10 May 2015

The latest federal Budget and capital investment

I haven't seen any good summaries on this topic on any of the standard websites, so here is my take on certain aspects of interest to management accountants.

Moving away from Class 29 CCA in 2016

This is rather interesting, in that the new Class 53 for manufacturing and processing equipment (effective for acquisitons after 2015 and before 2025) will be effective for at least ten years, at a 50% declining-balance amortization rate for the pool of assets concerned. This is a bit less attractive than the 25%-50%-25% amortization over a three-year period, but somewhat easier to calculate. Why they chose to move from the one method to the other is still not clear.

Why is it less attractive? It all comes down to simple math and standard capital investment appraisal techniques. For purposes of discussion, let us assume a gross investment (C) of CAD 100,000, a cost of capital (i) of 10%, and a combined federal/Ontario marginal tax rate (t) of 25% (ie, net of manufacturing and processing profits deductions).

The net present value after tax for investing in Class 29 assets is calculated using the formula

$ I \left [ 1-t\left (\frac{0.25}{1+i}+\frac{0.5}{\left (1+i\right)^2}+\frac{0.25}{\left (1+i\right)^3}\right) \right ] $

or approximately CAD 79,282.

Now let's take a look at the new Class 53, with its amortization rate (d) of 50%, subject to the half-year rule. The net present value after tax for that investment would be calculated using the formula

$ I \left [ 1-\left (\frac{td}{i+d}\right )\left (\frac{1+\frac{1}{2}i}{1+i}\right ) \right ] $

 or approximately CAD 80,113, which would an effective cost increase of about 1%.

The feds still maintain that the eventual fallback classification for such assets, for acquisitions after 2025, will be Class 43 at a rate of 30%. As they have been deferring this move for several years now, it remains to be seen whether it will ever come about, but the above formula would then suggest a net after-tax cost of about CAD 82,102, or 3.6% above the Class 29 amount.

The differences are not huge, and Canada's rates for such investments are still probably some of the most generous in the world. The real challenge will be getting Canadian managers to undertake any investment at all, which invites further discussion on our appetite for undertaking significant expansion and innovation. To date, there has been too much emphasis on improving the concessions for small businesses, but it has been argued that such measures constitute a disincentive for expansion, as too much activity is expended towards keeping such enterprises below the thresholds for applying higher rates, thereby limiting cash flows available for productive investments. That, however, is an argument for another day.

Integration of Eligible Capital Property within the CCA system

There will apparently be legislative proposals later on this year to deal with this matter, which will be quite welcome. It's been a long time coming for this idea to come about for getting rid of what was essentially a parallel r├ęgime. I look forward to seeing what the detailed measures will entail.