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Is CCA system in Canada meets fundamental principles?
In 1949 the introduction of Capital Cost Allowance (CCA) system was designed to be a simple method to depreciate capital property for tax purposes (Mida and Stewart, 1995). The CCA defined by Canada Revenue Agency (2014) as a tax deduction that Canadian tax laws allow a business to claim for the loss in value of capital assets due to wear and tear or obsolescence. Over time, the system whose aim was to ensure fair and equitable approach to asset depreciation for all taxpayers was significantly amended during tax reforms in 1972 and in 1987. Rock Lefebvre, Vice President of Research and Standards at CGA-Canada (CGA, 2013) argues that due to changes made to the system, the CCA becomes more complicated and its neutrality and equity was weakened. Over the years, the government used the CCA system as an instrument to achieve economic and policy objectives, for example, during economic downturn the government tried to stimulate certain industries by creating new classes and/or rates. These changes deemed to violate the principles of equity and neutrality because they target only specific industries and cannot be used by all taxpayers (Larter, 1988, in Pinto, 2013).
The purpose of this research is to critically evaluate the CCA system in Canada, assessing the fundamental principles outlined in Hogg et al (2013) - neutrality, equity, simplicity and international competitiveness.
- Changes in CCA system
After establishment of CCA system several changes was made and some of them deemed to add a complexity to the system. Among these changes are:
- Substantial increase in the number of CCA classes;
- Frequent change to CCA rate;
- Lengthy description of CCA classes;
- Introduction of CCA rules;
- Use of CCA system as an instrument to achieve economic and policy objectives.
The CCA system consists of 38 declining balance classes, 10 straight line classes and several “additional allowance” provisions. All CCA classes are outlined in 24 pages and similar assets may appear more than once in several classes (FEI Canada, 2008).
- Increase in CCA classes
The chart below illustrates the significant increase in the number of CCA classes since its establishment in 1949 with only 12 classes being present. The number of classes increased to 28 in 1972, grew to 37 in 1987 and reached 56 in present days.
The addition of CCA classes can be due for several reasons:
- The description of an asset need to be changed or explained more clearly comprehensible;
- The need to change CCA rate;
- To encourage an acquisition of certain assets;
- To stimulate certain industries;
- To support policy initiatives.
It is believed that the large number of classes adds complexity to the CCA system. For the companies which are using variety of CCA classes requires more time and effort to identify the class for an asset acquisition, comparing to small businesses, which are not affected by addition of classes as they mostly use common eighteen CCA classes. Another weakness is that some classes overlap between each other and some are no longer used (Pinto, 2013).
- Changes to CCA rate
Changes to CCA rates usually occur when new class are introduced and vice versa. This is done to encourage the acquisition of an asset which belongs to the new class and/or rate introduced, which cannot be considered very “neutral” approach, because the tax system should not influence decisions on capital asset acquisition. Increase or decrease in the rate of CCA class depends on government policy incentive (FEI Canada, 2008). As an example, the recent change to CCA rate for computer hardware was not effective and did not met its purpose of encouraging the acquisition of computers. According to Pinto (2013) the effectiveness of such changes is still in doubt and emphasizes the importance of ability to compare CCA rates with other countries, as it could increase the international comparability.
The maximum allowable allowance varies from 4% to 100% depending on CCA class and is adjusted on disposition of an asset (FEI Canada, 2008). The advantage of the system is that businesses are allowed to claim any amount, or none of it, up to a stated maximum allowable rate, regardless of amounts claimed previously (CGA, 2009).
- Lengthy description for CCA classes
Many CCA classes have long description. In addition, description in some classes refers to other classes or even overlaps each other, which is confusing and challenging for taxpayers to identify appropriate class for asset acquisition. In some cases the lengthy description is due to a government attempt to adjust description in order to achieve desired outcome (Pinto, 2013).
In the book edited by Filice (2005) can be found an asset list in alphabetical order indicating the class to which the asset belongs. However, the list does not include all assets described in every single class.
- CCA rules
With 9 years difference, two new rules were created in the CCA system. The “half-year” rule and “available-for-use” rule was introduced in 1981 and 1990 respectively. The both rules are used for tax purposes but not applicable for accounting purposes, which leads to book-tax differences. These differences will be explored later in the text.
The “half-year” rule was established to reduce the advantage of buying an asset at the yearend by restricting to claim the whole CCA allowable in the first year (CGA Education, 2009). Instead, in the first year of asset acquisition, only the half of allowable cost can be claimed.
The “available-for-use” rule requires an asset to become available for use before the taxpayer can start to claim CCA on that asset. According to Canada Revenue Agency (2014) the asset is available for use at “the earliest of:
- The time at which the property is first used by the claimant for the purpose of earning income; or
- The time the property is delivered or is made available to the claimant and is capable of producing a saleable product or service”.
As soon as the asset is considered to be available for use, the “half-year” rule applies.
As stated in Pinto (2013) both rules add unnecessarily complexity to already complex CCA system.
- Accelerated Capital Cost Allowance
Periodically, the government uses the CCA system as an instrument to achieve desired economic objectives. Therefore, to stimulate particular industries during economic downturn the government often change CCA classes and increase rates. The latest example of economic initiative is introduction of Accelerated Capital Cost Allowance (ACCA) rate for manufacturing, oil and gas industries to stimulate and assist them economically and to foster the international competitiveness.
Representatives of the aforementioned industries consider ACCA as effective and essential economic incentive, which makes many projects financially available, however, does not stimulate the acquisition of capital assets, but affect businesses decision-making, therefore deemed to violate principle of “neutrality”. It is believed that decision of asset purchase is driven by business necessities and not by tax benefits. Yet, ACCA rates are targeting specific industries cannot be viewed as “fair” and “equitable” (Pinto, 2013). In addition, the investment tax credits and government grants deemed to be more appropriate and effective (Bibbee, 2008).
- Book-tax differences
The book-tax differences occur because of differences in treatments of an asset between accounting and tax systems. When asset is treated for accounting purposes, known as amortization, the cost of producing the revenue is matched to net income and based on economic life of an asset. The businesses usually use straight line method to amortize the asset. In contrast, for tax purposes, the amortization of an asset is replaced by CCA system where declining balance method is commonly used (CGA Education, 2009). The CCA method cannot be viewed as “fair” and “equitable” due to the same treatment of the same not identically used assets by different businesses. Furthermore, the CCA does not reflect matching principle and often assets’ capital cost write-offs is faster that its useful life (Pinto, 2013).
The difference in recording of disposition of capital assets between accounting and tax systems is also leads to book-tax differences. For accounting purposes, disposition of an asset result in a gain or loss, depending on the receipts on disposition, for example if receipts exceed net book value of an asset – gain, and vice versa. In contrast with tax system, If there is a positive balance remaining in thepool after disposition, that balance is called aterminal loss and is deductible from income inthat year. Or, if there is a negative UCC balance at the end of the year, this balance is arecapture of capital cost allowance. This amount has to be included in income for that year.
Despite the fact that the difference positively impact fairness and equity, it still should be minimized, because the major differences can increase costs associate with extra time, training and effort (Pinto, 2013).
According to Mintz research (2007) the simplicity of the CCA system is very important. The more system is simple, the easier is to understand the methods used for acquisition and disposal of the assets, thus, helps with decision-making and results in profitability and international competitiveness.
- Recommendations and conclusion
In this research the Canadian CCA system has been critically evaluated. I can be concluded that amendments such as substantial increase in the number of classes and description, frequent change of rate, introduction of new “half-year” rule and “available-for-use” rule, which occurred in the system since its establishment added complexity and partly eliminated fundamental principles of neutrality, equity, simplicity and international competitiveness. A consensus of opinion among accounting professionals emphasize the need in reduction of CCA classes, the need in consolidation and shortening of description for some classes and the need to thoroughly review the necessity of rules introduced, such as “half-year” rule and “available-for-use” rule. Unnecessary amendments in the CCA system result in inefficiencies and allocation of extra time and effort.
As recommended in FEI Canada (2008), the CCA system should consist of 10 comprehensive classes and couple of classes should have accelerated rate on selected asset acquisition. Thus, all redundant classes and overlaps could be eliminated, reducing inefficiencies and increasing simplicity.
The incentive to stimulate certain industries during recession, such as manufacturing, gas and oil industries by introducing Accelerated Capital Cost Allowance is beneficial for the industry because it fostering international competitiveness and making major projects viable, however representatives from aforementioned industries believe that alternative processes, such as Investment Tax Credit or government grant could be more advantageous. It is recommended to assess the cost and benefits for all alternatives and compare them with ACCA.
International competitiveness is essentially important to Canadian businesses to achieve long-term success. Therefore, factors affecting international competitiveness should be examined in more details
Overall, the government often have to choose between economic growth and fundamental principles of tax system, such as simplicity, fairness and neutrality. But government should not use CCA system as an instrument for achieving economic incentives, because temporary introductions to the system are often not effective and leads to unnecessary complexity. Future investigation of other areas of complexity could improve profitability, sustainability, and international competitiveness of Canadian businesses.
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Pinto, O. (2013) Is the Capital Cost Allowance System in Canada Unnecessarily Complex?, CGA Canada [Online] Available at: http://ppm.cga-canada.org/en-ca/Documents/ca_rep_2013-04_cca.pdf Accessed: 7 April 2015