On November 21, 2018, the Department of Finance Canada (“Finance”) released the 2018 Fall Economic Statement (the “Statement”). In a clear response to the lowering of the corporate tax rate (and other corporate tax measures) in the United States, Finance introduced new measures that will lower the corporate tax otherwise payable by some corporations in Canada. However, Finance did not lower corporate taxes by lowering the actual tax rates. Rather, the proposed changes will allow corporations to accelerate the tax depreciation of certain capital investments, thus lowering the effective corporate tax rate (at least in the earlier years).
Finance proposed changes that will allow businesses to: (i) immediately write off the cost of machinery and equipment used for the manufacturing or processing of goods; (ii) immediately write off the full cost of specified clean energy equipment; and (iii) rely upon an accelerated investment incentive (the “AII”), which will allow all businesses, making capital investments, to claim an accelerated capital cost allowance (i.e. a business will be permitted to deduct larger amounts of depreciation expenses sooner rather than later).
According to Finance, the AII effectively triples the current first-year capital cost allowance rate for all tangible capital assets (and some intangible capital assets, including patents and other intellectual property). The AII applies to capital property, except property in class 53 (manufacturing and processing equipment), and classes 43.1 and 43.2 (clean energy equipment).[1] Instead, the new full expensing measures will apply to these classes (as discussed below). The AII will have two key implications.
First, the AII will “suspend” the half-year rule in respect of AII property. In the first year that a taxpayer uses an asset, the half-year rule generally provides that a taxpayer may only add half of the asset’s capital cost to the undepreciated capital cost of the asset’s class (the other half of the asset’s capital cost is added to the class in the following year). Instead, the AII provides that, in the first year of using an asset (i.e. an AII property), a taxpayer may add the full amount of the asset’s undepreciated capital cost to the asset’s class.
Second, the AII provides an enhanced allowance with respect to net additions to a class in a given year. In order to calculate the enhanced capital cost allowance, a taxpayer would apply a prescribed rate (for a given class) to an amount equal to one-and-a-half times the net addition to the class in the year (with the full cost of all new assets being added to the class – see suspension of half-year rule above). The taxpayer would then be able to deduct the enhanced capital cost allowance from the taxpayer’s income for the year.
While the AII permits a taxpayer to deduct a larger allowance in the earlier years of an asset’s lifecycle, the AII does not actually permit a taxpayer to claim a larger total capital cost allowance with respect to an asset. If a taxpayer deducts a larger capital cost allowance in the first year of an asset’s lifecycle, the undepreciated capital cost of the asset’s class will be reduced by the amount of the enhanced capital cost allowance (deducted in the first year). A taxpayer will, therefore, have to deduct lesser amounts of capital cost allowance in subsequent years.
If a taxpayer has a short taxation year, the AII will apply on a prorated basis – similar to the application of the current CCA rules to short taxation years. The current CCA regime also includes various rules that may restrict otherwise available deductions. The Statement emphasizes that, in addition to these restrictions (which remain in place), new restrictions will be placed on property eligible for the AII (these restrictions also apply to the first-year enhanced allowances provided under the full expensing measures – see below). In particular, the proposed rules will provide that property that has been used, or acquired for use, for any purpose before it is acquired by the taxpayer will be eligible for the AII only if both of the following conditions are met:
- neither the taxpayer nor a non-arm’s length person previously owned the property; and
- the property had not been acquired by the taxpayer on a tax-deferred “rollover” basis.
In addition to the AII, the proposed rules include full expensing measures for manufacturing and processing equipment (class 53) and clean energy equipment (classes 43.1 and 43.2). A taxpayer will be able to claim a first-year enhanced capital cost allowance with respect to assets under classes 43.1, 43.2, and 50, acquired after November 20, 2018 (and which become available for use before 2028). The first-year enhanced allowance will initially equal 100% of an asset’s cost, with such percentage being reduced throughout a phase-out period (which begins in 2024).
The Statement provides that the above changes will apply to qualifying assets acquired after November 20, 2018. However, the changes will be gradually phased out starting in 2024. The changes will no longer have effect after 2027.
Finance’s view is that the above changes will encourage businesses to invest greater amounts of after-tax profits in new capital assets (the Statement further provides that Canadian corporations’ after-tax profits are near record highs). For example, according to the Statement, the above changes will, respectively, promote: (i) the competitiveness of Canada’s manufacturing and processing sector, including competitiveness vis-à-vis the same sector in the United States; (ii) Canada’s clean technology sector and the shift to a “cleaner economy”; and (iii) businesses’ ability to quickly recover the initial costs of investments in capital assets which will, in turn, encourage greater amounts of investment, by businesses, in capital assets. The Statement further emphasizes that the above changes will lead to a reduction in Canada’s marginal effective tax rate from 17% to 13.8% – a rate that would be the lowest among G7 countries.
Canadian businesses that were considering making new investments, or shifting current investments, to the United States or other countries should take a closer look at the proposed accelerated CCA rules. Although temporary, these incentives should make capital investments in Canada more attractive, especially in the manufacturing, technology, telecommunications and clean energy industries.
[1] Other property that either already have additional allowances or are at the 100% rate are also excluded from the AII rules.
Kevin Yip has a broad income tax practice with expertise in all aspects of domestic and international tax planning, corporate reorganizations, and mergers and acquisitions. Kevin also regularly assists clients in transfer pricing, real estate transactions, corporate financing and executive compensation plans.