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Capital Cost Allowance Presentation Transcript

  • 1. 1 Wali Memon
  • 2. Important Terms (CCA) Capital gain Generally accepted accounting principles (GAAP) Capital loss Half-year rule Cash flow from operations Operating loss Cash flow statement Terminal loss CCA recapture Undepreciated capital cost Depreciation (UCC)2 Wali Memon
  • 3. CCA (CCA) is the ‘depreciation’ method used by taxpayers in Canada when reporting business income to CRA Canada Revenue Agency for tax purposes.3 Wali Memon
  • 4. 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.4 Wali Memon
  • 5. CCA gives rise to a ‘Tax Shield Benefit’ to theCompany 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)Tax Savings on CCA = Corporate Tax Rate × CCA = 40% × $2,000 = $800 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.
  • 6. 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 BEarnings Before CCA & Tax $10,000 $10,000CCA 2,000 0Taxable Income $ 8,000 $ 10,000Taxes @ 40% 3,200 4,000Net Income $ 4,800 $ 6,000Add back non-cash expense 2,000 0Cash 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. 6 Wali Memon If you look at net income, Company A appears to be worse off, however, that is only an accounting illusion!!
  • 7. CCA vs. Accounting Depreciation CCA like assets are grouped into Accounting Depreciation pools or classes choose the method that will the CCA rate used in each asset best represent the economic class is setout in the wastage of the asset (declining regulations to the Income Tax Act and may or may not reflect balance, sum-of-the-year’s economic wastage of the asset digits, straight-line, etc.) no estimate of useful life or of individual assets are salvage value depreciated as long as the firm remains in estimate of useful life and existence, and assets remain in salvage value is included the pool, residual UCC values will remain in the pool.7 Wali Memon
  • 8. CCA Rules 1/2 of the regular CCA rate for the class applies to the net additions to the pool for that year. CCA cannot be used to create a tax loss.8 Wali Memon
  • 9. CCA Over Time - A Simple ExampleAssume you acquire a depreciable asset with a cost base of $100,000 and there are no otherassets in this pool. The CCA rate for the pool is 10%. Note you are allowed only 1/2 the regularCCA rate on the net additions to the pool in the year of acquisition.Year UCC of pool Addition CCA @ 10% 1 0 100000 5000 2 95000 0 9500 3 85500 0 8550 4 76950 0 7695etc.9 Wali Memon
  • 10. CCA Tax Shield Over Time (Assume a corporate Tax Rate ‘T’ of 40%) Year UCC of pool Addition CCA @ 10% T(CCA) 1 0 100,000 5,000 2,000 2 95,000 0 9,500 3,800 3 85,500 0 8,550 3,420 4 76,950 0 7,695 3,078 5 69,255 0 6,926 2,770 6 62,330 0 6,233 2,493 7 56,097 0 5,610 2,244 8 50,487 0 5,049 2,019 9 45,438 0 4,544 1,81810 Wali Memon
  • 11. Tax Shield Over Time (A Graphical Representation) T(CCA) at 10% on $100,000 4000 3500 3000 2500 Asymptotic Tax Shield 2000 Curve 1500 1000 500 0 1 3 5 7 9 11 13 15 17 19 Year11 Wali Memon
  • 12. Observations In the foregoing you can now readily see: CCA provides large tax shields in the early years of the asset’s life residual values remain in the pool long after the asset was acquired…this means that the firm will never fully recoup the original cost of the asset … as the firm’s asset base ages, cash flows generated from CCA will not enable the firm to replace the original asset. If a capital intensive firm were to pay out all of its earnings in the form of dividends, there would not be sufficient cash flow left to replenish the asset base that is wearing out… eventually the firm would go out of business … its physical assets would be worthless and UCC would remain on it’s books!12 Wali Memon
  • 13. 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 Value13 Wali Memon
  • 14. 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 = UCCpool - Salvage Value14 Wali Memon
  • 15. 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.15 Wali Memon
  • 16. CRA Form 1 2 3 4 5 6 7 8 9 10 Class Undepreciated Cost of Proceeds of UCC Adjustments for Base amount Rate CCA UCC at thenumber capital cost additions in dispositions after additions current year for capital % for the year end of the (UCC) at the the year in the year and additions (1/2 cost (col. 7 times year (col. 5 start of the dispositions times (col. 3 allow ance 8 or an minus 9) year (col. 2 plus 3 minues 4)) If (col. 5 minus adjusted minus 4) negative, enter 6) amount) 6 91,874.00 32,880.00 25,000.00 99,754.00 3,940.00 95,814.00 0.1 9,581.40 90,172.60 6 90,172.60 11,900.00 54,008.00 48,064.60 0.00 48,064.60 0.1 4,806.46 43,258.14 TOTAL CCA = 14,387.86 TAX SAVINGS = 3,596.97 16 Wali Memon
  • 17. - Depreciation for tax purposes Class Rate Assets 1 4% Buildings acquired after 1987 8 20% Furniture, photocopiers 10 30% Vans, trucks, tractors and computers 13 Straight-line Leasehold improvements 16 40% Taxicabs and rental cars 22 50% Pollution control equipment 43 30% Manufacturing equipment17 Wali Memon
  • 18. CCA Schedule (simple) 1 2 3 4 5 6 7 8 9 10 Class Undepreciated Cost of Proceeds of UCC Adjustments for Base amount Rate CCA UCC at thenumber capital cost additions in dispositions in af ter additions current year for capital cost % for the year end of the (UCC) at the the year the year (Use and additions (1/2 allow ance (col. 7 times year (col. 5 start of the the low er of dispositions times (col. 3 (col. 5 minus 8 or an minus 9) year Original cost (col. 2 plus 3 minues 4)) If 6) adjusted or selling minus 4) negative, enter amount) price) "0" 6 10,000.00 0.00 0.00 10,000.00 0.00 10,000.00 0.1 1,000.00 9,000.00 18 Wali Memon
  • 19. CCA Schedule (simple over time) 1 2 3 4 5 6 7 8 9 10 Class Undepreciated Cost of Proceeds of UCC Adjustments for Base amount Rate CCA UCC at thenumber capital cost additions in dispositions in after additions current year for capital cost % for the year end of the (UCC) at the the year the year (Use and additions (1/2 allow ance (col. 7 times year (col. 5 start of the the low er of dispositions times (col. 3 (col. 5 minus 8 or an minus 9) year Original cost (col. 2 plus 3 minues 4)) If 6) adjusted or selling minus 4) negative, enter amount) price) "0" 6 10,000.00 0.00 0.00 10,000.00 0.00 10,000.00 0.1 1,000.00 9,000.00 9,000.00 0.00 0.00 9,000.00 0.00 9,000.00 0.1 900.00 8,100.00 8,100.00 0.00 0.00 8,100.00 0.00 8,100.00 0.1 810.00 7,290.00 7,290.00 0.00 0.00 7,290.00 0.00 7,290.00 0.1 729.00 6,561.00 19 Wali Memon
  • 20. CCA Schedule (simple – ½ net additions rule) 1 2 3 4 5 6 7 8 9 10 Class Undepreciated Cost of Proceeds of UCC Adjustments for Base amount Rate CCA UCC at the end number capital cost additions in dispositions in af ter additions current year for capital cost % for the year of the year (UCC) at the the year the year (Use and additions (1/2 allow ance (col. 7 times (col. 5 minus start of the the low er of dispositions times (col. 3 (col. 5 minus 8 or an 9) year Original cost (col. 2 plus 3 minues 4)) If 6) adjusted or selling minus 4) negative, enter amount) price) "0"Year20XX 6 0.00 20,000.00 0.00 20,000.00 10,000.00 10,000.00 0.1 1,000.00 19,000.0020X1 6 19,000.00 0.00 0.00 19,000.00 0.00 19,000.00 0.1 1,900.00 17,100.0020X2 6 17,100.00 0.00 0.00 17,100.00 0.00 17,100.00 0.1 1,710.00 15,390.00 The ‘bottom line’ here is that you are allowed only half the regular CCA on additions to the pool in the year of acquisition. 20 Wali Memon
  • 21. CCA Schedule (simple – ½ net additions rule) 1 2 3 4 5 6 7 8 9 10 Class Undepreciated Cost of Proceeds of UCC Adjustments for Base amount Rate CCA UCC at the end number capital cost additions in dispositions in af ter additions current year for capital cost % for the year of the year (UCC) at the the year the year (Use and additions (1/2 allow ance (col. 7 times (col. 5 minus start of the the low er of dispositions times (col. 3 (col. 5 minus 8 or an 9) year Original cost (col. 2 plus 3 minues 4)) If 6) adjusted or selling minus 4) negative, enter amount) price) "0"Year20XX 6 0.00 20,000.00 10,000.00 10,000.00 5,000.00 5,000.00 0.1 500.00 9,500.0020X1 6 9,500.00 0.00 0.00 9,500.00 0.00 9,500.00 0.1 950.00 8,550.0020X2 6 8,550.00 0.00 0.00 8,550.00 0.00 8,550.00 0.1 855.00 7,695.00 A ‘net addition’ to the pool is equal to additions minus disposals. 21 Wali Memon
  • 22. CCA Schedule (simple – changes over time) 1 2 3 4 5 6 7 8 9 10 Class Undepreciated Cost of Proceeds of UCC Adjustments for Base amount Rate CCA UCC at the end number capital cost additions in dispositions in af ter additions current year for capital cost % for the year of the year (UCC) at the the year the year (Use and additions (1/2 allow ance (col. 7 times (col. 5 minus start of the the low er of dispositions times (col. 3 (col. 5 minus 8 or an 9) year Original cost (col. 2 plus 3 minues 4)) If 6) adjusted or selling minus 4) negative, enter amount) price) "0"Year20XX 6 10,000.00 0.00 0.00 10,000.00 0.00 10,000.00 0.1 1,000.00 9,000.0020X1 6 9,000.00 0.00 0.00 9,000.00 0.00 9,000.00 0.1 900.00 8,100.0020X2 6 8,100.00 0.00 0.00 8,100.00 0.00 8,100.00 0.1 810.00 7,290.00 22 Wali Memon
  • 23. CCA Schedule (simple – changes over time) 1 2 3 4 5 6 7 8 9 10 Class Undepreciated Cost of Proceeds of UCC Adjustments for Base amount Rate CCA UCC at the end number capital cost additions in dispositions in af ter additions current year for capital cost % for the year of the year (UCC) at the the year the year (Use and additions (1/2 allow ance (col. 7 times (col. 5 minus start of the the low er of dispositions times (col. 3 (col. 5 minus 8 or an 9) year Original cost (col. 2 plus 3 minues 4)) If 6) adjusted or selling minus 4) negative, enter amount) price) "0"Year20XX 6 0.00 10,000.00 0.00 10,000.00 5,000.00 5,000.00 0.1 500.00 9,500.0020X1 6 9,500.00 0.00 0.00 9,500.00 0.00 9,500.00 0.1 950.00 8,550.0020X2 6 8,550.00 0.00 0.00 8,550.00 0.00 8,550.00 0.1 855.00 7,695.00 Compare this slide with the last one…note that the CCA in the first year is half as great as in the last slide…because there was a net addition to the pool of $10,000 and no beginning UCC. 23 Wali Memon
  • 24. CCA Schedule (Disposals) 1 2 3 4 5 6 7 8 9 10 Class Undepreciated Cost of Proceeds of UCC Adjustments for Base amount Rate CCA UCC at the end number capital cost additions in dispositions in af ter additions current year for capital cost % for the year of the year (UCC) at the the year the year (Use and additions (1/2 allow ance (col. 7 times (col. 5 minus start of the the low er of dispositions times (col. 3 (col. 5 minus 8 or an 9) year Original cost (col. 2 plus 3 minues 4)) If 6) adjusted or selling minus 4) negative, enter amount) price) "0"Year20XX 6 0.00 10,000.00 0.00 10,000.00 5,000.00 5,000.00 0.1 500.00 9,500.0020X1 6 9,500.00 0.00 0.00 9,500.00 0.00 9,500.00 0.1 950.00 8,550.0020X2 6 8,550.00 0.00 5,000.00 3,550.00 0.00 3,550.00 0.1 355.00 3,195.00 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. 24 Wali Memon
  • 25. CCA Schedule – changes over time 1 2 3 4 5 6 7 8 9 10 Class Undepreciated Cost of Proceeds of UCC Adjustments for Base amount Rate CCA UCC at the end number capital cost additions in dispositions in af ter additions current year for capital cost % for the year of the year (UCC) at the the year the year (Use and additions (1/2 allow ance (col. 7 times (col. 5 minus start of the the low er of dispositions times (col. 3 (col. 5 minus 8 or an 9) year Original cost (col. 2 plus 3 minues 4)) If 6) adjusted or selling minus 4) negative, enter amount) price) "0"Year20XX 6 0.00 25,500.00 0.00 25,500.00 12,750.00 12,750.00 0.1 1,275.00 24,225.0020X1 6 24,225.00 10,000.00 4,000.00 30,225.00 3,000.00 27,225.00 0.1 2,722.50 27,502.5020X2 6 27,502.50 0.00 2,000.00 25,502.50 0.00 25,502.50 0.1 2,550.25 22,952.25 25 Wali Memon
  • 26. CCA Schedule – Recapture 1 2 3 4 5 6 7 8 9 10 Class Undepreciated Cost of Proceeds of UCC Adjustments for Base amount Rate CCA UCC at the end number capital cost additions in dispositions in af ter additions current year for capital cost % for the year of the year (UCC) at the the year the year (Use and additions (1/2 allow ance (col. 7 times (col. 5 minus start of the the low er of dispositions times (col. 3 (col. 5 minus 8 or an 9) year Original cost (col. 2 plus 3 minues 4)) If 6) adjusted or selling minus 4) negative, enter amount) price) "0"Year20XX 6 0.00 25,500.00 0.00 25,500.00 12,750.00 12,750.00 0.1 1,275.00 24,225.0020X1 6 24,225.00 10,000.00 4,000.00 30,225.00 3,000.00 27,225.00 0.1 2,722.50 27,502.5020X2 6 27,502.50 0.00 30,000.00 -2,497.50 0.00 0.00 0.1 0.00 -2,497.50 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. 26 Wali Memon
  • 27. 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.27 Wali Memon
  • 28. CCA Schedule – Terminal Loss 1 2 3 4 5 6 7 8 9 10 Class Undepreciated Cost of Proceeds of UCC Adjustments for Base amount Rate CCA UCC at the end number capital cost additions in dispositions in af ter additions current year for capital cost % for the year of the year (UCC) at the the year the year (Use and additions (1/2 allow ance (col. 7 times (col. 5 minus start of the the low er of dispositions times (col. 3 (col. 5 minus 8 or an 9) year Original cost (col. 2 plus 3 minues 4)) If 6) adjusted or selling minus 4) negative, enter amount) price) "0"Year20XX 6 10,000.00 0.00 5,000.00 5,000.00 0.00 5,000.00 0.1 500.00 4,500.0020X1 6 0.00 0.00 0.00 0.00 0.00 0.00 0.1 0.00 0.0020X2 6 0.00 0.00 0.00 0.00 0.00 0.00 0.1 0.00 0.00 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’. 28 Wali Memon
  • 29. 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.29 Wali Memon
  • 30. 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)30 Wali Memon
  • 31. CCA Schedule – Capital Gain 1 2 3 4 5 6 7 8 9 10 Class Undepreciated Cost of Proceeds of UCC Adjustments for Base amount Rate CCA UCC at the end number capital cost additions in dispositions in af ter additions current year for capital cost % for the year of the year (UCC) at the the year the year (Use and additions (1/2 allow ance (col. 7 times (col. 5 minus start of the the low er of dispositions times (col. 3 (col. 5 minus 8 or an 9) year Original cost (col. 2 plus 3 minues 4)) If 6) adjusted or selling minus 4) negative, enter amount) price) "0"Year20XX 6 40,000.00 0.00 0.00 40,000.00 0.00 40,000.00 0.1 4,000.00 36,000.0020X1 6 36,000.00 0.00 0.00 36,000.00 0.00 36,000.00 0.1 3,600.00 32,400.0020X2 6 32,400.00 0.00 16,500.00 15,900.00 0.00 15,900.00 0.1 1,590.00 14,310.00 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. 31 Wali Memon
  • 32. CCA Schedule – Capital Gain and a Recapture 1 2 3 4 5 6 7 8 9 10 Class Undepreciated Cost of Proceeds of UCC Adjustments for Base amount Rate CCA UCC at the end number capital cost additions in dispositions in af ter additions current year for capital cost % for the year of the year (UCC) at the the year the year (Use and additions (1/2 allow ance (col. 7 times (col. 5 minus start of the the low er of dispositions times (col. 3 (col. 5 minus 8 or an 9) year Original cost (col. 2 plus 3 minues 4)) If 6) adjusted or selling minus 4) negative, enter amount) price) "0"Year20XX 6 16,500.00 0.00 0.00 16,500.00 0.00 16,500.00 0.1 1,650.00 14,850.0020X1 6 14,850.00 0.00 0.00 14,850.00 0.00 14,850.00 0.1 1,485.00 13,365.0020X2 6 13,365.00 0.00 16,500.00 -3,135.00 0.00 0.00 0.1 0.00 -3,135.00 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. 32 Wali Memon
  • 33. CCA Schedule template 1 2 3 4 5 6 7 8 9 10 Class Undepreciated Cost of Proceeds of UCC Adjustments for Base amount Rate CCA UCC at the end number capital cost additions in dispositions in af ter additions current year for capital cost % for the year of the year (UCC) at the the year the year (Use and additions (1/2 allow ance (col. 7 times (col. 5 minus start of the the low er of dispositions times (col. 3 (col. 5 minus 8 or an 9) year Original cost (col. 2 plus 3 minues 4)) If 6) adjusted or selling minus 4) negative, enter amount) price) "0"Year 20XX 20X1 20X2 33 Wali Memon
  • 34. 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)34 Wali Memon
  • 35. Finding Ending UCC You can always do a detailed table to finding ending UCC given the assumption of maximum use of available CCA in each year… However, you can also use a formula: r UCCn = C0 (1 − )(1 − r ) n −1 2 .1 UCC5 = $100,000(1 − )(1 − .1) 5−1 2 UCC5 = $100,000(.95)(.9 4 )35 Wali Memon UCC5 = $100,000(.95)(.6561) UCC5 = $62,329.50
  • 36. Finding ending CCA using a full CCA Schedule 1 2 3 Cost 4 5 6 7 Base 8 9 CCA 10 Class Undepreciated of additions in Proceeds of UCC Adjustments for amount for Rate for the year UCC at the endnumber capital cost the year dispositions in after additions current year capital cost % (col. 7 times 8 of the year (UCC) at the the year (Use and additions (1/2 allow ance (col. or an adjusted (col. 5 minus 9) start of the the low er of dispositions times (col. 3 5 minus 6) amount) year Original cost (col. 2 plus 3 minues 4)) If or selling minus 4) negative, enter 6 0.00 100,000.00 0.00 100,000.00 50,000.00 50,000.00 0.1 5,000.00 95,000.00 95,000.00 0.00 0.00 95,000.00 0.00 95,000.00 0.1 9,500.00 85,500.00 85,500.00 0.00 0.00 85,500.00 0.00 85,500.00 0.1 8,550.00 76,950.00 76,950.00 0.00 0.00 76,950.00 0.00 76,950.00 0.1 7,695.00 69,255.00 69,255.00 0.00 0.00 69,255.00 0.00 69,255.00 0.1 6,925.50 62,329.50 36 Wali Memon
  • 37. 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 Present Value of Tax Savings on CCA :  C Td  1 + .5k  =  0 ×   k + d   1+ k  This equation assumes the asset is purchased and held forever (there is no salvage value)…that the maximum CCA is claimed each year
  • 38. 38 Wali Memon