Can your business take advantage of the proposed accelerated-depreciation rules?

Canadian businesses that make investments in tangible and intangible depreciable property over the next five years may benefit from proposed federal tax changes to the capital cost allowance (CCA) system.

On November 21, 2018, the federal government put forth draft legislation, which provides accelerated tax deprecation—CCA—for capital spending on depreciable assets purchased in the period between November 21, 2018, and December 31, 2023 (Phase One).

Legislation that will provide accelerated CCA claims for capital expenditures made in the period January 1, 2024, to December 31, 2027 (Phase Two) was also proposed.

Take note that phase two will provide more generous CCA claims in the year of acquisition than those provided by the existing rules that predate the November 21, 2018, proposals. However, the Phase Two rules are not as generous as those that have been proposed for Phase One.

Together, both of these new proposals are known as the Accelerated Investment Incentive (AccII) proposals.

For businesses that are profitable, a faster write-off of expenditures for tax purposes means that there will be lower taxable income, and therefore a deferral of tax, in the year of acquisition of the capital asset.

Investments in manufacturing and processing equipment and clean energy equipment

Investments in manufacturing and processing (M&P) equipment have benefited from a faster tax write-off than many other types of equipment. Recently, in order to encourage investment in renewable-energy technologies, clean energy equipment has also enjoyed more favourable tax write-offs. The AccII proposals will continue to encourage this type of investment by allowing a full write-off in the year of acquisition during Phase One.

The charts below illustrate the difference in CCA that can be claimed in the year of acquisition of the equipment under the three different sets of rules:

• The rules that were in effect prior to the AccII proposals;
• Phase One of the AccII proposals; and
• Phase Two of the AccII proposals.

The calculations are based on the assumptions of one $10,000 addition to the class and no dispositions in the CCA class during the year.

Historically, the CCA claim in the year of acquisition is limited to one-half of the amount of CCA that could otherwise be claimed. M&P equipment that would qualify for Class 53, which has a 50% CCA rate (i.e., 50% of the balance in the class can be claimed as CCA for the year), would only qualify for a 25% CCA claim on net additions made to the class in the year. This is known as the half-rate rule. The AccII proposals change the rate of CCA that may be claimed in the year of acquisition. In Chart 1, you can see that the first year CCA that may be claimed is higher under the AccII proposals than under the historical half-rate-rule system. It is important to note that the AccII proposals allow a faster write-off of CCA claims, but they do not increase the total CCA claim allowed with respect to the asset. This is illustrated in the second row, which shows maximum CCA claims in the second year that the asset is owned. The maximum CCA claim in the second year is higher under the historical half-rate- rule system. Note that the maximum CCA claims for M&P and clean energy equipment are lower in the last two years of the Phase Two program than in the first two years of Phase Two. Chart 2 illustrates the first and second year CCA claims for eligible purchases of clean- energy equipment.

Investments in other equipment

Expenditures that do not qualify for inclusion in the M&P or clean energy CCA classes will still qualify for accelerated CCA under the AccII proposals, but at lower rates. For this other equipment, the half-rate rule is suspended for acquisitions made from November 21, 2018, to December 31, 2027. For non-M&P and clean energy equipment purchased in Phase One, the CCA rate will be three times what could be claimed with the historical half-rate rule in effect. For such equipment purchased in Phase Two, the CCA rate will be twice what could be claimed with the historical half-rate rule in effect.

In Chart 3, you can see that the first year CCA that may be claimed is higher under the AccII proposals than under the historical system that employs the half-rate rule. In the second row, you can see the maximum CCA claims that occur in the second year that the asset is owned. The maximum CCA claim in the second year is higher under the historical half-rate-rule system because a larger claim has been accelerated into the first year under the AccII proposals.

Chart 4 illustrates the maximum first and second year CCA claims for assets that fall into CCA Class 14.1. This class was introduced in 2017 to hold assets that would have qualified as cumulative eligible capital in years prior to 2017. Expenditures for depreciable, unlimited-life intangibles fall into this class. Such assets include customer lists, farm quotas, and purchased goodwill.

Investments in the Resource Sector

In certain resource related industries, such as mining, and logging, the amount of CCA that may be deducted in each year is generally based on the portion of the resource that is depleted in the year rather than a fixed percentage of the undepreciated CCA pool. For such properties, the taxpayer will be able to claim additional first year CCA under the AccII program at a rate of an additional 50% CCA for properties purchased in Phase One, and an additional 25% CCA for properties purchased in Phase Two.

For Canadian oil and gas development and exploration industries, new definitions have been introduced for the AccII program – “accelerated Canadian development expense” and “accelerated Canadian oil and gas property expense”. Expenditures that qualify as an accelerated Canadian development expense made in Phase One will qualify for an additional deduction of up to 15%. The additional deduction drops to a maximum of 7.5% for expenditures incurred in Phase Two. Expenditures that qualify as an accelerated Canadian oil and gas property expense made in Phase One will qualify for an additional deduction of up to 5%. The additional deduction drops to a maximum of 2.5% for expenditures incurred in Phase Two.

Federal and provincial differences

For purposes of claiming CCA, all provinces and territories except for Alberta and Quebec follow the federal rules, and the CCA claims in those provinces and territories do not differ from those claimed for federal tax purposes. However, the provinces of Alberta (for corporate income tax purposes) and Quebec (for both corporate and personal income tax purposes) have the ability to set their own CCA rates. That said, Alberta generally follows the federal rules when determining taxable income. To date, the Alberta government has not indicated that they would not follow the federal AccII proposals. Quebec has stated that they will follow the federal AccII proposals. In addition, Quebec provides a bonus depreciation on qualifying assets for Quebec tax purposes. This additional deduction for tax purposes is calculated based on the CCA claimed in the year. The 2018 Quebec Fall Economic Update proposed that effective December 4, 2018, the bonus depreciation rate for Quebec tax purposes will be 30%.

Available-for-use rules

It is important to understand that for purposes of the CCA rules, property must be "available for use" in order to claim CCA, including the proposed AccII CCA claims. This means that simply taking title to property is not sufficient to indicate that CCA can be claimed on that asset in the particular year. In general, available for use means that the asset has been used by the taxpayer for earning income. If this test is not met, then it may meet the available-for-use test if the property has been delivered and the equipment is capable, either alone or in combination with other property owned at that time, of producing a commercially saleable product or performing a commercially saleable service. There are other components to the available-for-use test applicable to certain acquisitions such as real property, but the two conditions outlined above cover most common situations. For a greater understanding of the available-for-use tests, please contact your BDO advisor.

Where some time has passed since the purchase of the property, but the other available-for-use tests have not been met, the property may be eligible for CCA under a relieving test. This test, known as the two-year-rolling-start rule, generally allows a CCA deduction in the second taxation year that follows the year the property was purchased by the taxpayer. Property eligible for CCA claims because of two-year-rolling-start rule is not subject to the half-rate rule. Under the draft AccII proposals, property eligible for CCA under the two-year-rolling-start rule will not be eligible for the accelerated CCA rates.

Are there any restrictions with respect to the AccII proposals?

While the proposed rules do not have many restrictions, a taxpayer cannot claim CCA under the AccII proposals if the property in question was acquired from a related taxpayer. It is acceptable for a taxpayer to purchase used equipment, but it must be purchased from an arm's-length taxpayer or partnership.

If you have questions about the AccII proposals and how they will affect your business, contact your trusted BDO advisor.

The information in this publication is current as of February 15, 2019.

This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.