Tax depreciation

What it means

Tax depreciation is set by the income tax act: the depreciation group, the period and the method. Book depreciation, by contrast, follows how the asset actually wears out.

The two figures therefore differ as a matter of course. The tax return reconciles them with an add-back or a deduction, and the books may carry deferred tax.

The method, straight-line or accelerated, is chosen separately for each asset when it enters use, where the law allows accelerated depreciation for that group, and it is not changed afterwards. Some assets are not depreciated for tax at all, land for example, and their cost reaches expenses only on sale.

How it works in practice

In the first year straight-line depreciation runs only from the month the asset entered use. The in-service date therefore feeds straight into the tax and cannot be backdated to suit.

A company may interrupt tax depreciation. It is a legitimate tool in a loss year, saving the deduction for a year when there is profit to reduce.

For every asset we keep a tax card with its depreciation schedule, separate from the book one. On sale or disposal it gives the tax net book value going to expenses straight away, with no need to rebuild depreciation from several years of returns.

What to watch out for

The common error is the wrong group or leaving a capital improvement in expenses. An audit corrects it across all the years and assesses back tax with interest.

Another error starts at the entry price: the acquisition cost includes transport, installation or duty, while a VAT payer leaves out the VAT it recovered. A wrong entry price then runs through depreciation for years and has to be corrected in every return it touched.