All business owners are faced with depreciation and the declining value of their assets. It’s a reality of owning an enterprise, particularly in capital-heavy sectors that rely on machinery, buildings and equipment. Depreciation affects the way you conduct your accounting and how you assess your overall performance.
Depreciation – The Diminishing Value of Your Property
When we talk about depreciation, there are different ways that a company’s assets can depreciate in value, including:
- Physical depreciation – Wear and tear on the asset
- Functional depreciation – The asset’s function becomes inadequate or unneeded
- Technological depreciation –Another means of performing the same function (better or cheaper) becomes available
- Monetary depreciation – The need to set aside additional money to replace an asset because inflation has pushed up the price of a replacement
Business owners from all industries should understand the impact that depreciation has on their long-term valuations, as well as the considerations that go into accounting and taxation calculations.
Some key considerations are described below. Business owners should consult their accountants for professional advice and services for their specific depreciation needs.
Canadian Tax Law on Depreciation – Capital Cost Allowance (CCA)
Canada’s tax law allows only one depreciation expense – the Capital Cost Allowance (CCA).
Under the CCA, the costs of capital assets are generally not fully deductible as an expense in the year of purchase. Rather, each year you can deduct a percentage of the asset’s cost.
For tax purposes, “depreciation” refers to the part of the cost you may deduct. This piece of tax law provides an incentive to keep businesses investing in productive assets, while recognizing the decreasing value of equipment through its life cycle.
The CCA groups assets in classes according to their type and use. The range is broad and there are over 50 different classes of assets, each with its own rate of depreciation. The rates are varied according to the government’s intention of encouraging certain purchases or better reflect the asset’s useful life.
CCA and Your Tax Return
When filing your tax return, each CCA asset class must be accounted for separately.
Business owners should rely on professional accountants to file their returns, but you can estimate the CCA depreciation benefits by following this formula:
- Begin with the capital costs of all assets in that class at the beginning of the year.
- Subtract the proceeds from the sale
- Add the cost of assets you purchased during the year (use the “allowable” cost – only 50% in the first year while the other 50% is shifted to the subsequent years)
- Subtract any government assistance or investment tax credits.
- Take the resulting figure – this is the un-depreciated Capital Cost for your tax calculations
- Apply the appropriate CCA Rate. The rates are specified on the CRA website.
Only 50% of the CCA can be claimed in the first year that an asset is required.
Get the Tax Relief
Here are a couple tips to remember when making capital purchases and filing your taxes. .
First, if you plan on purchasing assets early next business year, consider expediting the purchase before the year-end. In most cases you can then claim 50% of the CCA for the current year and the remaining deduction the next year.
Similarly, if you have non-capital losses, it may be advantageous not to claim CCA until all non-capital losses have been claimed. Non-capital losses expire after a defined period, but CCA can be carried forward indefinitely.
Understanding Depreciation – Your Turn
Has your company worked through a large capital or property purchase?
What has been your experience?