Canada To Adopt Expensing and Accelerated Cost Recovery

The Department of Finance in Canada has released its Fall Economic Statement, containing details of its proposal to enhance the cost recoveryCost recovery is the ability of businesses to recover (deduct) the costs of their investments. It plays an important role in defining a business’ tax base and can impact investment decisions. When businesses cannot fully deduct capital expenditures, they spend less on capital, which reduces worker’s productivity and wages. (depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. ) write-offs of capital investment in machinery, equipment, and buildings. The proposal is a significant step toward optimal taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. treatment of capital. However, the enhancements are currently planned to be temporary. They should be expanded and made permanent to maximize the benefits.

Objectives

The Department’s stated objectives for the proposal are to reduce the cost of investment, free up capital for business expansion, and create more well-paying jobs. The Department notes that the recent tax reform in the United States has narrowed the relative tax advantage enjoyed by investment in Canada (which has had a relatively low corporate tax rate and reasonably competitive depreciation schedule for cost recovery). The Canadian reform is intended to preserve a portion of that advantage and reduce the chance that Canadian investment and jobs will be shifted to the United States. The Department believes that the combined effect of the U.S. and Canadian reforms will be to encourage growth and investment in both countries to the benefit of both populations.

Structure, Coverage, and Duration

The Canadian proposal allows immediate expensing for equipment and machinery used in the manufacturing and processing of goods, and for clean energy investments. These assets may be written off in full in the year the assets are placed in service, instead of being depreciated over several years. The enhanced deductions will be available for assets acquired after November 20, 2018. They will be gradually phased out over the 2024 to 2027 period, and they will be eliminated in 2028.

The Canadian incentive is for a longer period than the expensing provision in the U.S. Tax Cuts and Jobs Act (TCJA) of 2017. TCJA provides full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. only through 2021, and phases it out over the 2022 to 2026 period, with a return to less-favorable prior law MACRS depreciation (the Modified Accelerated Cost Recovery System) in 2027. On the other hand, the TCJA is more generous than the Canadian plan in that it allows expensing for more types of assets in all sectors, not just manufacturing and processing. TCJA expensing covers all assets with tax lives of 20 years or less, regardless of sector.

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However, the Canadian proposal addresses vehicles, computers, and other assets by another mechanism available to all sectors. It will accelerate cost recovery for these assets by allowing up to three times the normal write-off for the first year of an asset’s life. For example, first-year write-off for computer software will rise from 50 percent to 100 percent of the cost; for computers, from 27.5 percent to 82.5 percent; for trucks and tractors for hauling freight, from 20 percent to 60 percent; for motor vehicles, earth-moving equipment, and data network equipment, from 15 percent to 30 percent; and for aircraft, from 12.5 percent to 25 percent. This acceleration is not as valuable as full expensing, but it is very helpful.

The Canadian acceleration proposal will cover nonresidential buildings as well. Buildings used in manufacturing and processing will see their first-year write-off rise from 5 percent to 15 percent of cost; other nonresidential buildings, from 3 percent to 9 percent. It is important to include buildings in the tax relief because they are a large part of the capital stock. The proposal gives long-lived buildings a smaller cost reduction than shorter-lived machinery because less of a building’s cost is written off in the first year. In that sense, it is not neutral among potential investments, although it will have some positive effect on construction. The U.S. TCJA provided no cost recovery relief for buildings, apart from the general benefit of the lowering of the U.S. corporate and noncorporate tax rates.

Permanence Would Be Better

Improved capital cost recovery arrangements, up to and including expensing, are good economic and tax policy. They should not be viewed as a tool to prevent a fixed amount of investment from moving from one place to another, or as a temporary countercyclical investment stimulus. They should be viewed as making it possible for the private sector to create and sustain a larger capital stock, leading to higher long-term productivity, wages, and GDP. They would be good policy even if Canada were the only country in the world, not simply as a way to compete with the U.S. The Canadian reforms would be even better policy on a permanent basis.

Conclusion

The Canadian expensing and accelerated depreciation proposals are significant improvements in the tax treatment of capital. They should avoid any great loss of competitiveness vis-à-vis the U.S. due to the recent TCJA, which contains a temporary expensing provision for short-lived assets. If made permanent, the enhanced Canadian cost recovery provisions will increase capital formation, GDP, and wages in Canada for the long term. If allowed to expire, the improvements in capital formation and wages will be temporary. As the Department of Finance has noted, the U.S. and Canadian reforms should benefit both nations. The tax competition that has led to these changes could result in permanent gains for workers in both countries if the changes are made permanent parts of both tax systems.

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