Capital assets are long-term assets owned by a business that contribute to its overall operations.
Typically capital assets provide benefits for more than one financial year. Capital assets can be of two types - tangible and intangible assets. Tangible assets include land, building, plant and machinery, automobile, etc. Intangible assets include patents, trademarks, goodwill, brand value, etc. Usually, it is not easy to sell off these assets for cash. Disposal of these assets is done only in extreme cases, such as financial restructuring or bankruptcy.
Capital assets are recorded on the balance sheet and not on the income statement. When you purchase a capital asset, you cannot show it as an expense. However, in case of specific assets, you can get tax benefits by accounting for a reduction in their value, which may be caused due to wear and usage. You can include this amount, known as depreciation/amortization, on the income statement. In Canada, this benefit is known as 'capital cost allowance' or CCA.
You purchased some machinery for $200,000 in 2013. For 2013, this item will be shown on the balance sheet at $200,000. However, in 2014, there will be a capital cost allowance at say 10% per annum, which you can include in the income statement. This deduction of $20,000 (10% of $200,000) will reduce the net book value of the asset to $180,000.
Since capital cost allowance is an expense item, it helps in reducing the tax liability. So in the above example, the expense of $20,000 will reduce your taxable income. However, you cannot determine the percentage of deduction on your own. The CRA has set out different CCA percentages for different types of asset classes. The annual rate of claiming capital cost allowance varies from 4% to 100% depending on asset type. For example, buildings are expensed at an annual rate of between 4-10%. The CCA for motor vehicles and some passenger vehicles is 30%. Certain taxis and vehicles used in daily-car rental businesses have a CCA of 40%. Only a few assets, like electronic processing equipment or computer hardware, can be expensed at a rate of 100%. So if you buy a computer hardware for $5,000, you can show the entire amount as an expense and claim the tax benefit within the same year.
There are different methods of calculating the capital cost allowance. The most commonly used method is the declining-balance method. Let's continue with the above example. Under this method, in the subsequent year, you will use the net book value of $180,000 of calculating CCA. At 10%, this amount will be $18,000, and it will reduce the net book value to $162,000. This process will continue for subsequent years.
Mostly, capital assets on their own do not offer any tax benefits. However, the Capital Cost Allowance available on some assets helps in reducing the tax liability.