Introduction to Corporate Finance

Financial Statements, Taxes and Cash Flow

Chapter 2: Section 2.5

Tax shields (CCA)

CCA = 0
----------------Sales
100,000
- Cost
20,000
- CCA
0
=EBT
80,000

CCA = 30,000
----------------Sales
- Cost
- CCA
=EBT

taxes (40%)
32,000
OCF = 48,000

taxes (40%)
20,000
OCF = 60,000

100,000
20,000
30,000
50,000

CCA tax shield = 12,000

CCA TS = taxes (CCA=0) taxes (CCA=30,000) = 32,000 20,000
Shortcut: CCA TS = CCA*tax rate = 30,000*0.4 = 12,000
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CCA Classes and Rates

Assets divided into classes:
All assets in a class: Asset Pool
Each class has its own CCA rate
Income Tax Act: sets classes and CCA rates
Intangible assets: straight line depreciation
All other assets: declining-balance depreciation (higher
depreciation cost earlier in an asset's lifetime)
Class
2
8
10 & 43

Assets
Buildings
Furniture, photocopiers
Vans, trucks, equipment

Rate
4%
20%
30%
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CCA Calculation: Single Asset

Half-year rule

I
0
2

CCA t
d UCC
t

in first year (t 1)
all other years (t 1)

d CCA rate or depreciation rate

UCCt undepreciated capital cost
CCA Tax Shield CCA t Tc
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Example 1: CCA Tax Shields

New computer system:
$160,000 cost
Class 10 (equipment)
30% CCA rate
Tax rate 40%
Year
1

UCCB

CCA 0.4

CCA

UCCE

*$160,000 $24,000 = $136,000

Tax shield
$9,600

$136,000

$40,800

$95,200

$16,320

$95,200

$28,560 $66,640

$11,424

$66,640

$19,992 $46,648

$7,996.80
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CCA Calculation: General Rules

When buy an asset: add its cost to the pool
apply half-year rule

When sell an asset: remove min(original cost; selling price)

from the pool
no adjustment for half year rule
if selling price > original cost capital gain the amount
subject to tax is: (selling price original cost) * inclusion rate

When buy and sell assets: net acquisitions rule

net acquisition = total acquisitions - min(original cost; sell price)

if net acquisition > 0 apply half-year rule to net acquisitions
if net acquisition < 0 no adjustment for half year rule

Use CCA deductions as long as asset pool is active

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Example 2:
Buy / Sell Assets (Net acquisitions rule)
The firm currently has a truck on the books at $50,000
CCA rate for trucks is 30%
Year 1:
Buy one truck for $100,000

(Add cost to pool)

Year 2:
Buy two vans for $50,000 and $150,000, respectively
Sell the truck bought in year 1 for $98,000

(Net acquisition rule)

Year 3:
Sell a truck (that originally cost $84,000) for $15,000

(Reduce pool)
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Example 2:
Buy / Sell Assets (Net acquisitions rule)
Year
1

UCCB
*$150,000

CCA
$30,000

UCCE
$120,000

150,000 = 50,000 + new acq of 100, 000

30,000 = (50,000 + 100,000*1/2)*0.3

*$222,000

$51,300

$170,700

net acq = 50,000 + 150,000 98,000 = 102, 000 > 0

222,000 = 120,000 + 102,000
51,300 = (120,000 + 102,000*1/2)*0.3

$155,700

$46,710

$108,990

155,700 = 170,700 15,000

46,710 = 155,700*0.3
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Example 3:
Sell Assets, Class Termination

Buy two Class 10 assets

Each costs $10,000
Buy Asset A in Year 1
Buy Asset B in Year 3
CCA rate 30%
Tax rate 40%
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Tax rate
CCA rate

Asset B
added

Year
1
2
3
4
5
.
.
.
10
.
.
.
30
.
.
.
60

40%
30%
UCCB
$10,000.00
$8,500.00
$15,950.00
$12,665.00
$8,865.50

CCA
$1,500.00
$2,550.00
$3,285.00
$3,799.50
$2,659.65

$1,490.02

$447.01

$1,043.02

$178.80

$1.19

$0.36

$0.83

$0.14

$0.000027 $0.000008

UCCE
Tax Shield
$8,500.00
$600.00
$5,950.00 $1,020.00
$12,665.00 $1,314.00
$8,865.50 $1,519.80
$6,205.85 $1,063.86

$0.000019 $0.000003
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Example 3:
Sell Assets, Class Termination
Year 4 UCCB = 12,665 => Suppose in Year 4:
Firm sells A for $5,000 but keeps B
What happens: sale proceeds < cost (5,000 < 10,000)
UCC = 12,665 5,000 = 7,665

Firm sells A for $11,000 but keeps B

What happens: sales proceeds > cost (11,000 > 10,000)
UCC = 12,665 10,000 = 2,665

Firm sells both A & B => class termination

What happens? next slide!

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LO5

Closing an Asset Class

When the last asset in an asset class is
sold, the asset class is terminated. This
can result in a terminal loss or recaptured
CCA.
Terminal Loss The difference between
the UCC and the adjusted cost when the
UCC is greater.
Recaptured CCA The taxable difference
between the adjusted cost and the UCC
when the UCC is smaller.
2013 McGraw-Hill Ryerson Limited

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Example 3:
Sell Assets, Class Termination
(1)

(2)

(3)

(4)

$12,665

$12,665

$12,665

$12,665

$6,600
$6,065

$4,000
$6,000

$4,500
$9,500

$4,500
$10,500

Balance in pool

$0

$2,665

($1,335)

($1,835)

Capital Gain

$0

$0

Year 4 UCC
Sell A
Sell B

Tax (40%)
CCA Pool
Cap Gain
Total Tax

Terminal loss

$0

$500

CCA Recaptured

$0
$0

$1,066
$0

($534)
$0

($734)
($100)

$0

$1,066

($534)

($834)

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CCA calculations
1. Buy asset: add its cost to the pool. Apply half-year rule for the new asset
2. Sell asset: asset class UCC is reduced by the min (original cost, sale price).
3. If step 2 leaves a negative balance, this amount is added to taxable income
(recaptured depreciation), and the UCC of the asset class is reset to zero.
4. If step 2 leaves a positive balance and there are no other assets in the asset
class, this amount is deducted from taxable income (terminal loss), and the
UCC of the asset class is reset to zero.
5. If step 2 leaves a positive balance and there are assets left in the class, the
balance becomes the new UCC for the class.
6. If the asset is sold for more than its original cost, the difference is a capital gain
(50% inclusion rate).
7. If new acquisition in the same year as an asset is sold. Define net acquisitions =
acquisitions - disposals. If net acquisitions are > 0, apply half year rule to net
acquisitions; if net acquisitions are < 0, do not apply the half year rule.
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