I previously provided my views on the NDP proposal to yet again extend the ACCA. I would like to follow up on that post by giving them (or any political party for that matter) advice on what they should focus on with respect to the CCA system in Canada. I realize no one will listen to me, but being an academic, a mum, and a wife, I am quite used to be ignored by the men in my life.
As I previously discussed, the rationale for the CCA system is the matching principle: matching income to expenses. Since its introduction with the Income Tax Act in 1949, the CCA system has been used and abused to achieve policy objectives separate from the matching principle (notably to stimulate pet industries/activities/purchases during economic recessions). The result is an increasingly complex CCA system that is neither ‘fair’ nor ‘neutral.’
When the CCA system was first established, there were 12 assets classes, but that grew to a whopping 56 classes by 2012. In many cases the expansion in the classes is the direct result of politicians introducing ‘special’ classes for some perceived economic benefit (cough, subsidy, cough) or futzing with the depreciation rates (repeat cough) that have no relationship to economic reality of the asset.
It makes absolutely no sense to depreciate equipment in, say, 2 years when it has a useful life of more than 20 years. These ACCA rule really only benefit small number of large businesses. And, little attention seems to be paid to the problems that this creates with CCA recapture. See when a depreciable fixed asset is sold (like when the business is sold to a new owner), its capital cost allowance (CCA) class is reduced by deducting the lower of its original cost, or its proceeds of sale. If, at the end of a fiscal year, the balance of the class is negative, a gain has occurred. This gain is referred to as a “recapture” of CCA, and must be included in business or property income for the year. Where there is still much useful life in an asset there will be a large tax bang at the end that could have been avoided. This large tax issue makes owners want more for their business (despite the fact they got it already) and can make negotiation for sale more difficult. Given that we are entering into a period where we expect a lot of business to be bought and sold given the aging population, this will become a bigger problem in the near future.
Have these changes been effective at achieving the federal government’s policy objectives? While the industry being targeted will say ‘yes,’ there is no evidence to support their views. Accountants are fairly unanimous in their views that the tax rules fail to stimulate the acquisition of an asset. In addition, there is little economic benefit in favouring one industry or asset acquisition at the expense of another. While I understand that we seem to be currently living through a period dubbed ‘decision-based evidence making’, a return to evidence-based decision making would be a welcome change to policy development in Canada.
Most of the existing CCA classes are not commonly used (CRA indicates that only 18 are commonly used) and many of them overlap making it difficult for businesses to identify the ‘right’ class (thereby wasting time and effort). These 56 classes need to consolidated, some even eliminated, and the descriptions revised which would provide for a more simple CCA system. You can put this initiative under reducing red tape for businesses. The CCA rates should then be modified to best reflect the useful life of these new asset class.
While more of a fringe element, the half year rule needs to go the way of the do-do bird. The half-year rule, introduced in 1981 and applied to some asset classes, means only half of the expense can be included in the purchase year for purposes of that year’s CCA deduction calculation. The rationale for the half year rule is to prevent a flurry of tax motivated purchases at the end of a tax year, for many assets. So on one hand we want to discourage tax motivated purchases, and then on the other, we want to, wait for it, encourage a flurry of tax motivated purchases. That my friends is the problem with political interference in the tax system. The problem with the half- year rule is that it is only used for tax purposes, not accounting purposes, so you have what is called a book-tax difference. And you wonder why businesses need to keep two books! Again, the half-year rule adds a layer of complexity that most likely has no real benefit.
So instead of futzing the the existing system and adding in more and more complexity and irrationality into the CCA system, I would love to see someone come out and say they want to simplify and stop using the tax system for political reasons.