An expense is deductible when calculating income from a business for tax purposes if it is made to earn business income in a particular tax year.
However, capital expenses are treated a little differently because they usually provide an ongoing benefit and contribute to income generation in future years as well.
As a result, most business assets, for accounting purposes, are capitalized and depreciated over the useful life of those assets.
The Canada Revenue Agency introduced the capital cost allowance (CCA) system as an attempt to mirror what the accountants are doing on financial statements.
It was designed to limit amortizing choices, but government also frequently uses it as a tool of fiscal policy or to stimulate manufacturing industries or equipment sales by allowing faster depreciation than the norm.
For example, in 2009 the federal government accelerated the CCA on computer purchases to one year. The government chose an arbitrary time period of Jan. 27, 2009, to Feb. 28, 2011. This may have had something to do with the downturn in the economy and giving taxpayers an incentive to buy electronics.
The CCA rate for these assets is normally 55 percent on a declining balance. Modified capital cost rules for computer equipment and certain other equipment provides an amortization rate that more accurately reflects the projected lifespan of the equipment.
It is usually considered unwise to make capital purchases based solely on the tax implications, but if you were going to make the purchase next year anyway, it might be worthwhile to move it up before the end of this year. That does not mean capital cost investments should ignore the impact of the capital cost allowance. The potential tax implications should also be considered against additional costs of moving up the capital investment.
The Income Tax Act allows you to claim up to 10 percent of farm equipment purchases in the first year with no dollar limit.
Part of the appeal of claiming the CCA early is that you don’t necessarily have to make the full investment all at once.
Under the Income Tax Act, you must possess actual ownership of the equipment, but you can arrange to finance it separately over a number of years. The interest rate on the loan is also deductible.
However, the advantage of a late-in-the-year equipment purchase is reduced by the half-year rule, which arbitrarily adjusts for the amount of time the equipment is owned.
An important requirement for moving up the capital purchase and claiming the capital cost allowance is that delivery of the machinery has to be completed and placed into operation before the end of the year.
However, producers who anticipate the tax rate will jump next year might be advised to postpone the capital purchase until then to get a break from the higher tax rate.