CCA and Deferred Tax

by Judy

How to Amortize Assets / Reconcile Statements When CCA Cannot be Claimed Due to Net Loss

For many years our family-business company's assets have been amortized on a declining balance based upon CCA tax rates for income tax purposes. We have always had sufficient net income that the entire CCA amounts were claimed, and therefore the amortization balances in our financial statements and our tax returns have been sustantially the same.

We do not have enough income this year to claim CCA :-( - we realize that CCA cannot be claimed if a net loss will result, and have read that CCA can be saved for future years if we haven't sufficient income to claim the entire amount of CCA that the tax class rates would allow.

We are unsure what to do with amortization if we do not claim or only claim a partial amount of CCA. (Your specific questions have been moved further down the page Judy.)

Thanks in advance for the help!

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Hi Judy,

Good questions. It shows you are thinking. CCA is a complex subject. To answer your questions I think I need to talk about (1) the difference between tax reporting and financial reporting; and (2) deferred taxes. So bear with me as I lay the groundwork before I specifically answer your questions.

I want to start by saying that deferred taxes is not one of my strengths but here is my understanding of the subject. I welcome corrections by readers if I have made an error.

Tax Reporting vs Financial Reporting

When dealing with taxes in general, it is important to remember there are different guidelines and objectives between tax reporting and financial reporting. I spoke briefly on not confusing the two in Unclaimed Capital Cost Allowance*.

So let’s look at a few of the differences.

Tax reporting is based on the Income Tax Act (ITA) while financial reporting is based on Canadian GAAP**.

Tax reporting’s objective is to legally minimize tax in the long term while financial reporting’s objective is a fair presentation of financial statements based on GAAP guidelines, and dependent on management objectives such as smoothing income … or maximizing/minimizing income.

Tax reporting calculates taxable income. The only reason to calculate taxable income is to determine how much income tax the company owes CRA.

Financial reporting calculates pretax accounting income. The reason to calculate pretax accounting income is to meet financial reporting standards and provide practical information for decision making by management and outside investors. It does not have any affect on the actual taxes paid by the company.

Deferred Income Taxes

Wikipedia explains deferred taxes are reported and generally arise because of temporary differences between accounting and income tax values of assets and liabilities. These differences give rise to future income tax (FIT).

I think that timing differences on the income statement are also to be considered when determining FIT but I’m no longer sure because of the coming switch to IFRS and ASPE beginning next year**.

Deferred taxes is something I like to leave to tax accountants to calculate and report on because it requires an advanced knowledge of both tax law and accounting principles ... which means it involves the accountant making judgements on whether there is a likelihood the tax difference will be utilized in future years ... and then booking estimations where appropriate.

Answers To Your Questions

Question (1) Is the amount of amortization recorded in our books equal to the partial or zero amount of CCA we end up claiming on our taxes, or is it equal to the full amount that would normally apply, even though we are not claiming the CCA? (Do we still need to fully depreciate the assets on our books?)

Simple Answer - Under GAAP, you still need to record your annual depreciation amount regardless of what happened in your tax reporting …

More Detailed Answer - ... but I think you are confusing tax reporting guidelines and financial reporting guidelines with respect to CCA being in accordance with GAAP.

CCA is an accelerated method of depreciation which allows a business to defer income tax … creating a temporary difference between tax reporting of taxable income and financial reporting of pretax accounting income.

Taxes are deferred because the business is allowed to increase their expenses thereby lowering their taxable income.

Question (2) If we still have to fully depreciate the assets on our books, how do we handle the resulting difference between our books and our tax return balances, in the current year and in future years?

Simple Answer - Timing differences due to book depreciation and CCA do not require any adjusting entry for depreciation … but it does affect your tax calculation.

More Detailed Answer - The difference in the depreciation balances affects your financial reporting income tax calculation in the current year. Future years are accounted for through a deferred tax calculation.

Normally, book depreciation does not equal the tax depreciation claims as CCA is not a GAAP method of accounting for depreciation. However it sounds like this is not the case for you because if I understood correctly, you have been using CCA as your depreciation method for your book value.

I am guessing the reason this method was chosen was to keep your accounting simple and cost effective. It is what I call hybrid accounting for the small business owner.

This is acceptable when the company is privately owned and does not have third parties interested in the financial statements. I discuss this in my sidebar chat "Do You Need GAAP/ASPE Financial Statements?".

If the financial statements are distributed outside the company ... to the bank or another creditor, it is very important to disclose your amortization/depreciation policy in the financial notes as this method is a departure from GAAP.

If this seems to fit your case, then I would continue recording just as you have in the past ... by matching whatever amount was or was not booked for CCA on your tax return ... to keep the two balances equal. This eliminates the need to book a deferred tax entry.

When doing books for small home based businesses that have no investors to report to, I usually don't account for deferred taxes. I believe this is referred to as the “no-allocation” method.

This means I disregard the effect of the timing differences and book the income tax expense as calculated on the tax return.

Because timing differences are expected between your books and your tax schedules, often times a reconciliation worksheet is prepared that tracks the timing differences between accounting net income (loss) and taxable income (loss).

Bookkeeping Entry

If you do want to book a deferred tax entry you need to calculate the tax effect of the timing difference.

First calculate book depreciation for the year. Let’s assume it is $2,000.

Now calculate your pre-tax income. Let’s assume it is a $5000 as profit is down due to the economy.

Next calculate your CCA claimed. Let’s assume $1,000 as you’ve been in business awhile.

Calculate your taxable income adjusting for the CCA timing difference. Pre-tax net income $5000 + book depreciation $2,000 - CCA claimed $1,000 = taxable income $6,000.

Let’s assume you are a CCPC with a federal tax rate of 11% . I will ignore provincial taxes for this example as it is differs for each province.

Your income tax entry on your books would be:

Debit income tax expense calculated as $5,000 x .11 = $550.

Credit income tax payable calculated as $6,000 x .11 = $660.

Debit deferred income tax calculated as the deductible temporary difference = CCA $1,000 - Book $2,000 = ($1,000) x .11 = $110.

Question (3) If we do not claim CCA (or only partial CCA) this year and possibly in future years as well, what happens in future years - is the total length of time we have CCA available for tax purposes simply lengthened, even though no further depreciation may show on our books, if we have to record full depreciation there regardless of the CCA we claim?

Answer - Your UCC balance does not have a time limit so it does not expire if not utilized like capital losses … as long as there are remaining assets in the class.

Once your assets are fully depreciated on your books, the only effect the timing difference will have is on your income tax calculation.

Question (4) Does the CRA allow us to claim both the balance of this year's unclaimed CCA plus all of next year's CCA, next year?

Answer -The amount of CCA deductible in a year is dependent on the declining balance formula. This automatically places limits on the amount that can be deducted in a tax year.

Judy, that is my understanding of how deferred taxes work. I would double check this with your own accountant. I hope my answers helped you out … and didn’t confuse you.

*The more appropriate terms are UCC = Undepreciated Capital Cost and CCA = Capital Cost Allowance.
**Effective January 1, 2011, small business will now have 2 reporting standards under Canadian GAAP from which to choose - IFRS found in Part I of the CICA Handbook ... OR ... ASPE found in Part II of the CICA Handbook.

Reference sources used in preparing this response: Wikipedia on Deferred Tax and Intermediate Accounting by Nelson, Conrad, Dyckman, Dukes and Davis

Comments for CCA and Deferred Tax

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Apr 13, 2010
Just to clarify ... ;-)
by: Judy

Thanks very much for the prompt response ;-).

Yes, our business is a two person 'mom and pop' private incorporated company. No investors, no debt, no third party reporting.

You have indicated (if I am understanding you correctly) that if the above is the case, we can post depreciation to our books just as in the past (matching the amount booked for CCA on our tax return, and keep the two balances equal).

Does this mean that if we cannot claim any CCA this year, we do not necessarily have to book any depreciation? If we have a net loss without depreciation, do I simply not post any depreciation at year end, leaving the blance sheet asset account balances the same at year end as they were at the start of the year?

Thanks again.

Apr 13, 2010
Tax Basis Financial Statements
by: Lakeshore Bookkeeping Services

Hi Judy,

Yes, that's what I would do ... match your CCA claimed on your tax return. If you claim zero CCA this year, then there will be no depreciation expense booked.

Depreciation expense is a non-cash entry that is booked to match revenue and expenses in a period.

You don't have any third parties using your financial statements, and you understand that your accounting policy for booking depreciation is on a tax basis not on a GAAP basis.

With this knowledge, recording your depreciation this way should not affect any management decisions you would make in a negative fashion when utilizing your financial information.

The only thing it skews is the true net book value of your assets on the balance sheet ... which I monitor to help determine when replacement of assets is necessary ... but you can mentally adjust for this when doing your financial planning.

It keeps your accounting simple and cost effective ... which is important to a small business.

Jan 17, 2012
Meals & Entertainment Expenses for a Corporation
by: M, Ontario, Canada

It's common practice when preparing a T2 corporation tax return reconciliation between accounting net income & taxable income that one half of Meals & Entertainment expenses, previously 100% booked to an expense account, are added back to accounting net income. Since this business entertaining has a personal element, what I would like to know is what then happens to the personal 50% of the expenditure?

The case I'm thinking of is an owner/manager/shareholder of a CCPC entertaining his/her clients. It seems like that person is extracting funds for personal use from a corporation without any accountability. I myself have been told to book such expenses 100% to a Meals & Entertainment expense account & since I also do the T4's, I know there is nothing on them in the way of a taxable benefit. We hand the books over to a Chartered Accounting firm to prepare the T2.

Does anyone know what happens at that point or do the CA's just overlook the 50% personal component? I do book 1/2 of the HST to the Shareholder Loan account & take an HST ITC for the other 1/2, so the HST part is correct.

I would love to know if there is some other mechanism that CA's use to account for that personal part so that the person is taxed on it? When I receive the year end adjusting entries back from the CA firm for posting, there is no entry to debit Shareholder account for that 50%. In the case I'm thinking 50% is a few thousand dollars?

Thanks for any knowledge anyone can share.

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100% of the meals and entertainment expenses are business expenses however only 50% are tax deductible. Just becasue they are not tax deductible does not mean they are not still a legitmate business expense.

This difference creates a permanent timing difference (as opposide to a temporary difference). This difference will show on the reconciliation the accountatn does between tax reporting and financial reporting.

As 100% of the meals and entertainment expense are legitimate business expenses, it is my understanding that the 50% not claimable ITC would be expensed; not recorded as a charge to the shareholder.

P.S. I would like to remind you there is a difference between information and advice. The general information provided in this post or on my site should not be construed as advice. You should not act or rely on this information without engaging professional advice specific to your situation prior to using this site content for any reason whatsoever.

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