Under basic Canadian tax rules, any goods you purchase for use in your business are deductible from your income, thereby reducing your taxes. However, the rules differ based on whether what you purchase is a capital good. Find out what you need to know to maximize your deductions.
Differentiating Current Expenses From Capital Expenses
A current expenditure is made with a view to short-term consumption. For example, basic office supplies, monthly rent and employee salaries are all current expenditures, since they are used immediately after being made. These expenses are deductible in the year when they are incurred.
In contrast, capital expenditures are made with a view to long-term use in your business. The clearest example is the purchase of a building to house your business. Normally, you would expect to stay in the building for several years. Other frequent examples include the purchase of specialized machinery and tenant improvements to rented premises.
Accounting rules are in place to record the loss of value of these capital assets over the period of their useful life in your business, known as depreciation. For tax purposes, there are similar rules for the capital cost allowance that allow you to deduct the portion of the capital asset that has been used by the business in the current year.
Claiming Capital Cost Allowance
Although there are exceptions, capital cost allowance can usually be claimed using the declining balance method. A percentage of the purchase price is deductible in the year when the property is acquired, and a percentage of the remainder is deductible in subsequent years, until the balance reaches zero.
The applicable percentages for all types of goods are found in the regulations made under the Income Tax Act. The percentages used for accounting purposes often differ from the ones used for tax purposes.
Capital cost allowance is claimed as an expense on your business’s income tax return. The deduction is not mandatory; you may choose not to claim it. You would make such a decision if you feel that the good has not really lost market value and that an eventual sale would cause you to pay more taxes than the deduction would save you. For example, buildings often go up in market value even though they can be depreciated for tax purposes. When such a building is sold, costly recapture can occur.
Recapture of Capital Cost Allowance
When a capital good is sold, any amount received between its depreciated value and its original purchase price is known as recapture and is included in regular income. Any portion of the sale price above that is a capital gain.
For example, a building purchased for $100,000 with a depreciated value of $70,000 that is sold for $120,000 would create taxable recapture of $30,000 and a capital gain of $20,000, 50 percent of which would be taxable.