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Depreciable Properties

From tax expert Gerry Vittoratos
August 15, 2017

In a previous instalment, we discussed the differences between a capital and a current expenditure. In this instalment, we will expand on the definition of depreciable properties by presenting some interesting perspectives provided by case law. How does the CRA define such properties? We will also see where, specifically in the Income Tax Act (ITA), we can find the different categories of depreciable properties.

Depreciable Property Defined

When it is determined that a specific expenditure is capital in nature, the expense has to be entered as a purchase of a depreciable property in order to amortize the expense. As per ITA 13(21), a depreciable property is essentially a property acquired for which the Capital Cost Allowance (CCA) deduction under ITA 20(1)a) is allowed to be taken. Two notable exclusions from the definition of depreciable properties are:

  • goods that are considered as inventory [R1102(1)b)]
  • acquired with no purpose to produce an income [R1102(1)c)].

The second regulation (no income purpose) has been debated in the courts. More specifically, how can one establish the intent to produce income with the acquisition of the depreciable property?

Hickman Motors Ltd. v. Queen [1998] CTC 213

In this decision, Hickman Motors Ltd. claimed CCA on equipment it rolled over from a windup [ITA 88(1)] of its equipment business, and after 5 days, sold to a new subsidiary. The CRA refused the CCA deduction, claiming that acquiring the equipment with the rollover mechanism of ITA 88(1) does not establish intent to use the property to produce business income. Moreover, the short lapse of time between the rollover and sale of the assets (5 days in this case), showed that Hickman Motors Ltd. used the rollover provision to get a tax advantage (CCA claim) instead of using the property to producing income. Hickman argued that it did not need to establish intent since the property was acquired in a business reorganization; alternatively, it did in fact produce income from those transferred properties. Hickman’s appeal was upheld, with 2 judges stating that the time lapse of the possession of the properties is not mentioned as a factor to consider for R1102(1)c), that the properties hold their quality as depreciable properties after the rollover [R1102(14)], and factually, the properties did produce income for Hickman. The fact that Hickman intended a tax savings with the transaction is not a factor considering the facts mentioned above.

Sherman v. Queen [2009] CAF 9

In this case, Mr. Sherman had claimed CCA for a software program that was not fully ready for use, and that had not yet earned any income. Mr. Sherman had argued that his intent was to produce income with the software based on preliminary meetings he had with several parties, but unfortunately these meetings did not bear fruit. Mr. Sherman possessed the software for 6 weeks before selling it. The CRA argued that there was no intent to produce income from the software due it not being available for use, and no actual income from the property could be established. The CRA won this case, based on the argument that the possibility for the property to produce income has to be established.

Classes of Depreciable Properties

The description of each class of depreciable property is located in Schedule II of the Income Tax Regulations.  The rates for each class are also indicated in Schedule II, and in R1100(1).

Other notable articles within the Income Tax Regulations are:

Methods of Depreciation

Most classes of depreciable properties use the declining balance method of depreciation. There are a few properties that use the straight-line method, such as Class 13 (Leasehold improvements) [R1100(1)b)/Schedule III] and Class 14 (Patents) [R1100(1)c)/Schedule III] .

Half-Year Rule

In the year of acquisition, you can only depreciate one half of the value of the acquisition by the CCA rate established for that property [R1100(2)]. There are exceptions to this rule, which are listed in R1100(2)a).

Other particularities of depreciable properties

Distinct Classes

Most additions of identical properties have to be added to the UCC of existing classes [Letter A of ITA 13(21)]. There are exceptions to this rule, in which the addition of an identical property is treated as a separate class. Some examples of this are:

  • Buildings under Class 1 used for non-residential purposes [R1104(2)/R1101(5b.1)]
  • Passenger vehicles  within Class 10.1 [R1101(1af)].

Recapture/Terminal Loss

In the case of a sale of the depreciable property, a recapture or terminal loss will get triggered if the property sold is not replaced by another of the same class. The simplified calculation is as follows:

UCC beginning of the year

XX

Minus – Lesser of:   [ITA 13(21) letter “F”]

  • Disposition amount                         XX
  • Original capital cost                         XX

(XX)

Negative result – Recapture [ITA 13(1)]/ Positive result – Terminal loss [ITA 20(16)]

XXX

The recapture amount gets added to business or rental income, while the terminal loss gets deducted from business or rental income. One exception to the recapture/terminal loss rules is the passenger vehicles in Class 10.1 [R1100(2.5)].

Capital Losses

No capital loss is allowed as per the ITA fo r a depreciable property [ITA 39(1)b)(i)]. Only terminal losses are allowable losses that you can claim (see above).
Availability for Use Rules

Depreciation (CCA) can be taken from the moment the property is made available for use. The Act distinguishes two categories of property: property other than buildings and buildings.

For property other than buildings, the property is generally considered as available for use at the earliest of [ITA 13(27)]:

  • the time the property is first used by the taxpayer for the purpose of earning income,
  • the time that is immediately after the beginning of the first taxation year of the taxpayer that begins more than 357 days after the end of the taxation year of the taxpayer in which the property was acquired by the taxpayer*,
  • the time that is immediately before the disposition of the property by the taxpayer.

* In this scenario, the half-year rule mentioned above does not apply [R1100(2)a)(vii)].

For buildings, the property is generally considered as available for use at the earliest of [ITA 13(28)]:

  • the time all or substantially all of the building is first used by the taxpayer for the purpose for which it was acquired,
  • the time the construction of the building is complete,
  • the time that is immediately after the beginning of the taxpayer’s first taxation year that begins more than 357 days after the end of the taxpayer’s taxation year in which the property was acquired by the taxpayer*,
  • the time that is immediately before the disposition of the property by the taxpayer.

* In this scenario, the half-year rule mentioned above does not apply [R1100(2)a)(vii)].

­Misclassified Properties

In the case of a misclassified property, the CRA may reassess the years involved in order to correct the misclassification and the CCA claimed. However, if such a correction has not been made, the Minister may make a direction under subsection 13(6) in respect of a tax year to deem a property to be of the incorrect class for the years prior to the year for which direction is made and to be transferred to the correct class beginning in the year for which the direction is made.
A taxpayer can request that a correction be made beginning with the first year in which the misclassified property was acquired or became misclassified. Reassessments will ordinarily be made to correct the CCA claimed in those years and no direction will be required under subsection 13(6).

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