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Part 2—Tax Evaluations and Research Reports

Tax Expenditures for Accelerated Deductions of Capital Costs

Introduction

Where a tax deduction is allowed for the cost of capital investments, the deduction is normally required to be spread over a number of years. This is based on the principle that capital assets are not entirely consumed in the period in which they are acquired, but instead contribute to earnings over several years. Therefore, the deduction is normally allowed at a rate which allocates the cost of the asset over the period that the asset contributes to earnings, or the period over which it loses its value—the asset’s useful life. Allocating the deduction for capital costs over the useful life of assets helps to ensure that the tax system is neutral in its treatment of capital assets with different useful lives.

For tax purposes, firms calculate their deductions for depreciable capital assets under the rules set out in the Income Tax Act and the Income Tax Regulations. The allowable deduction rates for most tangible capital assets are set out in the Regulations under Schedule II—Capital Cost Allowances (CCA). The CCA system groups capital assets into classes and assigns each class a depreciation rate. The rate is generally a specified percentage of the capital cost of the asset or group of assets included in the class and is reflective of the useful life of those assets. In most cases, the percentage is applied to the declining balance of undeducted costs remaining for each successive year.

While CCA rates are typically set to reflect the useful life of the assets in the particular class, there are cases where the rate at which certain capital costs may be deducted for tax purposes is more rapid than would be permitted under the useful life benchmark. Where that is the case, it results in a positive tax expenditure.

Tax expenditures are not estimated for accelerated CCA due to methodological challenges and the fact that data is not generally available to calculate these estimates with a reasonable degree of accuracy. In many cases, this is due to differences in categorization of assets and recording of related expenses between the tax system and possible benchmarks such as financial statements and studies of economic depreciation. In some cases, the accelerated category encompasses a range of assets or expenses, but tax data does not provide sufficient detail on the particular type of assets in which companies invest. The calculations may also be complicated by other differences between the tax system and the benchmark, including the discretionary nature of CCA deductions, differences between economic versus tax depreciation, and the fact that gains or losses related to disposal of assets generally adjust the undepreciated balance of the asset pools for tax purposes while the adjustments are made on an asset-by-asset basis for accounting and economic depreciation purposes.

The Department of Finance has received inquiries regarding the amount of support provided through accelerated deductions. In response to these requests, and as a part of its ongoing review of methodologies used to estimate tax expenditures, the Department has developed an illustrative methodology for estimating tax expenditures associated with certain accelerated CCA deductions.

This paper sets out, at a high level, the types of assumptions and steps the illustrative methodology entails, using as examples three long-standing accelerated CCA measures. Given the limitations of the approach and the substantial amount of work required to implement it, in addition to the simplifying assumptions that may call into question the precision of the resulting estimates, the estimates presented in this paper are illustrative only and will not be replicated on an annual basis.

Accelerated CCA

When the rate at which capital costs may be deducted for tax purposes is more rapid than would be permitted under the useful life benchmark, this can result in tax deductions that are higher (compared with the useful life benchmark) in the initial years of the life of an asset, but that are lower in later years. Even though the total nominal amount of tax paid over time may be unchanged (i.e., assuming that tax rates remain constant), the taxpayer may realize a financial benefit from the deferral of taxation due to the time value of money.

Chart 1 shows the pattern of the tax expenditure associated with accelerated deductions under a stylized example that compares the hypothetical tax reduction due to deductions in respect of a one‑time investment in a $100 asset under an accelerated CCA (deductible at 50% per year on a declining-balance basis) and under the benchmark CCA (deductible at 30% per year on a declining-balance basis). It is also assumed that the taxpayer claims all available CCA in each period. The difference between the accelerated deductions and the benchmark deductions, multiplied by the applicable corporate income tax rate (i.e., the federal corporate tax rate of 15%), is the federal tax expenditure.

Chart 1
Accelerated CCA Claims Versus Useful Life CCA Claims1

Chart 1 - Accelerated CCA Claims Versus Useful    Life CCA Claims. For details,  refer to the previous paragraph

Claims are lower in Year 1 than in Year 2 due to the “half-year rule,” which reduces the available CCA in respect of an asset by one half in the year of acquisition.

Initially, the accelerated deductions are higher than the benchmark deductions, which results in a tax expenditure. Since the accelerated deductions more quickly deplete the undepreciated capital cost of the asset than the benchmark deductions, benchmark deductions become higher than accelerated deductions over time. This leads eventually to negative tax expenditures in respect of the one-time investment and gives rise to the characteristic shape of the tax expenditure for deferral tax measures—positive costs initially, followed by a period where revenue receipts are higher than they otherwise would have been.

Cash-Flow Approach in the Context of Tax Expenditures for Accelerated CCA

Tax expenditures are generally calculated on a current cash-flow basis and represent the cost to the Government of a measure in a particular year. Deductions for capital expenditures are usually spread over a number of years—the asset’s useful life. In the case of accelerated deductions, therefore, cash-flow tax expenditure estimates not only represent the revenue impact of accelerated deductions claimed with respect to investments made in a particular year, but also take into account the impact of accelerated deductions claimed with respect to investments made in previous years.

The importance of taking prior-year investments into account is highlighted in Table 1. This stylized example uses the same baseline assumptions as the example from Chart 1, and assumes that annual investment grows by 5% per year. As in Chart 1, this example also assumes that the taxpayer has the fiscal room to use all available CCA in each year. Based on these assumptions, the table illustrates the impact of prior-year investments on the current net tax expenditure. In practice, actual results would vary due to other factors, including, for example, fluctuations in annual investments, whether taxpayers have revenue against which to claim available deductions, and whether or not taxpayers may claim other deductions instead of accelerated CCA to reduce their taxable income. Because of these factors, it may not be inferred that any actual tax expenditure would follow the same pattern as per the simplistic assumptions used to create Table 1.

Table 1
Breakdown of Accelerated CCA Tax Expenditures by Year of Acquisition—Stylized Example
($)
Year 1 2 3 4 5 6 7 8 9 10
Impact on tax expenditure estimates
 due to assets acquired in:
Year 1 1.5 1.8 0.1 -0.5 -0.6 -0.6 -0.5 -0.4 -0.3 -0.2
Year 2 1.6 1.9 0.1 -0.5 -0.6 -0.6 -0.5 -0.4 -0.3
Year 3 1.7 2.0 0.1 -0.5 -0.7 -0.6 -0.5 -0.4
Year 4 1.7 2.1 0.2 -0.5 -0.7 -0.7 -0.5
Year 5 1.8 2.2 0.2 -0.6 -0.7 -0.7
Year 6 1.9 2.3 0.2 -0.6 -0.8
Year 7 2.0 2.4 0.2 -0.6
Year 8 2.1 2.5 0.2
Year 9 2.2 2.7
 
Net tax expenditure 1.5 3.4 3.7 3.4 3.0 2.5 2.2 1.9 1.8 1.7

This example illustrates the difficulty of comparing cash-flow tax expenditure estimates for accelerated deductions to other cash-flow tax expenditure estimates: the net tax expenditure for an accelerated deduction is not equal to the potential revenue gain from eliminating the measure. Using Year 3 as an example, Table 1 shows that the net tax expenditure is $3.7. This is the result of the impact of the tax expenditure associated with investments made in Year 3 ($1.7) and in previous years ($1.9 and $0.1). If the Government decided in Year 3 to eliminate the measure going forward, the revenue gain in Year 3 would be less than suggested by the tax expenditure estimate for that year since only investments made in that year would be affected: government revenues would be $1.7 higher, rather than $3.7 higher as suggested by the net tax expenditure estimate. Conversely, eliminating the accelerated CCA in Year 8 would result in a revenue gain in that year that is higher than suggested by the net tax expenditure estimate (i.e., $2.1 rather than $1.9). Whether the potential revenue gain is higher or lower than the net tax expenditure estimate may depend on many factors, including the maturity of the accelerated CCA measure, trends in economic growth, market conditions and the ability of firms to make use of available deductions. The methodology illustrated in this paper will attempt to address the issue of comparability by breaking down the tax expenditure estimate according to the impact of investments made in the current year and in prior years.

Measures Considered

The illustrative methodology will be applied using the following three long-standing accelerated CCA incentives as examples:

Canadian vessels: Class 7 provides a 15% declining-balance CCA rate and includes vessels, railway cars and pumping equipment for hydrocarbons and CO2. However, specified qualifying vessels are eligible for a 33.3% straight-line accelerated CCA. This treatment was introduced in 1967.

Mining assets[1]: Generally, mining assets are included in Class 41, which provides a 25% declining-balance CCA rate. In 1972, an accelerated CCA was introduced that provides a maximum 100% deduction for these assets without the half-year rule[2] applying, but limited by project income. This treatment applies to tangible assets acquired since 1972 for new projects and certain eligible project expansions.

Clean energy generation and conservation equipment: Class 43.1 was introduced in 1994 and provides a 30% declining-balance accelerated CCA rate for investments in specified clean energy generation and conservation equipment. Class 43.2, which was introduced in 2005, provides an enhanced 50% declining-balance rate on investments made before 2020. In the absence of Class 43.1 and Class 43.2, qualifying assets would be deductible on a declining-balance basis at rates varying between 4% and 30%.

Methodology

Before describing the illustrative methodology presented in this paper, it is useful to lay out a number of specific features of the CCA system that complicate the calculation of tax expenditure estimates:

  • CCA deductions are discretionary. Under CCA rules, taxpayers may claim any amount up to the maximum CCA rate. For example, a corporation that has no taxable income could choose to deduct no CCA in that year. In this instance, while a business may be eligible for accelerated CCA, no tax expenditure should be recorded as no deduction is used.
  • CCA classes are broad and may include assets that are either eligible or not eligible for accelerated CCA. For instance, in addition to vessels eligible for accelerated CCA, Class 7 also includes railway cars and pumping equipment that are not eligible for the accelerated CCA rate. Similarly, mining assets included in Class 41 are eligible for accelerated CCA only if they are part of a new mining project or a major expansion. The tax data, however, does not explicitly identify accelerated CCA eligible assets. It is therefore necessary to develop assumptions in order to identify assets eligible for accelerated CCA.
  • Taxpayers in a taxable position may choose between using accelerated CCA to reduce their taxable income and using other types of available deductions and/or credits. This may complicate the determination of how much of the available accelerated CCA deduction will be utilized, and therefore affect the value of the accelerated CCA tax expenditure.
  • While the statutory corporate income tax rate is a straightforward determination in a given year, the effective tax rate to which a business would be subject in the absence of a tax incentive varies on a company-by-company basis, and depends on all of its tax attributes as well as other factors such as the availability of other deductions. The value of the tax expenditure is affected by the effective tax rate of each firm, which therefore must be taken into account.
  • Taxpayers in certain circumstances may reclassify assets from one CCA class to another and combine or split their CCA balances. Even where this means that no accelerated CCA could be used over time, it is important to continue to identify these assets. For example, the use of accelerated CCA in the first years of the useful life of an asset depletes the available deductions in future years and continues to impact the tax expenditure even where no accelerated CCA continues to be claimed.

The illustrative methodology used to estimate tax expenditures for accelerated CCA is based on an analysis of corporate income tax returns. The steps in this analysis are as follows:

  • Identification of the benchmark useful life CCA rate that would apply in the absence of the accelerated CCA. Typically, the rate will relate to a specific underlying CCA class;
  • Construction of corporation-level time series of the accelerated CCA claims on an
    asset-by-asset basis;
  • Construction of corporation-level time series of benchmark CCA claims (i.e., the claims that would have been made by a corporation in the absence of the accelerated CCA) based on assumptions regarding benchmark CCA rates and the extent to which taxpayers would make use of available deductions;
  • Calculation of the net current tax expenditures as the difference in the value of a corporation’s CCA claims under the accelerated versus the benchmark regimes, multiplied by the effective marginal tax rate of that corporation; and
  • Breaking down the impact on the net tax expenditures of current-year versus prior‑year investments.

The illustrative approach requires extensive data manipulation to generate historical and counterfactual time series amenable to analysis and comparison. Estimating the tax expenditures requires assumptions about benchmark CCA rates, taxpayers’ ability to make use of available deductions and effective marginal tax rates. The methodology does not account for the potential use of other available deductions in place of accelerated CCA—doing so would require that all such deductions be tracked through time, and that assumptions be developed regarding the manner in which they would have been used in the absence of accelerated CCA. Finally, in certain circumstances, additional assumptions are necessary to fill in data gaps—for example, although the measures used as examples are long-standing in the tax system, available data extends back only to 2000.

In light of these considerations, the tax expenditure estimates presented in this paper should be treated with a high degree of caution. They are not sufficiently robust to be reported as regular line items in the annual Tax Expenditures and Evaluations report and will not be calculated on an annual basis. The objective of this exercise is to demonstrate the complexity and difficulty in arriving at tax expenditure estimates of accelerated deductions. Each of the steps outlined above is discussed in turn below.

Benchmark CCA Rates

The first step is to establish what would be the tax treatment of an asset in the absence of an accelerated CCA incentive. Accelerated CCA is provided relative to the existing CCA regime; therefore, the appropriate benchmark is the underlying, non-accelerated CCA rate that would otherwise apply. In some cases, determining the accelerated CCA rate that would apply is relatively straightforward, since the Income Tax Regulations are clear about the otherwise applicable CCA class and rate. Table 2 shows the accelerated and benchmark CCA rates for Canadian vessels (Class 7) and mining assets (Class 41):

Table 2
Accelerated and Benchmark CCA Rates for Class 7 and Class 41
Measure Accelerated CCA Class and Rate Benchmark CCA Class and Rate
Canadian vessels Class 7
33⅓% (straight-line)
Class 7
15% (declining-balance basis)
Mining assets Class 41
100%, up to project income (no half-year rule)
Class 41
25% (declining-balance basis)

In other cases, however, the Income Tax Regulations do not provide a clear benchmark CCA class. For example, there is no specific underlying CCA class that can be identified as the benchmark for clean energy generation and conservation equipment eligible for Class 43.1 and Class 43.2. These classes include a broad variety of assets with potentially different benchmark CCA rates. In general terms, these CCA classes include electricity generation equipment (e.g., wind turbines, photovoltaic equipment), heat generation equipment (e.g., ground source heat pumps, solar thermal equipment) and equipment to produce fuel from waste (e.g., bio-oil, biogas). Given the diversity of assets that qualify for these classes, the fact that the same type of asset may be used in more than one industry, and the lack of adequate data, assumptions needed to be developed regarding appropriate general benchmark rates.

The approach used involves a two-step process that first determines whether the benchmark rate would be influenced by the industry of the taxpayer. Then, for cases where analysis of the industry does not suggest a clear choice of benchmark, assumptions regarding benchmark rates are developed by:

  • Broadly categorizing Class 43.1 and 43.2 eligible assets into three categories of equipment:
    • Electricity generation equipment;
    • Heat generation equipment; and
    • Equipment used to produce fuel from waste.
  • Identifying the statutory CCA rates that would apply to each category in the absence of Class 43.1 and Class 43.2; and,
  • Applying weights to these rates using publicly available data on clean energy generation output capacity in Canada (i.e., relative output capacity of renewable electrical energy, renewable thermal energy and renewable fuel production), which allows for the calculation of weighted average benchmark rates.

The resulting benchmark rates used for the purposes of this illustrative analysis for Class 43.1 and Class 43.2 are summarized in Table 3.

Table 3
Class 43.1 and Class 43.2 Benchmark CCA Rates
Industry Benchmark CCA Class(es) and Rate
Manufacturing Class 43 (30%)
Mining Class 41 (25%)
Greenhouses Class 6 (10%)
Utilities (weighted average) Class 1, Class 17 and Class 47 (8%)1
Other industries (weighted average) Class 1, Class 17 and Class 47 (7%)1
1 Benchmark CCA rates for electricity generating assets are based on a weighted average of applicable rates of CCA classes. Class 47 (8% rate) was introduced in Budget 2005. For assets acquired before that time, the benchmark CCA class was Class 1, providing a rate of 4%. Consequently, the weighted average in years prior to 2004 is 7% for utilities and 5% for other industries.
Building Historical Time Series

The second step of the analysis is the construction of historical time series of taxpayers’ accelerated CCA claims. It is not always possible, based on the information on a single tax return, to identify whether an asset was eligible for accelerated CCA (reasons for this are discussed below). In order to construct the time series, the model starts by identifying all corporations in the sample period (i.e., 2000 to 2009) that claimed accelerated CCA at least once during that period. It then retrieves all available CCA data for these corporations (i.e., including both accelerated and non-accelerated CCA) for all years in the data set. Finally, once the historical time series have been created, the model identifies and retains time series relating to accelerated CCA and drops all non-accelerated CCA series from the data set.

The time series are built using data on capital cost allowances (including accelerated CCA) reported on Schedule 8 of corporate income tax returns. For every taxpayer in the data set, a separate time series is created for each line reported on Schedule 8. This requires an initially large data set, encompassing both assets that are eligible and assets that are not eligible for accelerated CCA. This is necessary for reasons such as:

  • The same CCA class may be used more than once on a taxpayer’s Schedule 8 (for example, under Class 7 a separate line is required for each vessel that qualifies for accelerated CCA; under Class 41, a separate line is required for each new project or eligible project expansion). The tax data, however, indicates only the CCA class—it does not identify individual assets, making it difficult to track them through time;
  • In addition, as previously noted, certain CCA classes include both assets that are eligible and assets that are not eligible for accelerated CCA (e.g., Class 7 and Class 41). Since the tax data indicates only the CCA class, it is not possible based on any single return to distinguish between assets eligible and not eligible for accelerated CCA. This adds to the challenge of tracking the assets through time and increases the amount of data that must be analyzed;
  • Given that CCA deductions are discretionary, taxpayers with assets eligible for accelerated CCA may nonetheless claim less than would have been permitted under the benchmark rate. In order to avoid accidentally excluding accelerated CCA eligible assets (i.e., due to a low historical claim), it is therefore necessary to retrieve data even when the CCA claim is not at the accelerated rate. This increases the size of the data set to be analyzed as the data set will thereby be composed of both accelerated and non-accelerated deductions; and
  • Because taxpayers may under certain circumstances reclassify assets from one CCA class to another and combine or split their CCA balances, it is necessary to include data on other CCA classes for taxpayers with accelerated CCA claims, further increasing the size of the overall data set.

Once the data has been retrieved, a matching program is then used to build the time series by linking closing CCA pools in one period to opening CCA pools in the next. The program requires several iterations: it begins by linking only perfect matches (i.e., closing and opening balances perfectly equal). Balances for which the model is unable to generate a match are then flagged and reviewed manually. For example, the model is not able to match records where a taxpayer combines assets reported on separate rows in one return into one row on the next (or vice versa, splits one record into two)—these instances must be reviewed manually on an individual basis to allow the building of the time series.

Once the historical time series have been created, the model determines whether a time series relates to accelerated CCA eligible assets by checking if, in at least one period of that time series, the taxpayer makes a claim that exceeds the maximum allowed by the benchmark rate of the CCA class. Accelerated CCA time series are retained, while time series that are not flagged as containing accelerated deductions are dropped from the data set.

Counterfactual CCA Claims

The third step of the analysis is to generate counterfactual time series of CCA claims under the benchmark CCA rate, that is, the time series of the deductions that would have been claimed over time in the absence of accelerated CCA. To do so, the model assumes that the only change in taxpayer behaviour under the benchmark is a reduction in CCA claims (for example, the model does not assume that the availability of an accelerated deduction impacts the investment behaviour of firms, or that firms would use other discretionary deductions in the absence of accelerated CCA). In general, this is consistent with standard practice for estimating tax expenditures.

CCA Deductions Are Discretionary

CCA deductions are discretionary. If, in a particular period, a taxpayer eligible for accelerated CCA deducts an amount that is less than or equal to the amount available under the benchmark rate, then the behaviour of the taxpayer has not been altered compared to what it would have been under the benchmark. In this case, there is no tax expenditure. The model accounts for this by limiting counterfactual claims to the lesser of the benchmark CCA rate and the rate at which the taxpayer actually claimed CCA in the particular period.

Assets Acquired Prior to 2000

The data used to construct the historical time series extends back to 2000. For measures established prior to 2000, however, it is important to account for the fact that under a benchmark CCA regime, taxpayers’ undepreciated CCA pools in 2000 would have been higher than in the historical data, since CCA deductions under the benchmark regime would have been lower. Otherwise, the tax expenditure estimates would be overstated, since they would not account for the higher counterfactual CCA claims that would be available due to the higher undepreciated CCA pools under the benchmark system.

In order to limit this upward bias, it is necessary to estimate the aggregate opening balance of the CCA pools in 2000 under the benchmark CCA rate. Based on the following simplifying assumptions, it can be shown that, over time, the ratio of unclaimed capital costs under the accelerated regime versus the benchmark regime will become constant:

  • Taxpayers would have claimed accelerated CCA deductions prior to 2000 at a constant rate (e.g., equal to the average rate observed from 2000 to 2009);
  • In the absence of accelerated CCA, taxpayers would have claimed CCA deductions at a constant rate equal to the benchmark CCA rate (which is less than the average observed rate of claimed accelerated deductions from 2000 to 2009); and
  • Investment in accelerated CCA eligible assets prior to 2000 grew at a constant annual rate.

Using these assumptions, a ratio of the unclaimed capital cost balance under the accelerated regime versus the benchmark regime is estimated. The estimated ratio is used as a multiplier to infer what would have been the unclaimed capital cost balance in 2000 under the benchmark rate. To the extent that the simplifying assumptions may overstate (understate) CCA claims under the hypothetical benchmark CCA regime prior to 2000, the tax expenditure estimates would be overstated (understated).

For qualifying Canadian vessels under Class 7, the growth rate of capital expenditures on water transportation was assumed, on average, to be representative of the growth rate of investment in accelerated CCA eligible assets. For mining assets under Class 41, capital expenditures on mining were used as the proxy. Annual growth in investment in these assets was assumed to equal the average growth of expenditures in the proxy data. For Class 43.1, given the relatively short time frame from inception (1994) to the first year of available data (2000), the growth rate was calibrated based on the assumed accelerated and benchmark CCA claim rates and the opening CCA pool balance in 2000. Table 4 summarizes the other assumptions used and the multipliers calculated for each of the measures under consideration.

Table 4
Assumptions for the Estimation of the 2000 Unclaimed Capital Cost Balance
Measure Year of
Introduction
Accelerated
CCA Claims1
Benchmark
CCA Rate
Opening CCA
Pool Multiplier
Canadian vessels (Class 7) 1967 24% 15% 1.5
Mining assets (Class 41) 1972 30% 25% 1.2
Clean energy assets
(Class 43.1)
1994 20% 14%2 1.1
1 Observed average rate of claim, 2000–2009.
2 Weighted average based on benchmark CCA classes and rates identified in Table 3.

The model uses the estimated multipliers to gross up the aggregate counterfactual opening CCA pools in 2000. Aggregate counterfactual CCA claims due to assets acquired prior to 2000 are then recalculated to reflect the higher opening balance. To the extent that the multipliers may be too low, the tax expenditure estimates will be overstated. Conversely, overestimating the multipliers would result in an understatement of the tax expenditure results.

Total Tax Expenditure Estimates

The fourth step in the illustrative methodology is to estimate the total net tax expenditure. The difference in the value of the accelerated versus the counterfactual benchmark CCA claims is considered a change (either positive or negative) in taxable income. The tax expenditure estimate, at the corporate level, represents the additional tax that would have been payable with this additional taxable income, based on each corporation’s own marginal income tax rate.

Adjustments for Partnerships

Consistent with other corporate tax expenditure estimates, the illustrative model used in this paper estimates tax expenditures based on data in corporate income tax returns. However, partnerships, which play a significant role in certain sectors (e.g., in the mining sector, which affects Class 41 tax expenditure estimates), may also claim accelerated CCA. Ignoring the impact of partnerships in the overall tax expenditure estimates could understate the cost of the accelerated CCA. Therefore, additional analysis was undertaken to develop assumptions to gross up the overall estimates in order to account for the role of partnerships.[3]

The illustrative methodology is unable to explicitly model the behavior of partnerships since, prior to 2011, many partnerships did not always prepare detailed information returns.[4] Available partnership data, however, suggests that partnerships played a significant role in some of the accelerated CCA incentives analyzed. Therefore, assumptions were developed to estimate the relative share of accelerated CCA claimed by partnerships versus corporations. The tax expenditure estimates were then grossed up based on those relative shares. These shares, by their nature, are subject to a margin of error and depend on the assumption that partnerships and corporations claim CCA at about the same rate. To the extent that they may underestimate (overestimate) the role of partnerships, the resulting tax expenditure estimates would have a downward (upward) bias.

To account for accelerated CCA deductions claimed by partnerships, the model adjusts the results for Class 41 mining assets upward by 20% and the results for Class 43.1 and 43.2 by 35%. Available data suggests that the proportion of partnerships’ CCA claims under Class 7 was negligible.

Impact of Current-Year Versus Prior-Year Investments

In the fifth step of the analysis, the illustrative methodology allocates the net tax expenditure estimate between current-year investment and investments made in prior years. To do so, the model pro-rates the CCA claim of each taxpayer in a year between the relative amount of CCA available in that year due to the opening balance of the CCA pool and the amount available due to new investments. It does so for both the historical (accelerated) and the counterfactual (benchmark) time series.

The difference between the pro-rated historical and counterfactual CCA claims is then used to allocate the total net tax expenditure estimates according to the impact of investments made in the current year and in prior years.

Illustrative Tax Expenditure Estimates

Illustrative tax expenditure estimates for the three measures discussed are presented below. In addition to the significant possibility of biases introduced by the myriad assumptions necessary to arrive at these illustrative estimates, as with most tax expenditures estimates, other factors may influence the results obtained. For example:

  • Trends in economic cycles influence the profitability of firms and the degree by which deductions may be used to reduce taxable income;
  • Trends in investments from one year to another, influenced by various elements of global economic cycles, affect the acquisition of accelerated CCA eligible assets; and
  • The degree to which a specific deduction may be used is also influenced by the availability of other tax expenditures (deductions or credits) that firms may alternatively use to reduce their taxable income.

These factors are all highly variable in nature, which is reflected in the results obtained. The illustrative tax expenditure estimates are presented in the following tables.

Table 5
Illustrative Tax Expenditure for Class 7—Canadian Vessels, by Year of Acquisition, 2000–2009
($ millions)
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Prior-year additions 7 1 1 1 -1 1
Current-year additions 2 2 1 1 1 1 2 2
 
Net tax expenditure 9 3 1 1 1 1 0 0 0 3
Note: Totals may not add due to rounding.

Overall, the illustrative tax expenditure associated with investments in specified qualifying vessels in Class 7 suggests that the tax expenditure for this accelerated CCA has remained modest throughout the decade. Activity in the shipbuilding industry over the past decade has been relatively low, so this is not a surprising result. Also, vessels supported by the Government’s Structured Financing Facility, which was introduced in 2001, are not eligible for accelerated CCA.[5]

Table 6
Illustrative Tax Expenditure for Class 41—Mining Assets, by Year of Acquisition, 2000–2009
($ millions)
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Prior-year additions -5 31 28 14 66 48 172 -30 -70 -144
Current-year additions 10 3 3 18 13 18 70 29 136 151
 
Net tax expenditure 5 34 31 32 79 66 242 -2 66 7
Note: Totals may not add due to rounding.

The illustrative tax expenditure estimates for Class 41 mining assets exhibit significant variations from one year to the next. The variability of the results obtained may in part be explained by the design of the measure, which provides a 100% accelerated deduction limited by project income. The income of a mining project may, in practice, be influenced by many factors, including volatile commodities prices. A significant spike in project income in a particular year, leading to a similar spike in accelerated claims, could be expected to be followed by a number of years with relatively lower tax expenditures since the CCA pools would have been depleted (e.g., 2006 and 2007 estimates).

Table 7
Illustrative Tax Expenditure for Class 43.1 and 43.2—Clean Energy Generation and Conservation Equipment, by Year of Acquisition, 2000–2009
($ millions)
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Prior-year additions 1 3 24 18 30 25 19 9 7 10
Current-year additions 7 4 1 13 4 1 8 12 6 7
 
Net tax expenditure 8 7 24 30 34 27 27 22 13 17
Note: Totals may not add due to rounding.

Support for clean energy generation through Class 43.1 and 43.2 was expanded over time: the introduction of Class 43.2 in 2005 provided an enhanced 50% accelerated CCA rate for most clean energy assets previously included in Class 43.1. In addition, recent budgets have expanded the range of eligible assets. Recent examples include heat recovery equipment and district energy equipment, equipment that generates electricity using waste heat sources, and a broader range of bioenergy equipment.

Conclusion

Due to methodological challenges and data limitations, the Department of Finance has not published tax expenditure estimates for accelerated CCA incentives. This paper presents, at a high level, an illustrative methodology that attempts to address the challenges in order to estimate tax expenditures related to accelerated CCA. In doing so, it demonstrates the degree of difficulty in providing such estimates and the number of assumptions required to implement such a methodology. There were five key components to this methodology:

  • Determining useful life benchmarks for each accelerated CCA class;
  • Constructing historical time series data based on annual individual corporate income tax returns;
  • Recalculating CCA claims and balances under the counterfactual useful life benchmark rates;
  • Estimating the total current tax expenditures; and
  • Breaking the total current tax expenditures down by the impact of current- and prior‑years’ investments.

The quality of the estimates produced by this analysis is limited by the number of simplifying assumptions that are needed in order to derive an estimate. Because of the intensive nature of this exercise, the number of simplifying assumptions required to derive estimates, and the resulting lack of robustness of the estimates, the Department does not plan to publish them in the annual Tax Expenditures and Evaluations report or to carry out this exercise annually. The innovative methodology presented in this paper, however, provides a basis for better understanding the challenges inherent in estimating the tax expenditures associated with accelerated deductions.


[1] Accelerated CCA under Class 41 was also available for oil sands assets, but it is being phased out over the 2011–2015 period. Due to particularities of the oil sands industry, it was not possible to estimate tax expenditures for oil sands assets using the model developed in this paper. Therefore, the estimates presented refer only to traditional mining.

[2] The half-year rule reduces the available CCA in respect of an asset by one half in the year of acquisition.

[3] Accelerated CCA may also be claimed by unincorporated businesses. However, analysis of available data suggests that unincorporated businesses do not represent a significant proportion of CCA claims for the three measures reviewed in this paper.

[4] Prior to 2011, certain corporate partnerships were not required to file a partnership information return. Rules have been introduced such that, effective January 1, 2011, all corporate partnerships are required to file information returns.

[5] Accelerated CCA for vessels is not available in cases where the Minister of Industry has agreed to a Structured Financing Facility. In cases where a vessel or its attachments are financed with a benefit under the Structured Financing Facility program, the maximum CCA rate applicable to the vessel and its attachments is 15% (Class 7).

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