligible person or partnership. Qualifying depreciable property, referred to as “Designated Immediate Expensing Property” or DIEP, purchased during one of the two relevant application periods will qualify for this generous incentive. The two application periods are as follows:  April 19, 2021, to December 31, 2023: Applies to CCPCs, Canadian partnerships where all partners are CCPCs, and Canadian partnerships where partners are a combination of resident Canadian individuals and CCPCs;  January 1, 2022, to December 31, 2024: Applies to Canadian resident individuals and Canadian partnerships where all of the partners are Canadian resident individuals The annual deduction which is claimed as a CCA deduction is equal to the least of the following three amounts: 1. The “immediate expensing limit” for the taxation year, which $1.5 million 2. The capital cost of the depreciable property purchases that is DIEP 3. For all eligible persons and partnerships other than CCPCs, the income in the business or property source in which the DIEP is used net of all expenses except CCA. This rule prevents individuals and partnerships from using the immediate expense amount to create or increase a business loss or property loss. The third option does not apply to CCPCs; a CCPC could use the immediate expensing incentive even in the case that it will cause a net loss or if there is already a net loss. Example 5.22: An individual carries on a business throughout 2023. The fiscal period of the business is the calendar year. The 2023 business income after all expenses except CCA is $389,000. In 2023 the individual purchases depreciable property that qualifies for the immediate expense incentive in the amount of $810,000 The immediate expense amount would be the least of: 1. $1.5 million (the immediate expense limit), Chapter 5 21  Fanshawe College FINA 3043 - Taxation 1 Wasim A. Ismail 2. $810,000 (the maximum potential DIEP amount), or 3. $389,000 (the business income before CCA). As a result, the immediate expense amount would be limited to $389,000. The individual would be required to restrict the DIEP to that same amount. If the business owner were a CCPC instead of an individual, the income limitation would not apply and the immediate expense amount would equal $810,000, resulting in a 2023 business loss of $421,000 [$389,000 - $810,000]. Chapter 5 22