Tax Terms Demystified 0

Posted On December 6, 2022, by Admin

Like any other industry, the field of taxation has its own terminology that may look complicated to a nonexpert. Whether it is tax filing season or not, it is good to brush up on your tax vocabulary and tackle the filling process stress-free.

To simplify the entire procedure, we’ve compiled a list of key Canadian tax terms you should know if you’re running a business. Moreover, we have focused only on those that refer to business deductions since every business owner must understand what expenses are deductible for income tax purposes. Read on.

Depreciation and Amortization

Amortization is used to gradually deduct the cost of an intangible asset over the asset’s useful lifespan. It can reduce a company’s tax liability for acquiring and creating intangible assets. In contrast, depreciation works with tangible assets, like properties, cars, furniture, and more.

Instead of deducting the total cost of something you bought for your business in one year (e.g., equipment, furniture, etc.), depreciation allows you to write off parts of it over time. The useful lifespan of that object determines its depreciation period. In tax depreciation (capital cost allowance), assets are categorized into different classes, each with a different useful life.

An annual allowance is calculated using a prescribed rate per class, usually on a declining-balance basis. For instance, the prescribed annual rate is 4% for most buildings, 20% for most furniture and fixtures, 30% for general-purpose electronic data processing equipment, 100% for medical and dental instruments, and so on.

Before claiming CCA, you should know that:

  • You cannot claim CCA unless the property has been available for use.
  • You can claim any CCA amount up to the allowed maximum.
  • Any previously claimed CCA becomes subject to recapture if you sell an asset higher than the current undepreciated capital cost (UCC).
  • You cannot claim CCA on all your net income additions but only half of them in the year you bought the property (half-year rule) – some exceptions apply.

The Accelerated Investment Incentive (AII), a temporary change to CCA that began in 2018, brought a major benefit — more significant CCA deductions during the first year of an eligible depreciable asset acquisition. The measure applies to properties purchased after November 20, 2018, and will become available to use before 2028.

Businesses that can claim the 100% CCA deduction in the first year the property becomes available for use include clean energy investments, manufacturers, and processors.

Immediate Expensing of Capital Property for CCPCs

According to the 2021 Federal Budget, specific property acquired by a Canadian-Controlled Private Corporation (CCPC) was eligible for immediate expense for tax purposes. Properties must have been purchased on or after April 19, 2021, and become available for use before January 1, 2024, to qualify. Eligible properties are capital properties that are subject to the CCA rules. However, this measure does not apply to properties in classes 1 to 6, 14.1, 17, 47, 49, and 51.

A maximum eligible amount for immediate expensing is $1.5 million per year, available only in the year the property is available for use. All associated members of a group of CCPCs share this maximum, and any unused capacity cannot be carried forward. Corporations whose taxation year is shorter than 365 days can also claim the eligible amount, but it will be prorated. In this case, the half-year rule is suspended.

Eligible Capital Property (ECP)

The 2016 Federal Budget proposed that goodwill and other intangible capital properties would be treated differently for income tax purposes starting January 2017. This property is also called an eligible capital property (ECP) and is accumulated in an account called cumulative eligible capital (CEC). CEC accounts are used to track eligible capital property acquisition, amortization, and disposition.

On January 1, 2017, the new capital allowance class, Class 14.1 replaced the previous tax treatment of ECP. This class includes 100% of eligible capital expenditures subject to a 5% declining balance CCA rate. Properties in Class 14.1 are subject to the same rules as depreciable property, such as the half-year rule, recapture, and capital gains.

Expenditures not incurred in connection with a specific business’s property are subject to special rules. Since every company has goodwill associated with it, these expenditures will increase the capital cost of goodwill in the business and therefore affect the balance of the Class 14.1 pool.

However, capital expenditures made before 2017 remain subject to the 7% rate. Also, for the same 10-year period, taxpayers can deduct $500 each year as a CCA, plus their otherwise deductible amount. This additional deduction will be available for years ending before 2027.

Scientific Research and Experimental Development (SR&ED)

Canadian businesses of all sizes and sectors can benefit from the Scientific Research and Experimental Development (SR&ED) tax incentive. It is a business assistance program administered by the provincial and federal government to encourage and support organizations to engage in R&D (research and development) activities that might not otherwise interest them.

Incentives depend on the size and type of your business and include a deduction against income and a refundable and non-refundable investment tax credit (ITC). Individuals, partnership members, trusts, and corporations are eligible for these incentives.

SR&ED expenditures can be used to reduce your net income for tax purposes in a current year or deducted in a subsequent year, regardless of your work.

A non-refundable tax credit of 15% is available on qualified expenditures at the federal level. Private corporations under Canadian control are eligible to receive a 35% refundable credit on their first $3 million of qualified expenditures and possibly refundable provincial tax credits. The credits range from 4.5% to 30%, depending on the province.

Interest Expenses

According to the Canada Revenue Agency, you can deduct interest on the money you borrow if you use it to earn an investment income.

It may be possible to deduct the interest when investing with borrowed money. You can deduct the interest on your loan if your investments generate income, such as dividends or interest. However, capital gains are not eligible for deduction. You cannot deduct the interest on a loan for investments that only generate capital gains and don’t pay dividends.

If you use a mortgage to buy a property, a rental income from that property can be used to reduce the interest on a mortgage. You can deduct part of the interest even if you live in the property and only rent a part of it.

Insurance Premiums

When it comes to the deductibility of insurance premiums, there is no straightforward answer, as that depends on your company’s specific tax situation. Generally, life, health, and disability insurance tax deductions aren’t available to individuals or businesses. Only business owners who pay life insurance premiums for their employees may be eligible for deducting their expenses.

Life insurance usually cannot be deducted unless used as a loan or revenue-generation measure for the business (for example, if it only provides security for the owner or the company). But if the business owner requires life insurance in the form of a collateral insurance policy, then the deduction is possible.

On the other hand, if your insurance premiums cover exposures that are likely to harm your business’s profitability, such as fire, property, or cyber insurance, they will generally be subject to deductions.

An insurance premium may also be deductible if it relates to a capital asset. For example, fire insurance is necessary to protect capital assets such as office buildings, which you might lose when they burn down. You can also deduct your business insurance premiums when they cover equipment, fixtures, furnishings, and any inventory you have on hand.

Business Meals and Entertainment

A businessperson or a company can deduct a certain percentage of their business meals and entertainment expenses from their taxes. According to Canadian Income Tax law, food, beverage, and entertainment expenses are deductible at 50%.

This 50% rule applies when the amounts spent on food, beverages, and entertainment are capitalized (included in the cost of depreciable property), included in the cost of inventory or scientific research, and deductible as expenses. This covers meals incurred for entertainment purposes while travelling or attending a convention, conference, or seminar. It also includes overtime meal allowances, room rentals, and service charges.

However, in some rare instances, meals and entertainment are 100% deductible. This is when they are provided for a fund-raising event, included in an employee’s income, supplied to employees at temporary work camps, billed to your customer, provided as compensation to customers, or incurred for a Christmas/Holiday party or a similar event.

Non-Capital Losses

A company experiences non-capital losses (NCLs) when its permissible deductions exceed its taxable income during a tax period. For this reason, CRA has a loss carryforward provision that allows NCLs to offset future tax payments (to deduct losses from coming years’ profits). Generally, a business can carry NCLs back for three tax years and forward indefinitely.

Fines and Penalties

Fines and penalties are usually not deductible, but in certain circumstances, they may be. Each category of fine or penalty has a different tax treatment. If an individual or entity carrying the necessary authority imposes a fine or penalty under federal, provincial, municipal, or foreign law, it will usually not be considered deductible. Although this rule is generally true, there are a few notable exceptions.

The following types of fines and penalties can be deducted — interest charges, penalties paid under a private contract, those imposed before May 23, 2004, and amounts not classified as fines or penalties by the legislation imposing them.

A fine or penalty must also be a business expense and be logically connected to the business operation to qualify for the deduction. Similar to any other expense, you must include penalties in your regular business income calculation to be able to deduct them. A penalty will appear on your Statement of Business or Professional Activities and will be reflected on your income tax return.

Interest and penalties assessed by CRA are not deductible for tax purposes.

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This blog is not meant to provide specific advice or opinions regarding the topic(s)  discussed above. Should you have a question about your specific situation, please discuss it with your GBA advisor.

GBA LLP is a full-service accounting firm in the Greater Toronto Area, but we primarily service all of Ontario as well as the rest of Canada virtually, except Quebec. Our team of over 30, provides Audits and Reviews of financial statements, and Compilations of  financial information, as well as corporate tax returns.  We provide specialized corporate tax and succession planning for small and medium businesses, in addition to general advisory services.

If you would like to schedule a call to discuss your accounting or tax needs with one of  our team members, please complete the free no obligation meeting request on this page.

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