Depreciation sounds like it must be bad. After all, how can it be good when the things you own are going down in value? Farmers know, however, that depreciation is a powerful tool for understanding their operation’s financial health, as well as for evaluating future production plans and for distributing the cost of a capital asset as a non-cash expense over its useful liife.
On top of that, annual depreciation expenses are essential for accurate accrual income and expense statements, as well as for your farm balance sheet. They’re essential too for producing real-life cost-of-production calculations.
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So you might say that instead of an enemy, depreciation is a good friend for your farm.
If depreciation is a friend, however, then the capital cost allowance is someone you’ll want to invite over for Christmas dinner, especially since it can be one of your keys for income tax management.
What makes capital cost allowance (CCA) different from depreciation is that it’s used for income tax purposes only. CCA is the amount Canada Revenue Agency (CRA) allows you to claim as an expense for depreciable capital purchases. When you buy depreciable capital items for farm use, CCA means that you can spread out the deductions for their purchase cost on your income tax statement over the life of the item.
Unlike operating costs, you cannot immediately deduct the whole cost of capital assets such as buildings or equipment when you calculate your income tax for the year. Since the capital purchase will be used over a period of time, only a percentage of the purchase amount is included as a farm expense for income tax purposes. The amount of CCA claimed depends on the asset itself and your income tax needs.
By the way, there’s no CCA on land or animals. Also, CRA calls quota an “eligible capital property” and the price you paid is called an eligible capital expenditure instead of a CCA. You create a separate account to keep track of these numbers for quota, and 75 per cent of the purchase is deductible, at seven per cent per year.
Newfoundland and Labrador’s agriculture web-site has a useful fact sheet on the differences between depreciation and CCA. (Go towww.nr.gov.nl.ca/agric and search for the fact sheet Management Depreciation versus Capital Cost Allowance).
The fact sheet contains background about the declining balance method that is used to calculate CCA and can also be used for depreciation. Depreciation can also be calculated by the straight-line method, that is, the original cost minus the salvage value divided by the number of years.
With the declining balance method, an asset has a higher depreciation amount when it’s new, and the depreciation amount is less each year as the asset ages. An annual depreciation rate is chosen depending on the type of asset. For example, buildings have a longer useful life than machinery, so buildings depreciate more slowly.
You claim CCA on the cost of the purchase minus the CCA you claimed in previous years, if any. The remaining balance declines over the years as you claim it.
The federal finance department places assets into CCA classes and sets the rates for them. These rates generally don’t change much, and they are usually higher than the normal loss in value of the asset.
You can check the rates via the Farming Income Tax Guide or on the CRA website. You’ll find, for example, that tractors belong to Class 10 and have a CCA rate of 30 per cent, meaning 30 per cent of the non-depreciated capital cost of the asset can be claimed annually, except for the first year you buy it.
CRA rates are fair overall, says Allan Sawiak, chartered accountant with Kingston Ross Pasnak LLP in Edmonton-Leduc. “Generally equipment is written off for tax purposes faster than the decline in fair market value of the equipment,” he says.
You’ll also find that the writeoff rates for farm assets don’t always keep up with technology. “There are higher and higher writeoff rates for stand-alone electronic processing equipment but not for technology that is a significant and inseparable part of the equipment.” says Sawiak. “This issue is definitely a growing concern.”
For example, farm buildings are generally written off at 10 per cent per year, which is a fair rate, Sawiak says. But what if a building requires specialized computer equipment? “We review the client’s situation to determine if the equipment can be written- off at a higher CCA rate,” says Sawiak.
It’s a good tip to ensure your accountant is aware of this discrepancy relative to your building or equipment.
Accountants talk about the 50 per cent rule like farmers talk about seed placement. In the year that you acquire a depreciable property, you normally can claim CCA only up to half of your net additions to a class. For an asset-heavy business like farming, these deductions can make a huge difference in income tax rate.
Also, CCA is more flexible than depreciation since you don’t have to claim the maximum amount of CCA allowed in the class for the year. It can be applied to a later year, although Sawiak prefers to claim the CCA even in a poor year. Then he uses the optional inventory adjustment (OIA) to increase the income to a level acceptable to the client and for tax planning purposes. “In the end, the OIA helps to stockpile the deduction to prepare for a great year,” Sawiak says. Then you can claim all the stockpiled deductions in one year and reduce your tax bill.
For larger, expanding operations, a CCA deduction can be very significant, says Sawiak. “Certainly if the CCA deduction is low, then farmers are generally interested in buying equipment to increase their future CCA deductions.”
Still, CCA can sometimes cost you at the end of the year. For example, if you later dispose of the equipment and had claimed the CCA, you may have to add an amount to your income as a recapture of CCA. Alternatively you may be able to deduct more in what CRA calls a terminal loss, if you have no other assets remaining on hand in that class.
When you buy or sell capital you need to understand the tax implications and plan for them accordingly. For example, recapture can be avoided by buying additional equipment of the same class before the end of the year.
According to Statistics Canada in 2008, the average farm had a CCA adjustment of about $25,000. Don’t you wish everything you do could save you this much money?CG
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MICRO-FIT CCA
In some provinces, farmers have invested in energy producing capital assets. The CCA rate for Class 43.1 is 30 per cent per year and the CCA rate for Class 43.2 is 50 per cent per year, computed on the declining balance basis. Class 43.2 is for renewable energy property acquired after February 22, 2005 and before 2020.
“Generally, costs associated with the purchase and installation of renewable energy property are considered as capital costs of depreciable property, which are deducted over a period of several years, based on a prescribed percentage,” says Andy Meredith, communications manager, Ontario Region, Canada Revenue Agency. “This deduction is referred to as capital cost allowance (CCA).”
This CCA can go against the whole farm income, not just the energy income but it has to be generating income to be able to claim this CCA. Like all CCA deductions it starts the year after you pay for it.
