Candice Horbacz
Following Canada’s snap federal elections in the spring of 2025, the highly anticipated 2025 budget was placed on an indefinite hold. This legislative pause subsequently stalled several critical tax policies, particularly those related to capital cost recovery. In recent years, Canada’s capital cost recovery framework has undergone significant, often temporary, adjustments, making it imperative to analyze the current policy landscape, understand its economic implications, and advocate for the enduring benefits of maintaining and extending its most advantageous provisions. The decisions made in the coming months will profoundly impact Canada’s long-term economic competitiveness, investment climate, and productivity growth.
Understanding Capital Cost Recovery and Its Economic Impact
At its core, capital cost recovery refers to how the tax system permits businesses to recoup the cost of their investments through mechanisms like depreciation or amortization. These deductions directly influence taxable income, effective tax rates, and, crucially, investment decisions. A capital allowance, often synonymous with a depreciation allowance, represents the portion of capital investment costs a business can deduct from its revenue each year through the tax code. When businesses are unable to fully deduct capital expenditures in real terms, the economic consequence is a disincentive to invest in new equipment, machinery, technology, and facilities. This, in turn, leads to reduced capital stock, lower worker productivity, and ultimately, stagnating wages.
Economists and tax policy experts widely advocate that companies should be permitted to fully deduct the real cost of their capital investments. This ideal can be achieved either through ‘full expensing’ or a system of ‘neutral cost recovery.’ Full expensing allows businesses to immediately deduct the entire cost of qualifying investments in new or improved technology, equipment, or even certain buildings. This policy directly addresses a fundamental bias within the tax code that otherwise discourages investment. By reducing the after-tax cost of capital, full expensing incentivizes companies to invest more, which over the long run translates into higher worker productivity, robust wage growth, and increased job creation.
In contrast to immediate expensing, traditional depreciation schedules specify a multi-year period over which an asset’s cost can be written off. This period is typically derived from the asset’s estimated economic life. However, a critical flaw in most depreciation schedules is their failure to account for the time value of money, which includes both a normal rate of return and the corrosive effects of inflation. As a result, businesses cannot fully deduct the net present value of their capital investments. This under-deduction effectively inflates taxable profits, thereby increasing the cost of capital investment and discouraging economic expansion. Improving capital allowances, particularly through measures like full expensing, is considered an especially cost-effective strategy to stimulate investment because it directly lowers the cost of new capital without negatively impacting tax revenue derived from existing capital stock. This targeted approach ensures that new growth is encouraged without undermining the fiscal base.
A Chronology of Canada’s Evolving Capital Allowance Policies
The narrative of Canada’s recent capital allowance policies is one of reactive adjustments and temporary measures, largely influenced by the actions of its largest trading partner, the United States. In 2018, the Canadian government significantly increased its capital allowances. This move was a direct response to the temporary ‘bonus depreciation’ provisions introduced by the 2017 Tax Cuts and Jobs Act (TCJA) in the United States, which substantially lowered the cost of investment south of the border. Recognizing the potential for capital flight and a decline in domestic competitiveness, Canada swiftly adopted its own set of accelerated measures.
Specifically, in 2018, Canada implemented temporary immediate expensing for equipment and machinery used in the manufacturing and processing of goods. This also extended to qualified clean energy investments, signaling a dual aim of boosting industrial capacity and supporting environmental objectives. Concurrently, the government introduced accelerated depreciation schedules for non-residential buildings and intangible assets, broadening the scope of relief for businesses across various sectors.
These temporary policies were initially slated to begin phasing out in 2024, raising concerns among Canadian businesses about impending higher tax burdens and reduced investment incentives. However, amidst calls from industry stakeholders and a recognition of ongoing economic uncertainties, these crucial provisions were reinstated in 2025. They are now set to remain in effect until 2029, with a gradual phase-out planned between 2030 and 2033. Furthermore, the government expanded immediate expensing to include patents, data network infrastructure equipment, and general-purpose electronic data-processing equipment and systems software. This latest expansion applies to assets acquired after April 15, 2024, and available for use before 2027, reflecting an effort to stimulate investment in the digital economy and intellectual property.
The Looming Sunset: A Threat to Competitiveness
Despite these recent reinstatements and expansions, the temporary nature of Canada’s enhanced capital allowances remains a significant concern. The current policies are still scheduled to phase out completely after 2033, creating a looming fiscal cliff for businesses. The impact of this planned decline is substantial:
- Manufacturing and Processing Buildings: The first-year write-off for buildings used in manufacturing and processing is projected to decrease from 15 percent in 2025 to a mere 10 percent by 2034.
- Other Non-Residential Buildings: Similarly, the deduction for other non-residential buildings will fall from 9 percent to 6 percent over the same period.
- Equipment and Machinery: Crucially, without permanent full expensing, Canada’s deduction for equipment and machinery, currently at 100 percent in 2025, is expected to drop to 93.5 percent by 2034, when measured in net present value terms. This seemingly small percentage decline translates into a significant increase in the after-tax cost of investment for businesses.
- Intangible Assets: The situation for intangible assets is particularly stark. By the end of 2027, these assets are projected to experience the second-lowest capital cost recovery in the OECD, recovering just 43 percent of their value. This will severely hamper innovation and intellectual property development.
Overall, while Canadian businesses could deduct an impressive 85 percent of their capital investments across all asset types in 2025, this figure is projected to decline precipitously to 72.8 percent by 2034. Such a reduction in cost recovery fundamentally undermines the competitiveness of Canadian businesses and discourages the long-term capital formation necessary for sustained economic growth.
New Opportunities for Permanent Reform
Despite the uncertainty surrounding the 2025 budget and the scheduled phase-outs, new legislative and consultative opportunities have emerged that could pave the way for more permanent and robust capital allowance policies.
Currently, a second bill, designed to implement provisions from the stalled 2025 budget, is making its way through the Senate. This legislative package is anticipated to introduce immediate expensing for manufacturing and processing buildings. If passed, this temporary immediate expensing would apply to eligible buildings acquired on or after November 4, 2025. While still a temporary measure, it signals a continued governmental recognition of the importance of supporting the manufacturing sector through enhanced capital allowances.
Perhaps more significantly, the government has recently launched public consultations in preparation for the 2026 budget. This consultative process provides a crucial window for businesses, economists, and advocacy groups to press for comprehensive and permanent improvements to Canada’s business investment climate. It is an ideal platform to advocate for a departure from the cycle of temporary fixes and towards enduring policy reforms.
It is worth noting that the fiscal costs associated with accelerated depreciation typically peak in the initial years of implementation and then decline sharply. This is because accelerated depreciation schedules primarily shift capital allowances forward in time rather than increasing their nominal value indefinitely. This implies that the peak fiscal burden of the current temporary provisions has likely already been absorbed by the Canadian Treasury. Consequently, the argument against making these provisions permanent due to prohibitive ongoing costs may be less compelling, as the bulk of the initial revenue impact has already been incurred.
The Enduring Benefits of Permanent Full Expensing: Learning from the US Example
Under its current, albeit temporary, policy framework, Canada boasts the 5th best capital cost recovery system among OECD nations. This strong position is a testament to the effectiveness of the accelerated allowances implemented in recent years. However, this competitive advantage is precarious. Once the existing provisions expire, Canada is projected to plummet to the 12th position in the OECD rankings by 2034. To prevent this significant decline and maintain its attractiveness for investment, Canada should draw lessons from its past responses to US tax reforms and embrace permanent full expensing.
The United States, after initially adopting bonus depreciation in 2017, saw these provisions begin to phase out in 2023. However, in a decisive move in 2025, the U.S. government made full expensing permanent. According to detailed estimates by the Tax Foundation, this permanent provision is projected to raise U.S. GDP by 0.6 percent in the long run and increase the stock of capital by a substantial 1 percent. These figures underscore the powerful, long-term economic stimulus that certainty and permanence in tax policy can provide.
Furthermore, the U.S. is temporarily providing 100 percent expensing for qualifying structures, covering nearly all industrial buildings, provided construction begins after January 19, 2025, and before January 1, 2029, with placement in service before January 1, 2031. These provisions, while temporary, encompass roughly 10-15 percent of all buildings and structures in the U.S. This combination of permanent full expensing for machinery and equipment, coupled with temporary relief for structures, has temporarily propelled the U.S. to the 3rd best capital cost recovery system in the OECD, a dramatic leap from its 2024 ranking of 21st. This aggressive approach highlights the intense global competition for capital and the importance of a favorable tax environment.
The Pitfalls of Temporary Measures and the Case for Long-Term Vision
While temporary measures, such as those Canada has adopted and plans to implement, may provide a short-term boost by accelerating some pre-planned investment decisions, their impact on overall investment levels and sustained economic growth is inherently limited. The macroeconomic benefits derived from these temporary policies are fleeting; as the provisions phase out, investment tends to fall, and the capital stock gradually melts down to its previous level over time. This creates a cycle of uncertainty and uneven investment, making long-term business planning difficult and hindering sustained productivity gains.
Moreover, as previously noted, the peak fiscal costs of these temporary provisions have largely already been incurred by the Canadian Treasury. Continuing with a phase-out strategy means foregoing future economic benefits without significantly reducing past or current fiscal outlays. It is a suboptimal approach that sacrifices long-term prosperity for the illusion of future fiscal savings that may not materialize, or worse, are outweighed by the economic costs of reduced investment.
Rather than relying on a patchwork of temporary policies that are subject to constant review, phase-out schedules, and political machinations, Canada should strategically focus its efforts on comprehensive, long-term reforms to support investment. The path forward should include:
- Permanent Immediate Deductions for Machinery and Equipment: Making full expensing for machinery and equipment a permanent feature of the tax system would provide businesses with the certainty needed to plan major investments over extended horizons. This would unlock significant capital formation, driving innovation and productivity.
- Neutral Cost Recovery for All Other Capital Investments: For other asset classes, particularly buildings and structures, Canada should implement a system that provides adjustments for inflation and the time value of money. This ‘neutral cost recovery’ approach ensures that businesses can fully recover the real economic cost of their investments, eliminating the tax-induced bias against capital formation.
By adopting these fundamental reforms, Canada can solidify its position as a leading destination for business investment, foster sustained economic growth, enhance worker productivity, and secure its long-term prosperity in an increasingly competitive global economy. The current public consultations and legislative activities present a unique opportunity to transcend temporary fixes and embrace a truly transformative approach to capital cost recovery.
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