On November 20, 2018, the federal Government of Canada released their Fall Economic Update – a review of the country’s finances and economic health that addresses trends and changes taking place in Canada and the world since the federal Budget in the spring.
Of particular note in 2018 was the anticipated response to the U.S. tax reform enacted by the Trump administration. In addition to slashing corporate tax rates from approximately 35% to approximately 27% (including state taxes) – an amount that puts pressure on Canada’s corporate tax rates, which vary between 26.5% and 31% – the U.S. tax reform introduced a temporary Bonus Depreciation measure, allowing businesses to depreciate certain capital property at a much faster rate, thereby reducing taxes when they purchase capital property.
In the Fall Economic Update, the Government of Canada acknowledges that U.S. tax reform has hurt or eliminated the Canadian tax advantage, but chose not counter it with any changes to Canadian corporate tax rates. Instead, they are introducing three new tax measures that substantially increase the first-year tax depreciation available to businesses that invest in depreciable property in Canada. These tax measures are effective immediately as November 20, 2018, and continue to have full effect until the end of 2023, at which point they will slowly be reduced until their elimination by the end of 2027.
By way of brief background, owners of depreciable property, such as machinery, intellectual property and technology, may deduct a portion of the cost of such property from their taxable income each year. The portion is determined by the “Class” of the depreciable property as found in the Income Tax Regulations (Canada). However, most Classes are subject to the “half-year rule”, meaning that the tax deduction is reduced by 50% in the year that the property is purchased. With these new changes, the Government of Canada has effectively eliminated the “half-year rule”, giving owners a boost to the tax deduction they get in the year that the property is purchased.
Manufacturers & Processors: Prior to the Fall Economic Update, Class 53 depreciable property, which includes most manufacturing and processing equipment, had a tax depreciation rate of 50% per year, and was subject to the half-year rule in the year that the property was purchased. Starting on November 20, 2018, taxpayers are now permitted to deduct 100% of the cost of purchasing Class 53 depreciable property in the year that they acquire the property.
Clean Energy Investments: Prior to the Fall Economic Update, 43.1 and Class 43.2 depreciable property, which includes clean energy technology, had a tax depreciation rate of 25% and 50% per year, respectively, and was subject to the half-year rule in the year that the property was purchased. Starting on November 20, 2018, taxpayers are now permitted to deduct 100% of the cost of purchasing Class 43.1 and Class 43.2 depreciable property in the year that they acquire the property.
Accelerated Investment Incentive: For all other depreciable property, the Accelerated Investment Incentive applies, permitting taxpayers to claim and deduct from their taxable income one-and-a-half times the normal tax depreciation rate for all property.
What does this mean for taxpayers contemplating an investment? Purchasing depreciable property – especially manufacturing and processing equipment and clean energy technology – is now accompanied by an boosted tax deduction in the year in which the property is purchased, allowing taxpayers to lower their tax bill while they invest in their business.
A few restrictions do apply. All three of these tax incentives are pro-rated over a short taxation year, and will not be available again, so a portion of that boosted tax deduction is lost if the taxation year in which the property is purchased is less than twelve months.
Further, these tax incentives are also not available if the property was previously owned by the taxpayer or a non-arm’s length person or if the property was transferred to the taxpayer on a tax-deferred rollover basis.
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