Business expenses that are reasonable and paid out to earn income are deductible for income tax purposes unless disallowed by a specific provision in the Income Tax Act. Some expenses are deductible subject to limitation (e.g. charitable donations, entertainment expenses, the cost of providing an automobile to employees). Deduction of capital expenditures is specifically prohibited, but special provisions may allow depreciation or amortisation of these expenditures.
Because Canadian corporations are taxable on worldwide income, there are no territorial limits on the deductibility of related expenses. Payments to affiliates are deductible if they reflect arm’s-length charges. Transfers of losses and other deductions between unrelated corporate taxpayers are severely limited after an acquisition of control.
Depreciation and amortisation
Depreciation for tax purposes (capital cost allowance) is generally computed on a pool basis, with only a few separate classes (pools) of property. Annual allowances are generally determined by applying a prescribed rate to each class on the declining-balance basis. For example, the prescribed annual rate is 20% on most furniture and fixtures, 30% on automotive equipment, and 4% to 10% on most buildings. In the year of acquisition, only half of the amount otherwise allowable may be claimed on most classes of property.
Generally, capital cost allowance (CCA) may not be claimed until the taxation year the property is available for use. The taxpayer can claim any amount of CCA up to the maximum. CCA previously claimed may be recaptured if assets are sold for proceeds that exceed the undepreciated cost of the class.
The Accelerated Investment Incentive (AII) provides an increased first year CCA deduction for ‘eligible’ property acquired after 20 November 2018 and available for use before 2024 (generally equivalent to three times the usual first-year CCA deduction). The AII applies to all capital property subject to the CCA rules, except manufacturing and processing and specified clean energy equipment (see below for enhanced rules that apply to these properties), property previously owned by the taxpayer or a non-arm’s-length person, or property transferred to the taxpayer on a tax-deferred ‘rollover’ basis.
A 100% CCA deduction can be claimed in the first year the property becomes available for use, for:
- manufacturing and processing and specified clean energy equipment acquired after 20 November 2018 and available for use before 2024
- zero-emission vehicles acquired after 18 March 2019 and available for use before 2024 that are generally automotive vehicles designed or adapted to be used on highways and streets (off-road vehicles and equipment specifically excluded), and
- zero-emission automotive vehicles and equipment acquired after 1 March 2020 and available for use before 2024 that are generally trolley buses and vehicles designed or adapted to be operated exclusively on rails, i.e. off-road vehicles and equipment. To be eligible, the vehicle or equipment must be automotive (i.e. self-propelled) and fully electric or powered by hydrogen; vehicles or equipment that are powered partially by electricity or hydrogen (which includes hybrid vehicles) will not be eligible.
The 100% CCA deduction is gradually phased out if the property becomes available for use after 2023 and before 2028.
Immediate expensing of capital property for CCPCs
In the year that the eligible property becomes available for use, CCPCs can immediately expense up to CAD 1.5 million (shared among associated CCPCs) per taxation year of eligible property acquired after 18 April 2021 that becomes available for use before 2024. Eligible property consists of capital property subject to the CCA rules, other than property included in CCA classes 1 to 6, 14.1, 17, 47, 29, and 51.
Eligible capital property (ECP)
Before 2017, three-quarters of capital expenditures for goodwill and certain other intangible properties were included in a cumulative eligible capital (CEC) pool and could be amortised at a maximum annual rate of 7%, on a declining-balance basis. A portion of proceeds could be taxable as recapture or as a gain on disposition.
Starting 1 January 2017, the ECP regime was repealed and replaced with a new CCA pool, Class 14.1. Transitional rules apply. 100% of eligible capital expenditures are included in Class 14.1 and subject to a 5% declining-balance CCA rate. The rules that apply to depreciable property, such as the ‘half-year rule’, recapture, and capital gains, also apply to the properties included in Class 14.1.
Special rules apply to expenditures that do not relate to a specific property of a business. Every business is considered to have goodwill associated to it (even if no expenditures on goodwill have been made). Expenditures that do not relate to a particular property will increase the capital cost of the goodwill of the business and, consequently, the balance of the Class 14.1 pool.
A receipt that does not relate to a specific property will reduce the capital cost of the goodwill of the business, and therefore the balance of the Class 14.1 pool, by the lesser of the cost of the goodwill (which may be nil) and the amount of the receipt. Any excess will be treated as a capital gain. Any previously deducted CCA will be recaptured to the extent that the receipt exceeds the balance of the Class 14.1 pool.
CEC balances at 31 December 2016 were transferred to the new Class 14.1 pool as of 1 January 2017. The CCA depreciation rate for the transferred property in the Class 14.1 pool is 7% until 2027. Proceeds received after 31 December 2016, relating to property acquired, expenditures made, or goodwill generated before 1 January 2017, reduce the Class 14.1 pool at a 75% rate.
Mining and oil and gas activity
Generally, mining and oil and gas companies are allowed a 100% deduction for grassroots exploration costs. Other development costs are deductible at the rate of 30% on a declining-balance basis. Generally, pre-production mine development expenses are treated as ‘Canadian development expenses’ (CDEs) (30% declining balance) instead of as ‘Canadian exploration expenses’ (CEEs) (100% deduction). In addition, mining expenses incurred that relate to environmental studies, and community consultations that are required to obtain an exploration permit or meet a legal or informal obligation under the terms of the permit, will be treated as CEEs, which may provide an immediate 100% deduction.
Oil and gas expenditures related to drilling or completing a discovery well (or building a temporary access road to, or preparing a site of, any such well) are classified as CDEs.
The AII (see Depreciation and amortisation above) provides an enhanced first year deduction and also generally applies to eligible CDE and Canadian oil and gas property expenses incurred after 20 November 2018 (the short taxation year rule applies to the AII for resource expenditures). Capital property costs are subject to the depreciation rules (noted above under Depreciation).
For assets acquired before 2025, CCA rates are:
- 30% for equipment used in natural gas liquefaction (returning to 8% in 2025), and
- 10% for buildings at a facility that liquefies natural gas (returning to 6% in 2025).
Provinces levy mining taxes on mineral extraction and royalties on oil and gas production. Most are deductible for income tax purposes. In British Columbia a non-refundable 3% tax credit is available to qualifying corporations that develop natural gas, and have an establishment, in the province. The credit can reduce the effective British Columbia CIT rate to a minimum of 9% (from 12%). Any unused credit can be carried forward indefinitely.
ITCs are available federally (and in some provinces if certain criteria are met) to individuals who invest in shares to fund prescribed mineral exploration expenditures. The federal credit in 2023 for qualified ‘flow-through’ share investments is 15% of qualifying mining grassroots exploration expenditures. The credit can be used to offset current taxes payable or carried over to certain previous or subsequent taxation years. A 30% critical mineral exploration tax credit (CMETC) is available for eligible expenditures:
- incurred in the exploration and mining of eligible specified minerals that are used in the production of certain parts for zero-emission vehicles, or advanced materials, clean technology, or semi-conductors, and
- renounced under eligible flow-through share agreements entered into after 7 April 2022 and before 1 April 2027.
Eligible expenditures can only be renounced for either the CMETC or the 15% mineral exploration tax credit (discussed above). Draft legislation includes lithium from brines as a mineral resource for purposes of the:
- CMETC, for flow-through share agreements entered into after 28 March 2023 and before 1 April 2027, and
- flow-through share regime, for eligible expenses related to lithium from brines made after 28 March 2023.
Draft legislation introduces the carbon capture, utilisation, and storage refundable tax credit, and the federal government also proposes to introduce a refundable investment tax credit for clean technology manufacturing (including the extraction and certain processing activities related to specified critical minerals), both of which are relevant for the extractive sector (see Investment tax credit for carbon capture, utilisation, and storage and Other federal environmental incentives in the Tax credits and incentives section).
The flow-through share regime for oil, gas, and coal activities has been eliminated for flow-through share agreements entered into after 31 March 2023, thereby no longer allowing the renunciation of oil, gas, and coal exploration and development expenditures to a flow-through share investor.
Extractive Sector Transparency Measures Act
The Extractive Sector Transparency Measures Act requires public disclosure of government payments made by mining and oil and gas entities engaged in the commercial development of oil, gas, or minerals in Canada or elsewhere. It also applies to entities that control another entity that engages in these activities. However, an entity will be required to report only if it:
- is listed on a stock exchange in Canada, or
- has a place of business in Canada, does business in Canada, or has assets in Canada, and, based on its consolidated financial statements, meets minimum asset, revenue, and/or employee thresholds.
This mandatory reporting standard for extractive companies applies to payments of CAD 100,000 or more in a year that have been made to foreign and domestic governments at all levels, including Aboriginal groups. Both monetary payments and payments ‘in kind’ must be reported.
Scientific research and experimental development (SR&ED)
Canada provides a generous combination of deductions and tax credits for SR&ED. Current expenditures on SR&ED can be deducted in the year incurred or carried forward indefinitely to be used at the taxpayer’s discretion to minimise tax payable. See Scientific research and experimental development (SR&ED) credit in the Tax credits and incentives section for information on the tax credits currently available.
Start-up expenses
Expenses related to the incorporation, reorganisation, or amalgamation of a corporation (e.g. cost of affidavits, legal and accounting fees, costs of preparing articles of incorporation) are not deductible for income tax purposes (except for the first CAD 3,000 of incorporation expenses, which are deductible). They are considered to be eligible capital expenditures, for which 100% of the capital cost of the expenditure is included in Class 14.1 and subject to a 5% declining-balance CCA rate. Expenses incurred after the date of incorporation generally are deductible for income tax purposes if reasonable in amount and incurred to earn income from the business.
Interest expenses
Interest on borrowed money used for earning business or property income, or interest in respect of an amount payable for property acquired to earn income, is deductible, provided the interest is paid pursuant to a legal obligation and is reasonable under the circumstances.
Doubtful accounts and bad debts
A reasonable reserve for doubtful accounts may be deducted for tax purposes. The reserve calculation should be based on the taxpayer’s past history of bad debts, industry experience, general and local economic conditions, etc. Special rules apply for determining reserves for financial institutions. A taxpayer can deduct the amount of debts owing that are established to have become bad debts during the year, provided the amount has previously been included in the taxpayer’s income or relates to loans made in the ordinary course of business. Recoveries of bad debts previously written off must be included in income in the year of recovery.
Business meals and entertainment
Deductions for business meals and entertainment expenses are limited to 50% of their cost. This includes meals while travelling or attending a seminar, conference, or convention, overtime meal allowances, and room rentals and service charges, etc. incurred for entertainment purposes. If the business meal and entertainment costs are billed to a client or customer and itemised as such, the disallowance (i.e. the 50% not deductible) is shifted to the client or customer.
Insurance premiums
Insurance premiums relating to property of a business are generally deductible, but life insurance premiums are generally not deductible if the company is the named beneficiary. However, if a financial institution lender requires collateral security in the form of life insurance, a deduction is allowed for the associated net cost of any pure insurance for the period.
Charitable contributions
Charitable donations made to registered Canadian charitable organisations are deductible in computing taxable income, generally to the extent of 75% of net income. A five-year carryforward is provided.
Fines and penalties
Most government-imposed fines and penalties are not deductible. Fines and penalties that are not government-imposed are generally deductible if made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property.
Taxes
Federal, provincial, and territorial income taxes are not deductible in determining income subject to tax. The tax treatment of federal capital taxes and provincial payroll and capital taxes is discussed in the Other taxes section.
Net operating losses
Net operating losses generally may be carried back three tax years and forward 20. Special rules may prohibit the use of losses from other years when there has been an acquisition of control of the corporation.
Corporate loss trading
Where there has been an acquisition of control of a corporation, an anti-avoidance measure to support the restrictions on the deductibility of losses, and the use of certain other tax benefits, applies:
- when a person or group of persons acquires shares of a corporation to hold more than 75% of the FMV of all of the shares of the corporation without otherwise acquiring control of the corporation, and
- if it is reasonable to conclude that one of the main reasons that control was not acquired was to avoid the loss restriction rules.
Payments to foreign affiliates
Interest, rents, royalties, management fees, and other payments made to related non-residents are deductible expenses to the extent that they are incurred to earn income of the Canadian corporation and do not exceed a reasonable amount. In certain cases, the receipt of these payments by a foreign affiliate of the Canadian corporation or of a related person can give rise to FAPI, which is taxable on an accrual basis in Canada.
Article by PWC
