PRB 06-06E
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CAPITAL COST ALLOWANCE

Prepared by:
Sheena Starky
Economics Division
3 April 2006

TABLE OF CONTENTS

• WHAT IS A CAPITAL COST ALLOWANCE?
• CAPITAL COST ALLOWANCE RATES
• HOW IS THE CAPITAL COST ALLOWANCE DEDUCTION CALCULATED?
• SELECTED REFERENCES AND LINKS
• APPENDIX A - COMMON CAPITAL COST ALLOWANCE CLASSES
• APPENDIX B - RECENT CHANGES TO CAPITAL COST ALLOWANCE (CCA)
  RATES IN FEDERAL BUDGETS, 2000-2006

CAPITAL COST ALLOWANCE

WHAT IS A CAPITAL COST ALLOWANCE?

The cost of depreciable assets, such as buildings, furniture and equipment, acquired for use in business or professional activities cannot be deducted as an up‑front expense when calculating net income for tax purposes.  In recognition, however, of the fact that these assets wear out or become obsolete over time and are replaced, the federal government created the capital cost allowance (CCA).  The CCA is a non-refundable tax deduction that reduces taxes owed by permitting the cost of business-related assets to be deducted from income over a prescribed number of years.(1)

CAPITAL COST ALLOWANCE RATES

Canadian legislation sets out more than 40 classes of assets and their associated CCA rates, which are expressed in percentage terms.  In 1987, the federal government reduced many CCA rates to reflect more accurately what it believed were the useful economic lives of certain assets.  Since then, the federal government has indicated that it will follow a policy of setting and revising CCA rates to reflect the economic life of assets as closely as possible.  Appendix A provides a list of commonly used asset classes and their CCA rates as of 2005, while Appendix B provides an overview of changes to CCA rates in federal budgets between 2000 and 2006.

On occasion, a CCA rate is “accelerated” or clearly set above what would be required to reflect the economic useful life of the asset.(2)  By permitting an asset to be depreciated more quickly, an accelerated CCA rate can be used to increase the incentive for investing in the asset.  Accelerated CCA rates are available for items such as renewable energy and energy efficiency equipment, vessels, mining assets, and capital equipment used for scientific research and experimental development.  The 2005 federal budget established that, in the future, new accelerated CCA rates will be considered only for investments in green technology.

Differences in the classification of assets and the method of calculating the CCA (or its equivalent) make it difficult to compare meaningfully the generosity of CCA systems across countries.

HOW IS THE CAPITAL COST ALLOWANCE DEDUCTION CALCULATED?

Since the coming into force of the Income Tax Act in 1949, Canada has used the declining balance method for calculating the CCA deduction for most asset classes.(3)  This method involves applying the appropriate CCA rate to the undepreciated capital cost of an asset, or group of assets from the same class, at the end of each year.

The CCA rate is the maximum rate that can be applied to assets in that class in each year; only one-half of the normal CCA rate can generally be claimed in the year that an asset is acquired and first used, and a taxpayer may elect to claim a smaller deduction in any year if it is advantageous.(4)

The undepreciated capital cost of an asset class is equal to the full cost of any new assets plus the undepreciated balance from existing assets in the same class.(5)  Disposal of an asset reduces the undepreciated balance by the value of the proceeds of disposition up to the original capital cost of the asset.  Proceeds received in excess of the asset’s original capital cost are treated as a taxable capital gain.  If there is a positive undepreciated capital cost when all assets in an asset class are sold, this value is considered a “terminal loss” and may be deducted from income.  A terminal loss occurs when the CCA rate underestimated the true economic depreciation of the asset’s value.(6)  Conversely, if the sale or salvage value of the asset exceeds the undepreciated capital cost of the class of assets, there is a “recapture” of depreciation that is subject to tax.  A recapture, therefore, occurs when the CCA rate overestimated the true economic depreciation of the asset’s value.

Table 1 shows the CCA calculation for a hypothetical asset purchased in year 1 for $10,000 and subject to a CCA rate of 12% using the declining balance method.  The asset is assumed to be the only one in its class.

*  One-half (6%) of the normal CCA rate (12%) is permitted in the first year.

Source:  Calculations by the Library of Parliament.

The declining balance method produces relatively larger CCA deductions during the earlier years of an asset’s life, decreasing deductions over time, and an asset balance that never reaches zero.

Some asset classes are not subject to the declining balance method; the CCA is instead calculated using the straight-line method or a rate determined by the consumption of the asset.  Unlike the declining balance method, the straight-line method is calculated on an asset-by-asset basis and generates equal CCA deductions each year until the undepreciated balance reaches zero.  Table 2 shows the CCA calculation for the same asset as in Table 1, instead using the straight-line method and assuming a useful life of 10 years.

*  The half-year rule generally does not apply to asset classes that use the straight-line method to calculate the CCA; however, other rules may apply to specific asset classes.

Source:  Calculations by the Library of Parliament.

SELECTED REFERENCES AND LINKS

• Canada Revenue Agency
• Rose Filice, ed., Capital Cost Allowance in Canada, 2nd ed., CCH Canadian Limited, Toronto, 2005.

APPENDIX A

COMMON CAPITAL COST ALLOWANCE CLASSES

Note:       A complete list of CCA asset classes and their CCA rates is available in the Income Tax Regulations.
Source:   Canada Revenue Agency, T2 Corporation – Income Tax Guide, 2005, p. 33.

APPENDIX B

RECENT CHANGES TO CAPITAL COST ALLOWANCE (CCA) RATES
IN FEDERAL BUDGETS, 2000-2006(1)

Budget 2000

• Increased the CCA rate for certain rail assets, including railway cars, locomotives and rail suspension devices, to 15%.
• Increased the CCA rate for electrical generating equipment, heat production and distribution equipment, and water distribution equipment from 4% to 8%.

Budget 2001

• Expanded the scope of Class 43.1 assets to include larger hydro-electric projects and the equipment used to generate electricity from “blast furnace gas” (a by-product of the steel manufacturing process).

Budget 2003

• Expanded the scope of Class 43.1 assets to include:  certain stationary fuel cell systems; equipment acquired for electricity generation using bio-oil; and certain types of equipment used in greenhouse operations.

Budget 2004

• Increased the CCA rate for computer equipment from 30% to 45%.
• Increased the CCA rate for broadband, Internet and other data network infrastructure equipment from 20% to 30%.

Budget 2005

• Increased the CCA rate for combustion turbines that generate electricity from 8% to 15%.
• Increased the CCA rate for electricity transmission and distribution assets from 4% to 8%.
• Increased the CCA rate for oil and gas transmission pipelines from 4% to 8%, and set a 15% rate for compression and pumping equipment on such pipelines.
• Increased the CCA rate for cables used for telecommunications infrastructure from 5% to 12%.
• Expanded the scope of Class 43.1 assets to include distribution equipment used in district energy systems that rely on efficient cogeneration, as well as biogas production equipment.
• Created Class 43.2, which further accelerated the CCA rate for certain Class 43.1 assets acquired during the next seven years – including highly fossil-fuel-efficient and renewable energy generation equipment – from 30% to 50%.

Budget 2006(2)

• Expanded the scope of Class 43.1 and Class 43.2 assets to include cogeneration systems that use a type of biomass used in the pulp and paper industry, which is commonly referred to as “black liquor” or “spent pulping liquor.”(3)
• Increased the limit on the cost of tools eligible for the 100% CCA rate from $200 to $500.