CCA Short Preso

Capital Cost Allowance:

Capital Cost Allowance Amortization or Depreciation

CCA:

2 CCA Capital Cost Allowance (CCA) is the ‘depreciation’ method used by taxpayers in Canada when reporting business income to CRA Canada Revenue Agency for tax purposes.

Importance of CCA to Financial Decisions:

3 Importance of CCA to Financial Decisions Taxation issues must be explicitly addressed in each financial decision you make. Since CCA affects the net income from a business (and especially affects net cash flow), knowledge of the CCA system is essential for all business decision-makers.

CCA gives rise to a ‘Tax Shield Benefit’ to the Company:

4 CCA gives rise to a ‘Tax Shield Benefit’ to the Company CCA is a non-cash deduction from income that would otherwise be subject to income taxation. As a result of the CCA deduction, taxable income is reduced. This results in a savings in tax payable. The tax shield benefits is equal to: T(CCA) t = corporate tax rate CCA = the dollar amount of CCA claimed A firm with a 40% corporate tax rate and a $2,000 CCA deduction will save $800 in taxes.

Example: Consider two firms that report $10,000 in earnings before CCA and taxes, face a 40% tax rate. One firm has no CCA to claim, the other can claim $2,000 in CCA:

5 K. Hartviksen Example: Consider two firms that report $10,000 in earnings before CCA and taxes, face a 40% tax rate. One firm has no CCA to claim, the other can claim $2,000 in CCA Company A Company B Earnings Before CCA & Tax $10,000 $10,000 CCA 2,000 0 Taxable Income $ 8,000 $ 10,000 Taxes @ 40% 3,200 4,000 Net Income $ 4,800 $ 6,000 Add back non-cash expense 2,000 0 Cash flow from Operations $ 6,800 $ 6,000 Note that company A is better off by $800 because of the $2,000 non-cash deduction of CCA. That is the amount of taxes saved. If you look at net income, Company A appears to be worse off, however, that is only an accounting illusion!!

CCA vs. Accounting Depreciation:

6 CCA vs. Accounting Depreciation CCA like assets are grouped into pools or classes the CCA rate used in each asset class is setout in the regulations to the Income Tax Act and may or may not reflect economic wastage of the asset no estimate of useful life or of salvage value as long as the firm remains in existence, and assets remain in the pool, residual UCC values will remain in the pool. Accounting Depreciation choose the method that will best represent the economic wastage of the asset (declining balance, sum-of-the-year’s digits, straight-line, etc.) individual assets are depreciated estimate of useful life and salvage value is included

CCA Rules:

7 CCA Rules 1/2 of the regular CCA rate for the class applies to the net additions to the pool for that year.

Disposition of Assets and CCA:

12 Disposition of Assets and CCA A taxable capital gain would occur if the firm sold a depreciable asset for greater than it’s original cost. Capital Gain = Original Cost Base - Salvage Value

Disposition of Assets and CCA:

13 Disposition of Assets and CCA If the salvage value of the asset exceeds the UCC of the pool there is a recapture of depreciation recaptured depreciation is subject to tax Recaptured Depreciation = UCC pool - Salvage Value

Disposition of Assets and CCA:

14 Disposition of Assets and CCA When the last physical asset in the pool is sold and not replaced, the pool will be closed out. If there is a positive balance remaining in the pool after disposition, that balance is called a terminal loss and is deductible from income in that year….it is a non-cash deduction just like CCA.

CCA Schedule (Disposals):

CCA Schedule (Disposals) When you dispose of assets from the pool remember…that you are not allowed ANY CCA on the asset that has been disposed of even though you might have used the asset for the greater part of the fiscal year.

CCA Schedule – changes over time:

CCA Schedule – changes over time

CCA Schedule – Recapture:

CCA Schedule – Recapture If the proceeds on the sale of an asset in the pool cause the balance in the pool to become negative…that negative amount is a recapture of depreciation.

Recapture of Depreciation:

Recapture of Depreciation A recapture is ‘realized’ on the disposal of an asset in a CCA pool where the remaining balance in the pool turns negative….essentially this arises because the government has allowed you to depreciate for tax purposes the equipment at too great a rate. When you sold the equipment…the selling price did not reflect the ‘depreciated value’…the selling price exceeded not only the depreciated value of the individual asset…but if other assets remain in the pool, the selling price has exceeded the depreciated (or UCC) of all of the assets remaining in the pool. You will have to claim the recapture as income in the fiscal year that it was realized…and pay income taxes on it.

CCA Schedule – Terminal Loss:

CCA Schedule – Terminal Loss If the LAST physical asset in the asset class was finally sold for $5,000, and $4,250 was left in the pool…the $4,250 is a ‘terminal loss’.

Terminal Losses are Rare:

Terminal Losses are Rare These are usually pretty rare in practice…because, generally when old assets are worn out…they are replaced…and therefore, there remain physical assets in the pool. Only if a firm is getting out of a line of business…and disposing of all of their assets (or perhaps deciding to lease them all instead of owning them)…can you imagine a firm disposing of all of the assets in an asset pool.

Tax Treatment of Terminal Losses:

Tax Treatment of Terminal Losses In essence, a residual value left in the pool after the sale of the last physical asset…can only occur if the sale value of the assets (disposal values) were less than the UCC of the assets…this means that over time, the government’s CCA rate did not reflect the true ‘wastage’ of the assets. Consequently, a terminal loss can be deducted from income (just like regular CCA) Since a terminal loss is a non-cash deduction (like CCA) it will give rise to a tax shield (Tax shield = terminal loss times the corporate tax rate)

CCA Schedule – Capital Gain:

CCA Schedule – Capital Gain You sell an asset for $20,000 that originally cost you $16,500, you would use the lower of the two values to record this disposal for CCA purposes.

CCA Schedule – Capital Gain and a Recapture:

CCA Schedule – Capital Gain and a Recapture You sell an asset for $20,000 that originally cost you $16,500, you would use the lower of the two values to record this disposal for CCA purposes. If the sale causes the UCC to become negative…a recapture of depreciation will also be triggered by the transaction.

Capital Gains and CCA:

Capital Gains and CCA If you sell a depreciable asset for more than it’s original cost…then the difference is a realized capital gain: Capital Gain = Selling Price – Original Cost $3,500 = $20,000 - $16,500 You would use the lower of the Original cost or the selling price when recording the asset disposal for CCA purposes…. (in this case $16,500)

Finding ending CCA using a full CCA Schedule:

Finding ending CCA using a full CCA Schedule

CCA and Capital Budgeting:

CCA and Capital Budgeting Since the tax shield on CCA varies over time and the stream of tax shield benefits can go on forever, it is necessary to develop an equation for the tax shield on CCA This equation assumes the asset is purchased and held forever (there is no salvage value)…that the maximum CCA is claimed each year