Lec 7 Flashcards
Profitability
Revenues - Costs - Cost of Capital
Royalty-based taxation
Taxes levied on Revenues
Revenue - Op Ex - Taxes = Net Income AT
NI - Cap Ex = CF
Profit-based taxation
Taxes levied on Profits
Revenue - Op Ex = Net Income before allowances and taxes
NI BAT - Dep - other non-cash tax allowances = taxable income
TI - Taxes = NI_AT
Cash Flow formula
Cash Flow = Revenue - Operating Expenses - Taxes - Capital Expenditure
= Net Income + Depreciation + ONTA - Capital Expenditure
What is salvage value when depreciating for tax purposes
SV ignored
Recapture vs loss on disposal
Depreciation Recapture: If net salvage value* > undepreciated balance (book value), but does
not exceed purchase price, then difference is taxed
Loss on disposal: If net salvage value < undepreciated balance, then difference is
allowed as deduction for loss
Net Salvage Value
Net Salvage Value: Sales price - Dismantling and transport costs
Class 1, 10 and 24
Class 1 DBD @ 4 % – Brick and/or cement buildings
Class 10 DBD @ 30 % – Mobile equipment
Class 24 SL @ 50 % – Pollution control equipment
Capital gain
Sale of a depreciable or non-depreciable asset for more than its purchase price
- In Canada, 50% of a capital gain is taxable
Capital Loss
Sale of a non-depreciable asset for less than its purchase price
- Capital losses can only be used to offset capital gains
- In Canada, capital losses can be carried backwards for up to three years, and forwards indefinitely
What does capital tax factor represent
CTF = After-Tax Cost / Cost of Asset
CTF = (Cost of Asset – PV of Tax Savings) /Cost of Asset
CTF = 1 – PV of Tax Savings /Cost of Asset
Q: What is UCC in the Canadian tax system?
A: UCC (Undepreciated Capital Cost) is the tax book value of an asset, reduced annually by the Capital Cost Allowance (CCA).
Q: What happens when SV > UCC?
A: This results in recapture of CCA — the over-claimed depreciation is added back as income and taxed fully.
RecaptureTax=(SV−UCC)×t
What happens when SV < UCC?
A: This results in a terminal loss, meaning you didn’t depreciate the asset enough. The loss is deductible and provides a tax saving.
TaxSaving=(UCC−SV)×t
Q: What happens when SV > original cost (I₀)?
A: Two tax consequences:
Recapture up to original cost
Capital gain for the portion above I₀, taxed at 50%
CapitalGainTax=0.5×(SV−IC)×t
Is the half-year rule applied to Salvage Value?
A: No — the half-year rule only applies to acquisitions, not disposals.
What is Working Capital (WC) in project evaluation?
A: WC is the cash tied up to cover short-term needs like inventory and receivables. It is not depreciated and is included as a capital cost at the start of production.
WC is added as an outflow at the end of the preproduction period, right before revenues begin.
Recovered at the end of project (Note that working capital is non-depreciable and therefore, non-taxable when recovered at the end of the project’s
life.)
How are depreciable assets treated at the end of the project if not fully depreciated?
A: Their remaining Undepreciated Capital Cost (UCC) is treated as a salvage value or recovery, which appears as an inflow in the final year.
What are the after tax proceeds
Selling price - capital gains tax payed (no tvm)
Before tax CF vs AT CF
Before-tax CASH FLOW = Operating Profits - Capital Expenditures
After-tax CASH FLOW = Operating Profits - Income Taxes - Capital Expenditures
Loss Carry Forward rules
Canada: loss carried forward for 7 years (can reduce taxable income)
Carried backwards up to 3 years
What are asset pools in Canadian tax?
Groups of similar assets (same CCA class) combined for depreciation using declining balance method.
What depreciation method is used in asset pools?
Declining-balance depreciation.
