It is important to understand that there is a difference between an immediate expense, which is fully deductible in the year that it is incurred, and a depreciable expense, which can only be deducted over time. Depreciation expenses are costs that, while also part of the expenses used to calculate net income (or loss), are subject to the Capital Cost Allowance (CCA) rules.
CCA is the deduction that can be claimed over a period of several years for the cost of depreciable property, that is, property that wears out or becomes obsolete over time. Depreciable property includes assets such as buildings, furniture, or equipment that you use in an active business. The CCA regime is in place to approximate the expected lifetime of an asset; a business owner generally cannot simply claim the entire cost of the property as an expense in the year of purchase. Instead, a business owner is allowed to deduct the cost of the depreciable property gradually over the duration of the property’s use.
For example: if you buy a box of pens for your business, chances are they are going to be used rather quickly and provide you with a short term benefit. However, if you buy an office chair, it is going to be used for a longer time and provide you with a long term benefit. Thus, the chair would be considered depreciable property that you will have to expense (i.e. write off) over time, while the pens would be considered business expenses that you can expense immediately in the year of purchase. In tax terminology, the chair is a depreciable expense and the pens are a current expense.
CCA classes and rates
The CCA rate that you can claim depends on the type of property you own and the date you acquired the property. Furthermore, depreciable property is categorized into different CCA classes depending on the amount of CCA that you are entitled to claim on that particular property. For example: a building may belong to class 1, 3, or 6 depending on what the building is made of and the date that you acquired it. Depending on the class, the building can be expensed at 4% to 10% per year. On the other hand, a vehicle would fall into class 10 or 10.1 depending on its purchase price and the date it was purchased. A vehicle can be expensed at a rate of 30% per year.
Normally, the CCA allowed in the year that an asset is purchased is only 50% of the normal amount. This is called the “half-year” rule and provides that in the year that you acquire or make additions to property, you can generally only claim CCA on half of your net additions in a particular class of property. Thus, in the year that you purchased the class 10 or 10.1 vehicle for your business, you will effectively only be able to deduct 15% in the first year, as opposed to the full 30% (30% x 50% = 15%).
How to calculate CCA
Generally, a declining balance method is used to calculate your CCA. The declining balance method is a common depreciation-calculating system which involves applying the depreciation rate against the non-depreciated balance. Therefore, instead of spreading the cost of the asset evenly over its entire life, this system expenses the asset at a constant rate, which results in declining depreciation charges each successive period.
Last year, Martha bought a building for $60,000 to use in her business. On her tax return for last year, she claimed CCA of $1,200 on the building. This year, Martha calculates her CCA claim on the remaining balance of $58,000 ($60,000 – $1,200).
When your business has a fiscal year that is shorter than 365 days, you must pro-rate your CCA claim. Therefore, you must base your CCA claim on the number of days in your fiscal period compared to 365 days.
Martha starts her delivery business on June 1st and her first fiscal period ends on December 31st. Martha calculates her CCA to be $3,500 during her first fiscal year of business.
Since Martha’s fiscal period is only 214 days, the amount of CCA that she can claim is limited to $2,052 ($3500 x 214/365).
Benefits of CCA
CCA is a permissive deduction, meaning that you can claim any amount up to the maximum prescribed limit for the year. Therefore, a business owner is eligible to claim none of it, all of it, or any amount in between—up to the maximum amount that can be claimed each year. Furthermore, any amount of CCA that is not claimed can be carried over and available to you in the next year. This is a very useful for tax planning purposes since there is flexibility. For example, one would generally not make a CCA claim in a particular year if the business is in a loss position since the CCA claim would simply add to the loss and would effectively be of no economic benefit.