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Introduction to Corporate Finance
Financial Statements, Taxes and Cash Flow
Chapter 2: Section 2.5
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Tax shields (CCA)
CCA = 0
-----------------
Sales 100,000
- Cost 20,000
- CCA 0
=EBT 80,000
taxes (40%) 32,000
OCF = 48,000
CCA = 30,000
-----------------
Sales 100,000
- Cost 20,000
- CCA 30,000
=EBT 50,000
taxes (40%) 20,000
OCF = 60,000
CCA tax shield = 12,000CCA 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
(higherdepreciation cost earlier in an asset's lifetime)
Class Assets Rate
2 Buildings 4%
8 Furniture, photocopiers 20%
10 & 43 Vans, trucks, equipment 30%
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CCA Calculation: Single Asset
1)(tyearsotherallUCCd
1)(tyearfirstinId21
CCA
t
0
t
TcCCAShieldTaxCCA
costcapitaltedundepreciaUCC
rateondepreciatiorrateCCAd
t
t
Half-year rule
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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 UCCB CCA UCCE Tax shield
1 *$160,000 $24,000 = $136,000 $9,600
2 $136,000 $40,800 $95,200 $16,320
3 $95,200 $28,560 $66,640 $11,424
4 $66,640 $19,992 $46,648 $7,996.80
CCA 0.4
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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 UCCB CCA UCCE
1 *$150,000 $30,000 $120,000
2 *$222,000 $51,300 $170,700
3 $155,700 $46,710 $108,990
150,000 = 50,000 + new acq of 100, 000
30,000 = (50,000 + 100,000*1/2)*0.3
net acq = 50,000 + 150,000 98,000 = 102, 000 > 0222,000 =
120,000 + 102,00051,300 = (120,000 + 102,000*1/2)*0.3
155,700 = 170,700 15,00046,710 = 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 40%
CCA rate 30%
Year UCCB CCA UCCE Tax Shield
1 $10,000.00 $1,500.00 $8,500.00 $600.00
2 $8,500.00 $2,550.00 $5,950.00 $1,020.00
3 $15,950.00 $3,285.00 $12,665.00 $1,314.004 $12,665.00
$3,799.50 $8,865.50 $1,519.80
5 $8,865.50 $2,659.65 $6,205.85 $1,063.86
.
.
.10 $1,490.02 $447.01 $1,043.02 $178.80
.
.
.30 $1.19 $0.36 $0.83 $0.14
.
.
.
60 $0.000027 $0.000008 $0.000019 $0.000003
Asset Badded
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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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Closing an Asset Class
When the last asset in an asset class issold, the asset class is
terminated. Thiscan result in a terminal loss or recapturedCCA.
Terminal Loss The difference betweenthe UCC and the adjusted
cost when theUCC is greater.
Recaptured CCA The taxable differencebetween the adjusted cost
and the UCCwhen the UCC is smaller.
LO5
2013 McGraw-Hill Ryerson Limited
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Example 3:
Sell Assets, Class Termination
(1) (2) (3) (4)
Year 4 UCC $12,665 $12,665 $12,665 $12,665
Sell A $6,600 $4,000 $4,500 $4,500
Sell B $6,065 $6,000 $9,500 $10,500
Balance in pool $0 $2,665 ($1,335) ($1,835)
Capital Gain $0 $0 $0 $500
Tax (40%)CCA Pool $0 $1,066 ($534) ($734)
Cap Gain $0 $0 $0 ($100)
Total Tax $0 $1,066 ($534) ($834)
Terminal loss CCA Recaptured
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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 theUCC of the asset class is reset to zero.
5. If step 2 leaves a positive balance and there are assets left
in the class, thebalance 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 netacquisitions; if net acquisitions are < 0,
do not apply the half year rule.
