Operating expenses are expenditures that are necessary for a company to produce the goods and services that bring in the revenues. These items are “used-up” and are usually 100% deductible in the fiscal year they occurred, unless there are specific restrictions in the Income Tax Act. Most popular among them are supplies, advertising and promotions, salaries and wages, rent, communication costs, accounting and legal fees, etc.
Items considered “Capital Purchases” are assets that have been purchased with a unit value greater than $200 ($500 after May 2, 2006) which have a life expectancy greater than one year. The most common types of items considered as capital purchases are:
● Office furniture and equipment
● Computer hardware
● Cars, trucks, boats
● Manufacturing equipment
● Real estate
These items cannot be written off against income in the year of purchase. The cost is depreciated or amortized over a period of time. The allowable tax deduction is called “Capital Cost Allowance” (CCA).
Capital Cost Allowance, or depreciation, means deducting the cost of the business portion of an asset over its life or recovery period as set out by CRA (using so-called “Classes”). You bring the assets into the business at their current value or whatever you paid for them, whichever is less. You must use the lower of the two figures. If you paid less than what they are worth, and cannot prove it, you will have to use their current value. Make sure you have a receipt; otherwise it could be disallowed by CRA.
You can depreciate most assets by half of their normal rate in the first year and full rate thereafter (depending on the Class of that asset), until they are completely written off. To calculate your CCA deduction for an asset used in a business you must know the following:
The “basis” is a measure of the value of your property for tax purposes – usually the amount you paid for the asset. As you depreciate an asset, your depreciation deductions reduce the basis.
CCA Example: Car purchased for $10,000. The write off Classification is 30% (Class 10).
Year one depreciation = $10,000 x 15% = $1,500 (the so-called “half-year” rule)
Year two undepreciated capital cost (UCC) is $10,000-$1,500 (year one depreciation) = $8,500. You may depreciate the $8,500 by 30% = $2,550 in the second year. This leaves a UCC for the next year of $5,950.
CCA is known as a “permissive deduction”. The claim is made at the taxpayer’s option. Also, the law prescribes the maximum CCA amount allowed – you can use only partial CCA if this is to your advantage.
Final warning: DON’T ever try to deduct 100% of your capital purchases. CRA would disallow this deduction, and in most cases you will be severely penalized.
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