This article discusses changes to income tax treatment of patent acquisition costs in Canada. These reforms are a welcome change for Canadian companies acquiring patent rights as they allow for an investment in purchased patents to be recovered earlier for tax purposes.
On November 21, 2018, the Department of Finance Canada issued its Fall Economic Statement (FES). As part of the FES, the Accelerated Investment Incentive allows for a larger first-year deduction for capital assets purchased after November 20, 2018, provided the asset is available for use before 2028. This permits businesses to deduct costs of purchasing assets sooner, allowing businesses to recover investment costs earlier.
Capital assets are assets that are useful beyond the year they’re purchased. Because of this, Canadian income tax law generally requires that acquisition costs of a capital asset be gradually deducted over the asset’s useful life. The amount that can be deducted each year is known as the capital cost allowance (CCA). The Income Tax Regulations delineate different classes of capital assets and specify the annual CCA for these various asset classes. The CCA that can be deducted in the first year is generally limited to half the amount otherwise available (the “half-year rule”). First year deductions are increased by 3 times for most capital assets (including patents) with the Accelerated Investment Initiative.
Patents are capital assets, and costs incurred through their purchase can be recovered in subsequent years. Schedule II of the Income Tax Regulations permits businesses to deduct patent purchase expenses under one of two schedules. Class 14 provides a flat 5% CCA deduction of the patent acquisition cost (straight-line CCA), with the half-year rule not applying. The alternative is Class 44 which provides a 25% CCA deduction of the balance remaining after prior year deductions (declining-balance CCA), the half-year rule applying to the first year’s deduction.
When a greater current deduction is desired, Class 44 for purchased patents is preferred because 90% of the patent’s cost can be deducted as CCA within 8 years with the new changes. However, if a business’ profits are expected to be low in the near future but are expected to pick up thereafter, a deferred deduction may be desired. In this scenario where future profits will be taxed at a higher marginal tax rate, Class 14 would be preferred. The table below illustrates the difference in annual CCA deductions according to Classes 14 and 44 in an example scenario where a patent is purchased for $10,000, taking into account the accelerated first year deduction:
|Class 14 (5% straight-line)||Class 44 (25% declining balance)|
Other aspects of taxation involving patents remain unchanged. Costs incurred for research and development are fully deductible in the year they are incurred. Furthermore, current year deductions are permitted for any costs related to obtaining a patent, including government fees and amounts paid to patent attorneys.
These changes ultimately improve Canada’s competitive position in generating innovations. A tax regime that helps businesses to acquire patents stimulates a more robust intellectual property marketplace.
A general summary of the Accelerated Investment Incentive from the Government of Canada can be found here.
This article is not intended to provide any legal or tax advice. The assistance of a qualified tax professional should be sought for any tax planning advice.