Introduction to Federal Income Taxation in Canada with Study Guide 2023-2024 44th Edition By Nathali by Bobdocs

CHAPTER 1

Introduction Solution 1: Identify section of the Act The following summary is discussed in more detail below: Case (A) (B) (C) (D) (E) (F) (G)

Topic Person ..................................................... Donation by individual............................ Balance-due day...................................... Life insurance premiums......................... Capital dividend ...................................... Income tax instalments for individual ..... Qualified small business corporation share

Part XVII I XVII I I I I

Division — E — B B I C

Subdivision — a — a h — —

(H)

Information return for dividends .............

—

(I) (J) (K)

Definition of testamentary trust. ............. Employee loan. ....................................... Disposition of non-depreciable capital property ................................................... RRSP administration fees. ...................... Limit on deductible expenses.................. Taxable dividends received by Canadian corporation .............................................. RRSP excess contributions .....................

I I

B B

k f

Provision subsection 248(1) subsection 118.1(3) subsection 248(1) subsection 6(4) subsection 83(2) subsection 156(1) subsection 110.6(1) Reg. Part II, paragraph 201(1)(a) subsection 108(1) subsection 80.4(1)

XVII I I

— B B

— b f

subsection 248(1) paragraph 18(1)(u) section 67

I X.I

C —

— —

subsection 112(1) subsection 204.1(1)

(L) (M) (N) (O)

(A) Person — Part XVII, subsection 248(1): The term is used throughout the Act, so it is likely to be found in the interpretation section. The definition is similar to many in the Act in that it does not tell you exactly what a person is; it tells you what a person includes. (B) Donation by an individual — Part I, Division E, Subdivision a, subsection 118.1(3): Tax credits are found in Division E. Credits that are particular to individuals are found in Subdivision a of Division E. (C) Balance-due day — Part XVII, subsection 248(1): The term has application to all tax filers and, therefore, should be found in the interpretation section. However, the term has a different meaning depending on the type of tax filer. For trusts and individuals, specific timing is provided. For corporations, the provision refers to section 157. (D) Group term life insurance premiums paid by employer — Part I, Division B, Subdivision a, subsection 6(4): Payments made on behalf of an employee by an employer likely result in income from employment. Subdivision a includes the provisions for calculating income from employment. (E) Capital dividend — Part XVII, subsection 248(1): The term is found in subsection 248(1) but a definition is not actually provided, only a reference. It refers to another section — Part I, Division B, Subdivision h, subsection 83(2): Capital dividends are tax-free distributions by a corporation to its shareholders, so the provision is likely to be found in Part I, Division B, Subdivision h that deals with corporations and their shareholders. (F) Income tax instalments for an individual — Part I, Division I, subsection 156(1): The information that is required deals with payments to the CRA; therefore this information should be found in Division I dealing with returns, assessments, payment and appeals. [Some students may also identify subsection 155(1) as dealing with farmers and fishermen.] (G) Qualified small business corporation share — Part I, Division C, subsection 110.6(1): The capital gains deduction that is available for qualified small business corporation shares is a deduction that is available in computing taxable income and is therefore found in Division C.

Introduction to Federal Income Taxation in Canada

(H) Filing information return for dividends paid — Regulations Part II, subsection 201(1): The Regulations provide important detail regarding a number of the income tax rules. In order to ensure that individuals are advised of the information required to be reported on their personal tax returns (and to allow the CRA to ensure that the income is reported), corporations are required to file slips such as T5s for dividends paid. (I) Testamentary trust — Part I, Division B, Subdivision k, subsection 108(1): The phrase describes a trust so it is likely that the definition will be found in Subdivision k dealing with trusts. Section 108 contains definitions for the subdivision. (J) Interest-free loan benefit — Part I, Division B, Subdivision f, subsection 80.4(1): Since the amount relates to an employee, it might be expected that the provision would be found in section 6 (in fact the provision that requires an income inclusion is found in subsection 6(9)). However, the actual calculation of the amount of income is found in Subdivision f which contains rules related to the calculation of income. (K) Disposition of non-depreciable capital property — Part XVII, subsection 248(1): The term “disposition” is used throughout the Act, so it is likely to be found in this definition section. (L) Limit on deduction of RRSP administration fees — Part I, Division B, Subdivision b, paragraph 18(1)(u): At one time, when the fees were deductible, they were considered a carrying charge deductible in computing income from property. Therefore, the restriction on the deduction is found in section 18 which provides a list of items that are specifically not deductible in computing income from business or property. (M) Limit on deductible expenses — Part I, Division B, Subdivision f, section 67: The restriction on the amount of deductible expenses applies throughout the Act. Therefore, the provision is found in general rules for computing income that are found in Subdivision f. (N) Corporate dividend deduction — Part I, Division C, subsection 112(1): The concept deals with a deduction that is available to a corporation. It might be expected to be found in Division B, Subdivision b dealing with the calculation of income from property. However, in this case, the deduction is not considered to reduce income from property but is a general deduction available in computing taxable income. (O) Excess RRSP contributions — Part X.I, subsection 204.1(1): This is a special tax that is found in the Act and applies when an individual has contributed more to an RRSP than is allowed by the Act. In this case, the special tax is intended to discourage people from taking advantage of the benefits of an RRSP beyond those that are provided for in the rules.

Solutions to Chapter 1 Assignment Problems

Solution 2: Determine Income Using Ordering Rules [Note to instructors changes to this problem from the prior year include: Employment Income increased from $72,600 to $78,400; Business loss increased from 4275 to $400] Division B — Sec. 3 Par. 3(a) Subdivision a Sec. 5, 6, 7, 8

Employment income......................................................

Property income ............................................................... Rental property income....................................................

$ 78,400

Subdivision b Sec. 9 Sec. 9

775 975

1,750

Subdivision d: Miscellaneous sources

Par. 3(b)

Par. 56(1)(a)

Employment insurance.....................................................

Par. 56(1)(a)

Retiring allowance ...........................................................

600 800

1,400 $ 81,550

Subdivision c: Net taxable capital gains Par. 38

Par. 3(c)

Taxable capital gains (net of allowable capital losses).....

100 $ 81,650

Subdivision e: Miscellaneous deductions Sec. 62 Sec. 63

Moving expense ............................................................... Child care expense ........................................................... CPP enhanced deduction

$ 1,700 1,800 631

(4,131) $ 77,519

Par. 3(d)

Losses from non-capital sources: (400) Sec. 9 Business loss................................................................ Division B income ....................................................................................... $ 77,119 Division C: Deductions — Sec 111.1 Par. 111(1)(a) Non-capital losses .............................................................................. (600) Taxable income ....................................................................................................................................... $ 76,519 Division E: Basic federal tax — Sec. 118.92 Tax before credits ....................................................................................................................... $ 12,752 Sec. 118 Personal credits..................................................................................................... (2,250) Sec. 118.7 CPP contribution credit ....................................................................................... (469) Sec. 118.7 EI premium credit ................................................................................................ (150) Ssec. 118(10) Canada Employment tax credit ............................................................................ (205) Sec. 118.2 Medical expense credit ......................................................................................... (9) Sec. 118.1 Charitable donations credit ....................................................................................... (26) Basic federal tax..........................................................................................................................

$ 9,643

Introduction to Federal Income Taxation in Canada

Solution 3: Identify and Define Words/Terms Found in Section 2 Words and terms found in section 2 (A) Division A of Part I of the Act consists of section 2 of the Act. Section 2 consists of three subsections. Subsection 2(1):

“taxable income” — This is defined in subsection 2(2). “taxation year” — Subsection 249(1) contains the definition of a taxation year. For corporations, the taxation year is the fiscal period of the corporation; for individuals, the taxation year is the calendar year. “fiscal period” — This is also a defined term, found in subsection 249.1(1). “corporation” — This word is part of a defined term in subsection 248(1), “corporation incorporated in Canada”. “individual” — Subsection 248(1) defines individual as a person, other than a corporation, “person” — This is also defined in subsection 248(1). This is expanded below. “calendar year” — This is not defined in the Act. However, the Interpretation Act defines the term in paragraph 37(1)(a) to mean a period of twelve consecutive months commencing on January 1. “person” — The definition of person is found in subsection 248(1). Section 248 is an interpretation section and many of the words and terms used in the Act, which require definition, are found in this section. Person is defined to include any body corporate and politic, and the heirs, executors, administrators or other legal representatives of such body. “resident” — Although the Act includes a definition of deemed residents (subsections 250(1) and (4)), the word “resident” is not itself defined in the Act. Canadian residents are taxed on their worldwide income. As this term is fundamental to establishing a liability for Canadian tax, there have been many court cases centred on the issue of residency. The common law principles which have evolved from these cases are the basis for the interpretation of this word. Residency is more fully discussed in Chapter 2. “Canada” — Section 255 defines Canada to include certain sea beds adjacent to the coasts, as well as the airspace above the geographic boundaries of Canada. Subsection 2(2):

As mentioned above, subsection 2(2) is itself a definition. This subsection is for the purpose of defining “taxable income.” “taxpayer” is found in subsection 248(1). This is any person, whether or not liable to pay tax. “income for the year” — Section 3 contains the blueprint for the calculation of income. The term “income,” however, is not defined. Section 3 states: “The income of a taxpayer for a taxation year for the purposes of this Part is his income determined by the following rules ...” In order to determine income under section 3, one has to first know what income is. As income is not defined, we again must turn to jurisprudence and common language. Again, there are numerous court cases over the issue of what constitutes income. Subsection 2(3):

“employed” — Subsection 248(1) defines this word as performing the duties of an office or employment. “business” — Subsection 248(1) defines this word to include a profession, calling, trade, manufacture, or undertaking of any kind whatever, and an adventure or concern in the nature of trade. The definition excludes an office or employment. “carrying on a business in Canada” — Section 253 provides an extended meaning of this term, as it applies to nonresidents. This provides a number of criteria to expand when a business will be considered to be conducted in Canada. However, the term “carrying on a business” is not, itself, defined. Therefore, although we have an extended meaning of this term legislated by the Act, we will not find a legislated definition of the term itself. Again, there have been numerous cases disputing whether a business was carried on. “disposed” — Although the term disposed is not itself defined, “disposition” is defined in subsection 248(1) to be, in paragraph (a), any event or transaction which entitles the taxpayer to “proceeds of disposition.” “Proceeds of disposition” is, itself, a defined term found in subsection 13(21) and section 54. “taxable Canadian property” — This is defined in subsection 248(1) and is quite a lengthy definition. Taxable Canadian property includes, among other items, real property situated in Canada, shares of private Canadian companies, and certain partnership interests and trust interests which derive their value principally from these former two types of property. “taxable income earned in Canada” — Subsection 248(1) defines this term to mean taxable income determined in accordance with Division D of Part I, but in no case can this ever be less than nil.

Solutions to Chapter 1 Assignment Problems

A review of section 2 clearly emphasizes the importance of understanding the terms used throughout the Act. In many examples, the Act will expand upon terms or provide computational rules for certain terms, but does not extend to providing a statutory definition of the term itself. This is one of many reasons why interpretation of the statute remains, at times, an imprecise practice. It also demonstrates that, while the Act is the cornerstone for the taxation system, it cannot be studied in isolation as it draws meaning from other external sources.

Components of subsection 2(3) Subsection 2(3), like subsection 2(1), is a “charging provision”, because it charges someone with the responsibility to pay a tax.

Components of subsection 2(3) (i) the person who is the subject of the provision •

"a person who is not taxable under subsection (1)", i.e., a person who is not resident in Canada (i.e., a non-resident)

(ii) the activity, event or condition that must be met for the provision to apply •

a person • was employed in Canada • carried on business in Canada or • disposed of taxable Canadian property

•

note the use of the word "or" in the list of three activities

(iii) the consequences of the activity or event to the person who is the subject of the provision •

"an income tax shall be paid ... on the person's taxable income earned in Canada for the year ..."

•

note the use of the word "shall", indicating a mandatory payment

(iv) the timeframe for the application of the provision • income is earned •

at any time in the year or a previous year

CHAPTER 2

Liability for Tax Solution 1: Individual residency — Multi-Part 1. 2. 3. 4. 5.

6. 7.

Gather all the facts leading up to, during, and after the move. Develop your best arguments for both resident and non-resident status. Be balanced in your analysis. Analyze the strengths and weaknesses of your arguments by evaluating the facts rather than simply classifying or listing the facts. Arrive at a conclusion of resident, non-resident, or deemed resident consistent with your analysis. If there is a change in residency status, then determine the date on which that change most likely took place. In the year of change the individual will be a part-year resident, i.e., resident for part of the year and non-resident for part of the year. If your conclusion is non-resident, then did the individual sojourn in Canada for 183 days or more while a non-resident? If there is a change in residency status, then determine how the individual will pay tax: a. before the date on which their residency changed, b. after the date on which their residency changed, and c. for the year in which their residency changed.

(a) Anthony and his wife both moved to Canada this year and have indicated an intention to stay permanently. We don’t have any information on how they cut their ties with their home country or how they established their ties in Canada. We also don’t have any information on their immigration status. Assuming Anthony has made a fresh start in Canada this year, he will be considered to have become a resident in this year. While his wife and children moved on December 15th, he will likely be considered to have become a resident on the earlier date. His wife and children will become residents on December 15th. Because Anthony had a change in residency in the year, the next step is to determine when his clean break/fresh start took place. In this case there is limited information so the obvious choice is March 1st. As of March 1, this year, he will be taxed in Canada on his world income. He will also be deemed to have acquired any capital property that he owned on that date at fair market value, so his cost base in Canada will be that fair market value. Also, because he had a change in residency in the year, he is considered a part-year resident. Accordingly, he will be taxed on his worldwide income from March 1 to December 31. Prior to March 1, he would only pay Canadian tax on income from Canadian sources. (b) Lubie is a US citizen who has lived there her entire life. She does not have property or family in Canada. Since she only spends her working hours in Canada, it would be reasonable to assume that her strongest ties are to the United States. Her trading activities can be conducted from either her US home or from her Canadian workplace. Since all of her primary residential ties are to the United States, the evidence would suggest that she would be considered resident of the United States. The 183-day sojourner rule would not apply, because Lubie does not stay in Canada overnight. Since there is no change in residency status, she is not a part-year resident. In Canada, as a non-resident, she will be taxed on her employment income as she is “employed in Canada”. There will also be withholding tax on any investment income earned in Canada. As a US citizen and resident, Lubie will be taxed in the United States on her world income. Therefore, she will have to apply for a foreign tax credit on her US return for the tax she pays in Canada.

Introduction to Federal Income Taxation in Canada (c) Since Ephran moved for a job, the house he shared with his common-law partner was sold, and his common-law partner moved with him, it seems clear that the primary residential ties were broken and that Ephran did make a clean break during the current year. There is no evidence that would indicate otherwise. The next question is “On what date did he become a non-resident?” The CRA’s position is that it will not be May 1st when he moved, but July 30th when his house was sold and his common-law partner moved to be with him. This would be considered the date of the “clean break”. An argument could also be made that Ephran made a clean break from Canada on May 1st. The sojourner rule only considers that period during the year when Ephran was a non-resident. Since there is no indication that he spent any time back in Canada after July 30th, he would not be considered to be sojourning in Canada during the current year. Ephran and his common-law partner will pay tax in Canada on their world income up to July 30th. After July 30, he will only be taxed on income from Canadian sources. They will also be deemed to have disposed of all capital property on July 30th. (d) Although she is a U.S. citizen, Julia’s primary residential ties are to Canada so she will likely be considered a resident of Canada. She lives in Canada with her parents. She attends a Canadian university and, on completion of university, she took a full-time job in Canada. All evidence indicates that she became a Canadian resident. Her summer job in Colorado seems to have been temporary. The difficult question is “When did she become a Canadian resident?” Was it in August two years ago when she moved to Canada or this year when she began full-time employment in Canada? Or did she make a decision in last year to move to Canada on a long-term basis? It appears that this year, at the latest, she will be considered a resident of Canada and taxed on her worldwide income. Citizenship is irrelevant to a person’s resident status in Canada, but Julia will also be taxable in the United States, since they tax based on citizenship. Consequently, Julia will be taxed in both Canada and the United States and will need to apply for a foreign tax credit on her US return for the tax she pays in Canada. (e) Because Helen’s primary residential ties remain in the United States, she will not be considered a resident of Canada under common law. However, she has sojourned in Canada for 183 days or more and will, therefore, be deemed to be a resident of Canada and taxed in Canada on her world income. However, as a citizen of the United States, she will also be taxed there on her world income. To avoid double taxation, she will need to refer to the Canada–US tax treaty to resolve the issue.

Solutions to Chapter 2 Assignment Problems

Solution 2: Individual Residency—Case [Reference: Glow v. The Queen, 92 DTC 6467 (F.C.T.D.)] 1. Gather all the facts leading up to, during, and after the move. 2. Develop your best arguments for both resident and non-resident status. Be balanced in your analysis. 3. Analyze the strengths and weaknesses of your arguments by evaluating the facts rather than simply classifying or listing the facts. 4. Arrive at a conclusion of resident, non-resident, or deemed resident consistent with your analysis. 5. If there is a change in residency status, then determine the date on which that change most likely took place. In the year of change the individual will be a part-year resident, i.e., resident for part of the year and non-resident for part of the year. 6. If your conclusion is non-resident, then did the individual sojourn in Canada for 183 days or more while a non-resident? 7. If there is a change in residency status, then determine how the individual will pay tax: a. before the date on which their residency changed, b. after the date on which their residency changed, and c. for the year in which their residency changed. (A) Resident: taxed in Canada on worldwide income for the whole year. Criterion: continuing state of relationship with Canada; i.e., ties. Evidence: — born, raised and educated in Canada, — agreed to short-term contract abroad, — contract provided for living expenses, indicating the temporary nature of the stay abroad, — fees under the contract were paid to the client’s Canadian corporation, — he continued as a shareholder, director and officer of the Canadian corporation, — he maintained an interest in the activities of the Canadian corporation, — he maintained a Canadian bank account, — he owned a rental property in Canada, — he arranged a rental on a month-to-month basis to allow him to resume his habitation of the residence on short notice, — he stored his major furnishings and winter clothing in Canada, indicating an intention to return, — he retained credit cards issued in Canada and his RRSP accounts, — he maintained his health coverage in Canada, — he did not extend his visa in Nigeria, indicating an intention to return, — he did not pay income tax in Nigeria, indicating a lack of permanence in his stay there, — his girlfriend returned to Canada, spending only a fall term and a summer in Nigeria with him, indicating a lack of permanence in his stay, — he returned to Canada, leaving nothing in Nigeria.

Introduction to Federal Income Taxation in Canada

(B) Deemed resident of Canada: taxed in Canada on worldwide income for the whole year. Criterion: sojourned in Canada for an aggregate of 183 days or more in the year [par. 250(1)(a)]. Evidence: — when he was in Canada until July 2022, he was not sojourning, despite being in Canada more than 183 days in that year, — therefore, deemed residence is not a possibility in this particular case for 2021. (C) Part-year resident in 2021: taxed in Canada on worldwide income for the part of the year while resident. Criterion: “clean break”, i.e., severed ties in July 2022. Evidence: — the Canadian bank account was only to avoid foreign exchange difficulties and to maintain his rental property, — no withholding of income tax on his fees, — he intended to establish an international consulting business abroad and to that end attempted to promote such a business in Nigeria, — he intended to sell his rental property in Canada when market conditions were right and to this end he arranged a rental on a month-to-month basis to facilitate a sale, — he moved his personal effects to Nigeria, — he sold his car, — he cancelled his auto insurance and a gasoline company credit card, — he was accompanied to Nigeria by his girlfriend who stayed with him when not in school, — he rented an apartment in Nigeria because more permanent accommodation was not available, — he obtained a Nigerian driver’s licence, — he maintained two bank accounts and cars in Nigeria, — he joined clubs in Nigeria, — he had an office in Nigeria, — his business cards identified him as a consultant to the Nigerian government, — the credit cards he kept could be used internationally, — he maintained his health coverage in Canada only because it was a requirement of his contract. (D) Non-resident: taxed in Canada on Canadian-source income. Criterion: employed in Canada, i.e., performed services of employment in Canada. Evidence: — after leaving in July 2022, he was not providing services of employment in Canada, — therefore, non-resident taxable in Canada is not a possibility in this case. (E) Conclusion: — while the client stated an intention to establish residence abroad, he was not successful in doing so: — in fact, he returned immediately at the termination of a short-term contract, — he did not sever his major ties to Canada or establish strong ties abroad, — his ties to Nigeria were merely those necessary to sustain a lifestyle while there; OR — on the other hand, it could be argued that: — he made an effort to establish a consulting practice abroad and the lack of business was unforeseen and beyond his control, — he attempted to integrate himself into Nigerian society by living there and joining clubs, — his lack of more permanent housing was due to market conditions beyond his control.

Solutions to Chapter 2 Assignment Problems

Solution 3: Individual Residency—Case [Reference: Lee v. M.N.R., 90 DTC 1014 (T.C.C.)] 1. Gather all the facts leading up to, during, and after the move. 2. Develop your best arguments for both resident and non-resident status. Be balanced in your analysis. 4. Arrive at a conclusion of resident, non-resident, or deemed resident consistent with your analysis. 5. If there is a change in residency status, then determine the date on which that change most likely took place. In the year of change the individual will be a part-year resident, i.e., resident for part of the year and non-resident for part of the year. 6. If your conclusion is non-resident, then did the individual sojourn in Canada for 183 days or more while a non-resident? 7. If there is a change in residency status, then determine how the individual will pay tax: a. before the date on which their residency changed, b. after the date on which their residency changed, and c. for the year in which their residency changed. (A) Resident of Canada after a “fresh start”: taxed in Canada on worldwide income for the whole year. Criterion: “a continuing state of relationship”, i.e., continuing ties with Canada after a “fresh start”. Evidence of residence: — although U.K. passport indicated residence in U.K., can be resident in more than one place, — room in parent’s house maintained for his use before his marriage, but not likely after that time, — married in Canada to a person who continued to reside in Canada, — supported his wife who was wholly dependent on him in Canada, — his wife bought a house in Canada with funds which he provided, — house mortgaged in Canada with a guarantee provided by the client, — he provided an affidavit with the mortgage in which he swore that he was not a non-resident, — he regularly returned to Canada: — length of stay is not determining (see Thomson case), — the use of the term “visitor” by immigration officials does not mean that the term is applied with the same meaning under the Act, — income from his employment was deposited to a Canadian bank account, — he never filed or paid income tax anywhere: — it must be assumed that every person has at all times a residence (see Thomson case), — the mortgage on his first wife’s house in Britain and the Caribbean bank account may have been simply a foreign investment of a resident of Canada, — during the period in question, i.e., 2021 to 2023: — he purchased a car, — he obtained a Canadian driver’s licence, — he obtained a Canadian visa, — he became a landed immigrant. (B) Deemed resident of Canada for the years in question: taxed in Canada on worldwide income for the whole year. Criterion: sojourned in Canada for an aggregate of 183 days or more in a year [par. 250(1)(a)]. Evidence: — he may have been sojourning when he regularly returned to Canada, — but he was out of the country more than 183 days per year.

Introduction to Federal Income Taxation in Canada

(C) Part-year resident in Canada after a “fresh start” and not resident before that time: taxed on worldwide income for the part of the year after the “fresh start”. Criterion: “fresh start” preceded by a period of non-residence. Evidence of non-residence: — history in England, — U.K. passport held throughout the period in question: — passport indicates residence in U.K., — parents maintain a room in England available for his use at any time, — affidavit on which he swore that he was not a non-resident was not for income tax purposes but for Ontario land transfer tax: — the concept of a non-resident for the transfer tax may differ from that for income tax, — on his entry to Canada, the length of his stay was limited by the setting of a date for his departure, — immigration officials considered him to be a visitor on stamping his passport, — he was employed on a full-time basis outside of Canada: — he indicated that he did not want to work in Canada, — — he was not allowed to work in Canada, — he could not join OHIP, pay El, maintain an RRSP or join a pension plan in Canada, — he held a mortgage in Britain on his first wife’s house, — he had a bank account in the Caribbean, — the bank account in Canada may have been for convenience or an investment like any other that a nonresident might make in Canada. (D) Non-resident throughout the period in question: taxed on Canadian-source income. Criterion: employed or carried on business in Canada. Evidence: — during the period in question he was neither employed nor carried on business in Canada. (E) Conclusion: — he cannot be deemed a resident, because he does not meet the criterion, — if he is held to be a non-resident throughout the period in question, he will not be taxable in Canada because he has no Canadian-source income, — therefore, either he made a “fresh start” at some point in the period or he was a non-resident throughout the period: — his ties to Canada appear to have begun with his marriage in June of 2021 and the subsequent purchase of a matrimonial home to which he returned regularly, — at least, he could be considered to have become a resident in September of 2021 when he swore that he was not a non-resident. Note: A conclusion for non-resident is acceptable, if an argument for a weighing of the facts in that direction is presented.

Solutions to Chapter 2 Assignment Problems

Solution 4: Individual Residency—Case [Reference: Dale Boston v. The Queen, 98 DTC 1124 (T.C.C.)] 1. Gather all the facts leading up to, during, and after the move. 2. Develop your best arguments for both resident and non-resident status. Be balanced in your analysis. 3. Analyze the strengths and weaknesses of your arguments by evaluating the facts rather than simply classifying or listing the facts. 4. Arrive at a conclusion of resident, non-resident, or deemed resident consistent with your analysis. 5. If there is a change in residency status, then determine the date on which that change most likely took place. In the year of change the individual will be a part-year resident, i.e., resident for part of the year and non-resident for part of the year. 6. If your conclusion is non-resident, then did the individual sojourn in Canada for 183 days or more while a non-resident? 7. If there is a change in residency status, then determine how the individual will pay tax: a. before the date on which their residency changed, b. after the date on which their residency changed, and c. for the year in which their residency changed. (A) Resident of Canada: taxed in Canada on worldwide income for the whole year(s) in question. Criterion: “a continuing state of relationship”, i.e., continuing ties with Canada. Evidence of residence: — during the entire period in question his wife and 3 children (including one minor child) remained in Canada; — he had the family home in Edmonton available to him throughout the entire period in question as his wife and youngest son continued to reside in this home; — he remained on the payroll of the Canadian subsidiary of Exxon; — his monthly pay was deposited into his Edmonton bank account; — he remained a member of the pension plan of the Canadian subsidiary of Exxon; — he did maintain some Canadian investments: — his 50% interest in the family home in Edmonton, — a 50% investment in rental property which his wife purchased after his move to Malaysia because she thought it would be a good investment, — his RRSP, — his company savings plan, and — a few personal shares in Canadian public companies. (B) Deemed resident of Canada for the years in question: taxed in Canada on worldwide income for the whole year(s) in question. Criterion: sojourned in Canada for an aggregate of 183 days or more in a year [par. 250(1)(a)]. Evidence: — he may have been sojourning when he came to Canada for brief periods during 2018 and 2019; — but in neither of these years did he sojourn for a period in aggregate of 183 days; visits were 14 days in each of 2018 and 2019 and no days during 20, 2021 and 2022 prior to his return during the summer.

Introduction to Federal Income Taxation in Canada

(C) Part-year resident in Canada in year of “clean break” or resident before the time: taxed on worldwide income for the part of the year prior to the “clean break”. Criterion: “clean break”, i.e., severed ties in September 2016. Evidence: — his employer obtained a work permit for him in Malaysia; — he sold his car in Canada; — he cancelled his Canadian provincial health plan; — his employer obtained private health insurance for him; — he closed all of his existing bank accounts at the Royal Bank; — he opened a savings account at the Bank of Nova Scotia because this bank had a branch in Kuala Lumpur, the capital of Malaysia; — although he was paid by the Canadian subsidiary of Exxon, the cost of his pay was transferred from the Canadian subsidiary to Exxon International; — no Canadian income taxes were withheld at source on his salary; — he allowed his membership in the Edmonton Petroleum Club to lapse; — he allowed his participation in the Model Guided Plane Association to lapse; — although his wife remained in Canada, their marriage was unstable (evidenced by the eventual separation) throughout the period in question and thus her presence in Canada cannot be considered a strong tie; — he was employed in Malaysia in a senior managerial capacity; — he hoped to stay on after the initial three years and in fact did remain for close to another four years; — he maintained a dwelling in Malaysia in which he slept, took his meals, and kept his personal effects; — he joined the local Malaysian yacht club; — he opened Malaysian bank accounts and obtained local Malaysian credit cards; — he purchased a car in Malaysia and obtained a Malaysian driver’s licence; — he did not come back to Canada at all in 2017 or for the period 2020 through the summer of 2022; he returned only briefly during 2018 and 2019. (D) Non-resident throughout the period in question: taxed on Canadian-source income. Criterion: employed or carried on business in Canada. Evidence: — during the period in question, he was neither employed nor carried on business in Canada; — although his pay was from a Canadian subsidiary of Exxon, his employment was outside of Canada. (E) Conclusion: — he cannot be a deemed resident, because he does not meet the 183-day criterion; — if he is held to be non-resident throughout the period in question, he will not be taxable in Canada because he has no Canadian-source income; — therefore, either he made a “clean break” at some point or he was a full-time resident throughout the period; — his ties to Canada quite clearly appear to have been severed in September 2016 when he moved to Malaysia to commence his new position; — he may have re-established ties to Canada in the summer of 2022 when he retired from Exxon and returned to Canada or in July 2023 when his employment in Thailand ended; — for the period from September 2017 through the summer of 2022 he appears to have been a nonresident of Canada.

Solutions to Chapter 2 Assignment Problems

Solution 5: Corporate Residency—Multi-Part (a) Since ABI is incorporated in Canada after 1965, the company will be taxed on its worldwide income throughout the fiscal year regardless of where its operations and control occur. (b) Even though Nickel Company is incorporated outside of Canada, the facts indicate that the corporation’s “mind and management” reside in Canada. The fact that all of the directors and the president live in Canada, maintain all of the books and records in Ontario, and meet in Toronto for their monthly director’s meetings, clearly indicates the mind and management of the corporation is in Canada. Accordingly, it will be taxed on its worldwide income throughout the year. (c) Saffron Ltd. is considered a resident of the United States for tax purposes. The corporation would be taxable in the United States. Since the sales are direct, and no branch exists in Canada, the corporation is not subject to any income tax in Canada.

Introduction to Federal Income Taxation in Canada

Solution 6: Corporate Residency—Case (A) Resident → taxed on worldwide income. (i) where “central management and control actually abides”: — central management and control in Korea, — general manager and other active officers live in Korea and have their offices there, — directors live in Korea; (ii) on the other hand, — company had a bank account in Canada, — company used the services of a Canadian investment dealer and a Canadian lawyer, — purchase and sale transactions were made in Canada. (B) Deemed resident under subsection 250(4) → taxed on worldwide income: (i) must be incorporated in Canada, — cannot be deemed resident because incorporated in United States. (C) Non-resident → taxed only on Canadian-source income [par. 2(3)(b)]: (i) must “carry on business in Canada”, 1. definition of “business” includes “an undertaking of any kind whatever and an adventure in the nature of trade” [ssec. 248(1)], — purchase and sale of aviation fuel could be an adventure in the nature of trade; 2. definition of “carrying on a business” includes offering anything for sale in Canada [par. 253(b)], — sale of shares and aviation fuel would both be included in the extended meaning of carrying on of business in Canada; 3. in the Tara case, the Court stated that an adventure in the nature of trade does not in itself constitute “carrying on a business in Canada” within the meaning of the words “carrying on business” (see also IT-459, par. 3), — the transaction could be considered to be part of the larger activity and, therefore not an isolated transaction; the purchase of fuel was part of the usual business that it was actively carrying on, — to carry on something involves continuity of time or operations as contemplated in the ordinary sense of a “business”; the purchase transaction in question was one of many of that nature over time, — the activities must be engaged in on a continuing basis, rather than as an isolated transaction to fall within paragraph 253(b). (D) Effect of Canada–Korea Income Tax Convention → possible exemption from tax: (i) business profits not earned from a permanent establishment in Canada are not taxed in Canada, 1. even if considered to be carrying on a business in Canada, insufficient evidence to substantiate a permanent establishment as defined in Article 5, — nothing more than a bank account, temporarily rented storage facilities, and arrangements with an investment dealer and a lawyer. (E) Conclusion: (i) not resident in Canada because central management and control appear to be in Korea, (ii) it may be considered to have carried on business in Canada, — however, the tax that would otherwise be paid from the carrying on of business is exempted by the Canada–Korea Income Tax Convention, because it did not carry on business through a permanent establishment in Canada.

Solutions to Chapter 2 Assignment Problems

Solution 7: Corporate Residency—Case (A) Resident — Taxed on worldwide income: — where “central management and control” abides: — central management and control abides in the United States; — controlling shareholder, Board of Directors in the United States; — United States is major market; Canada is incidental; — on the other hand; — company had a bank account in Canada; — had an employee in Canada; — short-term supply contracts made in Canada; — but contracts more promotional; longer-term contracts required U.S. approval. (B) Deemed resident — Taxed on worldwide income [ssec. 250(4)]: — must be incorporated in Canada; — WCG incorporated in the United States; therefore, cannot be deemed resident. (C) Non-resident — Taxed only on Canadian-source income [par. 2(3)(b)]: — must carry on business in Canada; — activities mostly promotional; — but did conclude one short-term contract in Canada; — business includes an adventure in nature of trade; — activity may be considered an adventure in nature of trade because of isolated sale, marketing effort for one product; — possible argument that adventure in nature of trade does not constitute “carrying on” a business, because of lack of continuity. (D) Effect of Canada–U.S. Income Tax Convention: — even if carrying on a business in Canada, business profits must be from a permanent establishment in Canada to be taxable in Canada; — no business address in Canada; only employee with short-term accommodation in Canada. (E) Conclusion: — not resident in Canada because of central management and control in the United States; — unlikely to be considered to have carried on business in Canada: — event may be adventure in nature of trade, but no continuity; — no Canadian permanent establishment so Treaty exempts the corporation from Canadian taxation of any business profits.

Introduction to Federal Income Taxation in Canada

Solution 8: Corporate Residency—Case [Reference: Capitol Life Insurance Company v. The Queen, 84 DTC 6087 (F.C.T.D.)] (A) Resident: taxed in Canada on worldwide income for the whole year: (i) “where central management and control actually abides”: — central management and control in Denver, — all corporate meetings as well as all levels of management took place in the United States, — Canadian operations were not kept separately from U.S. operations, no Denver personnel were charged with Canadian operations and there were no special Canadian claim forms or procedures, — all investments were administered and managed in Denver, (ii) on the other hand: — certificates listed the Canadian head office of Capitol as being in Don Mills, Ontario, — the chief agent countersigned the cheques on Capitol’s general bank account. (B) Deemed full-time resident: taxed in Canada on worldwide income [ssec. 250(4)]: (i) must be incorporated in Canada, — cannot be deemed resident because incorporated in the United States. (C) Non-resident: taxed in Canada on Canadian-source income [par. 2(3)(b)]: (i) must “carry on business in Canada”, as evidenced by: — the authority and duties of the chief agent, — the federal and provincial registrations and licensing, — the powers of attorney deposited with the federal and provincial departments of insurance, — the operating Canadian bank accounts, — listing of Don Mills, Ontario as the Canadian head office of Capitol, — the moneys on deposit in Canada pursuant to a special trust, — the wording change to the agreements to refer to “a premium collection fee” on the insistence of the Canadian insurance authorities, — the brochure was issued to Canadians, (ii) on the other hand, — all of these activities resulted from the requirement to comply with the superintendent of insurance and would not have otherwise existed, except for the Canadian banking facilities which were maintained to expedite the transfer of funds, — the maintenance of registration under FICA served to avoid duplications in provincial jurisdictions with respect to such matters as the amount of deposits required to be maintained to guarantee the fulfillment of obligations, — the completion of contracts with a Canadian company, Associates, does not constitute doing business in Canada, as the contracts were made in the United States, — the individuals whose lives and health were covered by the insurance were Canadians. However, it was Associates who was insured, not the individuals. (D) Effect of Canada–U.S. Income Tax Convention: — business profits must be attributable to a permanent establishment in Canada to be taxable in Canada, — there was no permanent establishment in Canada. (E) Conclusion: — not resident in Canada, as central management and control were exercised in Denver, — had not carried on business in Canada, as insurance policies were all signed in the United States and all other activities in Canada were undertaken to comply with insurance regulations, except for the nature of the deposits to the Canadian accounts (which was a minimal level of activity).

Solutions to Chapter 2 Assignment Problems

Solution 9: Transfer to France This is a planning situation. The students are to recommend planning points that would support the desired result of the family being non-resident. There are two main issues in this case. The first is whether Sally and Harry will be able to support non-resident status given their circumstances. The second is, if they can argue non-resident status, what their date of “clean break” is. Non-Resident Status In order for the members of this family to plan to become non-residents, they need to support their argument that they have severed ties to Canada, and they need to establish that they have become residents of France. To sever ties to Canada, Sally and Harry need to plan around the following main issues: Length of stay in France: The family is going to be in France for at least two years, but that may be extended. Clearly, the shorter the stay, the greater the risk that they will not be able to successfully defend non-resident status if challenged. Golf club: Given that Sally and Harry do not want to give up their golf club membership, they will need to see if the club has a non-resident membership status that would allow them to keep their membership, pay lower annual fees, and clearly indicate to the CRA and others that they have left. However, a stronger case for non-residency could be made if they gave up their membership altogether. It should be noted that the golf club “non-resident” classification probably also applies to those who have moved to, for example, another province. Home: While it is clearly best for them to sell their home to establish a break in ties, they are reluctant to do this. If they wish to keep it, they should rent the property to a third party. In paragraph 1.12 of Folio S5-F1-C1: Determining an Individual’s Residence Status, the CRA states: Where an individual who leaves Canada keeps a dwelling place in Canada (whether owned or leased), available for his or her occupation, that dwelling place will be considered to be a significant residential tie with Canada during the individual's stay abroad. However, if an individual leases a dwelling place located in Canada to a third party on arm's-length terms and conditions, the CRA will take into account all of the circumstances of the situation (including the relationship between the individual and the third party, the real estate market at the time of the individual's departure from Canada, and the purpose of the stay abroad), and may consider the dwelling place not to be a significant residential tie with Canada except when taken together with other residential ties (see ¶1.26 for an example of this situation and see ¶1.15 for a discussion of the significance of secondary residential ties). If they do decide to keep the house, then this will increase their risk of being considered residents of Canada. Harry is on leave, he did not resign: Harry’s circumstances must be considered in this case. He is not planning to resign from his teaching position; instead, he is taking an unpaid leave. This indicates a less permanent move. It would be a stronger argument for non-resident status if he did resign. Family ties: Sally and Harry’s extended family ties are clearly still in Canada. There is nothing they can do about this. Visits back to Canada: They will need to be careful how often they come back to Canada on visits, and how long they stay. The more frequent the trips, and the longer the stays, the weaker the non-resident argument. Remember, the courts can view the next few years to determine whether the family severed their residential ties this year. Other issues: Sally and Harry should also do the following: 1. Advise those authorities who administer drivers’ licenses and medical coverage that they are now nonresidents. 2. Close out their Canadian bank accounts or tell the bank that they are non-residents so withholding tax can be deducted from interest payments. 3. Move their investments to France and make sure their advisers are notified of their non-resident status. 4. Indicate on their tax returns the date of ceasing to be resident (see Date of clean break, below).

Introduction to Federal Income Taxation in Canada

Establishing residency in France: For the family to be considered non-residents of Canada, they need to have established residential ties somewhere else—in this case, in France. In ¶1.21 of Folio S5-F1-C1: Determining an Individual’s Residence Status, the CRA states: Where an individual leaves Canada and purports to become a non-resident, but does not establish significant residential ties outside Canada, the individual's remaining residential ties with Canada, if any, may take on greater significance and the individual may continue to be resident in Canada. However, because the Courts have held that it is possible for an individual to be resident in more than one place at the same time for tax purposes (see ¶1.40–1.52), the fact that an individual establishes significant residential ties abroad will not, on its own, mean that the individual is no longer resident in Canada. Renting a furnished apartment may be appropriate for Sally when she first arrives, but she should find more permanent accommodations when the family arrives. Date of clean break Assuming the family can successfully argue that they have become non-resident, you need to determine what day they officially achieved this status. Sally is to be in France on May 15, so, if she leaves May 10, is that the date? Alternatively, Harry and the children will leave, say, July 15, so is that the date? In paragraph 1.22 of Folio S5-F1-C1: Determining an Individual’s Residence Status, the CRA states: The date upon which a Canadian resident individual leaving Canada will become a nonresident for tax purposes is a question of fact that can only be determined after reviewing all of the relevant facts and circumstances of a particular case. Generally, the CRA will consider the appropriate date to be the date on which the individual severs all residential ties with Canada, which will usually coincide with the latest of the dates on which: • the individual leaves Canada; • the individual's spouse or common law partner and/or dependants leave Canada (if applicable); or • the individual becomes a resident of the country to which he or she is immigrating. The first two of the three dates set out above are easy to determine in this case. The third may be more difficult and is discussed above. This is not a particularly significant issue in that if you are arguing between May 10 and July 15—it is only about two months, and it only affects the tax return in the year of departure. Conclusion There is always a risk that the CRA and the courts will not agree with Sally and Harry’s filing position that they are non-resident. All the adviser can do is arrange the given facts in the best way to minimize the risk. In this case, the risks of reassessment centre on the following issues: 1. Keeping the home 2. Length of stay in France 3. Establishing residential ties in France

Solutions to Chapter 2 Assignment Problems

Solution 10: Move to Chile In this case, it is necessary to determine Jennifer’s residency status for tax purposes. Since residency is not defined in the Act, it is necessary to consider the facts underlying each case. As a resident of Canada, Jennifer would be taxed on her worldwide income over the two-year period. The facts that support this status are: (1) Jennifer’s Canadian background and her permanent return to Canada at the end of the two years; (2) her return visits to Canada; (3) Jennifer retained a Canadian bank account and her Canadian American Express credit card; (4) she kept substantial assets (i.e., furniture and car) in Canada; (5) her family and social ties remained in Canada; (6) she maintained her provincial health care policy; and (7) her intentions to stay in Chile were not clear (i.e., unfinished Canadian degree, fiancé remaining in Canada, not learning the native language, and not integrating into Chilean society). As a deemed resident of Canada, Jennifer would be taxed on her worldwide income throughout each year. However, there are no facts supporting this residency status as she did not sojourn in Canada for more than 182 days in either of her two years spent in Chile. As a part-year resident of Canada, Jennifer would be taxed on her worldwide income for the portion of the year that she was considered a resident. However, a clean break must be established for Jennifer to be given partyear status. The facts supporting a clean break include: (1) she cancelled her student club memberships and abdicated her position as chair; (2) her sole source of income was from a Chilean source; (3) she moved most of her personal and household belongings to Chile; (4) her contract contained the option to extend her position for more than two years; and (5) she cancelled her Canadian chequing account and her Canadian Visa card. As a non-resident of Canada, Jennifer would be taxed only on her Canadian-source income. Since Jennifer’s income for the two years will be from Chilean sources, she would not be liable for Canadian tax. The facts that support non-resident status are the same as the ones supporting her clean break for part-year residency. If it is concluded that she made a clean break at a point in time, then she will be considered to be a non-resident after that time. Conclusion In all probability, the courts would rule that Jennifer is a full-time resident of Canada. The reasoning behind this decision is two-fold: she did not sever all her ties to Canada, nor did she attempt to integrate into Chilean society. The facts supporting this conclusion may outweigh the facts supporting her intentions to make Chile her permanent residence. Consequently, she will be taxed on the income she earned in Chile during her two-year stay. However, as a result of international tax treaties, Jennifer will most likely be eligible for a foreign tax credit for the amount of tax she has had to pay to the Chilean government and her Canadian taxes payable will be reduced by the amount of the credit. An actual case, with facts much like those in the above case in which the Court came to a similar decision, is Glow v. The Queen, 92 DTC 6467 (F.C.T.D.).

Introduction to Federal Income Taxation in Canada

Solution 11: Individual residency (See York v. MNR, 80 DTC 174) - full-time resident of Canada by common law principle: taxed in Canada on worldwide income - continuing state of relationship with Canada, i.e., continuing ties - history of residence in Canada - owned a house in Canada - wife and children lived in Canada and he supported them here - provided services in Canada - memberships in Canadian engineering organizations - bank account in Canada -

deemed full-time resident of Canada by par. 250(1)(a): taxed in Canada on worldwide income sojourned in Canada for 183 days or more in 2023 he was sojourning (visiting), but he was here much less than 183 days - part-time resident of Canada: taxed in Canada on worldwide income for the part of the year resident - “clean break” or “fresh start” - moved back to United States in December 2022 where he occupied an apartment - he practiced as a self-employed engineering consultant from the United States - his visits to Canada were infrequent and short - his marriage had broken down and his children were young adults - the ownership of the house in Canada was for the purpose of providing shelter for his wife and children - when he stayed there it was as a visitor - the bank account and memberships were “debris” of a closed phase of the taxpayer's life - the tax return filed in Canada was a mistake - non-resident employed in Canada or carrying on business in Canada: taxed on employment or business income earned in Canada - during 2023 he was carrying on business in Canada, but the Canada–U.S. Tax Convention would exempt him from taxation in Canada because he did not have a fixed base in Canada - conclusion - the taxpayer's ties with Canada were tenuous and, hence, he should be considered a non-resident for 2023.

Solution 12: Taxation of Indigenous Canadians [Note to Instructors – Perry’s earned income changed from $300,000 to $365,000; Ethan’s % of income earned off reserve changed from 35% to 40%] A) All of Mike’s $100,000 is exempt from taxation because he is registered for Indian status, lives and earns his income on reserve. B) All of Perry’s $365,000 income is taxable because the income is earned off of reserve land. C) All of Cindy’s $120,000 income is taxable because the income is earned off of reserve land. D) All of Sherry’s $85,000 income is taxable because Sherry is not registered for Indian status. E) Because Ethan is registered for Indian status, the 60% of income that he earns on reserve land is exempt from taxation. Therefore of the $300,000, $180,000 is exempt from taxation while $120,000 earned in Barrie is taxable.

CHAPTER 3

Employment Income Solution 1: Auto Benefits—Company-Owned Versus Leased The following changes were made to the problem for this edition: •

Car purchase was increased to $50,000 from $40,000.

•

Monthly lease was increased to $1,100 from $950

•

Tax rate was increased to 42% from 41%

Driving the car more than 50% for business purposes entitles Lisa to a reduced standby charge and the alternative operating benefit of 50% of the standby charge.

Option 1 – Company-Owned Standby Charge: 40% Business (<50%) A/B x [2% x (C x D) + 2/3 (E – F)] = 20,004/20,004 x [2% x ($56,5001 x 12)] = 60% Business (>50%) A/B x [2% x (C x D) + 2/3 (E – F)] = 9,600/20,004 x [2% x ($56,500 x 12)] = Operating Benefit: 40% Business (<50%) Personal kilometres x $0.33 = 14,400 x $0.33 = 60% Business (>50%) Lower of 50% of standby charge (50% x $6,507 = $3,254) or per km benefit ($0.33 x 9,600 = $3,168) Total benefit = Cost at a tax rate of 42% = Difference Notes: 1 $50,000 x 1.13 =$56,500

13,560

6,507

4,752

$ $

18,312 $ 7,691 $ $3,627

3,168 9,675 4,064

Introduction to Federal Income Taxation in Canada

Option 2 – Company-Owned Standby Charge: 40% Business (<50%) A/B x [2% x (C x D) + 2/3 (E – F)] = 20,004/20,004 x [ 2/3 x ($16,272 – 0)] = 60% Business (>50%) A/B x [2% x (C x D) + 2/3 (E – F)] = 9,600/20,004 x [ 2/3 x ($16,272 – 0)] = Operating Benefit: 40% Business (<50%) Personal kilometres x $0.33 = 14,400 x $0.33 = 60% Business (>50%) Lower of 50% of standby charge (50% x $5,206 = $2,603) or per km benefit ($0.33 x 9,600 = $3,168) Total benefit = Cost at a tax rate of 42% = Difference

10,848

5,206

4,752

$ $

15,600 $ 6,552 $ $3,272

Based on this analysis, Lisa would prefer that the company lease the car regardless of whether she uses it 60% or 40% for business. Note that the when the vehicle is only used 40% of the time for work, we must calculate the operating benefit using the per kilometre rate (currently $0.33) x the number of personal kilometres

2,603 7,809 3,280

Solutions to Chapter 3 Assignment Problems

Solution 2: Stock option—Comparing CCPC to Public Company For employee stock options, the amount and nature of the income does not vary with the type of corporation; only the timing varies Use this drawing to show the relationship among the values. $

Expected value

FMV at exercise

New ACB Employment income = $5/share

Exercise price

Calculate benefit – public company stock option Amount of benefit to report as employment income: 1,000 shares x ($35 - $30) = $5,000 When is this reported? As a public company, this employment benefit is reported in the year that the option is exercised. Impact on ACB The amount of the employment income reported increases the ACB of the shares. ACB = 1,000 x $30 + $5,000 = $35,000 The $35,000 represents the total tax-paid cost of the shares which should be returned tax free on a disposition, because tax has already been paid on that amount.

Calculate benefit – private company stock option Amount of benefit to report as employment income: 1,000 shares x ($35 - $30) = $5,000 When is this reported? As a private company, this employment benefit is reported in the year that the shares are sold. Impact on ACB The amount of the employment income reported will increase the ACB of the shares in the year that it is reported, i.e., in the year that the shares are sold. This new ACB represents the total tax-paid cost of the shares which should be returned tax free on a disposition, because tax has already been paid on that amount.

Introduction to Federal Income Taxation in Canada

Solution 3: Employee Benefits—Multi-part 1.

A salary of $90,000 per year, payable by direct deposit on the last day of each month. a. Taxed on the cash basis as the income is received [5(1)]

A bonus payable based on the year-end results of the company. The bonus would be up to $10,000. a. Taxed when received as long as not artificially delayed. b. There is a benefit to receiving it in the next calendar year if there is a lower tax rate in the following year. Tax is withheld at source.

Motion Tech has a defined contribution registered pension plan where Rishma and the company each contribute 6% of her salary. a. Rishma’s contribution is specifically allowed as a deduction [8(1)(m)] within the RPP limits. b. The company’s contribution is not a taxable benefit – specific exclusion [6(1)(a)(i)] c. All payments out of the RPP will be taxed when she withdraws (receives) them.

Since she will have to move to Waterloo to take up this position, the company will pay her an allowance of $15,000 to cover her moving expenses. a. Allowances must be included in income unless there is a specific provision to exclude. The first $650 of the moving allowance can be considered non-taxable providing the employee can certify that they incurred moving expenses. The remaining balance would be taxable. [6(1)(b)] b. She can deduct her eligible moving expenses in excess of $650 against her employment income in the new location. [62]

Motion Tech will cover the annual dues for a fitness club up to a cost of $2,000 per year. a. If it is primarily for Rishma’s benefit, then it is taxable. b. If it is primarily for the benefit of Motion Tech, then it is not taxable. c. Who benefits most from having a healthy employee?

The company will pay for Rishma to have her personal tax return prepared at a cost of up to $1,000. a. Taxable benefit [Income Tax Folio S2-F3-C2, Benefits and Allowances Received from Employment]

The company provides a group health plan administered by Manulife, including glasses. Rishma will pay about $200 per month and the company will pay about $800 per month. a. Rishma’s payment is not deductible but it will be eligible for a medical expense credit [118.2(2)(q)] b. The company’s portion is not taxable to Rishma – specific exclusion [6(1)(a)]

Solutions to Chapter 3 Assignment Problems

Solution 4: Employee Benefits—Multi-part Explain the tax consequences to the employees of each of the following options. 1.

Free parking. a. Generally, employer-provided parking is considered a taxable benefit. However, it may be difficult to determine the value of the benefit if it is an open parking lot. If it is a reserved spot that is rented at a monthly rate, then the cost of the spot including HST will be included as a taxable benefit.

Wedding or birthday gifts of up to $200. a. Cash and near-cash gifts are always a taxable benefit. b. Non-cash gifts with a combined total value of up to $500 annually can be received. If the gifts total more than $500 then the excess is taxable.

All-expense paid holiday won as part of a sales contest. a. This is considered an award for job performance and is taxable.

The employee uses frequent flyer points for a personal trip. These points were earned as a result of business trips. a. This is no longer considered a taxable benefit, unless the points are converted to cash.

The company provides an employee discount of 24% on products sold by Auto Supply. a. Discounts are generally not considered to be taxable benefits. b. However, if the price is below the company’s cost then there will be a taxable benefit for the difference between cost and the price charged.

The company pays to provide financial counselling for all vice presidents including the preparation of their personal tax returns. a. If the financial counselling is related to re-employment or retirement, then there is no taxable benefit. Otherwise it is taxable. [6(1)(a)] b. Tax return preparation is a taxable benefit. [Income Tax Folio S2-F3-C2]

The company will pay for annual professional dues for employees, for example, for accountants and lawyers. a. If the professional membership is a requirement of employment, then there is no taxable benefit.

Introduction to Federal Income Taxation in Canada

Solution 5: Employee Loans, Car Expenses

Benefit would be the sum of: (A)

(B)

Car loan—prescribed rates 1st quarter 2nd quarter 3rd quarter 4th quarter

7% × $15,000 × 90/365 = 6% × $15,000 × 91/365 = 8% × $15,000 × 92/365 = 7% × $15,000 × 92/365 =

$259 224 302 265

$ 1,050

7% × $100,000 × 90/365 = 6% × $100,000 × 91/365 = 7% × $100,000 × 92/365 = 7% × $100,000 × 92/365 =

$1,726 1,496 1,764 1,764

$ 6,750

7% × $10,000 × 90/365 = 6% × $10,000 × 91/365 = 8% × $10,000 × 92/365 = 7% × $10,000 × 92/365 =

$173 150 202 176

$ 701

Home purchase loan(1) The lesser of the prescribed rate at the time of the loan (i.e., 7%) and the prescribed rate per quarter. 1st 2nd 3rd 4th

$8,501 Less amounts paid(2) (a) 6% × $15,000 × 365/365 . . . . . . . . . . . . . .. . (b) 4% × $100,000 × 365/365 . . . . . . . . . . . . . .. . (c) 7% × $10,000 × 365/365 . . . . . . . . . . . . . .. .

$ 900 4,000 700

5,600 $ 2,901

The Act would deem $150 of the car loan interest ($1,050 - $900) to be paid in the year and, therefore, eligible for an interest deduction, since the interest was deemed to be paid within 30 days of the year-end, as required. An Interpretation Bulletin indicates that the deemed interest expense must be prorated for employment use. 27,000 km

ITA: 80.5 ITA:8(1)(j), 80.4(1)(c)

IT-522R, par. 27

× $150 = $90

45,000 km

The interest deduction provision would deny a prorated deduction of the $900 paid on January 15 of the following year, since it was not paid in the taxation year in question. However, this amount would be eligible for a deduction in the following taxation year to the extent of the business use.

ITA:8(1)(j)

ITA:67.2 The interest limitation restricts the interest to the lesser of (a) $90 and (b) $$10× 365× 27,000/45,000 = $2,190. Note the formula to limit the interest in the act is $300 x # days/30. CRA simplifies the calculation using $10 a day.

Solutions to Chapter 3 Assignment Problems

—NOTES TO SOLUTION See Chapter 10 for a complete discussion of this provision. The ‘‘lesser of’’ comparison is made on a quarter-by-quarter basis. (1)

ITA:110(1)(j), 248(1)

(2) The interest benefit is calculated on an aggregate basis. Any excess interest payment on one loan effectively reduces the deemed interest benefit on the other loans.

ITA:80.4

Introduction to Federal Income Taxation in Canada

Solution 6: Commission Expenses and Limitation The amount Reille may claim as an expense deduction is limited in the $24,000 he made in commission income if he claims under paragraph 8(1)(f). Sales expenses under paragraph 8(1)(f): Reille is permitted to claim 50% of the entertainment meals and 50% of the out-of-town meals if he was out of town for more than a 12-hour period when he had these meals (subsection 8(4)). Reille may claim the $18,000 spent on hotels and airfare. Professional dues of $250 are deductible under paragraph 8(1)(i). Hotel and airfare ……………………................. Out-of-town meals (4,000 X 50%) ……………. Entertainment meals (2,500 X 50%) ………….. Total sales expenses (paragraph 8(1)(f)) ……… Professional dues (paragraph 8(1)(i)) ………… Total employment expenses allowable ………..

$18,000 2,000 1,250 21,250 250 $21,500

The $21,250 is less than the $24,000 made in commissions so it, plus the $250 for professional dues, is deductible as employment expenses. The cost of the notebook computer is not deductible since it is a capital asset. Also, CCA is not allowed on the computer because the only CCA that can be claimed against employment income is for automobiles and aircraft.

Solutions to Chapter 3 Assignment Problems

Solution 7: Employee Travel Expenses The mileage in this question was changed to 16,000 kms from 15,000. Allowances and related expenses: There are two conditions that must be met in order to permit the allowance to be excluded from income: (a) the allowance must relate to travel outside of the municipality in which the employer’s office is situated; (b) the allowance must be a reasonable amount. The $10,000 accommodation allowance is a taxable allowance, since the amount is an unreasonable amount on the assumption that the incurred expenses of $12,000 were reasonable. Therefore, she is entitled to a deduction, since she meets the other conditions of this paragraph; namely, she ordinarily travels in respect of her employment duties and is required by her employment contract to pay for her own expenses. Total accommodation expenses Less: disallowed meal portion (50% X $4,500)

$12,000 2,250 $ 9,750

The car expenses are deductible since she meets the conditions of this paragraph which are quite similar to paragraph 8(1)(h), described above, to the extent of the following calculations: Gas Maintenance Capital cost allowance (1.5 × 30% × $36,000 × 1.13) Insurance Licences Interest — lesser of: (a) $4,000

$1,500 500 18,306 1,200 90

(b) $10 x 361 $3,600 $24,179 Deductible car expenses: 16,000 km 20,000 km

X $24,179

= $19,343

Introduction to Federal Income Taxation in Canada

Solution 8: Employed Versus Self-Employed—Chow The facts in this case are very similar to those in the Wiebe case, which is still the landmark case in this area [Wiebe Door Services Ltd. v. M.N.R., 87 DTC 5025 (F.C.A.)]. In the Wiebe case, the company had been treating the workers as self-employed contractors. The CRA believed the workers to be employees and assessed the company for failure to withhold employment source deductions. The Tax Court of Canada agreed with the CRA and the company appealed. The case was decided on the basis of the economic reality test. The Federal Court of Appeal held that the economic reality test really encompasses the control test and the integration or organization test. As well, ownership of tools and the chance of profit or risk of loss must be considered. It is not necessary that all tests be independently satisfied. The economic reality test is decided on the basis of the overall scheme and the relative importance of each of these factors. Subsequent to the Wiebe decision, the courts start their analysis by providng a conceptual foundation on which to build their analysis of the Wiebe factors to come to a conclusion on the specific facts of the case that they are deciding. The courst first consider, in a general way, whether there is a mutual understanding or common intention between the parties regarding their relationship. A written contract may be most helpful, although the courts have indicated that such a contract can be self-serving in some situations, necessitating a deeper consideration of the specific facts of the case using the factors applied in Wiebe to guide their analysis of the facts. In this particular case, which is in fact a very lightly disguised version of the Wiebe case, there does not appear to be a written contract to refer to, but the practice or behaviour of the parties may suggest the intended relationship. Chow informed the workers that they would be considered to be independent businesspersons. In doing the work under these conditoins, the workers could be seen to have accepted that independent status, thereby reflecting a common intention. Having taken the step of attempting to find a common intent of either an independent contractor or an employment relationship, the courts then proceed to apply the relevant factors outlined in Wiebe to support the determination of that mutual intent on the specific facts.Since the Wiebe case was decided the courts have focused their determinants of the economic realities of the situation to three main tests: Control, Ownership of tools and Profit/Loss (1) Economic Reality Tests (a) Control Test Taken in isolation, the control test is indecisive on these facts. The workers had a fair degree of autonomy in that they could accept or refuse specific assignments, could choose when and how to do the jobs they accepted, within reason, and were not required to report to a specific workplace. This is indicative of selfemployment. On the other hand, the company assigned the jobs to the installers and had the right to require defective work to be fixed by the workers and the workers were required to comply with this. This aspect of control is more indicative of an employer relationship. As a result, the control test does not distinguish the case of employed versus self-employed very well. (b) Ownership of Tools The ownership of tools test is indicative of self-employed status. Each worker supplied the majority of the required tools, including the truck to transport the doors. Although the company would supply certain specialized equipment on request, this was considered ancillary to the basic ownership responsibility. Interestingly, the Court did not address the ownership of the doors and component parts, either under this or any of the other tests. The rationale for this exclusion may be that the supply of such parts was unique to the company’s business, while the tools necessary to install or repair such parts could be used by the workers for any other assignments they undertook. (c) Chance of Profit, Risk of Loss The chance of profit, risk of loss test would also indicate self-employed status. Although the fee provided for each job was decided primarily by the company, the worker had some control over whether he or she would make a profit or incur a loss. If the worker was efficient and accepted more jobs, his or her chance for profit increased. Adversely, if the worker was careless and was required to redo much of his or her work, the risk of loss increased. Additionally, the workers were hired for a specific task — to install or repair a specific door. Although the worker may be hired for a number of installations, the worker was hired for a specific project, not for an indeterminate period of time.

Solutions to Chapter 3 Assignment Problems

Conclusion On the basis of the facts and the application of the economic reality test, and all three of the subtests, the Federal Court of Appeal ruled that the economic reality of the relationship of the workers to the company was that of independent contractors, consistent with the intention of the parties. Based on the findings in the Wiebe case and striking similarity in the facts, it would appear that the installers at Chow will be considered independent contractors.

Introduction to Federal Income Taxation in Canada

Solution 9: Offer of Employment—Compensation Options The following changes were made to this problem: •

Salary was increased to $142,000 from $132,000,

•

Company loan was decreased to $180,000, and

•

The prescribed rate was changed as follows: Quarter the loan was received – 4%, last two quarters – 3%

•

The $142,000 gross salary will be included in income for tax purposes in the year of receipt [ssec. 5(1)]. The allowance of $25,000 for moving will be included in income for tax purposes in the year of receipt, because there is no exclusion for such an allowance [par. 6(1)(b)]. The first $650 of a nonaccountable moving allowance provided to the employee by the employer is not taxable provided that the employee can certify they incurred expenses for the amount because of an employment-related move. (T4130 Employer's guide - taxable benefits and allowances) The company contribution to the registered pension plan will not be included in income for tax purposes [spar. 6(1)(a)(i)]. The company payment of the premiums for extended health care coverage and a dental plan is specifically excepted as a benefit, since these are private health services plans [spar. 6(1)(a)(i)]. Tax return preparation is a taxable benefit under paragraph 6(1)(a), since it does not fit the exception in subparagraph 6(1)(a)(iv) [Income Tax Folio S2-F3-C2, Benefits and Allowances Received from Employment]. The club membership fee in this particular case is likely to be a taxable benefit, because it is not likely that the membership would be principally to the employer’s advantage. She will be the Director of Taxation, a position that is not likely to require the membership for business purposes [Income Tax Folio S2-F3-C2 ] The housing loan benefit included in her employment income [par. 6(1)(d), ssec. 6(9), and sec. 80.4] will be computed as follows according to the CRA’s administrative practice.

•

• • •

•

61 4%(1) of $180,000 × 3%(1) of $180,000 × 3%(1) of $180,000 ×

365 92 365 92 365

= $1,203 = $1,361 $ 3,925

= $1,361

Less: interest paid (2% of $180,000 ×

245 365

) .......................................

Net employment income inclusion.......................................................

2,416 $ 1,509

—NOTE TO SOLUTION (1) The lesser of the prescribed rate for the quarter and the prescribed rate at the time the loan was made.

Solutions to Chapter 3 Assignment Problems

Solution 10: Calculate Employment Income—Benefits, Stock Options Employment Income Section 5 — Gross salary Section 6 — Provincial mandatory public health care (Note 1) Hawaii trip Section 7 — Stock option benefit (Note 2) Section 8 — Registered pension plan Income from employment

79,000 6,000 7,000 (3,000) $ 89,000

Notes: 1. The CRA states in Income Tax Folio S2-F3-C2, Benefits and Allowances Received from Employment that public health care premiums for a provincial hospital insurance plan or a provincial medical care insurance plan that the employer is required to pay by law are not a taxable benefit. A provincial employer health tax is not considered to be a taxable benefit either. 2.

Stock option benefit FMV at exercise date Employee cost Taxable benefit

= =

$19 × 1,000 $12 × 1,000

= =

$19,000 (12,000) $ 7,000

Since Erin exercised her option in a public corporation, she must report the stock option benefit in 2022. 3. 4. 5. 6. 7. 8.

The charitable donations, CPP, and EI are personal credits and not deductions. The private dental plan is specifically excluded from income. The reimbursement of moving expenses will reduce her moving expense claim; a reimbursement of actual costs is not a taxable benefit. The club membership dues are primarily for the benefit of her employer. The bonus declared and not paid will be taken into income when received. The hard hat and safety glasses are not for personal use.

Introduction to Federal Income Taxation in Canada

Solution 11: Compensation Alternatives—Salary, Bonus or Stock Option The following changes were made to this question: Value of the condo in Hawaii increased to $9,000 from $3,000.

(a) A cash raise would increase the taxes payable of the senior executives by $2,250 or ($5,000 × 45%). It is a good method of compensation if the executives are in need of cash flow. Net cash is $2,750. (b) The bonus would increase their following year taxes by $2,475 or ($5,500 × .45). This is assuming that their tax rate remains constant over the next year. However, this is one-time, not ongoing, compensation. This is a good method of compensation if the executives are not in need of immediate cash flows or if their marginal tax rate will be lower in the following year. However, if the bonus is meant to be a motivational tool, the incentive may lose its effectiveness if it is not paid out immediately. Net cash is $3,025. (c) Using the condo would create a taxable benefit of $9,000. This would increase the executives’ taxes payable by $4,050 ($9,000 × .45). It is a good method of compensation if the executives want to go to Hawaii, have the money to buy plane tickets and can get the time off work. This alternative will depend on the executive’s desire to have a luxury vacation over cash. (d) A taxable benefit would have to be recognized in the year the executives exercise the options. If the option is exercised in December 2023, the stock option benefit will be $1,500 (($5 − $3.50) × 1,000). They will not be eligible for the 50% reduction of the benefit because the exercise price is less than the market price on the date of grant. Therefore, this option will increase their current year taxes by $675 ($1,500 × .45). If they sell the shares in December 2024 at $6.50, they’ll have a taxable capital gain of $750 ($6,500 − $5,000 × 50%) and the tax will be $338 ($750 × 45%). Net cash is $1,987 ($6,500 – 3,500 − $675 − $338). By exercising these stock options, the executives are exposing themselves to the risk of the stock prices falling. However, management expects the share price to increase, which may result in increased compensation for the executives. They also need to have cash of $3,500 for the purchase. Although the executives believe that their performance can directly affect the share price, the executives cannot directly influence the share price on a day-to-day basis. Recommendation As mentioned within each point above, there are many tax and non-tax implications when deciding on the best compensation plan. If the executive is in immediate need of cash flow, the cash raise or interest-free loan would be most desirable. If the executive is not in immediate need of cash flow, he/she would consider the alternatives of the bonus, use of the company condominium, or the stock option arrangement. The condo would be desirable if the executive was planning a trip to Hawaii only and was in need of accommodation. Otherwise, it could be a wasted benefit. The stock options would be desirable if the share price increased as expected, but it is a very risky form of compensation and will result in a taxable benefit in 2023. The bonus would likely be the best alternative if immediate cash flow was not needed. This is because it is not risky; the executive will receive the money and will not have to pay taxes on this money until April 30, 2025. However, the best choice may be the salary increase, since the $5,000 would be paid each year into the future.

Solutions to Chapter 3 Assignment Problems

Solution 12: Compensation Alternatives—Forgivable Loan, Stock Option (a) The stock option benefit is $500,000 (100,000 shares at $5 per share). It is planned that the shares will be sold in the same year that the option is exercised. The ACB of the shares will equal their sale price ($15), so no capital gain arises. A deduction of 50% of the stock option benefit will be allowed under paragraph 110(1)(d), so only $250,000 of the option is ultimately taxed. (b) Under subsection 6(3), the signing bonus is taken into employment income in the year in which it occurs, so the player would recognize an additional $300,000 in his employment income figure. Under subsections 6(9) and 6(15), the employee loan will carry with it two tax burdens. The first will arise annually to account for the taxable benefit received by virtue of the interest-free component. The taxable benefit is calculated as the loan amount multiplied by prescribed rates. The second tax consequence arises in the year that the loan is forgiven. Under subsection 6(15), the amount of the forgiven loan is included in the calculation of employment income for the year in which it is forgiven. (c) Assuming the loan is not forgiven, the deemed interest benefit of the loan for: 46 days (i)

Current taxation year:

(ii)

Next taxation year:

$100,000

365 days

365 days 365 days

$504

$4,000

Introduction to Federal Income Taxation in Canada

Solution 13: Auto Benefits—Company Owned Versus Leased Mitch — Employer-owned automobile: Standby charge [par. 6(1)(e)](1) 20,004km

× (2% of $38,772 × 12) ..................................................................................

9,305

20,004km Operating cost benefit [par. 6(1)(k)](2) 10,000 km  $0.33 = Total benefit...................................................................................................................... ........... Less: reimbursement .................................................................................................................... Minimum net benefit ...................................................................................................................

3,300 12,605 1,400 $ 11,205

Darly — Employer-leased automobile: Standby charge [par. 6(1)(e)]

9,000 km 2   ($12,450 − $1,650) = ........................................................................... 20,004 km 3

3,239

Operating cost benefit [par. 6(1)(k)](2) Lesser of: (a) 9,000 km  $0.33 = (b) ½  $3,239 =

$2,970 $1,620

Total benefit ............................................................................................................................. ................... Less: reimbursement................................................................................................................ .................... Minimum net benefit ............................................................................................................................. ......

1,620 $ $

4,859 810 4,049

—NOTES TO SOLUTION (1) Mitch is not but Darly is eligible for the reduction in the standby charge based on business use in excess of 50%. (2) Darly is eligible for the election method [spar. 6(1)(k)(iv)] since the car is used more than 50% for business purposes, as long as Darly informs her employer by December 31. Darly is better off taking this election since one-half of the standby charge is less than the prescribed rate times the personal-use kilometres.

Solutions to Chapter 3 Assignment Problems

Solution 14: Car Allowance Versus Reimbursement Bing should be not be indifferent between the two compensation packages, as (a) is clearly superior. In (a), the allowance he receives would not be included as a taxable benefit in his income because it is a reasonable amount. Therefore, he will be fully compensated for the operating expenses and depreciation on his Jeep without paying any additional taxes. In (b), Bing will be fully compensated for his operating expenses because the employer will fully reimburse him. This would not be considered a taxable benefit as he had to account for his actual expenses. He can also deduct the employment portion of CCA on his Jeep yearly (65% × $3,000). The tax savings from claiming the capital cost allowance will be $878 (assumed tax rate of 45%, so 45% × 65% × $3,000). The total compensation then under (b) is $4,878. There will be a rebate of the GST/HST component in the CCA claimed. The rebate will reduce Bing’s CCA claim in the following year, when the rebate is received. Therefore, the reasonable allowance of $6,000 is superior. Also, when examining the administrative requirements of each package, Bing should prefer (a), although he is still required to keep a detailed log of kilometres driven for employment. For alternative (b), he would need to keep a record of all operating expenses he incurs and a detailed log of all kilometres he drives for employment and personal purposes. In (a), he would not have to keep any records (other than a log for kilometres driven); therefore, it would be a much simpler system for him.

Introduction to Federal Income Taxation in Canada

Solution 15: Payment on Termination [Reference: Mercier v. M.N.R., 92 DTC 2309 (T.C.C.)] It should be noted that it was agreed that the $15,000 payment could not be for the purchase of the sales territory, as Chrisa had always been a David employee and the sales territory had always belonged to David. The taxpayer argued that the $15,000 payment was to reimburse her for expenditures (payments for the floor space) made over the period of employment, which she had not deducted from income. Thus the payment was non-taxable. The Minister, on the other hand, argued that the $15,000 received by Chrisa was not paid as a reimbursement of expenses, but must be deemed to be remuneration for services rendered by Chrisa in the course of her employment. She received the $15,000 in consideration or partial consideration of a covenant with reference to what Chrisa was, or was not, to do after the termination of her employment. Chrisa received the $15,000 from David on account or in lieu of payment of an obligation arising out of an agreement made between David and Chrisa during or immediately after a period that Chrisa was in the employment of David. Thus for the purposes of section 5, the $15,000 should be deemed to be remuneration for services rendered by Chrisa during her period of employment, in accordance with subsection 6(3). The court found that the taxpayer produced no evidence which showed how much of the $15,000 receipt represented compensation for expenses incurred by her. Part of this decision seemed to be based on the fact that some portion of the payment was likely for the non-competition clause and the fact that the taxpayer was unable to substantiate the actual non-deductible cash amounts that she paid over the years. This would lead one to believe that if the payment had been clearly allocated between a reimbursement of substantiated, deductible costs and a payment for the non-competition clause, the reimbursement portion might have been held to be non-taxable.

Solutions to Chapter 3 Assignment Problems

Solution 16: Calculate Employment Income—Benefits The following changes were made to this question: •

Salary increased to $90,000 from $80,000

•

Taxes withheld increased to $26,100, CPP to $3,754 and EI to 1,002.

(A) Employment income Salary — gross ..................................................................... Group term life insurance..................................................... Trip to Europe ...................................................................... Income protection payments ($12,000 – $2,300) ................. Stock option benefit (1,000  ($4.50 – $2.00)) .................... Less: Registered pension plan .............................................. Professional fees........................................................... Employment income ............................................................

$ 90,000 250 6,000 9,700 2,500 $108,450 $ 5,500 800

(6,300)

ITA Reference 5 6(1)(a) 6(1)(a) 6(1)(f) 7 8(1)(m), 147.2(4)(a) 8(1)(i)

$ 102,150

(B) (i) Private health plans such as those offered by Sun Life and Liberty Mutual are statutory exemptions [par. 6(1)(a)]. In addition, Health Services tax levies, such as those in Manitoba, Ontario, and Newfoundland, are not taxable benefits. (ii) Membership fees paid by the employer for social clubs may not be included in the income of the employee if the membership was principally for the employer’s advantage rather than employee’s [Income Tax Folio S2-F3-C2 ] (iii) There is no stock option benefit when the option is granted. The sale of shares in December results in a capital gain of $0.50 per share (i.e., $5.00 – $4.50), which is not employment income. (iv) Registered retirement savings plan — Subdivision e, not Subdivision a deduction. (v) Income tax not deductible — Subsection 8(2). (vi) Charitable donation — Division E tax credit, (vii) CPP contributions and El premiums are tax credits deductible under Division E. (viii) Enhanced CPP contribution is a deduction under subdivision e (paragraph at 60(e.1) in the calculation of net income for tax purposes, not employment income.

Introduction to Federal Income Taxation in Canada

Solution 17: Calculate Employment Income—Expenses The following changes were made to this question: •

Salary was increased to $6,000 from $4,000

•

Bonus was increased to $1,000 from $300

•

CCA was increased to $3,000 from $2,000

Income from Employment Gross salary Commissions Taxable Benefits Bonus (Note 1) Life insurance Conference—spouse (Note 2) Interest benefit (Note 6) Gross employment income Less: Employment expenses Meals and entertainment (Note 3) CCA (Note 4) Operating expenses (Note 5) Promotional materials Total deductions Income from employment

ITA/Income Tax Folio References ITA: 5(1) ITA: 5(1)

$6,000 18,000 1,000 400 800 491

Income Tax Folio S2-F3-C2 ITA: 6(4) Income Tax Folio S2-F3-C2 $26,691

( 1,150) ( 3,000) ( 1,255) ( 1,500)

ITA: 8(1)(f) ITA: 8(1)(j) ITA: 8(1)(f) ITA: 8(1)(f) ( 6,905) $19,787

Notes: 1. 2. 3. 4. 5. 6.

Conference: spousal portion of trip is a taxable benefit. Meals and entertainment: subsection 67.1(1), only 50% deductible. Question stated CCA is already based on the employment portion, therefore no adjustment. Gas and operating expenses and deemed interest expense: (7,500/12,500) × ($1,600 + 491) = $1,255. Interest benefit (subsection 6(9)): $21,000 × 7% × (122 days/365 days) = $491. EI, CPP, and charitable donations qualify for non-refundable tax credits that reduce federal taxes payable. Enhanced CPP contribution is a deduction under subdivision e (paragraph at 60(e.1) in the calculation of net income for tax purposes, not employment income.

Solutions to Chapter 3 Assignment Problems

Solution 18: Calculate Employment Income—Benefits, Expenses, Stock Option Income from Employment Base salary Gross commissions Day care subsidy Stock option benefit (Note 1) Less: Employment expenses Meals and entertainment (Note 2) Hotel and travel Airfare Union dues Total deductions Income from employment

$48,000 23,500 1,200 700

$73,400

( 1,150) ( 1,780) ( 1,800) ( 280)

ITA References ITA: 5(1) ITA: 5(1) ITA: 6(1)(a) ITA: 7(1) ITA: 8(1)(f) ITA: 8(1)(f) ITA: 8(1)(f) ITA: 8(1)(i)

( 5,010) $68,390

Notes: 1. Stock option benefit = ($2.50 - $1.80) × 1,000 = $700. 2.

Meals and entertainment: 50% × $ 2,300 (subsection 67.1(1)).

Stock option deduction = ½ × $700 benefit. This is not a deduction from employment income. Rather, it is a subsection 110(1) deduction from net income for tax purposes in the computation of taxable income.

EI and CPP qualify for a non-refundable tax credit against taxes payable. Income tax paid is not a deduction in the calculation of employment income. It is considered an instalment towards the taxes owed in the year. Enhanced CPP contribution is a deduction under subdivision e (paragraph at 60(e.1) in the calculation of net income for tax purposes, not employment income.

Introduction to Federal Income Taxation in Canada

Solution 19: Calculate Employment Income—Travel Expenses Sylvanna’s income from employment Gross salary Bonus based on sales Standby charge (2% × $36,000 × 12 30-day periods)

$48,000 40,000 8,640

Operating cost benefit ($0.33 × 9,900) Taxable benefits ($350 + $150) Total

3,267 500 $100,407

Sylvanna’s employment expenses Travel expenses ($5,200 + 7,800 + 500 + (1,500 × 50%)) Sales expenses ($700 + (2,200 × 50%) + 3,500) (Note 1) Total Other deductions from employment Contributions to RPP Income from employment

$14,250 5,300 $19,550 $ 4,000 (23,550) $76,857

Notes: 1. Sylvanna qualifies for sales expenses under paragraph 8(1)(f ) as her bonus is a commission based on sales.

Solutions to Chapter 3 Assignment Problems

Solution 20: Calculate Employment Income—Comprehensive Benefits The prescribed interest rates were changed in this question: •

Quarter 1 from 2% to 3%, Quarter 2 from 1% to 2%, Quarter 3 from 3% to 4% and Quarter 4 from 1% to 2%

•

Part B was removed from the question

(A) Employment income Salary — Gross ......................................................................................... Disability payments — Amount received............................. $ 1,600 Less amount paid (2020–2023) ............................................... (350) Preparation of 2022 income tax return(1) .................................................. MBA tuition fees(1) .................................................................................... Director’s fee............................................................................................. Birthday gift(2) ........................................................................................... Imputed interest(3)...................................................................................... Gas allowance ($250  12) ........................................................................ Standby charge(4) ....................................................................................... Car operating costs(4) ................................................................................. Bahamas condo — Fair market value(1) ............................... $ 500 Less amount paid ...................................................................... 100

90,000

Sec. 5

1,250 424 1,000 2,000 200 134 3,000 9,240 5,280

Par. 6(1)(f) Par. 6(1)(a) Par. 6(1)(a) Par. 6(1)(c) Par. 6(1)(a) Ssec. 6(9); 80.4 Par. 6(1)(b) Par. 6(1)(e); 6(2) Par. 6(1)(k)

400 $112,928

Par. 6(1)(a)

Omissions (i) Income taxes are not deductible under section 8 [ssec. 8(2)]. (ii) CPP and El provide tax credits under Division E. Enhanced CPP contribution is a deduction under subdivision e (paragraph 60(e.1) in the calculation of net income for tax purposes, not employment income. (iii) Group accident disability insurance premiums are not deductible under section 8 [ssec. 8(2)]. (iv) Employer-paid group accident disability insurance premiums are not a taxable benefit [par. 6(1)(a)]. (v) The employer-paid retirement planning advice is not a taxable benefit [clause 6(1)(a)(iv)(B)]. (vi) The employer-paid tuition for the two-day computer workshop is not a taxable benefit [Income Tax Folio S2-F3-C2]. (vii) A 30% employee discount which is available to all employees is not a taxable benefit, since the price is not below cost [Income Tax Folio S2-F3-C2]. (viii) According to ITTN No. 40, frequent-flyer points are not considered to be taxable benefits. (See ¶3,140 of the text)

—NOTES TO SOLUTION (1) These issues are discussed in Income Tax Folio S2-F3-C2, Benefits and Allowances Received from Employment. (2) To meet the administrative exception, the gift cannot be cash or near cash. This was a cash gift. (3) 3%  $8,000  76/365....................................................................................... $ 50 2%  $8,000  9l/365 ....................................................................................... 4%  $8,000  92/365....................................................................................... 4%  $8,000  92/365.......................................................................................

Less: 1%  $8,000  35l/365.............................................................................

40 81 40 $ 211 (77) $ 134

Introduction to Federal Income Taxation in Canada

(4) Standby charge [par. 6(1)(e) and ssec. 6(2)]:

20,004 km

 (2% 12) $38,500= $9,240

20,004 km Operating cost including HST benefit [par. 6(1)(k)]: 16,000 km  $0.33 = $5,280 Anita is not eligible for either the standby charge reduction or the paragraph 6(1)(k)(iv) election method since she does not use the automobile more than 50% for business purposes, which is required for these provisions.

Solutions to Chapter 3 Assignment Problems

Solution 21: Calculate Employment Income—Comprehensive Expenses (A) Employment income: Inclusions: Sec. 5 Sec. 5 Spar. 6(1)(b)(v) Spar. 6(1)(b)(x) Par. 6(1)(b) Par. 6(1)(b)

Salary (gross)........................................................................................................... Bonus based on sales/commission income .................................................. Allowance for meals, accommodation and air travel (actual reasonable expense $21,200 > allowance) ........................................................................................... Allowance for car (not based solely on kilometres)..................................... Entertainment allowance ............................................................................. Moving allowance (not an exception – first $650 not taxable) ....................

$ 84,800 34,000 13,000 6,300 2,000 14,350 $ 154,450

Deductions: Par. 8(1)(f) (limited to $34,000 commission/bonus income) Gas and oil.......................................... Licences.............................................. Insurance ............................................ Maintenance .......................................

$ 3,900 100 1,900 1,000 $ 6,900  38K km/45K km .................. Meals (50%  $7,000) [ssec. 67.1(1)].............................................. Accommodation............................................................................... Air travel.......................................................................................... Home office expenses(1) [IT-352R2, par. 6]: Insurance ($800  15%) ........................................................... Property taxes ($4,500  15%).................................................

Spar. 8(1)(i)(ii) Spar. 8(1)(i)(iii)

Par. 8(1)(j)

5,827 3,500 10,000 4,200

120 675 $ 24,322 Total par. 8(1)(f) ...................................................................................................... Salary (includes amounts deductible under par. 8(1)(l.l))........................................ Home office expenses [IT-352R2, par. 5]:(2) $ 180 Fuel ($1,200  15%) ................................................................ 105 Hydro ($700  15%) ................................................................ 45 General maintenance ($300  15%) ......................................... Painting of office...................................................................... 100 Supplies ........................................................................................ 700 Total spar. 8(1)(i)(iii) CCA on car (($36,000 + $5,400 (HST))  (1.50  30%)  38K km/45K km ................................................... Interest on car [sec. 67.2] — lesser of: (a) Amount paid = $3,600 (b) $10 x 290 days (or $300  290/30) = ....................... $2,900 Lesser amount $2,900  38K km/45K km................................................

(B) Deductions: 8(1)(f) deductions ............................................................................................... $24,322 8(1)(i) deductions ($15,000 + $1,130) .................................................................. 16,130 Lease costs [sec. 67.3] — lesser of: (a) ($950 x 1.15 x 290) / 30 = $ 10,561 (b) ($1,100 x 10) x $36,000 x 1.15) 85% of the greater of: = $ 11,000 (i) l00/85  ($36,000  1.15) = $48,706 (ii) $48,500 8,918 Lesser amount $10,561  38K km/45K km.................................................... Total............................................................................................................ $ 49,370

(24,322) (15,000)

(1,130) (15,732)

(2,449) $ 95,817

Introduction to Federal Income Taxation in Canada

—NOTES TO SOLUTION (1) Fuel and hydro can be claimed under paragraph 8(1)(f) or subparagraph 8(1)(i)(iii). A deduction under subparagraph 8(1)(i)(iii) is better, since it is not limited by commission income. (2) He cannot claim mortgage interest and he cannot use the fair market value rent if he owns the home [IT-352R2].

Solutions to Chapter 3 Assignment Problems

Solution 22: Calculate Employment Income—Comprehensive Benefits, Auto Expenses Employment income Gross salary.................................................................................................. Rent ($1,200  .75  12) .............................................................................. Bonus ........................................................................................................... Monthly allowance for incidentals ($150  12) ........................................... Imputed interest [$8,000  .01  90/365](1) ................................................. Group income protection benefits [$11,500 − $2,880]] ............................... Less: RPP — Current service(2)...................................................... $ Union dues ............................................................................ Travel expenses (related to monthly allowance)................... Car expenses(3) ............................................................................................................

5,000 800 1,200 11,222

$ 115,000 10,800 12,500 1,800 20 8,620 $148,740

$ 18,222 $ 130,577

Reference Sec. 5 6(1)(a) Sec. 5 Par. 6(1)(b) Ssecs. 6(9), 80.4(1) Par. 6(1)(f)

Par. 8(1)(m) Spar. 8(1)(i)(iv) Par. 8(1)(h) Pars. 8(1)(h.1), (j)

Excluded items (i) The 25% of the monthly rent on Anita’s home in Toronto that she reimburses to the company does not form part of the taxable benefit calculation as it is not paid by her employer. (ii) Income tax withheld is not an allowable deduction under section 8 by virtue of subsection 8(2). (iii) CPP and El premiums paid are not an allowable deduction under section 8 by virtue of subsection 8(2), but these amounts will be allowed as tax credits under Division E. Enhanced CPP contribution is a deduction under subdivision e (paragraph 60(e.1) in the calculation of net income for tax purposes, not employment income. (iv) Contributions to the company group RRSP are not deductible under section 8 by virtue of subsection 8(2) but are deductible under section 60 of the Act subject to the applicable limits. (v) Group accident income protection insurance premiums are not deductible under section 8 by virtue of subsection 8(2). (vi) The monthly rent reimbursed by Anita to the company is not deductible under section 8 by virtue of subsection 8(2). (vii) The company payment of the board and lodging costs when Anita is out of town is not a taxable benefit as it meets the condition for exemption set out in subsection 6(6) because: • her duties at these locations are temporary; • she maintains a principal place of residence at another location (Toronto) that is available to her throughout her period of stay at these out-of-town locations and her principal place of residence is not rented to any other person during these periods; • due to the distances involved, she could not reasonably be expected to return to her principal place of residence in Toronto from these out-of-town locations on a daily basis; and • she is never at an out-of-town location for less than 36 hours. (viii) The provision of boots and company uniform is not a taxable benefit by virtue of Income Tax Folio S2-F3-C2, paragraph 29. (ix) The company contribution to a registered pension plan is not a taxable benefit by virtue of paragraph 6(1)(a)(i). (x) The fitness club membership dues paid by the company would not be taxable by virtue of paragraph 6(1)(a) if the membership is principally for the employer’s advantage than for Anita’s personal enjoyment [Income Tax Folio S2-F3-C2]. If the membership was determined to be principally for Anita’s personal enjoyment, the taxable benefit is $805. —NOTES TO SOLUTION (1) The imputed interest is based on total days the loan is outstanding for 2023 excluding the day that the loan was actually repaid [31 + 28 + 31]. (2) Anita’s contribution would be fully deductible if both her contributions and Car Parts Inc.’s contributions did not exceed the actuarially permitted amounts [par. 147.2(4)(a)].

Introduction to Federal Income Taxation in Canada

50 (3) Car expenses:

Lease costs (see Note (a)).............................................................. Gasoline and oil............................................................................. Insurance ....................................................................................... Maintenance .................................................................................. Licence .......................................................................................... Interest (see Note (b)).................................................................... CCA ..............................................................................................

Acquired car N/A $ 2,880 1,333 400 90 20 1,207 $ 5,930

Leased car $ 4,326 1,440 667 240 30 N/A N/A $ 6,703

Deductible car expenses [pars. 8(1)(h) and 8(1)(j)] Acquired car 35,000 km $5,930 = 40,000 km Leased car 18,000 km × $6,703 = 20,000 km Total car expenses

5,189

$ $

6,033 11,222

Note (a): The car lease costs are subject to the restrictions in section 67.3. Lease cost — Lesser of: (a) (b)

=$ ($950  1.13  122/30) – $0 ($1,243 × 4 months) × $36,000 × 1.13 =$ 85% of the greater of: (i) $36,000  1.13  100/85 = $47,859 (ii) $55,000

4,366 4,326

Note (b): The imputed amount of interest is deductible by virtue of section 80.5. The amount is subject to the restriction under section 67.2 that is the lesser of $900 (i.e., $10 x 90 days or ($300  90/30 days)) and the $20 deemed paid. The lesser amount is $20.

Solutions to Chapter 3 Assignment Problems

Solution 23: Calculate Employment Income— Comprehensive Benefits, Auto Expenses Employment Income and References Reference Employment inclusions: Salary — Gross ............................................................... Group term life insurance premiums paid by employer .. B.C. provincial health care premiums paid by employer Monthly allowance to cover travel and automobile expenses(1) ............................................................... Travel expenses to Bermuda for Ned’s wife(2) ................ Outside financial counselling fees paid by employer(3)............................................................... One-half of reimbursement on former residence  $15,000................................................................. Employer-paid rent ($1,200  3) (4) ................................. Moving allowance ($15,000 - $650) ............................... Mortgage interest reimbursement .................................... Employment deductions: Registered pension plan contributions made by Ned ....... Automobile expenses: Lease cost(5) ...................................... 10,200 Gasoline and oil ................................ 1,300 Insurance........................................... 1,050 Maintenance...................................... 180 Licence.............................................. 120 Subtotal............................................. $ 12,850 Employment use 22,500/36,000........ Travelling expenses: Meals (50%  $7,200)....................... Accommodation................................ Total employment income................................

125,000 90 640

Sec. 5 Ssec. 6(4) Par. 6(1)(a)

9,600 1,400

Par. 6(1)(b) Par. 6(1)(a)

514

Par. 6(1)(a)

750 3,600 14,350 2,000 $

157,944

Ssec. 6(20) Par. 6(1)(a), 6(23) Par. 6(1)(b) Par. 6(1)(a), 6(23)

6,750

Par. 8(1)(m)

8,031

Par. 8(1)(h.1)

3,600 12,000

Par. 8(1)(h), 67.1 $ 30,381 Par 8(1)(h) $ 127,563

Items Omitted (i) Income taxes paid are not deductible [ssec. 8(2)]. (ii) EI contributions and CPP contributions qualify for tax credits deductible under Division E. Enhanced CPP deduction is taken under paragraph 60(e.1) and taken when calculated other deductions. (iii) Group income protection premiums and group term life premiums paid by the employee are not specifically deductible under subsection 8(1) of the ITA and thus are prohibited [ssec. 8(2)]. Premiums paid by an employee can be used to reduce the income inclusion required [par. 6(1)(f)]. (iv) Dental plan premiums are private health plan premiums and are exempted under the ITA [par. 6(1)(a)]. (v) Group income protection premiums paid by the employer are exempted under the ITA [par. 6(1)(a)]. (vi) Ned’s travelling expenses to Bermuda are not a taxable benefit to him because he was on employer business. (vii) The birthday gift is not included in income because it was less than $500 and it was not cash or near cash [administrative position]. (viii) The portion of the financial counselling fees that relates to retirement planning is not taxable [spar. 6(1)(a)(iv)]. (ix) No benefit is taxable related to the use of the private swimming pool as recreational facilities provided by the employer are not normally a taxable benefit [Income Tax Folio S2-F3-C2]. (x) The first $15,000 of reimbursement on loss of a former residence is not a taxable benefit. The balance of the reimbursement in excess of $15,000 is one-half taxable [ssec. 6(20)].

Introduction to Federal Income Taxation in Canada

(xi) Taxable benefits under par. 6(1)(a) or (e) which are not taxable supplies: a)

Exempt supplies: BC provincial health care premiums ....................................................................... $ 640 Group term life insurance ........................................................................................ 90 Rent ......................................................................................................................... 4,800 The spouse’s travel expenses are outside the scope of the GST. They would not be subject to GST if the spouse purchased the supplies directly. The supplies which include air travel to a point outside Canada, accommodation and meals outside Canada and other miscellaneous items consumed outside Canada, are not subject to GST.

—NOTES TO SOLUTION (1) The monthly allowance to cover travel and automobile expenses must be reasonable [spar. 6(1)(b)(v)] in order to be excluded from income. The $400 monthly travel allowance is unreasonably low as compared to the actual travel costs of $19,200 and thus is taxable [spar. 6(1)(b)(v)]. The automobile allowance is not based solely on km driven for employment purposes. The allowance is thus deemed not to be a reasonable amount [spar. 6(1)(b)(x)]. Since both allowances are taxable, Ned is entitled to deduct both automobile and travel expenditures per paragraphs 8(1)(h.1) and 8(1)(h) respectively. (2) Ned’s wife’s travelling expenses to Bermuda are a taxable benefit to Ned unless she was engaged primarily in business activities on behalf of her husband’s employer at the Bermuda site [Income Tax Folio S2F3-C2]. (3) The ITA excludes counselling in respect of mental or physical health or re-employment or retirement [spar. 6(1)(a)(iv)]. General financial counselling does not fall into these categories. This is confirmed in Income Tax Folio S2-F3-C2 . (4) It is arguable that the temporary rent in Victoria is in the course of the move and is not a taxable benefit. (5) Deductible lease costs [sec. 67.3] lesser of: (a) (b)

$950 × 1.12 × 549

= $ 14,886 − $4,585 30 = $ 10,200 (12 × $850) × $36,000 × 1.12 85% of the greater of: (i) $36,000  1.12  100/85 = $47,435 (ii) $33,000

Solutions to Chapter 3 Assignment Problems

Solution 24: Employed Versus Self-Employed Issue To determine whether Sandra is an employee of Global Investments or an independent contractor. If Sandra is considered an employee for tax purposes she will be somewhat restricted in her ability to deduct expenses incurred to earn income. Analysis Using the analytical method currently used by the courts, first consider whether there is a mutual understanding or common intnetion between the parties regarding their relationship. •

Sandra has expressed the wish for more independence in her career

•

Global offerred, and she accepted, a one-year contract, renewable for one year at a time dependent on her achieving a minimum level of sales.

To support either independent contractor or employment, the courts generally consider three tests in determining the economic reality of the relationship: Economic Reality Tests (a) Control Test • Based on this test, Sandra appears to be an employee because she is not allowed to work for anyone else, and must obtain the VP’s signature to close investment agreements. • Although she does have the ability to bill the company for services rendered, she appears to be accountable to the VP. (b) Ownership of Tools • She must use her own office, supplies, and equipment. • She must pay her own travel and entertainment expenses and have liability insurance. Global provides the research and “back room” expertise. (c) Chance of Profit, Risk of Loss • Who carries the business risk? • Although Sandra has access to supplies and promotional materials from Global, she is responsible for carrying her own business insurance, locating her own sales clients, and using her own supplies and equipment. She was also required to purchase a license to operate for $10,000. • It is evident that Sandra carries the business risk. • She doesn’t get paid unless she sells investments. • Must have sales of $750,000 to continue employment. • Not contract oriented. • Sandra is paid at the completion of each sale. • Specific Results Test Conclusion Sandra is likely an independent contractor for the following reasons: • She carries the majority of business risk. • She purchased a license, which gives her the right to operate her own sales office. As a self-employed person, Sandra will be able to claim expenses she wouldn’t be entitled to as an employee. These include her office in the home costs, CCA on her computer, printer and fax machine, and amortization of her $10,000 licence cost.

Introduction to Federal Income Taxation in Canada

Solution 25: Employed Versus Self-Employed Issue To determine whether Betina Harty is considered an independent contractor or an employee, the courts will start with a consideration of whether there is a mutual understanding or common intention between the parties regarding their relationship. The contents of the contract may provide evidence of that mutual understanding, but sometimes a contract can be self-serving and the specific facts must be examined in detail. The courts will apply the following tests to determine the economic reality of the relationship. Economic Reality Tests (a) Control Test Betina has broad limitations on what she uses to beautify the campus and the University retains the final vote on what pieces Betina uses. However, she is not limited in how she goes about beautifying the campus, does not have to report on a daily basis to a supervisor, and has a great deal of latitude in choosing the particular pieces. As Betina was engaged to beautify the campus, she was employed for a specific purpose. This tends to establish an independent contractor relationship between the University and Betina. Accordingly, this test does not definitively show whether Betina is an employee or an independent contractor, but does lean towards an independent contractor finding. (b) Ownership of Tools She used her own tools to create art and she used her own resources to search out other art. (c) Chance of Profit, Risk of Loss Since Betina had to absorb the costs if the University did not like how she beautified the campus, she bears economic risk. Accordingly, this test leads to the conclusion that Betina is an independent contractor. Conclusion The application of these leads to a conclusion for the independent contract status. Based on the results of these tests, the courts would almost certainly conclude that Betina is an independent contractor.

Solutions to Chapter 3 Assignment Problems

Solution 26: Employed Versus Self-Employed, Resident Issue To determine whether Sherry should object to her notice of assessment that claims that she is a resident of Canada for tax purposes. Is she an employee or an independent contractor? How should the fringe benefits be treated? Residency If Sherry were to go to court, the judge would consider the facts that would indicate that her continuing state of relationship is with Canada. Facts to support residency: • stored furniture at mother’s; • kept health care card, Visa, and bank account in Canada; • cheques deposited in Canadian bank account; • boyfriend visited her for six months and then returned; and • letters indicated that she wanted to come home. Based on the above facts, it is obvious that Sherry did not sever all of her ties and, during her absence, her intentions to return home were obvious. Employer vs. Independent Contractor • Sherry was employed with TSE prior to going overseas and considered herself as part of the TSE team. For example, she used TSE letterhead and business cards. • The Iraq government contracted with TSE, and not directly with Sherry. Therefore, it would follow that Sherry conducted herself more like a TSE employee by not incurring any financial risk. She also went to Iraq under the direction of TSE (Control and chance of profit/risk of loss tests). Conclusion • Sherry is a resident of Canada between the period of March 2021 and October 2022; therefore, she must pay tax on her worldwide income. • Since Sherry is also considered a full-time employee of TSE, her income would include the $12,000 received from TSE, together with the value of fringe benefits. Some of the personal living expenses may not be considered a taxable benefit, because Sherry is living in a remote location. However, the length of stay may prevent her from being viewed as living in a remote location. • Sherry may be entitled to an overseas employment tax credit, which would essentially allow $80,000 of employment income to be tax exempt if certain conditions are met. This credit is discussed further in Chapter 10. Assuming that she was granted the overseas employment tax credit, it is recommended that a notice of objection not be filed. This avoids professional legal fees and administration costs. Interest and penalties will continue to accrue during the period of objection, unless the income tax is not outstanding.

Introduction to Federal Income Taxation in Canada

Solution 27: Employed Versus Self-Employed, Resident Claire was reassessed as being an employee resident in Canada for both 2022 and 2023. The two issues to be considered are her residency status and whether she is an independent contractor or an employee. Issue Residency is described by case law as a question of fact rather than meaning. The CRA takes into consideration the continuing state of the relationship the individual has with the country. For 2023, the courts would look at factors such as: • Claire is Canadian and returned to Canada permanently. • She married upon her return to Canada and resumed employment with her previous employer. • She kept her furniture in Canada. • Her family ties remained in Canada. • Her contract was a temporary contract depending on demand and she had the intention to return to Canada when it was terminated. • She was absent less than two years without completely severing all ties. • Claire did cancel her YWCA membership; however, it is not mentioned if all associations were cancelled, nor is it mentioned whether she cancelled her health care. • Her intention to stay in Saudi Arabia is not supported. It is not stated if she tried to learn the language, if she joined any clubs or if she tried to integrate into the society. (It is stated that she was happy to return home.) • Claire’s employment ties remained in Canada. The facts of the situation lead to the conclusion that Claire is a resident of Canada in 2023. The tax consequences of this are that she would be taxed on her worldwide income in 2023. Employee vs. Independent Contractor First, consider whether there is a mutual understanding or common intent between the parties regarding their relationship.Claire considers herself an independent self-employed dental hygienist. She is contracted by the Canadian Forces Dental Unit to work on a day-to-day basis. The Mobile Dental Unit contracts her in advance depending on the regional need. Under the contract, she is not treated like an employee, particularly, in terms of remuneration. The courts will apply various tests to determine the economic reality of the relationship. Economic Reality Tests It is important to consider the economic reality and what can be expected of a professional worker who is subject to the self-regulation of her profession. No matter how independent the relationship, Claire has to be subject to the supervision of a dentist. In the situation of providing services in Saudi Arabia, it may not be reasonable for her to provide her own tools, no matter how independent the relationship. The context for providing the services has to be examined realistically. (a) Control Test This test tries to determine if Claire is free to organize her work independently. In this case, she decides how she does her work based on special knowledge, skill, and judgment. Her work is limited by the regulatory requirements of her profesional association, which is self-regulating. However, she is responsible to the dentist who is required by the Canadian Dental Association to supervise her work. The clinic organizes her clients and if a workday is less than 60% booked, the clients are rescheduled to another day. The contract also specifies that she be available four days a week and this prevents her from obtaining work elsewhere. Claire would likely not pass the control test. (b) Ownership of Tools While Claire used her own car in Canada, she would not have a car in Saudi Arabia, and she would use the equipment provided. In this type of situation, it might not be reasonable to expect an independent contractor to provide her own tools. As an independent contractor, could she reasonably be expected to provide her own dental chair? (c) Chance of Profit, Risk of Loss This test is an attempt to determine if the individual incurs business risk, legal liability, and his/her own expenses. In this case, Claire does not run the risk of financing the supplies, tools, and support staff. She is also not responsible for seeking out clients. She has no control over the support staff that provides services to her. Also, there is limited legal risk as the dentist is professionally responsible.

Solutions to Chapter 3 Assignment Problems

However, there is the risk that she may be without work because she is hired on a day-to-day basis depending on demand and it is not unusual to be temporarily laid off. She is not contracted to achieve a specific result, but to supply her services as needed over the contracted period of time. The dental unit appears to bear most of the risk and Claire may not pass this test, but there is still an argument to be made for independent contractor status in this fact situation. Specific Results Test Conclusion The analysis of the specific facts in this context can be seen to favour either employed or independent contractor status. (1) If one argues that the economic reality tests are not conclusive, then the intention of the parties that the relationship is one of an independent contractor characterizes the relationship (2) If one argues that the economic reality tests conclusively identify the relationship as employer- employee this would supercede the intention of the parties and, her income would be included in employment income and her deductions would be limited. This applies for both 2022 and 2023. In 2022, Claire would be taxed on her worldwide income. She would have to include all of the benefits received or enjoyed in the year that she received as a result of her employment. The FMV of the free room and board provided in Saudi Arabia would have to be included in her employment income under paragraph 6(1)(a). Also, the deductions she could claim would be limited to those specified in subsection 8(1). Her deductions for laundry, uniforms, and shoes would not be allowed. The travel expenses could be deducted if she qualifies for the deduction under paragraphs 8(1)(h) and (h.1). That is, if she is required by work to incur her own expenses for employer-related travel or if she is required to carry on duties of employment away from the employer’s place of business. Arguably, the travel expenses are not deductible as she does not perform her duties away from her employer’s place of business. The fact that there is a change to the employer’s place of business is irrelevant. In 2023, Claire’s income would be classified as employment income. She would be limited to employment expenses as mentioned for 2023, but again her entitlement is doubtful. The difference between employment income and business income of an independent contractor in her case may not be enough to justify incurring the costs of defending independent contractor status.

Introduction to Federal Income Taxation in Canada

Solution 28: Employment Income—Comprehensive Calculation (A)

Employment Income — Subdivision a

Sec. 5

Par. 6(1)(b) Spar. 6(1)(b)(v) Spars. 6(1)(b)(v), (x) Par. 6(1)(c) Par. 6(1)(f)

Ssec. 6(3) Ssec. 6(4) Ssec. 6(9)

Sec. 6(19), (20) Ssec. 7(1)

Par. 8(1)(b) Par. 8(1)(h.1), (j)

Salary (gross) ($50,450 + $49,550) .......................................................................................................... Other inclusions: Moving — disruption allowance .......................................................................................................... Accommodation allowance .......................................................................................................... Car allowance (not based solely on kilometres) .......................................................................................................... Director’s fees .......................................................................................................... Regal Assurance — income protection ................................................................................... 15,000 Less: 2023 payments ................................................................................... 1,050 prior year payments ……………………… 0 Receipt not to compete .......................................................................................................... Group term life insurance premium paid by employer .......................................................................................................... Imputed interest benefit: home purchase (.04 × $150,000 × 184/365) ........................................................................... $3,025 car (.04 × $10,000) ........................................................................... 400 Total ........................................................................... $3,425 less: interest paid in year or within 30 days of year: home purchase ........................................................................... Nil car (.03 × $10,000) ......................................................... $300 300 Housing loss paid by employer ( ½ × ($25,000 - $15,000)) .......................................................................................................... Stock option benefit (2,000 shares × $35 - $25) .......................................................................................................... .......................................................................................................... .......................................................................................................... Deductions: Legal expenses .................................................................................................. Total deductible car expenses (1)

......................................................................................... Par. 8(1)(h) Par. 8(1)(h) Par. 8(1)(m); 147.2(4)(a)

Meals (50% of $11,250)[assume 12 hour rule met] .................................................................................................. Accommodation expenses .................................................................................................. RPP — current contribution paid via payroll deduction ..................................................................................................

$100,000

5,000 30,000 5,550 5,000

13,950 50,000 600

3,125 5,000

20,000 $238,225

$5,000 13,331 5,625 23,750 4,000 $51,706

Employment income — Subdivision a ............................................................................................................................. .................

(B)

$186,519

Items not included in part (A) — $8,000 termination payment is not included in income under subdivision b of Division B. It is taxable under subdivision d [ssec. 56(1)(a)(ii)]

Solutions to Chapter 3 Assignment Problems

— $4,000 employer’s contribution to RPP is a statutory exemption [par. 6(1)(a)] — $2,125 employer’s contribution to premiums for Extended Health Care is not a taxable benefit since it is a private health services plan [par. 6(1)(a)] — $1,050 employer-paid premium to group income protection is a statutory exemption [par. 6(1)(a)] — $3,500 membership fee in Petroleum Club is not taxable if the membership is primarily for the employer’s benefit and not for the employee’s [Income Tax Folios: S2-F3-C2, Benefits and Allowances Received from Employment] — Stock option deduction of ½ × $20,000 is available since the option was equal to or greater than the fair market value of the shares at the grant date. However, this deduction is available only under Division C of the Income Tax Act [par. 110(1)(d)] and therefore does not impact the calculation of income from employment in Division B. — $12,000 moving expenses reimbursed and $15,000 of the $25,000 loss on sale of house not a taxable benefit but a reimbursement of expenses [Income Tax Folios: S2-F3-C2, Benefits and Allowances Received from Employment] — $41,000 income tax is not deductible [ssec. 8(2)] — CPP and EI contributions withheld are not deductible; tax credits available in Division E. Enhanced CPP (ECPP) is eligible for deduction under paragraph 60 (e.1). — Group income protection premiums of $1,050 paid via payroll deduction is not deductible [ssec. 8(2)] — $6,000 reimbursed travel costs are the employer’s expenses not the employee’s — Interest @ 2% on house loan was not paid within 30 days of 2021 and, therefore, cannot be used to reduce the taxable benefit. Note that the “lesser of” ▪ the actual quarterly prescribed interest rate and ▪ the prescribed interest rate in effect at the date the loan was received is available in computing this benefit; in this case, the actual prescribed interest rate is constant at 4% for the entire year, so the “lesser of” option is equal to the actual prescribed interest rate for the year

— NOTE TO SOLUTION (1)

Deductible car expenses: Gasoline .................................................................................................................... Maintenance .............................................................................................................. Insurance ................................................................................................................... Licence ...................................................................................................................... Interest (paid ($300) and deemed paid ($100) by sec. 80.5)...................................... Capital cost allowance...............................................................................................

Deductible car expenses: 9,000km 16,000km

$20,855

Accident Total

$1,700 800 * 1,800 90 400 ** 16,065 *** $20,855

$11,731 1,600* $13,331

* Accident repair expenses, whether incurred to repair damages resulting from the accident to a “motor vehicle” driven by the employee or to the property of others, are deductible in full if the vehicle was being used to earn income from an office or employment at the time of the accident. Any amount deductible is net after recoveries through insurance or damage claims. No portion of such expenses is deductible if the vehicle was being used for personal purposes at the time of the accident [IT-522R, par. 7]. ** Lesser of: (a) $300 + $100 = (b) $10 x 365 days or $300 × 365/30 =

$400 $3,650

*** 1.5x 30% × [$36,000 x 1.05] = $17,010; no PST in the province of Alberta.

Introduction to Federal Income Taxation in Canada

Solution 29: Employee Versus Independent Contractor The first step that the courts would take would be to determine the parties’ intentions. In this case Mr. Gee considers himself an independent contractor; however, the firm’s intention appears to be employee, by virtue of their payroll tax submissions. This suggests that the economic reality tests will determine the characterization of the relationship: The Economic Reality Tests (a)

The Control Test — a major criterion to be used in determining whether an individual is employed or self-employed is control, i.e., the nature and degree of control exercised by one person over another — the senior lawyers periodically examined his work because the firm was legally liable (provided the insurance) — the senior lawyers exercised greater control over the conduct of the business — the firm selected a replacement if he could not do the work — his contract with the firm’s partners had to be renewed annually — on the other hand — the nature of his work and the way it was conducted was similar to that of the senior lawyers and dependent on his specialty — he was free to follow his own direction under the general policy of the firm — he was not told how to do the work; he chose the steps — his working hours were of his own choosing.

(b)

Ownership of Tools — he was not responsible for expenses of the firm such as staff support or liability insurance; the firm provided these facilities. — he is provided with all of the facilities of the firm, including support staff, billings and collection, liability insurance.

(c)

Chance of Profit/Risk of Loss — another important criterion is the method of remuneration or, more generally, the economic reality of the situation — he was paid a fee based on a percentage of gross income with a cash advance paid every two weeks and a final accounting at the end of the year — this is similar to earning a commission — “since his fee is based on ‘gross profit’, it is effectively based on revenue not net profit, hence there is no risk of loss” — he was not responsible for billings or collections of his own fee — he had no investment in the firm generally or ownership interest in client accounts which would give him a right to a return on investment through profits. the nature of the contractual relationship with respect to selection and dismissal and whether a specific service or general services must be examined — an employee provides personal services which are at the disposal of the employer during a certain period of time — a self-employed person agrees to do certain specified work which when finished marks the end of the agreement; a particular individual need not do the work — in this case, Mr. Gee agreed to make his services available for the firm exclusively — the work was not specified and the contract provided that he would do the work.

—

Solutions to Chapter 3 Assignment Problems

Conclusion Collectively the economic reality tests suggests that the factors support a characterization of an employer\employee relationship. As the parties joint intentions are not clear, the conclusions drawn from the economic reality tests are likely to determine the court’s decision. Specifically the court’s determination of an employee relationship would be based on the following factors: —

—

the firm, through its senior lawyers, probably exercised as much control over Gee as is possible in the exercise of his profession as a lawyer — it did so because it assumed full responsibility for his acts by contracting for liability insurance — the fact that he acted independently in the manner of doing the work does not help in the distinction between an employed or self-employed lawyer because of the nature of the work and the exercise of professional judgment the method of remuneration, based on a percentage of gross income, does not determine whether he is employed or self-employed because it is much like a commission which could be earned by an employee or a self-employed agent — as well, the fact that he had no investment in the firm would suggest that he was not subject to any risk of loss the exclusivity of his services provided to the firm would suggest that he is an employee — also, the fact that the work was not specified by the contract would suggest he was an employee making his services available for a period of time

Introduction to Federal Income Taxation in Canada

Solution 30: Employment Income—Comparison Under Two Alternative Employment Offers Inclusions: Offer 1 $58,000 12,000 5,400 n/a n/a

Salary Commission Mileage allowance ($450 × 12) Travel allowance ($1,500 × 12) Operating costs re: insurance Standby charge — 6,000 × [2/3 × ($5,200 x 1.13)](3) 20,004 Deductions: Salesperson's expenses: Travel costs - meals (50% of $3,200) - accommodation Entertainment ($4,000 - 1,100) × .50) Home office expenses - house insurance - municipal taxes Car insurance, gas, oil and maintenance (80% × $4,300) Deductions limited to commission Travelling expenses: Travel costs (meals and accommodation) Car, gas, oil and maintenance (80% × $3,000) Automobile costs: Interest on car loan (80% × 10% × $19,000(4)) CCA 80% × ($19,000 × 30% × 1.5) Utilities(5) Telephone long distance Office supplies RPP Employment income

Offer 2 $ 70,000 n/a n/a 18,000(1) 588(2)

n/a

1,175

$75,400

$89,763

$12,000

n/a

n/a n/a

$6,600 2,400

1,520 6,840 200 1,000 500 4,200 26,260 $49,140

n/a n/a 200 1,000 500 4,200 14,900 $74,863

$ 1,600 5,000 1,450 160 500 3,440 $12,150

Solutions to Chapter 3 Assignment Problems

Notes: (1) (2) (3)

(4) (5)

$18,000 is in excess of reasonable travelling expenditures of $11,200 (i.e., $8,200 + 3,000). ½ × $1,175 (standby charge) is less than $0.33 × 6,000 personal kilometres. Graham must notify his employer before the end of the year of his intention to use this alternative method. The standby charge is calculated on the $6,300 of annual lease payments net of the $1,100 of annual insurance charges included in the lease payments. Since the car is used primarily for business (greater than 50%), a reduction in the standby charge is possible. Not in excess of the $10 a day limit ( or $300 per 30-day limit). Deductible under spar. 8(1)(i)(iii) and not limited by commission income per IT-352R, par. 3.

Items excluded from calculations: - Employer's contributions to a private health plan such as a dental and drug plan are not a taxable benefit. - Employer's contributions to a Registered Pension Plan are not a taxable benefit. - Employer contributions under the group accident insurance plan are not a taxable benefit to the employee [6(1)(a)]. - Club dues paid by the employer are not a taxable benefit by administrative practice if it is primarily to the advantage of the employer to have the employee as a club member. - Outlays on account of capital are not deductible except for interest and capital cost allowance on a car used in the course of employment [ssec. 8(2), spar. 8(1)(f)(v), par. 8(1)(j)]. Therefore, the interest expense on the home mortgage, interest expense on the office equipment loan, and the capital cost allowance on both the home and the equipment are not deductible. - Club dues paid by a salesperson are specifically denied as a deduction from commission income [spar. 8(1)(f)(vi)].

CHAPTER 4

Income from Business: General Concepts and Rules Solution 1: Independent Issues—Deductibility of Expenses 1.

The company made charitable donations of $15,000 in the year. −

These are deductible for accounting purposes

−

Donations are not incurred to earn income and are, therefore, not deductible for tax purposes.

−

However, they are deductible by a corporation under Division C in the calculation of taxable income [110.1]

While looking at the accounts receivable you noticed that they had set up an allowance for doubtful accounts for $120,000, calculated, based on their past history, as 60% of the accounts receivable that have been outstanding more than 60 days. −

This should be deductible for accounting purposes.

−

An allowance for doubtful accounts is allowed for tax purposes [20(1)(l)]

−

They appear to have established that accounts over 60 days old are doubtful and that 60% is a reasonable estimate of the amount that will not be collected. This should be allowed for tax purposes [IT-422R]

−

Therefore, no adjustment is needed.

−

If they took 60% of all accounts receivable, then this would probably not be allowed given that it is too general.

−

Last year’s allowance must be taken into income this year [12(1)(d)]

−

Normally the accounting and tax treatment are the same and no adjustment is needed.

You also noticed that they wrote off bad debts of $15,000 during the year. −

Where they have made serious attempts to collect the account and have been unsuccessful, they are allowed to deduct bad debts for tax purposes [20(1)(p)].

−

If a bad debt is subsequently recovered, it must be brought back into income [12(1)(i)]

−

Normally the accounting and tax treatment are the same and no adjustment is needed.

−

If these were in the allowance for doubtful accounts then the new allowance will be lower and the old allowance will be brought back into income.

Introduction to Federal Income Taxation in Canada

They included in revenue $10,000 received from a customer for goods to be delivered about two months after the year end. This is not a material amount so no adjustment was made at year end to set this up as deferred revenue.

−

The proper accounting treatment would be deferred revenue but because this was a small amount it was ignored.

−

This has to be included in income for tax purposes as the cash was received. This is the same as the current accounting treatment. [12(1)(a)]

−

However, a deduction can be taken [20(1)(m)] to remove it from income and recognize it when the goods are delivered

−

Therefore, a deduction/reserve of $10,000 can be taken this year. This amount will be included in income next year. [12(1)(e)]

You noticed that the professional fees showed legal and accounting fees of $25,000 related to the re-financing of the company’s long-term debt. −

This will not be fully deductible this year for tax purposes.

−

Instead, it will be deductible at 20% per year over 5 years [20(1)(e)]

−

Therefore, $25,000 will be added back and $5,000 will be deducted for tax purposes on Schedule 1.

In miscellaneous expenses you saw that some application software of $12,000 was expensed as was $30,000 for landscaping the grounds around their office building. −

The application software is a capital expenditure and is not deductible [18(1)(b)]. Therefore, $12,000 is added back to income for tax purposes and CCA is taken on the software.

−

The landscaping is also a capital expenditure but it is specifically allowed as a deduction for tax purposes [20(1)(aa)]. Therefore, no adjustment is needed.

The company expensed a total of $55,000 on meals and entertainment including $18,000 for the summer picnic party for all employees. −

50% of the cost of the meals and entertainment is required to be added back [67.1]

−

However, there is an exception where the meals and entertainment are provided to all employees of that location and there are not more than 6 of these events in the year. [67.1(2)(f)]

−

Therefore, add back $18,500 [($55,000 - $18,000) x 50%]

They also expensed the cost of club dues for senior executives amounting to $8,000. This covered the dues for the Westmount Golf Club, the Board of Trade and the Downtown Racquet Club. −

Sporting club membership dues are specifically disallowed [18(1)(l)].

−

However, the Board of Trade would not fall into this category so it should be deductible.

−

Therefore, get a further breakdown of the $8,000 to see how much was for the golf and racquet clubs and add these back to income.

Solutions to Chapter 4 Assignment Problems 9.

The company expensed the costs of maintaining a small lodge located in In the Muskoka area of Ontario north of Toronto and used throughout the year for the purposes of entertaining clients. -

The costs of maintaining a lodge are specifically prohibited as a deduction [18(1)(l)]

Therefore, add these expenditures back to income.

10. You know from experience that the company pays $0.62 per kilometer as the mileage rate for the use of employee-owned cars. You noticed that some of the employees are travelling a lot with two employees driving 6,000 km in the year. −

A restriction has been placed on the amount of the mileage allowance that can be deducted [18(1)(r), 7306]. These amounts can change annually, although they are not indexed.

−

If the payment is over $0.68 for the first 5,000 km and $0.62 after then the excess is not deductible.

−

Reg. 7306 i. Total km x $0.62 + (lesser of total km and 5,000) x $0.06 (.68-.62) = 6,000 km x $0.62+ (lesser of 6,000 km and 5,000 km) x $0.06 = $4,020 ii. Actual = 6,000 km x $0.70 = $4,200 iii. Disallowed = $180

Introduction to Federal Income Taxation in Canada

68 Solution 2: Home Office Conditions for home office [18(12); par. 4,265]

In order for home office expenses to be deductible to earn business income the tests are very similar to those used for employees with home offices. The space must be either − −

The individual’s principal place of business, or Used exclusively by the individual on a regular and continuous basis for meeting clients, customers or patients.

In this case neither of the tests will be met, so she will not be able to deduct any costs related to her home. She can still deduct direct expenses such as office supplies and CCA on computers and printers.

Solutions to Chapter 4 Assignment Problems

Solution 3: Debt Forgiveness Commercial borrowings (the $300,000 loan) that are subsequently forgiven are applied to the following items in this order [80(2)(c); Par.4,034]: 1. Non-capital loss carry forwards 2. Net capital loss carry forwards 3. Capital cost (and UCC) of depreciable property 4. Resource expenditures 5. ACB of capital property Any balance remaining will be treated as a capital gain. Time line and transactions: − − −

Last year – Carson received a loan of $300,000 This year – Loan is forgiven Next year – possible sale of land and building

Results this year: Forgiven amount

$300,000

Non-capital losses

(120,000)

Net capital losses

(30,000)

Building

(150,000)

Land

(nil)

Balance remaining = capital gain

$ nil

Taxable capital gain (50%)

$ nil

Results next year: If the cost/UCC of the building and the ACB of the land is reduced then on the sale there will be a higher potential capital gain.

Introduction to Federal Income Taxation in Canada

Solution 4: Income Versus Capital Intention of the Taxpayer (A) Primary intention: The corporation stated that it intended to construct an apartment building on the property, not to purchase the property itself for resale at a profit. Unexpected circumstances resulted in the sale of the property. These statements of intention must be substantiated by facts which can be observed objectively, as discussed below. (B) Secondary intention: The question of whether the corporation intended, at the time of purchase and as a motivation for the purchase, to resell the property at a profit if the primary intention was frustrated must be answered by reference to other factors discussed below. Factors Used to Substantiate the Intention of the Taxpayer (A) Relationship of the transaction to the corporation’s business: The corporation was not normally in the business of buying and selling land. This was a relatively new corporation at the time of the transaction. In addition to the land which it sold, it purchased another property which it has developed into a commercial/industrial plaza and which it holds as a rental property. Furthermore, the principal shareholder of the corporation owns and operates an electrical contracting business and, thus, cannot be said to be in the business of buying and selling land. (B) Nature of the activity surrounding the transaction: The transaction involving the sale of the property should not be considered of a business nature or “an adventure in the nature of trade”. The sale was made only after it was determined that the property location was not suitable for development into an apartment building. It was listed for sale with the realtor only at that time and not immediately after purchase. It could be argued that the minor improvements made were to make the property more marketable for resale purposes. (C) Type of asset: The land was to be developed for an apartment building used for rental purposes and, hence, would have been considered a capital asset rather than inventory. Plans were made for the development of the property to the extent that surveys were made and that the land was stripped and excavated in preparation for construction. The fact that no income was ever earned from the property as a capital asset could be used to suggest it was held as inventory. Also, surveying and stripping the land could be regarded as preparing the land for resale at a profit. (D) Number and frequency of transactions: Since this is a new corporation and the transaction in question was the first of its nature, there is no track-record on which to base an assessment of number and frequency despite a short (i.e., six-month) holding period. As a result, this should not be a determining factor in this case. (E) Articles of incorporation: There is nothing in the Articles of Incorporation to suggest that the corporation can engage in the purchase and resale of land as a business activity. On the other hand, the articles are very broad and might be interpreted to encompass this type of business activity. (F) Other factors: IT-218R, paragraph 3 suggests other factors which might be considered in the evaluation of real estate transactions, including: (i) the feasibility of the taxpayer’s intention; (ii) the geographical location and zoned use of real estate acquired; (iii) the extent to which borrowed money was used and the terms of the financing; (iv) the length of the holding period (relatively short, i.e., six months, in this case); (v) factors which motivated the sale. Conclusion From the foregoing analysis of the facts, it is reasonable to conclude that the profit realized on the sale of the property was a capital gain. The intention to develop the property as an income-producing capital asset, in the same manner as the development of the other property, is substantiated by the nature of the transaction, the type of asset and the Articles of Incorporation.

Solutions to Chapter 4 Assignment Problems

While it may be possible to argue that the corporation had a secondary intention to sell the property at a profit, if the primary intention of developing it as a capital asset was frustrated, the evidence is not strong for that argument. Such a secondary intention is best supported by evidence of a person, such as a realtor, who is knowledgeable in the real estate market. Neither the corporation nor its principal shareholder was engaged in the real estate business or could be said to have specialized knowledge of real estate markets, unless the electrical contracting business can be considered to provide special real estate knowledge and insights. Furthermore, the property was not listed or made available for sale immediately after purchase, but only after the location was found to be unsuitable. It is possible to regard the amount of development activity as consistent with holding the land as inventory for resale, but relative to the other facts supporting a capital transaction the income receipt alternative is less likely.

Introduction to Federal Income Taxation in Canada

72 Solution 5: Four Independent Issues

(a) Both Dan and Mike are performing business services and, therefore, a value needs to be assigned to the work they have done and the amount added to their business income. The value of the work exchanged could be based on either Dan or Mike’s normal rate. This is a verbal transaction unlikely to be added to either tax return. The CRA would probably assign the higher rate for the work done if this were caught on an audit. (b) The $100,000 is an extraordinary item from business. Nevertheless, it would be taxed as business income as it was earned in the course of carrying on business. This amount is usually shown separately on a company’s income statement with the tax effects also shown separately. (c)

The government grant of $10 per hour is taken into business income and the $15 per hour paid to Cornell is an expense. The net result is that the company is only paying $5 per hour for Cornell’s services. (d) Jessy will have a taxable benefit equal to the fair market value of the rent for the apartment (paragraph 6(1)(a)). As Jessy uses one room as an office, she would be able to deduct that portion of assigned rent and other household expenses relating to the home office from the taxable benefit for the apartment as well as her supplies. If Jessy is considered an employee, she will not be allowed any CCA on her equipment.

Solutions to Chapter 4 Assignment Problems

Solution 6: Reasonable Expectation of Profit [Reference: Coupland v. The Queen, 88 DTC 6252 (F.C.T.D.)] There was a personal element to this fact situation, since the property was purchased as a holiday property for the taxpayer and his family and it became their principal residence. Later, a house on the property was occupied by the taxpayer’s daughter at a rent that was not sufficient to cover the mortgage costs of the property. Therefore, it would appear that under this fact situation, application of the “source of income” test is appropriate. The Supreme Court of Canada, in the Stewart case, established a “pursuit of profit” source test, which requires analysis, where there is some personal or hobby element to the activity in question. Since a personal element was found to exist in this case, the question of whether the taxpayer intended to carry on a business for profit must be addressed and it was, as is evident from the above excerpts from the decision. The following has been edited from the Court’s decision in the Coupland case (which, in actuality, preceded the Stewart decision, 2002 DTC 6969 (S.C.C.) and would not have been guided by it). The issue to be determined is purely one of the fact: did the [taxpayer] during the years in question incur the expenses for the purpose of producing income from a business, that is, was he engaged in an activity with a reasonable expectation of making a profit therefrom. … … I could not conclude on the basis of the evidence in this case, that the expenses in question were incurred by the taxpayer for the purpose of producing income from a business. I do not conclude that the activities in which the [taxpayer] was engaged were carried on with a reasonable expectation of a profit. … My conclusion that the [taxpayer’s] activities were not carried on with a reasonable expectation of profit,[i.e., there was no commerciality in the activity and, hence, nosource of incme] is based on the reasons which follow. The profit and loss record of the [taxpayer’s] business never showed a profit from the first year of its operation, in 1975 to 1985. … With respect to the taxpayer’s training, I have no doubt that the [taxpayer] had adequate managerial and the other abilities to develop the campground and run the operation had he chosen to do so as a serious business venture, and, had he had the capital to do so. His past experience in various managerial functions, albeit not in the private sector, and his obvious ability to deal well with people would have made him an ideal candidate to operate such a business. And, in any event, the running of a campsite is not a high skill occupation. While I have no doubt that the [taxpayer] had the experience and ability to run a campground operation as a business, he was not in fact doing so. He was not on the property much of the time. He had a full-time job in Ottawa during the whole period and only returned to the Lanark property on weekends. There is no evidence of a concerted effort to try to ensure a full occupancy rate of even the limited number of campsites which were in existence. (By full occupancy I mean what would constitute average occupancy in the industry.) There is no evidence of any concerted advertising of the campground property. … There is no evidence of any definite or specific plans for conversion of the house — merely the [taxpayer’s] vague statement that this was intended. … … Mr. Bingham’s evidence was that the business was marginally viable in 1976 and that with the expansion of the facilities, the business could become truly viable. … I have no doubt that the operation of a campground in the area might be a viable enterprise — especially had the suggested improvements been made. But, the issue is whether the business, as the [taxpayer] was operating it, was one which was being run with a reasonable expectation of profit. I do not think it was.

One approach to addressing the issues of this case is to apply the checklist of factors in Exhibit 4-2 in Chapter 4 of the text to the facts of this case, to the extent that they are known. The Exhibit is reproduced here for that purpose. Recognize, however, that this list of factors was developed from U.S. jurisprudence which has no legal precedent status in Canada.

Introduction to Federal Income Taxation in Canada

Exhibit 4-2 Checklist of Factors Used to Determine the Commerciality of an Activity or of Operating in a Businesslike Manner (1) Manner in which activity is operated: (a) activity held out to community as a business (b) activity operated in a businesslike manner or similar to comparable profitable businesses (c) unsuccessful methods discontinued and new ones adopted (d) formal books, records and bank accounts maintained

(2)

(3)

(4)

(5)

(6)

(e) record keeping system provides for the determination of segment profits and relevant costs (f) detailed non-financial records maintained (g) operating methods changed to improve profitability (h) level of advertising or promotion undertaken (i) development plan formulated and followed (j) scale of operations sufficient to be profitable. Elements of personal pleasure or recreation: (a) taxpayer obtains personal pleasure from the activity (b) conduct of activity involves social or recreational functions (apart from the activity itself) (c) long-time interest in activity as a hobby (d) personal use separately accounted for. Expertise of the taxpayer or his advisers: (a) prior experience in the activity (b) profit potential determined prior to entry (c) pre-entry and post-entry advice sought and followed (d) taxpayer belongs to business-related associations (e) new or superior techniques developed. History of income and loss: (a) average ratio of receipts to disbursements (b) percentage years receipts less than disbursements (c) average magnitude of losses, trend of losses declining (d) number of years activity was operated (e) losses due to circumstances beyond taxpayer’s control (f) percentage of years with profits (g) trend of gross revenues. Time and effort expended: (a) competent and well-informed manager and labour employed (b) average time spent on activity by taxpayer (c) taxpayer withdrew from another business to devote most of his/her time to the activity Financial status of taxpayer: (a) taxpayer’s average income before activity loss (b) extent of tax savings from net losses (c) taxpayer maintains an extravagant standard of living (d) majority of taxpayer’s other income is from investments (e extent of other net assets of taxpayer (f) amount of capital invested in the operation.

Solutions to Chapter 4 Assignment Problems

(7) Amount of occasional profits: (a) ratio of average profit to average loss (b) amount of largest profit earned (c) ratio of net losses to net assets. (8) Sale or discontinuance of activity: (a) activity sold or discontinued because no chance for profit (b) activity sold or discontinued for any reason. (9) Success of taxpayer in other activities: (a) extent of experience in similar successful business (b) history of losses in a similar activity. (10) Expected appreciation of asset value: (a) taxpayer expected property to appreciate in value as the major source of investment return. Sources: Jane O. Burns and S. Michael Groomer, “An Analysis of Tax Court Decisions That Assess the Profit Motive of FarmingOriented Operations,” The Journal of the American Taxation Association, Fall 1983, pp. 23-39. Jack Robison, “Tax Court Classification of Activities Not Engaged in for Profit: Some Empirical Evidence,” The Journal of the American Taxation Association, Fall 1983, pp. 7-22.

Introduction to Federal Income Taxation in Canada

Solution 7: Schedule 1 Reconciliation Income Effect In order to fully understand the income tax implications and thus the resulting adjustments that are needed in computing income for tax purposes, the underlying accounting for the given transactions needs to be discussed. The following solution will address the net impact on the income statement for accounting purposes of each of the transactions and will then compare this to the required income tax treatment of each item. The comparison of the accounting and tax treatment will indicate any necessary adjustments. The major discussion of the tax treatment of each item is found in the notes. Net impact on income statement Warranty reserve(1)

Net impact as per Income Tax Act

Difference (resulting in T2 Schedule 1 Adjustment)

$(12,000)

$(19,500)

Accounts receivable(2)

(6,000)

Nil

TalkTech Inc.(3)

120,000

40,000

(80,000)

Phones’N’Things(4)

$ (7,500)

Notes: (1) For accounting purposes, the increase of $12,000 in the balance sheet warranty reserve (a liability account) will be recorded on the income statement as a warranty expense for the year. The $19,500 subtraction from the balance sheet warranty reserve will simply reduce the cash balance as it represents the actual outlays during the year to honour warranties that were recorded in the current or previous year(s). For tax purposes, the $12,000 increase in the warranty reserve is not an allowable deduction because it represents a contingent amount (not an amount which is paid or payable) which is specifically denied per paragraph 18(1)(e). The amount does not qualify for deduction under paragraph 20(1)(m.l) since it is not an agreement for an extended warranty nor is it insured by a third party insurer. For tax purposes, the $19,500 paid during the year to honour warranty claims is fully deductible because it represents a cost of doing business under paragraph 18(1)(a). (2) The bad debt expense for the year will be reflected as a single amount on the income statement. However, this expense can often be made up of a number of additions and/or subtractions to this account. The income tax analysis of the bad debt expense on the income statement requires that each individual component of this amount be justified in terms of the relevant provision of the Income Tax Act. For example, — the addition to the allowance for doubtful accounts (and corresponding addition to the bad debt expense) must meet the requirements set out in paragraph 20(1)(l), — the write-off of bad debts must meet the requirements of paragraph 20(1)(p), and — the recovery of previously written off bad debts is included in income under paragraph 12(1)(l). The final net amount for both accounting and tax purposes should be the same. TalkTech Inc.’s $7,500 addition to the allowance as a result of the year-end aging is recorded as a bad debt expense and thus will be a deduction on the income statement. The $5,000 written off from the allowance during the year will be a balance sheet adjustment only as it represents amounts previously included in the allowance and thus previously deducted for accounting purposes (as bad debt expense in the previous year). The collection of $1,500 of previously written-off bad debts will be a credit adjustment to the bad debt expense for the year. Thus, the net impact on the income statement is as follows: Expense — Bad debt expense ................................................................................................. ‘‘Contra expense’’ — Collection of previously written-off bad debt ...................................... Net expense for the year ..........................................................................................................

$ $

(7,500) 1,500 (6,000)

For tax purposes, the opening balance in the allowance account must be added to income as per paragraph 12(1)(d), and the closing balance in the allowance is deductible as per paragraph 20(1)(l). The $5,000 write-off of bad debts is allowed as per paragraph 20(1)(p) and the $1,500 of recovered write-offs is income under paragraph 12(1)(l). Thus, the net impact for tax purposes is as follows: Add opening balance per 12(1)(d)........................................................................................... Subtract closing balance per 20(1)(l)....................................................................................... Subtract bad debt write-off per 20(1)(p).................................................................................. Add bad debt recovery per 12(1)(i) ......................................................................................... Net impact for the year............................................................................................................

32,000 (34,500) (5,000) 1,500 $ (6,000)

Solutions to Chapter 4 Assignment Problems

(3) The sale to TalkTech Inc. will result in $120,000 of net income for accounting purposes ($300,000 of sales and $180,000 of cost of goods sold) since the phones were delivered on May 1 of this fiscal year. For tax purposes, the net income for accounting purposes of $120,000 must be included in income due to section 9 but an $80,000 reserve is allowable under paragraph 20(1)(n) to account for the amount not due. Thus, a net profit of only $40,000 is recorded for the year ended October 31, 2023. The paragraph 20(1)(n) reserve for amounts due later is calculated as that portion of the gross profit on the sale that relates to the uncollected proceeds where at least some part of the proceeds are due more than two years after the date of the original sale (April 1, 2023). The taxation year-end of TalkTech Inc. does not play a role in the calculation of this reserve. The reserve of $80,000 is calculated as $200,000/$300,000  ($300,000 – $180,000). (4) The deposit received from Phones’N’Things is considered deferred revenue for accounting purposes and will be recorded on the balance sheet only (as a liability). For tax purposes, the $40,000 deposit received must be included in income per paragraph 12(1)(a), although none of that amount has been earned since it is potentially refundable if the shipment of the product does not take place. However, an offsetting reserve of $40,000 is available under paragraph 20(1)(m) because none of the goods are going to be delivered until after the end of the October 31, 2023 taxation year. Thus, the net impact on income for tax purposes is NIL for the year ended October 31, 2023. The reserve recognizes the fact that none of the amount received and included in income has been earned. This process requires all amounts received to be accounted for in income and that the full amount deducted as a reserve be justified as unearned. Doubtful Accounts The $800 amount would not be part of the amount deductible per 20(1)(p) as there is still some hope of collecting it. Therefore, the deductible amount under paragraph 20(1)(p) for the year will be $5,000 − $800 = $4,200. However, the method described in IT-442R, paragraph 24 would suggest that a reserve for 100% of debts outstanding more than 180 days is reasonable. Thus, a closing reserve that includes this amount could be claimed per paragraph 20(1)(l). Thus, the closing reserve for fiscal 2022 could be increased by $800 to $35,300. The net impact on income for tax purposes for fiscal 2022 would be the same. Add opening balance per 12(1)(d)....................................................................................... Subtract amended closing balance per 20(1)(l)($34,500 + $800)........................................ Subtract amended bad debt write-off per 20(1)(p) ($5,000 - $800)..................................... Add bad debt recovery per 12(1)(i) ..................................................................................... Net impact for the year........................................................................................................

32,000 (35,300) (4,200) 1,500 $ (6,000)

However, in 2024, the $800 will have to be added to income per paragraph 12(1)(d) as it is part of the 2023 year-end allowance. This is a different result than in Part (A) because as a bad debt written-off in fiscal 2023, the $800 would not otherwise be taken into 2024 income unless it was recovered in 2024.

Introduction to Federal Income Taxation in Canada

Solution 8: Schedule 1 Reconciliation Net income from a business for tax purposes Net income for accounting purposes Add: Golf dues (not allowed) Amortization expense Cycle Safety Program (personal) Meals & entertainment (50%) Cash register (capital) Late instalment interest (not allowed) Shelving & lighting (capital) Sale of Disney rights (gain) ($13,000 - $7,800) Business income for tax purposes before CCA

$13,000 3,000 8,000 1,500 2,000 1,200 3,000 3,200 5,200 $40,100

Notes: The legal fees would be deductible as an accrual of an actual liability for legal services received by year-end. As Leo actively trades in rights, the gain on the Disney right is business income.

Solutions to Chapter 4 Assignment Problems

Solution 9: Schedule 1 Reconciliation

Net income before tax for accounting purposes .............................................................. Add: Unrecorded receivable (paragraph 12(1)(b)) ..................................................... $16,500 Meals and entertainment ($10,200 × 50%) (subsection 67.1(1)).............. 5,100 Charitable donations (paragraph 18(1)(a)) ............................................... 2,200 Club dues (paragraph 18(1)(l))................................................................. 2,000 Interest penalty for late filing (paragraph 18(1)(t)) ................................ 8,100 Amortization (paragraph 18(1)(b))......................................................... 8,000 Less: Sale of design contracts........................................................................... (19,000) CCA (paragraph 20(1)(a))....................................................................... ( 8,900) Business income for tax purposes ................................................................................

$205,400

41,900 247,300

( 27,900) $219,400

Notes: 1. The capital gain on the sale of real estate represents the sale of real estate that was purchased with the intent of selling the homes for a profit after they had been redecorated. There is also no attempt to rent the homes to a third party. Thus, the full amount will be included in business income. 2.

Since the reimbursement to employees for business use of their automobiles is below the prescribed amounts in Regulation 7306 (paragraph 18(1)(r)), it is an allowable deduction for Source Renovations Ltd.

The sale of design contracts would be considered a capital gain and not business income.

Introduction to Federal Income Taxation in Canada

Solution 10: Schedule 1 Reconciliation Note to instructors: Net income per financial statements was changed to $690,000 ITA Reference Net income per financial statements Add (deduct): Legal Personal expenses of shareholder Advertising Interest expense Amortization Meals Exempt income CCA Bonus paid after 180 days after year end Lease termination payment Lease termination payment (Note 1) Financing costs Financing costs (Note 2) Business income for tax purposes

$ 690,000 18(1)(e) 18(1)(a) 19.1(1) 18(1)(t) 18(1)(b) 67.1(1) 18(1)(c) 20(1)(a) 78(4) 18(1)(q) 20(1)(z) 18(1)(b) 20(1)(e)

15,000 30,000 10,000 5,000 80,000 20,000 50,000 (165,270) 80,000 100,000 (9,918) 30,000 (6,000) $928,812

Notes: 1. Paragraph 20(1)(z) applies since the property is still owned at the end of the year. At the time the lease is cancelled there are 1,825 days remaining in the lease term (five years × 365 days, ignoring leap years). The number of days remaining in the current year to June 30 is 181 days (from January 1 to June 30). The calculation is as follows: 181/1,825 × $100,000 = $9,918 2.

$30,000 × 20% = $6,000. Paragraph 20(1)(e) limits the deduction for financing costs to 20% per year.

Solutions to Chapter 4 Assignment Problems

Solution 11: Income From Business • Business Income Business loss (section 9) Add: Charitable donations (subsection 18(1)) Salary to proprietor Accounts receivable — accrue (subsection 12(1)) Meals & entertainment (section 67.1) (462 × 50%) Club dues (paragraph 18(1)(l)) Income From Business

Notes: The car won in the raffle as a prize is not a taxable item.

(2,330) 380 15,500 6,650 231 460 $20,891

Introduction to Federal Income Taxation in Canada

Solution 12: Schedule 1 Reconciliation Net income Add: Accounting amortization (paragraph 18(1)(b)) Tennis club dues (paragraph 18(1)(l)) Political donations (paragraph 18(1)(n)) Charitable donations (paragraph 18(1)(a)) Meals & entertainment (50%) (section 67.1)) Less: CCA Income from business

$64,300 4,000 2,500 1,000 8,000 1,700 (22,400) $59,100

Solutions to Chapter 4 Assignment Problems

Solution 13: Income From Business With Home Office Traci does not prepare financial statements in accordance with ASPE, as her only need is to prepare statements for tax. Revenue for current year Consulting fees Reserve for doubtful accounts — prior year (Note 1) Tax deductible expenses Materials (Note 2) Association dues Entertainment ($300 × 50%) Computer World CCA on equipment Home office expenses (Note 3) Telephone expenses Reserve for doubtful accounts — current year Bad debt expense Automobile expense (Note 4) Income from business

Notes: 1. 2.

18,300 50 150 80 1,500 981 250 1,200 300 735

$35,500

(23,546) $11,954

Traci must include the $500 reserve into this year’s income (paragraph 20(1)(l)). The value of Traci’s ending inventory is at the lower of cost or market (replacement cost) and so is valued at the $1,200, which means the cost of part used is $1,500 + $18,000 − $1,200 = $18,300. Home office expenses are added together and then the business portion is taken as a deduction. The telephone expenses are deducted at 100% for the amount used for business. Condo fees Mortgage Utilities Total Deductible portion used for business ($7,850 × 50/400)

$35,000 500

$1,800 5,250 800 $7,850 $ 981

Automobile expenses (gas, oil, and repairs) and CCA are added together and the business portion is taken as a deduction. ($1,500 + $350 + $600) × 4,500/15,000.

Introduction to Federal Income Taxation in Canada

Solution 14: Schedule 1 Reconciliation—Comprehensive Note to instructors: Reference to Schedule 1 of the T2 corporate tax return may be helpful in completing reconciliation problems.

Net income per financial statements ........................................................................ Add: Provision for income taxes .......................................................................... $2,528,000 Charitable donations ............................................................................ 57,000 Overcontributions to company pension plan(1) .................................... 2,490 Loss on disposable of depreciable assets ............................................. 35,900 Depreciation and amortization............................................................. 4,560,000 Club dues............................................................................................. 12,700 54,750 Meals and entertainment ($109,500  50%) ........................................ 4,000 Hockey tickets ($8,000  50%) ........................................................... Non-deductible life insurance — Vice-president ......................... 2,000 1,500 — President ($300  5 months).... 23,440 Legal and accounting expenses re issuance of shares (80%  $29,300)....................................................................................... Costs re bank loan (80%  $46,100).................................................... Costs re equipment purchase ............................................................... Appraisal cost for bank (80%  $5,100) .............................................. Accrued early retirement payments(2) .................................................. Total additions ..................................................................................... Subtotal........................................................................................ Deduct: Capital cost allowance ......................................................................... Income from business..............................................................................

$ 3,784,000

Sec. 9 Par. 18(1)(e) Par. 18(1)(a) Ssec. 147.2(1) Par. 18(1)(b) Par. 18(1)(b) Par. 18(1)(l) Sec. 67.1 Sec. 67.1 Par. 18(1)(a) Par. 18(1)(a) Par. 20(1)(e)

36,880 38,700 4,080 672,000

Par. 20(1)(e) Par. 18(1)(b) Par. 20(1)(e) Par. 18(1)(e) 8,033,440 $11,817,440 5,835,000 $ 5,982,440

Par. 18(1)(b)

Items Not Included in Computation: 1. The reserve for inventory obsolescence, although called a “reserve,” is deductible since the amount is determined by identifying specific items that are obsolete and, therefore, is not a reserve or contingent liability [par. 18(1)(e)]. 2. Group term life insurance is deductible as part of the remuneration provided to employees and meets the “incurred to earn income test” in paragraph 18(1)(a). 3. The life insurance premiums on the president are deductible after June 1, 2022 since the insurance was held as collateral by the bank [par. 20(1)(e.2)]. 4. The costs related to the wrongful dismissal charge are deductible as a cost of doing business [par. 18(1)(a)]. 5. The repairs to the outside of the building are deductible as a cost of doing business as long as they are not enhancing the value of the building [pars. 18(1)(a), (b)] and the costs of landscaping are specifically allowed [par. 20(1)(aa)]. 6. The interest on the municipal taxes is a cost of doing business [par. 18(1)(a)]. 7. The severance payments are deductible as a cost of doing business [par. 18(1)(a)]. 8. Theft by an employee is an inherent risk for most businesses and as such the theft usually is a deductible business expense [Income Tax Folio S3-F9-C1, par. 1.37 and Cassidy’s Limited v. M.N.R., 89 DTC 686 (T.C.C.)]. 9. Sponsoring of the local theatre company and sponsoring of the little league teams are deductible as a cost of doing business [par. 18(1)(a)] as long as they are reasonable in the circumstances. [See No. 577 v. M.N.R., 58 DTC 307 (T.A.B.), and No. 601 v. M.N.R., 55 DTC 128 (T.A.B.).] 10. The costs of the staff holiday party and summer barbeque is exempt from the 50% limitation for meals and entertainment [par. 67.1 (2)(f)], to the extent that these occasional events do not exceed six times in a year. 11. The interest earned on the cash on hand is considered business income if the income is incidental to the business. The funds were only held for a short time and related to payments on contracts [sec. 9]. 12. The interest and penalties on the income tax instalments is not a deductible expense [par. 18(1)(t)]. However, the expense has been recorded as part of income tax expense. Therefore, it has already been added back to income as part of the income tax expense addback. No further adjustment is required.

Solutions to Chapter 4 Assignment Problems

—NOTES TO SOLUTION (1) RPP [par. 20(1)(q) and ssec. 147.2(1)] President Least of: (a) Employer plus employee RPP contributions ............. (b) Money-purchase limit for 2023................................. (c) 18% of compensation ................................................ Least amount .................................................................. Less: employee and employer contributions........................... Amount to be added back (exc ess of actual over deductible)

34,050 31,560 45,000 31,560 34,050 2,490

Vice-President $

20,500 31,560 27,000 20,500 20,500 Nil

Accountant $

10,800 31,560 12,600 10,800 10,800 Nil

(2) Generally accepted accounting principles require the accrual of the expected payments under the early retirement package if the probability of the payment is likely and the amount can reasonably be estimated [CICA Handbook ASPE Section 3290]. A reserve for a contingent liability is disallowed for tax purposes [par. 18(1)(e)]. The deduction will be allowed for tax purposes when there is a legal obligation to pay the amount under the package.

Introduction to Federal Income Taxation in Canada

Solution 15: Income From Business With Home Office Note to instructors: The following changes were made to the question: •

Sales revenue – increased to $105,000

•

Travel meals increased to 2,500 from 1,500

•

Amortization increased to $5,800from 3,800

Net loss before tax for accounting purposes Add: disallowed deductions (Note 1): Provision for returns (subparagraph 12(1)(a)(ii)) Non-deductible portion of travel meals (Note 2) Non-deductible car expenses (paragraph 18(1)(a)) (Note 3) Health club dues (paragraph 18(1)(l )) Nanny expenses (paragraphs 18(1)(a),(h)) (Note 4) Non-deductible portion of entertainment (Note 2) Renovation costs (paragraph 18(1)(b)) (Note 5) Straight-line amortization (paragraph 18(1)(b)) Home office expenses (paragraph 18(1)(b)) (Note 6) Less: allowable deductions: Bad debts expense (paragraph 20(1)(p)) Business income

($4,500) $1,200 1,250 653 2,200 12,000 900 21,200 5,800 1,400

46,603 (380) $32,223

Notes: 1. The private dental plan expenses are for the staff and hence, are deductible as compensation. 2.

Subsection 67.1(1) only allows a deduction of 50% of meal and entertainment expenses.

Only business portion deductible: ((5,000/18,000) × $2,350).

Wynn’s child care expenses are not deductible in the computation of business income for tax purposes. He would, however, be entitled to take a child care expense deduction on his personal tax return in determining his overall net income.

This is an outlay on account of capital, therefore, it is not deductible against current income. The amount is added to the relevant CCA pool.

Wynn does not qualify for home office deductions due to the restrictions under subsection 18(12), because it is not his principal place of business and he does not use it to continuously meet clients.

Solutions to Chapter 4 Assignment Problems

Solution 16: Schedule 1 Reconciliation Note to instructors: The following changes were made to the question: •

Sales revenue – increased to $955,000

•

R&D was increased to $75,000 from $65,000

•

Amortization was increased to $40,000

•

Company’s RPP contribution was increased to $7,500

Note that the financial statements presented in the problem are unaudited and, hence, may not follow ASPE. $ 313,000 Net income after taxes per income statement Add: Provision for income taxes .......................................................... $ 52,000 Payment to registered pension plan in excess of $5,820 (i.e., (18% of $74,000) – $7,500) deductible in 2023 ($7,000 – $5,820)(1)............................................................................... 1,680 Warranty reserve on company’s product(2) ................................... 16,000 Depreciation expense.................................................................... 40,000 Cost of shareholder agreement (an expenditure of a capital nature pertaining to the sale of shares by shareholders)(3)..... 8,500 10,160 Non-deductible issue expense (4/5  $12,700)(4) ........................... Golf club membership fees ........................................................... 2,200 Donation to United Way (not deductible from business income) . 3,000 Non-deductible portion of meals and entertainment (50% of $4,000).................................................................................. 2,000 Appraisal fee (an expenditure of a capital nature) ........................ 6,200 Life insurance premium (does not earn income)........................... 2,800 Unpaid management bonuses(5) .................................................... 20,000 Amortization of bond discount(6) .................................................. 3,400 Interest and penalties .................................................................... 1,250 Net income from business and/or property for tax purposes......................................

Pars. 18(1)(e), (t) Par. 20(1)(q) Par. 18(1)(e) Par. 18(1)(b) Par. 18(1)(b) Par. 20(1)(e) Par. 18(1)(l) Par. 18(1)(a) Sec. 67.1

169,190 $ 292,190

Par. 18(1)(b) Par. 18(1)(a) Ssec. 78(4) Par. 18(1)(b) Par. 18(1)(t)

Items not included in computation above: — Landscaping costs deductible [par. 20(1)(aa)]. — Interest on loan to buy shares deductible [par. 20(1)(c)]. — Interest on property taxes deductible as incurred to earn income [par. 18(1)(a)]. — Insurance proceeds to compensate for profits included [sec. 9]. — Dividends received are included in income from property [par. 12(1)(j)]. — Volume rebates and purchase discounts reduce the cost of goods sold as a part of normal business operations. —NOTES TO SOLUTION (1) The excess contribution would not be in violation of RPP registration requirements, since it was contributed in the first 120 days of 2024 and will likely be deductible in respect of 2023. 18% of the presidents net income of $74,000 ($13,320) is the lessor amount (2023 RPP limit is $31,560). (2) Paragraph 20(1)(m.1) permits a manufacturer to deduct prepaid insurance premiums paid to insure against risk under extended warranties sold to customers. The reserve must be in respect of goods to be delivered or services to be rendered under the warranty and cannot exceed the prepaid portion of the premium that was payable to an insurer that carried on an insurance business in Canada. The reserve in this case does not qualify. (3) The potential subsection 15(1) benefit to the shareholder is not considered in this problem. (4) One-fifth of legal and accounting fees deductible [par. 20(1)(e)]. (5) The amount of a bonus unpaid 180 days after the end of the employer’s fiscal period can only be deducted when it is paid and not when it was incurred. (6) A deduction for a bond discount is available within the limits of paragraph 20(1)(f) only at the earlier of redemption or maturity of the bonds when the amount is paid. Since no amount is paid, as required by paragraphs 18(1)(f) and 20(1)(f), the amortization is like a reserve which is denied [par. 18(1)(e)] or is considered to be on account of capital and denied [par. 18(1)(b)].

Introduction to Federal Income Taxation in Canada

Solution 17: Income Versus Capital, Soft Costs Issues (1) Determine if the first plot of land was purchased with the intention of selling it for a profit. (2) Assess whether the expenses relating to the second plot of land are deductible for tax purposes. Issue 1: Analysis The first plot of land is being reassessed by the CRA as business income rather than capital gain. This will increase the taxable income on the land by $45,000 ($90,000 × .50), the amount of the capital gain that was not taxable. The CRA and the courts will look at (at least) three factors in determining if Nine Iron Ltd. was engaged in an adventure or concern in the nature of trade with the land. (a) The number and frequency of the transactions. The courts will look at whether Nine Iron Ltd. has purchased land in the past and sold it for a profit, and if so, how often. This information in the question does not tell us about the past but does tell us that Nine Iron Ltd. purchased another plot of land in the same year. The purchase of that land is (purportedly) related to Nine Iron Ltd.’s main business of mini golf. The courts would probably find that the purchase of land is not a habitual event for Nine Iron Ltd., so the company would pass this test. (b) Nature of the transaction. This is where the courts will look at the purpose of the purchase and the reason for the sale. In this case, Nine Iron Ltd. purchased the land for development and sold it due to an investor backing out. This was an unforeseen event and any astute businessperson would look to the next best method of dealing with the land, including an immediate sale. The sale of land is not the adventure or concern in the nature of trade for Nine Iron Ltd.’s business, so it would pass this test. (c) Nature of the asset. Nine Iron Ltd. purchased the land with the stated intent of developing a retail outlet or, as a second option, a gas station with a park for RVs. A capital asset seems to have been intended. There was no intent to sell the land for a profit, as inventory, even though Ryan knew that the land would probably appreciate in value. Nine Iron Ltd. did not sell the property at its earliest profitable opportunity, but instead waited until an investor withdrew to sell the land. The purchase of the second property tends to confirm Nine Iron’s intent to use this first property as an asset for a new outlet or expansion of its business. This supports Nine Iron Ltd.’s intent to develop the property and so the company should pass this test as well. Conclusion On the basis of the above three tests, Nine Iron Ltd. was correct in qualifying the profits from the sale of the land as a capital gain and not business income. Issue 2: Analysis The second plot of land is under development but has not yet produced any income. The CRA has disallowed the deductions on the basis that they were not valid expenses incurred for the purpose of gaining or producing income. In other words, the property is being held for disposition as inventory and not for development in the eyes of the Department. The amount spent on architect’s fees and so on should be capitalized as part of the cost of the land to make it ready for business. The amount for interest and property taxes is deductible if the property is being used for gaining or producing income in the year in question. Since the land was not used to produce income in the year, the expenses are not deductible. Recommendation Nine Iron Ltd. should file a notice of objection with the CRA immediately in respect of the business income versus capital gain issue of part (a). It must also pay the assessment, even if disputed, to avoid further interest charges on unpaid amounts. Nine Iron Ltd. definitely owes the tax in respect of the disallowed expenses in part (b). The CRA will pay interest on money it collected in error.

Solutions to Chapter 4 Assignment Problems

Solution 18: Company Automobile—Impact on Employer Option 1: the company owns the car and pays the operating costs. The company can claim CCA on the value of the car up to $36,000. [ssec. 13(2)] The company can only claim the HST input tax credit based on the $34,000 not on the purchase price of $35,000. Therefore, they will lose the HST paid on the difference of $780 ($6,000 x 13%). The insurance and operating costs of $8,000 are fully deductible.

Option 2: the company leases the car and pays the operating costs. The company can claim a deduction for the lease costs of up to $900 per month based on a formula [sec. 67.3]. The company can only claim the HST input tax credit based on the deductible lease costs and not the actual. The insurance and operating costs of $8,000 are fully deductible.

Introduction to Federal Income Taxation in Canada

Solution 19: Stock Option—Impact On Employer Expense—Public Company or CCPC Stock Option The amount of the benefit under a stock option plan is not deductible to the company as it relates to the issuance of stock and is capital in nature. Both IFRS and ASPE call for the expensing of stock options at the time they are granted, so this will need to be added back on Schedule 1.

Solutions to Chapter 4 Assignment Problems

Solution 20: Employee Benefits—Impact on Employer Motion Tech 1.

A salary of $90,000 per year, payable by direct deposit on the last day of each month. a.

A bonus payable based on the year-end results of the company. The bonus would be up to $10,000. a.

Deductible when paid, payable or accrued

If the bonus is not paid within 180 days of the year end then it is not deductible at November 30th (and will need to be added back on the corporate tax return) but it will be deductible when paid.

Motion Tech has a defined contribution registered pension plan where Rishma and the company each contribute 6% of her salary. a.

These fees are not deductible – specifically disallowed [18(1)(l)]

The company will pay for Rishma to have her personal tax return prepared at a cost of up to $1,000. a.

The company can deduct this when paid, payable or accrued

Motion Tech will cover the annual dues for a fitness club up to a cost of $2,000 per year. a.

The company can deduct their contribution for November 30 th if it is paid within 120 days of the year end

Since she will have to move to Waterloo to take up this position the company will pay her an allowance of $15,000 to cover her moving expenses. a.

Deductible when paid, payable or accrued

This is deductible when paid, payable or accrued

The company provides a group health plan administered by Manulife, including eyeglasses. Rishma will pay about $200 per month and the company will pay about $800 per month. a.

Deductible when paid, payable or accrued

Introduction to Federal Income Taxation in Canada

Solution 21: Employee Benefits—Impact on Employer Auto Supply 1.

Free parking. a.

Wedding or birthday gifts. a.

Sales amounts included in income are lower by the amount of the discount, therefore effectively deductible

The company pays to provide financial counselling for all vice presidents including the preparation of their personal tax returns. a.

There is no direct impact on the company.

The company provides an employee discount of 24% on products sold by Auto Supply. a.

The cost of this prize is deductible.

The employee uses frequent flyer points for a personal trip. These points were earned as a result of business trips. a.

The cost of these gifts is deductible.

All-expense paid holiday won as part of a sales contest. a.

The costs related to providing the parking are deductible

The counselling costs are deductible.

The company will pay for annual professional dues for employees. For example, professional accountants and lawyers. a.

The costs of the professional dues are deductible.

Solutions to Chapter 4 Assignment Problems

Solution 22: Employed Versus Self-Employed Employment vs. Business Income Coco Hardy’s sewing service would appear to generate business income and not employment income. The characteristics noted below would suggest that she is not an employee. The Economic Reality Tests (a) The Control Test The facts suggest that Ms. Hardy is engaged to achieve a prescribed objective and is given all the freedom she requires to attain the desired result. The fact that she may perform the same services as an apprentice with her employer, does not mean that the services performed on her own time cannot be independent. (b) Ownership of Tools Test Ms. Hardy owns her own tools such as the sewing machine and provides the work space. (c) Profit\Loss Test She takes at least some financial risk in doing the sewing by incurring the direct costs. Ms. Hardy has agreed to perform a specific task for each particular clothing manufacturer instead of agreeing to be at their disposal on an ongoing basis. Comparison of Employment vs. Business Income from business for one year, assuming a reasonable expectation of profit: $ 7,200 Billings ($600 per month  12) ................................................................. Direct expenses [$6,025 - (50% of $500)]........................................................(5,775) Allocated costs (excluding home office) ........................................................ (1,975) Loss from business before home office costs ............................................ $ (550)

The CRA’s IT-514, paragraph 4 implies that a deduction for capital cost allowance on office furniture is not limited by subsection 18(12). Home office expenses from this year (allocated costs other than capital cost allowance) are, in effect, available for indefinite carryforward: Rent ($1,000 per month) ........................................................................... Utilities...................................................................................................... Insurance ................................................................................................... Allocation to sewing room ........................................................................

$ 12,000 2,100 400 $ 14,500  20%

$ 2,900

Comments: (1) All of the expenses listed (with the exception of 50% of the meal and entertainment expenses) should be deductible on the basis that they were incurred to earn business income as long as an argument can be made that Ms. Hardy has a reasonable expectation of profit. — While an expenditure need not actually result in income in a particular instance, there must be a reasonable expectation that the business will be profitable within a reasonable time. — Ms. Hardy is presently operating at capacity and has no business plan to show how increased billings could be achieved. Without a plan to increase her work volume or her hourly rate, she must be expecting to continue incurring a loss for the foreseeable future. Ms. Hardy does not appear to have a reasonable expectation of profit. Thus, her excess expenses and allocated costs are not deductible for income tax purposes. — Consequently, the excess expenses and allocated costs will be considered to be personal or living expenses as defined in subsection 248(1). Paragraph 18(1)(h) will deny a deduction for such amounts. — However, the capital cost allowance of $1,975 may be deductible even if it creates a business loss. The preamble to subsection 20(1) includes the phrase “notwithstanding paragraphs 18(1)(a), (b) and (h) ” This may indicate that a deduction for capital cost allowance in subsection 20(1) overrides the limitation in paragraph 18(1)(h).

Introduction to Federal Income Taxation in Canada

(2) Home office expenses, as part of the determination of income from business, must also meet the conditions set out in subsection 18(12). Had there been a reasonable expectation of profit, the home office expenses should have been deductible [spar. 18(12)(a)(i)] as the home office is Ms. Hardy’s principal place of business, but would have been required to be carried forward as they would have increased a loss. Based on the wording in paragraph 18(12)(c), the $2,900 of home office expenses should have been available for indefinite carryforward. (3) It was determined in this problem that Ms. Hardy was earning business income. However, had she incurred the same expenses and allocated costs as part of her employment and had been required by the terms of her employment to maintain an office in her home, the impact on employment income would have been as follows: Employment income ($600  12)........................................................................................................ Deductions: Sewing supplies [spar. 8(1)(i)(iii)]........................................................................... $ 2,890 Delivery [pars. 8(1)(h), (h.1)] .................................................................................. 1,500 Automobile (CCA) [par. 8(1)(j)] ................................................................................. 1,200 Income before home office expenses Less: home office expenses per ssec. 18(13): Rent [spar. 8(1)(i)(ii)] .............................................................................................. $ 12,000 Utilities [spar. 8(1)(i)(iii), IT-352R2] ...................................................................... 2,100 Insurance [IT-352R2, par. 6] ....................................................................................... Nil $ 14,100 Allocation to sewing room ..............................................................................................  20% Employment income ...........................................................................................................................

$ 7,200

5,590 $ 1,610

2,820 Nil

The excess home office expenses of $1,210 (i.e., $2,820 - $1,610) would be available for carryforward [par. 8(13)(c)]. Presumably, the employer would reimburse the employee for other costs such as the meals and entertainment of $500, the long distance telephone calls to manufacturers of $710, and the sewing machine repairs of $425.

Solutions to Chapter 4 Assignment Problems

Solution 23: Sales Expenses of Employee or Self-Employed Please note that since Peter lives in Saskatchewan, the HST does not apply, but PST and GST do. Notes on restriction of deductions as an employee: — Total deductible home office expenses cannot be used to create a loss from employment income [ssec. 8(13)]. However, any excess can be carried forward against employment income, in effect, indefinitely. This loss limitation rule will not have an effect in this particular case since total deductible expenses do not exceed remuneration. However, one of the following conditions must be met: (a) the home office must be the place where the individual principally performs the duties of the office or employment, or (b) the home office was used exclusively and on a regular and continuous basis for meeting customers in the ordinary course of performing the duties. Since Peter uses one room in his home exclusively as a home office, uses the office most days and evenings, and visits his office at work only once a week, spending the rest of the time on the road, it appears that condition (a) is met because his home office is the place where he “principally” performs the duties of the office or employment. This assumes that his duties are considered to be performed principally from his home office and not principally from either his office at work or on the road. If it can be argued, based on the facts of the situation, that his duties are performed principally on the road, then neither condition (a) nor (b) is met and no home office expenses are allowed. — Mortgage interest, capital cost allowance on computer and interest on loan to purchase computer are outlays on account of capital which are not deductible in computing employment income [spar. 8(1)(f)(v)]. Subparagraph 8(1)(f)(v) does not permit the deduction of outlays of a capital nature except as described in paragraph 8(1)(j). The only amounts permitted under paragraph 8(1)(j) which are applicable, in this case, are capital cost allowance and interest on a car. — Utilities and maintenance and repairs all qualify as supplies under paragraph 8(1)(i), but house insurance and municipal taxes do not [IT-352R2, paragraph 5]. — House insurance, municipal taxes, and the rental of the photocopies and fax machine are only deductible under paragraph 8(1)(f). — Long distance telephone calls are deductible under subparagraph 8(1)(i)(iii) as supplies [IT-352R2, par. 9(d)]. — Section 67.1 restricts the deduction for entertainment to 50% of the amount incurred. This applies to the theatre tickets. — Meals (limited to 50%) are deductible. However, subsection 8(4) denies the deduction for meals consumed by an employee unless the employee incurs these expenses while performing his/her employment duties, for a period of not less than 12 hours, away from the municipality where his/her employer’s establishment is located and where he/she ordinarily reports for work. — The country club membership ($3,200) is not deductible because paragraph 8(1)(f) does not allow the deduction of expenses referred to in paragraph 18(1)(l). — Travelling expenses re car: because only 32,000 km out of the 40,000 km driven are employment-related, only 80% of the car expenses are deductible with the exception of the cellular phone airtime and parking expenditures which are 100% employment-related. These amounts are deductible under paragraph 8(1)(h.1) or 8(1)(f), except for the cellular phone airtime which is deductible under subparagraph 8(1)(i)(iii) as supplies per IT-352R2, paragraph 9(d). — The maximum CCA claim is restricted to the CCA on $34,000 (2022 acquisition) plus GST (5%) and PST (6%). 80% of the CCA claim is deductible [spar. 8(1)(j)(ii)]. Notes on restriction of deductions as a proprietor: — The home office restrictions in subsection 18(12) are very similar to the rules in subsection 8(13). Home office expenses cannot be used to create a loss but any excess can be carried forward, in effect, indefinitely. Subsection 18(12) only allows the deduction of home office expenses in the computation of business income if one of the conditions in subparagraphs 18(12)(a)(i) or (ii) are met. These conditions are very similar to the conditions in subparagraph 8(13)(a)(i) and (ii) as outlined above for an employee. — The home office expenses as a self-employed person are not restricted to deductions in section 8 — therefore the mortgage interest, the CCA on the computer and the interest on the computer loan are allowed. Peter could deduct capital cost allowance on office portion of the house (the amount is not given in the question), but it is not advisable since it would disqualify that portion of the house from a principal residence exemption. (See Chapter 7) — Subsection 20(10) allows a deduction for up to two conventions in locations which are consistent with the territorial scope of a business. There is not a similar rule ot allow this deduction for employees.

Introduction to Federal Income Taxation in Canada

COMPARISON OF INCOME for Mr. Peter Rajagopal Employed Home office: Utilities (10%  $3,100) ............................... Mortgage interest(2) (10%  $12,000)........... House insurance(2) (10%  $1,150)............... Municipal taxes(2) (10%  $3,050)................ Maint. and repairs (10%  $2,700) ............... CCA on computer ($6,900  15%) ............... Rental of photocopier ................................... Rental of fax machine................................... Office supplies.............................................. Interest on computer loan ............................. Telephone: Long distance calls ....................................... Promotional expenses: Meals (with clients) (50%  $2,100) ............ Peter’s meals (50% x $2,000) ....................... Theatre (50%  $1,200)................................ Promotional gifts .......................................... Country club membership............................. Automobile expenses: Gas & oil (.8  $2,000)................................. Insurance (.8  $1,100)................................. Licence (.8  $90)......................................... Repairs (.8  $800) ....................................... Cellular phone airtime .................................. Parking.......................................................... CCA on car(3)................................................ Interest on loan (.8  $800) [under employee limit of $300/mo.] ........................ Other travel expenses: Airfare .......................................................... Accommodation ($4,960 – $2,400) .............. Meals (50%  $2,400) .................................. Convention (excl. meals) .............................. Meals and entertainment ($3,200  50%)..... Total ..................................................................... Limit ..................................................................... Deduction(5) ..........................................................

$ $

310(1) — 115 305 270 — 1,200 200 750 —

Proprietor $

310 1,200 115 305 270 1,035 1,200 200 750 320

Differences

— 1,200 — — — 1,035 — — — 320

1,000

—

1,050 — 600 1,300 —

1,050 1,000 600 1,300 —

— 1,000 — — —

1,600 880 72 640 700 320 13,586

— — — — — — (360)

640

—

4,520 2,560 1,200 — 1,600 34,820 None(6) 36,418

4,520 2,560 1,200 800(4) 1,600 38,175 None(6) 39,773

— — — 800 — 3,995 None(6) 3,995

$ $

—NOTES TO SOLUTION (1) Deductible [spar. 8(1)(i)(iii)], as explained in IT-352R2, par. 5. (2) Based on the case of Felton v. M.N.R., 89 DTC 233 (T.C.C.), and concurred with in The Queen v. Thompson, 89 DTC 5439 (F.C.T.D.), mortgage interest, municipal taxes, and house insurance are not deductible by an employee as office rent under subparagraph 8(1)(i)(ii). (See also IT-352R2, paragraph 6, which indicates that taxes and insurance are deductible under paragraph 8(1)(f).) (3) For an employee, the CCA would be $13,586 (32,000/40,000  $34,000  1.11  30% x 1.5). Note immediate expensing does not apply because it was not taken in the year it became available for use, 2021. Peter would receive a GST rebate in 2022 for all his deductible expenses except the car CCA and car insurance with an offsetting income inclusion of 5/105 of the same amount. As a sole proprietor and a GST registrant, he would receive an ITC for all his expenses except the CCA and car insurance. The CCA would be $11,586(32,000/40,000  $34,000  1.11 x 30% x 1.5). To receive an ITC on the car purchase, he would need to be using the car 90% or more for commercial use in the business. He can however claim an ITC equal to $660 (32,000/40,000 x 5/105 x 34,000 x 1.11 x 30% x1.5). Note that immediate expensing of the first $1.5 Million of eligible capital purchases would not apply as Peter is not incorporated as a CCPC.

Solutions to Chapter 4 Assignment Problems

Capital cost allowance and interest on car, deductible under paragraph 8(1)(j), and certain office costs and supplies deductible under paragraph 8(1)(i), (IT-352R2, pars. 5 and 9) are not restricted by the amount of commission income. The restriction applies only to amounts deductible under paragraph 8(1)(f). (4) Note that the provisions in sections 18, 19, and 20 pertain to expenditures including convention expenses deductible from income from business. However, the deduction of such expenditures is far more restricted in subsection 8(1) and, while convention expenses are allowed by subsection 20(10), convention expenses would not be allowed by any of paragraphs 8(1)(f), (h), (h.1), or (i). Note that only 50% of the cost of meals consumed at a convention is deductible, where the cost of meals is known; otherwise 50% of $50 or (i.e., $25) per day is deductible. (5) Neither of the deduction limits in subsections 8(13) or 18(12) applies in this case, because there will not be an employment or a business loss. (6) Deductions under paragraph 8(1)(f) cannot exceed renumeration based on volume of sales, like the bonus in this case. However, in this case all deductions total less than the $35,000 of that type of remuneration.

Introduction to Federal Income Taxation in Canada

Solution 24: New Job Offer—Employee and Employer Explanation of Tax Implications Note #

Employee Benefit Salary

Employee Tax Impact Taxable to employee

Employer Tax Impact Deductible as compensation expense if paid within 179 days of year-end

Bonus

Taxable to employee

Deductible as compensation expense if paid within 179 days of year-end

Interest-free loan Moving cost reimbursement Group life insurance plan premiums

Imputed interest taxable benefit Not taxable to employee Taxable benefit to employee

No impact for employer Deductible as business expense Deductible as compensation expense

Not taxable to employee

Deductible as compensation expense

4 5

Private health, dental, and drug plan premiums Spouse's travel expenses Automobile standby charge

Taxable benefit to employee $6,800 taxable benefit to employee

6 7

Automobile operating benefit Fitness club access Physical health counseling services

$3,360 taxable benefit to employee Not taxable to employee Not taxable to employee

May not be deductible by employer Lease cost deductible as business expense to a specified limit Deductible as business expense Not deductible for employer Deductible as compensation expense

RPP contributions

Not taxable to employee

Yacht access

Taxable benefit to employee

Specified amount deductible by employer if paid within 120 days of year-end Not deductible for employer

Salary and Bonus The full amount of Valerie’s salary, wages, and other remuneration, including bonuses, received in the calendar year are included in the computation of her income from an office or employment under subsection 5(1) for that particular calendar year. A bonus tied to performance in respect of one calendar year, but paid in the following calendar year, is taxed only in the year it is received. Salaries, wages, and other remuneration paid to Valerie by Key are considered expenses incurred to earn profit from the business under subsection 9(1) and not denied under paragraph 18(1)(a) as not incurred for the purpose of gaining or producing income from the business. Therefore, it is deductible. These amounts, including the bonus, must be paid to Valerie within 179 days after the firm’s taxation year to be deductible by Key or they become deductible in the taxation year in which they are actually paid [subsection 78(4)]. Interest-Free Loan This creates a taxable benefit annually equal to the amount by which the prescribed interest on the loan exceeds the actual amount of interest paid on the loan in respect of the year up to 30 days after the end of the year [ssec. 6(9), 80.4(1)]. Because the loan is interest-free, the benefit is equal to the prescribed interest. Since the loan will be used by Valerie to buy a home, the prescribed rate used to calculate the taxable benefit, for five years, will not exceed the prescribed rate in effect at the time the loan is made [ssec. 80.4(4)]. Subsection 80.4(6) deems the loan to be renewed every five years at the prescribed rate in effect on that five-year anniversary date. The home loan results in no tax implications to the employer, since it neither paid nor received interest on the loan. If the company had to borrow to fund the loan then the interest expense would be deductible as a compensation-related expense. Reimbursement of Moving Costs This is not considered to be a taxable benefit by administrative policy [IT-470R]. Typically, a reimbursement allows an employee who paid an expense to recover an amount that is the business expense of the employer. The reimbursement would reduce the amount the employee can claim as a moving expense under section 62. Group Life Insurance and Health Services Employer-paid premiums to group term life insurance and health services plans (including health, dental, and drug plans) are specifically exempted from inclusion as a fringe benefit in calculating income from an office or employment under subparagraph 6(1)(a)(i). However, this exemption is overruled for group term life insurance

Solutions to Chapter 4 Assignment Problems

premiums by subsection 6(4), which states that the full amount of these specific premiums paid on an employee’s behalf is to be included in the income calculation as a taxable benefit. Key will be able to deduct the full amount of premiums paid as compensation expense. Spousal Travel Amounts paid in respect of Matt’s travel are considered a taxable benefit to Valerie under the general rule that benefits of any kind are taxable as employment income, unless otherwise exempted [par. 6(1)(a)]. Expenses relating to Matt’s travel may not be deductible by Key, as they may not be considered to have been incurred for the purpose of gaining or producing income from the business [par. 18(1)(a)] or they may be considered to be personal or living expenses [par. 18(1)(h)]. However, it may also be argued that this is part of the normal compensation package and therefore deductible by the employer. Automobile Valerie will receive both a taxable operating cost and standby charge benefits with respect to the automobile. The standby charge (capital benefit) is taxable under paragraph 6(1)(e) and is calculated using the formula in subsection 6(2). Since the automobile is not used primarily (more than 50%) in the performance of employment duties, the operating benefit is calculated using the “kilometre method” presented in subparagraph 6(1)(k)(v). The calculation of the income inclusions is as follows: ITA 6(1)(k) Operating benefit 20,000 km x 33¢ $ 6,604 ITA 6(1)(e) Standby charge: ITA 6(2) 2/3 x $950 x 12 months 7,600 $14,200 All operating expenses paid during the year in respect of the car are deductible as a compensation expense by Key. The cost of leasing the BMW will be deductible by Key as well up to the limit allowed by the calculations outlined in section 67.3, which is $950 plus HST on the $950. Fitness Club By administrative policy (IT-470R), the benefit derived by an employee, through use of employer-provided recreational facilities, is not normally taxable. Recreation club expenses or dues are specifically excluded from being deducted by Key under paragraph 18(1)(l). Health Counselling The value of any benefit received by Valerie relating to counselling services in respect to her physical health is specifically exempted from being a taxable benefit under clause (6)(1)(a)(iv)(A). The expenses incurred by Key in respect of physical health counselling will be deductible as compensation expenses. RPP Contributions By exception to the general rule on benefits, RPP contributions are not taxable when they are contributed to the plan (spar. 6(1)(a)(i)). Both the contributions and the investment returns on the contributions remain non-taxable until the year which they are paid out to Valerie. The payments to the RPP by Key are deductible under paragraph 20(1)(q) to the extent that they are paid to the RPP within 120 days after the end of the taxation year and do not exceed an amount that is in accordance with the plan as registered [par. 147.2(1)(a)], equal to the lesser of: a) the money purchase limit for the year as defined in subsection 147.1(1), and b) 18% of the employee’s compensation as defined in subsection147.1(1).

100

Introduction to Federal Income Taxation in Canada

Company Yacht The use of the company yacht by Valerie would give rise to a taxable benefit, under the general rule of paragraph 6(1)(a), equal to the cost that she would have paid to an independent third party for its use, less any expenses paid by her in respect to its operation while in her use. Expenses relating to the use or maintenance of a yacht cannot be deducted by Key as these expenditures are explicitly disallowed for tax purposes by subparagraph 18(1)(l)(i) Assuming Valerie moves from Alberta to Ontario sometime during the calendar year, she will be subject to Ontario provincial tax rates as her province of residence will be Ontario on December 31. Tax-Related Compensation Issues In general, when designing a compensation package, the objective is to maximize the after-tax benefit received by the employee, while minimizing the after-tax cost to the employer. Benefits that are not subject to tax when received by the employee, but that are still deductible by the employer, are ideal as long as the benefit is of value to the employee. Premiums paid to a group health or dental plan and certain counselling services are popular examples of this type of benefit. Conversely, benefits that are taxable when received by the employee but that cannot be deducted for tax purposes by the employer are less attractive, especially when the benefit is of little or no value to the employee. Access to a company yacht is an example of these benefits. As already mentioned, one thing to consider when designing a compensation package is the overall value that the employee will derive from the individual components of the package. Employees are likely to value any benefit that covers an expense that they would have incurred themselves using their after-tax income. Employers can provide a number of benefits such as subsidised meals or discounts on their products and services that will not give rise to a taxable benefit for employees, as long as they pay an amount sufficient to cover the employer’s costs. Timing is another important issue to consider in designing a compensation package. Remuneration in the form of wages, salaries, and bonuses must be paid to an individual no later than 179 days after the end of the fiscal year or the company will be unable to deduct the related expense in that fiscal year. The impact that these payments have on a company’s cash flows needs to be considered. Stock bonus plans are a popular way that companies can reward employees for their service with no up-front cash cost. The Income Tax Act makes a distinction between regular salaries and wages and commission income in determining the deductibility of employment-related expenses by the employee. Because of this distinction, the introduction of a commission element to an employee’s compensation package may be to his or her benefit, as long as they meet the following restrictions imposed by paragraph 8(1)(f) of the ITA: • The employee must be involved in selling property or negotiating contracts. • The employee must be required to pay his or her own expenses as stipulated in the contract of employment. • The employee must be ordinarily required to carry on the duties of the employment away from the employer’s place of business. • At least a part of the employee's remuneration must be dependent on volume of sales or contracts (like a commission). • A non-taxable travel allowance cannot be received. Where an employee meets these conditions, paragraph 8(1)(f) allows for the deduction of all expenses incurred during the year for the purpose of earning employment income (limited to the amount of commission income earned) except for expenses relating to capital expenditures or those relating to recreational clubs as outlined in paragraph 18(1)(l). Employees who do not meet the conditions of paragraph 8(1)(f) are limited to the allowable deductions for travel and motor vehicle expenses outlined in paragraphs 8(1)(h) and 8(1)(h.1), respectively, as well as any of the other applicable deductions allowed in subsection (8)(1) that are not dependent on the type of income earned (like commissions).

Solutions to Chapter 4 Assignment Problems

101

Solution 25: Reassessment, Employee Compensation To: Samara c.c.: Eden Prospects Ltd. From: Adviser This memo is to inform you of the tax consequences of the items brought out by the CRA reassessment. The reassessment has raised the following issues: (1) Is the bonus declared in 2023 deductible for tax purposes? (2) How is the interest on the interest-free loan accounted for? (3) Is your relationship with Eden Prospects that of an employee or that of an independent contractor? (4) Are the expenses relating to the fishing lodge deductible? I will assume that Greater Prospects year end is December 31. The bonuses paid to Samara and the senior vice-president were not paid out within 180 days of the end of the year and, therefore, according to subsection 78(4), they are not deductible in 2023, although they are deductible in 2024 when paid. There will be an imputed interest benefit on the loans as a taxable benefit to the employees, pursuant to subsection 6(9). Eden Prospects will be able to deduct the $20,000 interest paid on its loan as an employment expense. The employees may be able to deduct their taxable benefit as interest expense against investment income, but this has nothing to do with the company. Samara’s status as an independent contractor through Sole Trust is being challenged by the CRA. The issue is whether Samara is really an employee. If she is, Eden Prospects was required to make the appropriate deductions for tax, EI, and CPP. The issue would be decided on the tests of employee versus independent contractor. Based on the limited information in the question, it would appear Samara and Sole Trust would fail all four tests — control, integration and organization, economic reality (risk borne), and specific results. Samara is an employee of Eden Prospects. Thus, the company is liable for any assessment for failure to deduct tax, EI, and CPP. The fishing lodge rental is denied under paragraph 18(1)(l). This is an explicit prohibition and could not be successfully challenged. Some corporations carry out corporate retreats in hotels and convention centres and the related expenses are successfully deducted. The meals and entertainment costs for clients are being restricted by the CRA under an explicit rule in section 67.1.

Introduction to Federal Income Taxation in Canada

102

Solution 26: Accounts Receivable and Warranty Claims Allowance for doubtful accounts •

The allowance has to be supportable if a deduction is to be allowed for income tax purposes. If the allowance is unreasonable it must be added back on the T2S(1) for tax purposes. Also, the allowance for tax purposes will usually be the same as for financial accounting so by maximizing the tax deduction you are also making the financial statements look worse.

•

It has to be a bad debt and not just allowed for to get an HST refund. In order to be a bad debt some effort must have been made to collect the receivable. It has to be more than just doubtful.

Exchange of goods for accounts receivable •

An entry will have to be made to set up the asset on the balance sheet and credit the accounts receivable.

Warranty claims •

As she repairs the valves the costs will certainly be deductible.

•

However, if she wants to set up a reserve for future warranty claims, this is a contingent liability [par. 18(1)(e)] and not deductible.

•

However, if she can establish that the liability is not contingent, then she could argue that expenses not yet spent are deductible. If she can identify the customers who have the problem with her valves, estimate the cost of repairing them and notify the customers, then she may have established and quantified the liability.

Set up a reserve for potential law suits •

This reserve would not be deductible for tax purposes, since the liabilities cannot be specifically identified and quantified.

Solutions to Chapter 4 Assignment Problems

103

Solution 27: Business Start-Up Costs This case deals with: • the start-up of a business, and • the form of ownership. 1. Opening party • Are the deductible costs limited to 50% [sec. 67.1]? • Who attended the party? If it was mainly for suppliers and customers, then it does not meet the exception in subsection 67.1(2). 2. When did the business start? [See IT-364: Commencement of business operations] • This determines when the expenses start to be deductible. • IT-364 states that “a business commences whenever some significant activity is undertaken that is a regular part of the income-earning process in that type of business or is an essential preliminary to normal operations”. • Market research is an essential preliminary. 3. Trip to California • This will not be deductible since there was no business being carried on at the time. • They were just searching for a business. 4. Expenses incurred before incorporation [See IT-454: Business transactions prior to incorporation] • The Canada Business Corporations Act and some provincial jurisdictions allow the company, within a reasonable time after it came into existence, to adopt any contracts made in its name or on its behalf before it came into existence. • If the jurisdiction of incorporation does not allow for this, then the CRA will allow the deduction by the corporation of pre-incorporation transactions if five conditions are met. (a) The facts clearly indicate that it is the intention of those persons who authorize the transactions in the situations described above that the business will be carried on by a corporation. This will usually be so where application for incorporation is made before or at the time the business is commenced or purchased. (b) The period of time between the commencement or purchase date and the incorporation date is relatively short or, if not, the delay is not due to any action taken or not taken by the parties involved. (c) There is no dispute between the persons authorizing the transactions and the newly formed corporation as to who will account for the transactions. (d) The effect on the combined tax liabilities of the parties involved is negligible. (e) The corporation adopts any written contract made in its name or on its behalf before it came into existence in respect of the pre-incorporation transactions it is accounting for. • eleven months may be too long a period to accumulate pre-incorporation transactions 5. Partnership alternative • Jordana and Noa could carry on business as a partnership and deduct the start-up losses against any personal income they might have. • Once the business becomes profitable, they could transfer the business to the corporation [ssec. 85(1)] to defer tax through the small business deduction. 6. Ownership of share capital or partnership interest • Noa is going to manage the business and Jordana is providing the capital. • How will they share the ownership if they want a 50/50 interest? • Jordana could take preference shares for his capital and receive dividends on these shares. They could then each have 50 common shares. • Jordana could loan the capital to the corporation with or without interest being charged. This way, he could get security on his loan. 7. Incorporation costs • These are deductible in the current year up to a maximum of $3,000. Expenses beyond $3,000 will be included in class 14.1 as goodwill.

104

Introduction to Federal Income Taxation in Canada

8. Financing costs • Deductible at 20% straight line over five years [par. 20(1)(e)]. 9. Leasehold improvements • Amortize over the term of the lease plus one renewal period [Class 13]. • Accererated Investment Incentive applies to the first year • Keep the initial term and renewal period less than 5 years in total to maximize the deduction. 10. Travel and entertainment expenses • Entertainment expenses limited to 50% [sec. 67.1]. 11. Purchase of assets • Inventory—deducted in the year it is sold. • Customer list—eligible capital expenditure. • Accounts receivable—the section 22 election should be made to allow the purchaser to deduct any losses on the collection of the accounts receivable as a business loss and not a capital loss. o Need to acquire at least 90% of the active business assets in order for the election to be available. • Equipment will be added to the CCA class to which it belongs. 12. Compensation • Noa is providing the labour and Jordana is providing the capital. • How will they each be compensated? • Jordana could receive dividends or interest on his capital as suggested above while Noa would receive a salary. o Jordana would have difficulty receiving a bonus since he is not active. • Consideration should be given to paying Jordana a guarantee fee for providing his guarantees. • Once the salary, interest and guarantee fees are paid they could share the extra profits as dividends. • If a partnership is used then the sharing of profits is much easier, all they have to do is agree between themselves. 13. Legal agreements • Either a shareholder or a partnership agreement is necessary.

Solutions to Chapter 4 Assignment Problems

105

Solution 28: Business income and expenses — implications to payor and recipient

Item Salaries Commissions

Gift

(A) Meshigoneh ded. [par. 18(1)(a)]: to earn income ded. [par. 18(1)(a)]: to earn income; accrual basis allowed by GAAP 2023: if not paid on or before June 28, 2024, not deductible until paid [ssec. 78(4)] Deductible – See Income Tax Folios S2-F3-C2

Fee

2023 ded. [par. 18(1)(a)]: to earn income

Bonuses

2022 incl. [ssec. 78(1)]: income in 2025 (unless election filed by June 30, 2025

2021 incl. [ssec. 78(1)]: income in 2024; (unless election filed by June 30, 2024)

(B) Recipient incl. [sec. 5]: remuneration not received in 2023; therefore, no employment income until 2024 [sec. 5] not received in 2023; not employment income until received [sec. 5] incl. [sec. 5] (included on T4) [par. 6(1)(a)]. Administrative policy treats gift certificates like cash and all cash and cash-like gifts are taxable. If it was not a cash-like gift and the total value did not exceed $500 for all such gifts for the year, it would not be taxable. not received in 2023; not included in property income if using cash basis not received in 2023; not included in property income if using cash basis (included as property income in 2024 if deemed [by election] to be paid on Jan. 1, 2024) not received in 2023; not included in property income if using cash basis (included as property income in 2023 if deemed [by election] to be paid Jan. 1, 2023) N/A

Bond amortization Redemption

not ded. [par. 18(1)(b)] capital outlay; add back ded. 1/2 [par. 20(1)(f)]: since discount> 3% on issue at $930,000; par. 18(1)(f) prohibits ded. of payments except above

proceeds of disposition of capital property (capital receipt)

Costs of issue

ded. [par. 20(1)(e)]: specifically allowed, but only 20% deductible over each of five years not ded. [par. 18(1)(b)]: capital outlay; add back but ded. CCA [par. 20(1)(a); Reg. 1100]; capital cost of automobile limited to $36,000 [par. 13(7)(g) and Reg. 7307]

business income to recipient [ssec. 9(1)]

$20,000 re undistributed catalogue is a prepaid expense not ded. [ssec. 18(9)] deduct $30,000 expense of distributed catalogues

incl. full $50,000 [par. 12(1)(a)]; ded. reserve for $20,000 (i.e., 40%) of services not rendered [par. 20(1)(m)]

Depreciation

Advertising

N/A; except benefit to president for personal use of car [pars. 6(1)(e), (k)]: 2% × 11 mo × ($42,500 + HST)

CHAPTER 5

The Capital Cost Allowance System For Depreciable Property, Including Intangibles Solution 1: Purchase and Sale of Assets

Memorandum Acme Inc. To: From: Date: Subject:

Controller Staff Accountant Month xx, Year xx CCA Calculations and Adjustments

The following are the calculations and the identification of adjustments that you requested. Immediate expensing doesn’t apply because the company is a public company. Schedule 8 CCA Calculations: Case

Class

Rate

Balance

CCA

Single Building

Note 1

$ 825,000

$(1,275,000)

$ (450,000)

Multiple assets

20%

30,000

(3,000)

27,000

5,400

Multiple assets

30%

20,000

(7,000)

19,000

5,700

10.1

Single auto

30%

13,000

1,950

6,000

$ 450,000

$ 13,050

Note: since there are no net additions, the accelerated investment incentive does not apply in this situation.

Identification of Necessary Schedule 1 Adjustments:. Add back: − Amortization is added back as it is not deductible for tax purposes − Recapture on the building is added − Taxable Capital Gains on the building $112,500 (50% x (1,500,000 – 1,275,000)are added − Accounting loss on the sale of Class 8 asset of $600 ($3,000 - $3,600) is added back − Accounting loss on the sale of Class 10.1 asset of $20,000 ($15,000 - $35,000) is added back Deduct: − Capital Cost Allowance is deducted in place of amortization − Accounting gain on building of $,600,000 ($1,500,000 - $900,000) on the sale of any asset is deducted − Accounting gain on sale of Class 10 asset of $2,500 ($8,000 - $5,500) is deducted to remove it.

107

Recapture

$ 450,000

Introduction to Federal Income Taxation in Canada

108

Identification of Necessary Schedule 1 Adjustments: Add:

Deduct:

Recapture on building Accounting loss on Class 8 asset TCG on Class 1 building TCG on Class 10 asset Accounting loss on Cl. 10.1 asset Accounting amortization TCG if any on land

$ 450,000 600 112,500 500 (20,000)

Accounting gain on building Accounting gain on Class 10 asset CCA Accounting gain if any on land

(600,000) (2,500) (13,050)

$3,000 - $3,600 50% x (1500000-1275000) ($8,000 - $7,000) x 50% ($15,000 - $35,000) Outstanding Outstanding $1,500,000 - $900,000 $8,000 - $5,500 Outstanding

$(71,950) Review of Tax Effects of Transactions and Identification of Missing Information: During the year it had the following transactions: 1.

Acme sold the building and moved into rented space. The company received proceeds of $1,500,000 for the building which had an original cost of $1,275,000 and a net book value of $900,000. a.

Credit the lower of cost and proceeds to the class and add recapture of $450,000 (UCC less the proceeds of disposition).

Deduct accounting gain of $600,000 ($1,500,000 - $900,000) to remove it from income for tax purposes.

The proceeds of disposition on the building are greater than the original cost, therefore a taxable capital gain will be included in income. The taxable capital gain is $112,500 (50% x ($1,500,000 $1,275,000)).

There must have been land sold as well so there is missing information. We would require the proceeds of disposition and the original capital cost in order to calculate the tax implications of the disposition.

Acme sold a class 8 asset for $3,000 which had an original cost of $6,500 and a net book value of $3,600. a.

Credit $3,000 to the pool and continue to claim CCA since there are still assets in the pool

Add back the accounting loss of $600 ($3,000 - $3,600).

Acme bought a class 10 asset for $6,000. The company also sold a class 10 asset for $8,000 which had an original cost of $7,000 and a net book value of $5,500. a.

Add $6,000 to the pool for the new asset purchased

Remove the lower of cost or proceeds (LCOP) of $7,000 from the pool. This leaves a balance of $19,000 before CCA. Accelerated CCA does not apply, since the disposals were greater than the additions. .

Solutions to Chapter 5 Assignment Problems

109

The class 10 asset was sold for proceeds greater than the original cost. There is a capital gain on the sale of $1,000. Note that the capital gains are covered in Chapters 7, so the students may not discuss this point yet.

Deduct the accounting gain of $2,500.

Acme sold the class 10.1 asset for $15,000 which had an original cost of $45,000 and a net book value of $35,000. a.

There is no recapture [13(2)] or terminal loss [20(16.1)] on class 10.1. CCA can be claimed on the opening balance for the year at ½ of the normal 30% rate in the year of disposition [1100(2.5)].

Add back the accounting loss of $20,000.

Missing Information −

Amortization

−

Details on the sale of land

Introduction to Federal Income Taxation in Canada

110

Solution 2: Leasehold Improvements

Memorandum Acme Inc. To: From: Date: Subject:

Controller Staff Accountant Month xx, Year xx Leasing Issues

What is included? New walls, electrical, plumbing or other structural changes to make the space accommodate them. Immediate expensing doesn’t apply because the company is a public company. Maximum CCA Deduction Leasehold improvements – $250,000 – Class 13 CCA in year 1 = lesser of: a. 1/5 of the capital cost of $250,000 = b. $250,000/(5+5) =

$50,000 $25,000

First year CCA = 1.5  $25,000 = Second and subsequent year CCA

$37,500 25,000

Final year CCA

12,500

Ideal Lease Term The ideal term would have been an initial term plus the renewal period totaling five, e.g., 1+4, 2+3, 3+2, 4+1. Then the deduction would have been $75,000 in the first year and $50,000 in the subsequent years and $25,000 in the final year. From a time value of money this has value. If Acme wanted more security, they could have a term of 2+3+10, giving them 15 years of comfort.

Solutions to Chapter 5 Assignment Problems

111

Solution 3: Luxury Automobile Note to Instructors: The corporate year-end was changed to December 31

Memorandum To: From: Date: Subject:

Tax Manager Accounting Associate Month xx, Year xx Seaforth Consulting Inc.

Immediate expensing doesn’t apply as the company is a public company. Impact on Seaforth Consulting

2019 Addition 2019 CCA 2020 CCA 2021 CCA

Class 10.1 2019 Car 2023 Car $30,000 (13,500) (4,950) (3,465)

2022 CCA Balance Addition 2023 Disposal

(2,426) 5,659

(30,000 x 1.5 x 30%) ((30,000-13,500) x 30%) ((30,000-13,500-4,950) x 30%) ((30,000-13,500-4,950-3,465) x 30%)

$36,000 Limit in 2023 is now $36,000

Add: Accelerated Investment Incentive CCA 2023 Closing balance

Limit in 2019 was $30,000

18,000 (50% x 36,000) (849) (1) -

(16,200) $19,800

(1)

(5,660 x 50% x 30%=849)

No terminal loss [20(16)] or recapture [13(2)] in year of disposal of Class 10.1 asset. Instead, calculate 50% of the normal CCA for the year [1100(2.5)] then close the class. HST ITC on $36,000 not $60,000 –> 13%  $24,000 = $3,120 lost. Company is eligible for the ITC of $4,680 (13% of $36,000_as the vehicle is used principally for commercial activities. For accounting purposes there is a book loss of $2,000 ($25,000 - $27,000) on the disposal of the 2019 car which should be added back on Seaforth’s Schedule 1. Impact on T4 for Judy 2023 – Judy’s T4 will have standby charge on the value of the new car of $60,000 + HST = $67,800. 1,900/20,004  ($60,000 x 1.13)  2%  12 months = $1,546. Operating benefit – Lesser of: 1,900 x $0.33 = $627 and ½ of standby charge $773(vehicle is used primarily in the performance of duties of office or employment.)

112

Introduction to Federal Income Taxation in Canada The company will have an HST remittance for the employment benefit ( a remittance is required when a full ITC is received on the $36,000 limit).

Solutions to Chapter 5 Assignment Problems

113

Solution 4: Goodwill in Class 14.1 (5%)

Memorandum To: From: Date: Subject:

Tax Manager Accounting Associate Month xx, Year xx Green Proprietorship

Health Food Proprietorship – purchase and sale of goodwill Immediate expensing isn’t available for a Class 14.1 property.

2023 Purchase 2023 CCA (5% x 80,000 x1.5) 2024 CCA

2025 CCA

2026 CCA

2027 CCA 5% 2028 UCC 2028 Sale (LOCP) (Recapture)\ Term. Loss Capital Gain (loss) (Proceeds - Cost)

$ 80,000 (6,000) $ 74,000 (3,700) $ 70,300 (3,515) $ 66,785 (3,339) $ 63,446 (3,172) $ 60,273

Proceeds $100,000

Proceeds $80,000

60,273 (80,000) (19,727) 20,000

60,273 (80,000) (19,727) $0

Results for 2028 −

Business income from recapture or business loss from terminal loss to report

Proceeds $40,000

15,068 (40,000) 20,273 $0

Introduction to Federal Income Taxation in Canada

114 Solution 5: Short Fiscal Year

Memorandum To: From: Date: Subject:

Tax Manager Accounting Associate Month xx, Year xx Farthing Proprietorship

Taxation Year of a Proprietorship (ITA: 249(1)(c) and CCA Proration (ITA: 11(1); ITR: 1100(3) The first fiscal period of the proprietorship business begins when Vicky started business activity, May 1, 2023 and ends on December 31, 2023. Subsection 11(1) indicates that the taxation year for proprietorship business income is the fiscal period. While Vicky is eligible for immediate expensing, Class 1 is not an eligible asset for immediate expensing. Therefore, the short fiscal year rule in ITR 1100(3) applies to prorate the CCA for a short fiscal period. CCA = $350,000  4%  1.5 x 245/365 = $14,096 This will be a Class 1 asset with a 4% rate, since the building had been used before purchase by Ms. Farthing. Taxation Year of a Corporation and CCA Proration The incorporation took place on May 1 so, with a December 31 year-end, it was only in existence for 245 days. As a result, it must prorate the CCA to reflect this short fiscal period. As Ms. Farthing’s corporation will be a Canadian-controlled private corporation, it would normally be eligible for immediate expensing. However, class 1 is not an eligible asset for immediate expensing, therefore CCA would be calculated as follows: CCA = $350,000  4%  1.5  245/365 = $14,096 This results in the same amount as for the proprietorship since the corporation was incorporated on May 1 and had a December 31, year-end. .

Solutions to Chapter 5 Assignment Problems

115

Solution 6: Available For Use

Memorandum To: From: Date: Subject:

Tax Manager Accounting Associate Month xx, Year xx Huang Manufacturing Inc.

Available for Use [13(26)] Although the equipment was received in 2023, it was not “available for use” until 2024. As a result, there is no CCA available in 2023 for this machine. In 2024, the machine would be added to Class 53. Class 53 in 2024 is eligible for full expensing at a 100% CCA rate. Immediate expensing is available for the corporation as it is a CCPC and Class 53 properties qualify but the result is the same. CCA = $500,000  100% = $500,000

Introduction to Federal Income Taxation in Canada

116 Solution 7: Asset Disposition

Memorandum To: From: Date: Subject:

Tax Manager Accounting Associate Month xx, Year xx Sylvia Fields

The contents of the letter to Sylvia should include the following. Your decision to sell your van and replace it with a leased van has a number of income tax implications. First, CCA class 10 balance is reduced by the lower of cost or proceeds, or $8,300. The balance of $2,514 becomes a terminal loss (subsection 20(16)), which is fully deductible in computing your business income on your personal tax return in the year of disposition.

UCC on van Disposition Lesser of cost or proceeds Terminal loss

$10,814 8,300 $2,514

Second, the lease payments are limited in deduction to $950 but may be further reduced depending on the MSRP which has not been provided. (assumes a full input tax credit for HST) The van was included in Class 10 because it doesn’t meet the definition of an automobile in subsection 248(1) i.e. a motor vehicle that is a van used all or substantially all to transport goods, equipment etc.

Solutions to Chapter 5 Assignment Problems

117

Solution 8: CCA Schedule a) Immediate Expensed Items Class 50 Computer equipment and software 8 Office furnishings 10 Delivery van 8 Chairs and tables 10.1 Automobiles 14 Licence to manufacture 13 Leasehold improvements Total of immediate expensed items

Cl 1-MB: 10% May to Dec 2023 Purchases: Manufacturing Building Manufacturing equipment Tools (costing under $500 Dies and moulds Customer lists Design software Dec. 31, 2023 UCC before adjustment Accelerated Investment Incentive UCC before CCA CCA prorated 245/365 days Jan. 1, 2024 UCC Disposals:

Cl. 10 30%

CCA Recapture Terminal loss Jan. 1, 2025 UCC

Cl. 12: 100%

Cl. 14.1: 5%

Cl. 53: 100% $

500,000 20,000 16,000 8,000 4,000 22,000 $

500,000 250,000

46,000

4,000 2,000

20,000

750,000 (50,342)

46,000 (30,877)

6,000 (201)

20,000 (20,000)

449,658

3,799

Automobile(1) Design Software Small tools Dec. 31, 2024 UCC before CCA

12,000 15,000 28,000 2,500 36,000(1) 30,000(2) 9,000 $ 132,500

(25,000) (18,000) (5,000) $

449,658

(25,000)

25,000

7,877

(7,877)

(44,966)

404,692

(190)

3,609

118

Introduction to Federal Income Taxation in Canada

— NOTES TO SOLUTION (1) The maximum cost for Class 10.1 is $36,000 (for 2023) plus HST [Reg. 7307(1)(b)]. HST would be a refundable ITC as vehicle is used primarily for commercial activities. When a class 10.1 vehicle is immediately expensed, the recapture or terminal loss rules apply on the disposition of a Class 10.1 vehicle. Since the vehicle was immediately expensed the year before, there would be recapture equal to the lower of the proceeds of disposition or $36,000. A standby charge and operating benefit will need to be determined for the sales manager’s T4 slip. An HST remittance will be required by the corporation for the benefits. (2) The $30,000 licence to manufacture, based on patented information, “Tax is a Microcosm of Life ” acquired on May 1, 2023, with a 3 year licence can be treated as: (a) a Class 44 asset or a (b) a Class 14 asset Either class is eligible for immediate expensing.

Solution 9: CCA on Change of Use [Note to Instructors: The purpose of this problem is to illustrate the application of the change-in-use rules on the calculation of capital cost allowance. It does not address the treatment of deductions for capital cost allowance in respect of rental property, nor does it address the principal residence exemption.]

Memorandum To: From: Date: Subject: 2021

2022 2023

Tax Manager Accounting Associate Month xx, Year xx Sale of Residence

Acquisition of depreciable capital property on January 20, 2021: Lesser of [par. 13(7)(b)]: (i) FMV of the property at January 20, 2021................................................................................. (ii) the total of: (A) original cost at the time of change in use........................................................... $ 580,000 (B) FMV of the property at January 20, 2021 .................................... $ 620,000 Less the original cost at the time of change in use .................... 580,000 Excess, if any ....................................................................... $ 40,000 ½ of the above excess, if any ..................................................................... 20,000 Lesser amount = UCC at January 20, 2021 ................................................................................... CCA claimed (½  $600,000  .04) [no short-year proration] .......................................................... UCC at January 1, 2022 ................................................................................................................ CCA claimed ($588,000  .04) ..................................................................................................... UCC at January 1, 2023 ................................................................................................................ Disposition of depreciable capital property on June 1, 2023: Lesser of: • FMV of the property at June 1, 2023 [par. 13(7)(a)]......................................... $ 605,000

$ 620,000

$ 600,000 $ 600,000 (12,000) $ 588,000 $ (23,520) $ 564,480

• capital cost ........................................................................................................ $ 600,000 lesser amount ................................................................................................................................. (600,000) UCC Balance before Recapture $(35,520) Recapture included in income ....................................................................................................... UCC Balance at January 1, 2024

(35,520) $0

Comments: The impact of the change-in-use rules on the calculation of a capital gain or loss on the building is as follows: January 20, 2021 disposition: Proceeds of disposition ...................................................................... $ 620,000 Adjusted cost base................................................................................... (580,000) Capital gain ........................................................................................ $ 40,000 June 1, 2023 disposition: Proceeds of disposition ...................................................................... $ 605,000 Adjusted cost base (January 20, 2021 proceeds) ..................................... (620,000) Decline in value (capital loss - not deductible) .................................. Note that we have ignored the change in use and disposition of the land for our above calculations.

107

15,000

Introduction to Federal Income Taxation in Canada

108

Solution 10: Class 14.1 (5%) Intangible Asset Transactions 2023

December 31, 2023 January 1, 2024 2024 December 31, 2024 January 1, 2025 December 31, 2025 January 1, 2026 2026 December 31, 2026 January 1, 2027

Purchase of band name

$56,000

Purchase of licence

25,000

UCC balance

$81,000

CCA @ 5% x 1.5

($6,075)

UCC balance

$74,925

Sale of licence (LOCP; CG = $1,000)

(25,000)

UCC balance

$49,925

CCA @ 5%

($2,496)

UCC balance

$47,429

CCA @ 5%

($2,371)

UCC balance

$45,057

Sale of band name (LOCP; CG = $4,000)

(56,000)

UCC balance

($10,943)

Recapture

10,943

UCC balance

Solutions to Chapter 5 Assignment Problems

109

Solution 11: Class 14.1 (5%) Intangible Asset Transactions Although Con-Glo is a CCPC, immediate expensing doesn’t apply to Class 14.1. 2023

Purchase of goodwill

68,000

Purchase of liquor licence of second restaurant Subtotal

2024 2025

CCA @ 5% x 1.5 x subtotal above

(7,789)

UCC balance at January 1, 2024

$96,061

CCA @ 5%

(4,803)

UCC balance at January 1, 2025

$91,258

Purchase of franchise 1

103,000

Subtotal

$194,258

CCA @ 5% x subtotal UCC balance at January 1, 2026 2026 2027

2028

CCA @ 5% x UCC balance

(9,713) $184,545 (9,227)

UCC balance at January 1, 2027

$175,318

Disposal of franchise (LOCP; CG = $7,000)

(103,000)

Subtotal

$72,318

CCA @ 5% x subtotal

(3,616)

UCC balance at January 1, 2028

$68,702

Disposals: Goodwill (LOCP; CG = $12,000)

(68,000)

Liquor licence (LOCP; CG = $24,150)

(35,850)

Subtotal

($35,148)

Recapture (business income inclusion)

2029

35,850 $103,850

35,148

UCC balance at January 1, 2029

Disposal of goodwill (LOCP; CG = $250,000)

($0)

UCC balance at January 1, 2030

—NOTE TO SOLUTION 1. Accelerated investment incentive no longer applies for purchases in January 1, 2024 to December 31, 2027, the half year rule would not apply either Since the Con-Glo goodwill was internally generated, no CCA was ever deducted, therefore no recapture would result from the sale of the balance of the restaurants in 2029. There would be a capital gain of $250,000. The costs incurred in 2025 with respect to the presentation to the liquor licensing board would be considered costs of representation and, therefore, fully deductible [par. 20(1)(cc)].

Introduction to Federal Income Taxation in Canada

110

Solution 12: Five Independent Issues (a) Janice has a terminal loss of $3,300 ($13,500 - $10,200) on selling her car, but she cannot claim this as subsection 20(16) does not apply to employees. (b) The building is a Class 1 asset and the CCA rate is 4%. Applying the accelerated investment incentive, Ramesh’s maximum CCA in the class would be the lower of: $34,500 (4% x $575,000 x 1.5 ($34,500), $32,000 (rental income before CCA). Ramesh cannot create a rental loss with CCA therefore the maximum he can deduction would be $32,000. As rent is property income and not business income, there is no proration for number of days, because the taxation year for the owner who is an individual is the full calendar year. (c) As each building cost in excess of $50,000, each is a separate class. Consequently, William will have a recapture on one but will be allowed CCA on the other: Class 1 UCC Disposition CCA/Recapture UCC

Bldg. 1 $345,000 — (13,800) $331,200

Bldg. 2 $345,000 (460,000) 115,000 $0

(lesser of cost/proceeds)

(d) Land is not a depreciable property. Colin is not allowed any CCA. (e) The building’s gross proceeds were $750,000 but Randi also paid legal fees of $15,000 on the sale of the property. The legal fees should be allocated between the land and building based on the selling price ratio. The proceeds of disposition for the land and building would be: Building P of D before legal fees

Legal fees Net P of D

750,000

Land $

11,250 $

738,750

250,000

Total $

3,750 $

246,250

1,000,000 15,000

985,000

Solutions to Chapter 5 Assignment Problems

111

Solution 13: CCA Schedule Immediate expensing is not available for the following CCA classes: 1 to 6, 14.1, 17, 47, 49 or 51. The following amount could be immediately expensed, up to a maximum of $1.5 million. Note that since this is a CCPC, it could create a loss with immediate expensing, although in this case a loss would not be created since the immediate expensing amount is lower than the business income before CCA.

Immediate Expensing Office Equipment Radio Equipment Leasehold improvements Distributing license Immediate expensed property

47,000 60,000 51,000 240,000 398,000

Cl. 1-MB:

Cl. 1:

Cl. 6:

Cl. 8:

Cl. 10:

10%

20%

30%

$ 39,000

$170,000

UCC, Jan 1/23

$568,000

Additions: Building

$1,300,000

Steel fence

$ 65,000

Disposals: Office equipment Building UCC, Dec. 31/23 before adjustment Accelerated Investment Incentive Adjustment UCC before CCA CCA or recapture for 2023 UCC for Jan. 1/2024

UCC, Jan 1/23

(1,950) (568,000)

$ 1,300,000

(1)

$ 65,000

650,000

$ 37,050

$170,000

$ 36,075

$170,000

32,500

$ 1,950,000

$ 97,500

(195,000)

(9,750)

(7,410)

(51,000)

$ 1,105,000

$ 55,250

$ 29,835

$119,000

Cl. 13

Cl. 14:

Cl. 14.1:

Cl. 17:

Cl. 53

100%

$ 165,000

$ 87,393

(1)

Additions: Parking lot

97,000

Manufacturing equipment

$255,000

Legal fees(4)

31,500

UCC, Dec. 31/23 before adjustment Accelerated Investment Incentive Adjustment

$ 165,000

UCC before CCA

$ 165,000

CCA or recapture for 2023 UCC for Jan. 1/2024

$ 87,393

$ 31,500 -

(23,600) $ 141,400

15,750

$87,393 (2)

(22,100) $ 65,293

$97,000

$ 47,250 (3)

$255,000

48,500 $

145,500

$255,000

(2,363)

(11,640)

(255,000)

$ 29,138

$ 85,360

Introduction to Federal Income Taxation in Canada

112 The maximum CCA that can be deducted is: Immediate Expensing Normal CCA * Total CCA in the year

$ 398,000 577,863 $ 975,863

* Normal CCA $577,863 ($195,000 + 9,750 + 7,215 + 51,000 +23,600 + 22,100 + 2,363 + 11,640 + 255,000). —NOTES TO SOLUTION (1)

Lower of cost ($1,400,000) and proceeds ($568,000); recapture of $0.

(2)

2021: lesser of

(a) (b)

2022: lesser of

(a) (b)

$81,600 5 $81,600 5+1

= =

$13,600

$100,000 5 $100,000 6+4

$20,000

$16,320 }

$13,600

}

$10,000

$10,000 $ 23,600

Total CCA (3)

Licences

$110,500 (5 x 365)**

365 days

$ 22,100 $ 22,100

Total ** Remaining days from April 22, 2021 (excluding leap year effects) of five-year licences. (4) Legal fees pertaining to the capital structure of the firm would be treated like incorporation costs as eligible capital expenditures. The first $3,000 may be deducted under 20(1)(b).

Solutions to Chapter 5 Assignment Problems

113

Solution 14: Immediate Expensing (a) $500,000 is a class 10 asset and is eligible for immediate expensing (b) The asset is a class 14.1 asset which is not eligible for immediate expensing (c) Immediate expensing is not available to public corporations (d) $100,000 is class 13 and is eligible for immediate expensing (e) Class 1 assets are not eligible for immediate expensing (f) $50,000 is a Class 10 asset and is eligible for immediate expensing and can be deducted up to the amount of income from the business. (g) $2.5 million is eligible for full expensing provisions provided by the accelerated investment incentives. Therefore, immediate expensing, which would limit the current year immediate expensing at $1.5 Million would not be applied.

Introduction to Federal Income Taxation in Canada

114

Solution 15: Schedule 1 Reconciliation and CCA Schedule Notes to Instructors: (1) The “Required” does not (on purpose) ask for closing UCC balances (because most problems of these type do not), so the solution does not do them in this case. (2) Most of the CCA calculations have been put in the reconciliation rather than the notes to simulate the calculations that students should do in this type of problem. The alternate tabular calculation is also presented.

Net income after income taxes ...................................................................................... Add: Provision for income taxes .................................................................................... Amortization.......................................................................................................... Reserve for future decline in the value of inventory .............................................. Increase in the reserve for warranty expenses........................................................ Donations to registered charities............................................................................ Golf club membership dues for the Vice-President of Sales.................................. Meals and entertainment at golf club (50%  $2,000) ........................................... Accrued bonus not paid until June 30, 2024.......................................................... Financing fees (4/5  $8,000) ................................................................................. Legal fees in connection with purchase of shares .................................................. Accounting software update for payroll tax information ....................................... Class 12: Recapture ($300 (software) – $500 (small tools)).................................. Bond discount amortization ...................................................................................

ITA Reference 9

$ 440,000

Deduct: Gain on disposal of property, plant and equipment ............................................... Capital cost allowance, etc.: Class 1-NRB (6%): CCA = $700,000 1.5  6% ................................................. Class 1 (4%): terminal loss = $200,000 – $180,000 Class 8 (20%): CCA = 20% of ($60,000 + 1.5  ($25,000 – $4,000)).................. Class 10 (30%): CCA = $80,000  30%................................................................ Class 13 (SL): (see Schedule 1) ............................................................................. Class 14.1 (5%); CCA = $100,000 x 1.5 x 5% Class 17 (8%): CCA = $20,000  1.5  8% ........................................................... Class 44 (25%): (see Schedule 2) ..........................................................................

400,000 80,000 15,000 11,000 4,000 1,500 1,000 23,000 6,400 5,000 300 200 2,000 $ 989,400

18(1)(e) 18(1)(a) 18(1)(e) 18(1)(e) 18(1)(a) 18(1)(1) 67.1 78(4) 20(1)(e) 18(1)(b) 18(1)(b) 13(1) 18(1)(f)

(40,000)

18(1)(b)

(63,000) (20,000)* (18,300) (24,000) (11,000) (7,500) (2,400) (7,500)

20(1)(a) 20(16) 20(1)(a) 20(1)(a) 20(1)(a) 20(1)(a) 20(1)(a) 20(1)(a)

$ 795,700

Alternate Tabular Calculation of CCA Cl. 1

Cl. 1-NRB

Cl. 8

Cl. 10

Cl. 12

Cl. 13

14.1

Cl. 17

Cl. 44

20%

30%

100%

25%

$60,000

$80,000

—

$37,500

—

UCC 1/1/23

$200,000

—

Purchases

— (180,000)

$700,000

25,000

—

$300

28,000

$100,000

$20,000

—

(4,000)

—

(500)

—

Disposals UCC 12/31/23

—

$20,000

$700,000

$81,000

$80,000

($200)

$65,500

$100,000

$20,000

Acc. Inv. Incent. Adjmt UCC before CCA

—

350,000

10,500

—

50,000

10,000

1,050,000

91,500

80,000

—

65,500

150,000

30,000

Recapture

—

200

CCA

—

(63,000)

(18,300)

(24,000)

—

(20,000)

—

$637,000

$62,700

$56,000

Terminal loss* UCC 1/1/24

— —

— (11,000)1 — $54,500

—

(7,500)2

(2,400)

(7,500)

—

$92,500

$17,600

$12,500

* Note to instructors: Subsection 13(21.1) will not apply because there is no capital gain on the land.

Solutions to Chapter 5 Assignment Problems

115

Notes (1) 2021 Improvements: Lesser of: (a)

5 capital cost:

$45,000 = $9,000 5

$45,000 capital cost = $5,000 = 4+5 remaining lease term plus first renewal option

(b)

The lesser amount is $5,000. 2023 Improvements: Lesser of: (a)

5 capital cost:

$28,000 = $5,600 5

(b)

$28,000 capital cost = $4,000 = 2+5 remaining lease term plus first renewal option

The lesser amount is $4,000. The CCA for 2023 is $4,000  1.5 = $6,000 The total CCA for the 2021 and 2023 improvements is $5,000 + $6,000 = $11,000. (2) The $20,000 licence to use patented information which expires June 30, 2033 can be treated as a Class 44 or Class 14 asset on an elective basis. The 2023 CCA in class 44 is $20,000  25% x 1.5 = $7,500. Class 44 treatment allows for a faster write-off and is automatic. Class 14 treatment, which is possible if a taxpayer elects [Reg. 1103(2h)] not to have Class 44 apply, allows for CCA claim computed on a straight-line basis over the 3,650-day life of the licences. The 2023 Class 14 claim would only be $20,000  184/3,650 X 1.5 = $1,512. The Class 44 CCA is, therefore, better. Class 44 treatment is therefore recommended. Items not Adjusted for in the Reconciliation: — $9,000 loss from a theft by warehouse employee is deductible according to Income Tax folio S3-F9-C1 par. 1.35 and Cassidy’s Limited v. M.N.R., 89 DTC 686 (T.C.C.). — $62,000 paid to employees on May 31, 2024 is paid before the 179-day deadline(1) in subsection 78(4) and is deductible providing there is a legal obligation to pay it. — A $15,000 year-end party for all employees is exempted from the 50% rule [par. 67.1(2)(e)]. — $18,000 of interest on bonds issued to buy shares in another company is deductible [par. 20(1)(c)]. — $50,000 of interest on the mortgage on the new plant is deductible [par. 20(1)(c)]. —NOTE TO SOLUTION (1) IT-109R2 paragraph 10 permits payment to be made on the 180th day without invoking subsection 78(4).

Introduction to Federal Income Taxation in Canada

116

Solution 16: Insurance and Damage Receipts Impact on taxable income for the current year:

Insurance receipts — business interruption Moving costs Lease cancellation penalty Impact on taxable income

$80,000 (12,000) (4,400) $ 63,600

The compensation payments will impact taxes based on the timing of their receipt and the proprietorship’s corresponding actions. The personal injury damage award will not affect the proprietorship as it is income exempt under paragraph 81(1)(g.1). The inclusion of the recaptured depreciation from both the truck and the leasehold improvements would normally be included in income. However, since this is an involuntary disposition of depreciable assets, the recaptured depreciation will be included in the same pool as the replacement assets, providing the assets are replaced before the end of the second taxation year following disposition. [Note: replacement property rules that allow a deferal of recapture and capital gains are discussed in detail in Chapter 8.] Correspondingly, the only insurance receipt that should be included in income is that for business interruption, as it represents income foregone because of the vandalism. Please note that recapture is included in income in the current year. If the assets are replaced by the end of the second year, the company will need to file an amended return to reverse the recapture inclusion in net income from a business. Class UCC, beginning balance Proceeds Recapture — income UCC, ending balance

10 $ 15,000 (30,000) (15,000) 15,000 $ 0

13 $ 10,000 (15,000) (5,000) 5,000 $ 0

When a business changes locations it can incur several expenses as is the case here. The moving costs can be deducted for tax purposes, as they represent a bona fide business expense. The lease cancellation penalty may also be deducted from income for tax purposes under paragraph 20(1)(z). Normally, the deductible portion of a lease cancellation penalty is prorated based on the remaining term of the lease. As mentioned above, leasehold improvements will be included in Class 13 capital assets. The expense that was determined for business interruption cannot be deducted from income, as it does not represent a real business expense but, rather, an estimate of foregone profits attributable to the inconvenience of the move. This estimate could be viewed as an opportunity cost of moving. Business-related expenses incurred during the shut down period would be deductible for tax purposes as incurred for the purpose of earning future income.

Solutions to Chapter 5 Assignment Problems

117

Solution 17: Purchase and Sale of Assets The main tax issues in this case relate to the acquisition of fixed assets, including goodwill. 1. Capital versus expense •

Are the repairs on the new equipment an expense or capital? [IT-174R]

• Would it make a difference if the repairs were carried out by employees of Dundas Holdings? [IT-174R] 2. Available for use •

Would the equipment be available for use by the end of the taxation year in which it was acquired and, thus, eligible for CCA? 3. CCA versus depreciation •

Printing presses are included in Class 8 — 20%. Subject to the accelerated CCA

•

As a sole proprietor, he would be eligible for immediate expensing, assuming the immediate expensing does not create a loss.

•

For accounting purposes, the presses will added to property, plant and equipment and depreciated over their useful life, i.e., five years for the used press they bought. 4. Luxury automobiles •

•

Special rules apply for luxury automobiles costing over $36,000 [par. 13(7)(g)] o Class 10.1—30% Subject to accelerated CCA. o CCA limited to $36,000 on the new car o If the new vehicle is a zero-emission vehicle, it would be in Class 54 – 100% full CCA deduction available for up to a limit of $61,000. o Limitation on interest [sec. 67.2] and leasing cost [sec. 67.3] No recapture [ssec. 13(2)] (unless immediate expensing applies) or terminal loss [ssec. 20(16.1)], but one-half of normal CCA for Class 10.1 when disposed of [Reg. 1100(2.5)], since conditions met

•

Recapture applies for Class 54 with a limitation applicable.

•

Immediate expensing would be available.

• Standby charge taxable benefit on full cost of car including HST, not just the $36,000 5. Goodwill •

Deduction for goodwill as Class 14.1 CCA at 5% Subject to accelerated CCA.

• Goodwill is not eligible for immediate expensing. 6. Incorporation If Bill incorporated the business before acquiring the assets of the competitor he could also immediately expense eligible assets. Note that corporations can create a loss with immediate expensing whereas a sole proprietor cannot. He would be able to fully deduct the cost of all of the assets purchased except properties that would be included in Classes 1 to 6, 14.1 (the goodwill), 17, 47, 49 and 51. 7. Asset purchase With an asset purchase Bill benefits from the tax shield on the properties acquired and deducted for CCA. The net present value of the tax shield can be determined and reduces his cost of purchase.

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118

Solution 18: Schedule 1 Reconciliation and CCA Net income (per Income Statement) ............................................................................................... Add: Provision for income taxes ................................................................................................... Contingent inventory reserves [par. 18(1)(e)]: 2023 ............................................................ Meals and entertainment ($11,500 × 50%)........................................................................... Golf club memberships [par. 18(1)(l)].................................................................................. Charitable donations [par. 18(1)(a)] ..................................................................................... Depreciation [par. 18(1)(b)] .................................................................................................

$460,000 300,000 40,000 5,750 10,000 5,000 29,000 $849,750

Deduct: Contingent inventory reserves [par. 18(1)(e)]: 2022 ............................................................ Gain on disposal of truck...................................................................................................... Capital cost allowance [par. 20(1)(a)]: Office equipment (Schedule 1).................................................................................. Trucks (Schedule 2) .................................................................................................. Leasehold improvements (Schedule 3): $3,750 + $1,500 ......................................... Intangible assets (Schedule 4) ................................................................................... Net income from business or property for tax purposes..................................................................

(25,000) (2,500) (8,600) (23,700) (5,250) (4,200) $780,500

Schedule 1: Office Equipment Class 8: 20% UCC, December 31, 2022 ............................................................................................ $ 43,000 CCA for 2023 ($43,000 × 20%) .......................................................................................... (8,600) UCC, December 31, 2023 ............................................................................................. $ 34,400 Schedule 2: Trucks UCC, December 31, 2022 .............................................................................................. Disposals (lesser of cost and proceeds) .......................................................................... Additions ........................................................................................................................ Net additions in 2023 ($20,000 − $10,000) ................................................ $10,000 Accel. Inv. Incent. Adjustment (One-half of net additions)........................................... CCA for 2023 ($79,000 × 30%) UCC, December 31, 2023 (74,000 -23,700)

Class 10: 30% $ 64,000 (10,000) 20,000 $ 74,000 5,000 $ 79,000 (23,700) $ 50,300

Schedule 3: Leaseholds Class 13: S.L. UCC, December 31, 2022 ............................................................................................ $ 24,375 Addition..................................................................................................................... .... 6,000 CCA: 2021 improvements: Lesser of: 1 (a) /5 × $30,000 ......................................................... $ 6,000 (3,750) 1 x $30,000 $ 3,750 (b) 5 + 36 ............................................................. CCA: 2023 improvements: Lesser of: 1 (a) /5 × $6,000 .............................................................................. $ 1,200 1 × $6,000 $ 1,000 (b) ............................................................. 6 3+3 1.5x$1,000 .............................................................. (1,500) UCC, December 31, 2023 ....................................................................................................................... $ 25,125

Solutions to Chapter 5 Assignment Problems Schedule 4: Class 14.1(5%) Intangible Assets January 1, 2023 UCC balance Additions: Goodwill License December 31, 2023 UCC before CCA Add: Accel Inv. Incentive Adjustment (½ net addition) UCC CCA @ 5% January 1, 2024 UCC balance

119 $0 $36,000 20,000

$56,000 56,000 28,000 84,000 (4,200) $51,800

— NOTES TO SOLUTION (1) The unpaid bonus must be paid by June 28, 2024, to be deductible in 2023 [ssec. 78(4)]. The client should be advised of the need for payment by this date. (2) Net book value for accounting purposes is irrelevant for capital cost allowance purposes. (3) Interest income is taxable [par. 12(1)(c)]. (4) Dividends received are included in income from property in Division B [par. 12(1)(j)]. (5) Volume rebates are included in income, because they reduce the cost of purchases. (6) The denominator in the formula to determine CCA for leasehold improvements is equal to the number of years remaining in the lease, plus the number of years in the first renewal period. (7) Provincial payroll taxes are deductible.

CHAPTER 6

Income from Property Solution 1: Dividends—Eligible, Other, Foreign 1.

Dividends from Canadian public companies. −

Dividend + 38% gross-up = taxable dividend

−

Dividend tax credit ((federal) 6/11 + (provincial) 5/11)  38% gross-up = gross-up

Dividends from Canadian private companies earning active business income taxed at the low rate. −

Dividend + 15% gross-up = taxable dividend

−

Dividend tax credit ((federal) 9/13 + (provincial) 4/13)  15% gross-up = gross-up

Dividends from foreign public companies. −

Dividend without any gross-up

−

No dividend tax credit, but perhaps a foreign tax credit

CDN Public Cash dividend Gross-up

(A) 38%

Private

$1,000 380

Foreign

$1,000

(E)

150

Tax withheld

100

Taxable dividend

Federal tax

$1,380

53%

731

Dividend tax credit = gross-up

$1,150

53%

610

(380)

$1,000

53%

530 —

(150)

Foreign tax credit

Withheld

Net federal tax

$351

$460

(F)

Foreign tax paid Total tax paid After tax cash retained

$900

(100) 430 100

(B)

$351

(D)

$460

(A-B)

$649

(C-D)

540

137

$530 (E-F)

470

138

Introduction to Federal Income Taxation in Canada

Solution 2: Sale With Earn Out (A) As a fixed sum, the $50,000 cash payment is treated as proceeds of disposition for the assets of the business. [IT-462, par. 5(b)] (B) The $60,000 paid on the basis of sales over the next three years with any balance remaining at the end of the third year payable at that time is not subject to paragraph 12(1)(g). Since the total payment amount is set, the sales are simply determining the timing of the payments, not the amount that should be paid. Hence, the amount is also considered to be proceeds of disposition for the assets. It is not the amount of this receipt, but the timing of the instalments of the $60,000 that is dependent on production or use (i.e., sales). [IT-462, par. 8] (C) The receipt of 25% of the gross sales over the next five years is dependent on production or use and, hence, must be included in property income when received [par. 12(1)(g)]. It is neither a capital receipt nor proceeds of disposition for goodwill. (D) Fees earned for consulting services by Rudolph would be taxable as either employment income or business income from self-employment, depending on whether he is considered an employee or a self-employed individual in respect of the consulting services.

Solutions to Chapter 6 Assignment Problems

139

Solution 3: Interest Versus Dividend (A) Dividend Fund: Dividend Income (3% of $200,000).............................................................................. $ 6,000 Add: gross-up of 38% of dividend ................................................................................ 2,280 Grossed-up dividend subject to tax ............................................................................... $ 8,280 Federal and provincial tax on grossed-up dividend @ 53% .......................................... $ 4,388 Less: dividend tax credit (assumes provincial and federal total the gross-up) .............. (2,280) Net tax payable.............................................................................................................. $ 2,108 After-tax dividend ($6,000 – $2,108)............................................................................ $ 3,892 Income Fund1: Interest income (4% of $200,000) ................................................................................. $ 8,000 Federal and provincial tax payable @ 53% ................................................................... $ 4,240 After-tax interest ($8,000 – $4,240) .............................................................................. $ 3,760 The difference between the two is $3,892 – $3,760 = $132. As a percentage of the $200,000 principal invested, this difference is marginal (less than 1% of the principal invested), so non-tax factors may affect the decision. The marginal tax rate on the income from the dividend fund is 35.14% (1.38x53%-.38). The marginal tax rate on income from the income fund is 53% so every dollar of income from the fund is subject to a higher rate of tax. Even though the rate of return on the dividend fund is lower pre-tax, after-tax the return is higher compared to the income fund. 1 The international income fund may have foreign tax withheld. If this is the case, the individual would receive a foreign tax credit.

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Introduction to Federal Income Taxation in Canada

Solution 4: Expenses of Vacant Land The interest and property taxes on vacant land can only be deducted to the extent of income from the land in excess of all other expenses [ssecs. 18(2) and (3)]. None of the exceptions in subsection 18(2) is met by the facts of this case. (a) The land is not used in the course of the taxpayer’s business. (b) The land is not held primarily for the purpose of gaining or producing income therefrom. (c) Leasing, rental, sale or development of land is not the taxpayer corporation’s principal business. Any remaining non-deductible amounts can be added to the cost base of the land held as a capital property [par. 53(1)(h)]. Thus, $10,000 is included as income and $10,000 of interest and property taxes may be deducted in the current year. While the remaining $25,000 of interest and property taxes is not deductible, it can be added to the cost base of the land.

Solutions to Chapter 6 Assignment Problems

141

Solution 5: Income From Rental Properties Income or loss from rental property: Rental revenue .............................................................................................................................. Deduct/Add: Interest on mortgage .............................................................................................................. Operating costs ...................................................................................................................... Promotion cost for sale of property (expense of disposition, not current expense)................ Recaptured CCA on 509 Brunswick Ave. (Schedule 1) ........................................................ Subtotal ......................................................................................................................................... CCA on 356 Spadina Road (Schedule 1) ...................................................................................... Net income from property.............................................................................................................

$ 60,000 (40,000) (15,000) 0 10,250 15,250 (15,250) Nil

Schedule 1 509 Brunswick(1) Class 1: 4% UCC, opening .................................................................................... $383,500 Disposition in the current year (lesser of cost and proceeds) ............. (393,750)(2) Balance .............................................................................................. $ (10,250) Recaptured CCA in the current year .................................................. 10,250 0 CCA for the current year, at 4% (limited).......................................... 0 UCC, closing......................................................................................

356 Spadina(1) Class 1: 4% $400,000 — $400,000 — $400,000

Total

$10,250 $15,250

(15,250)(3) $384,750

—NOTES TO SOLUTION (1) Regulation 1101(1ac) requires that rental buildings with a cost over $50,000 be placed into separate CCA classes. Assumes that these are residential buildings therefore not eligible for the additional CCA rate. (2) Sale of 509 Brunswick Ave.: Building Proceeds of disposition (75% of ($550,000 – $5,000)) ......................................................... $ 408,750 Cost base (75% of $525,000) ................................................................................................ $ 393,750 (3) The inclusion of recaptured CCA in income from property allows for more CCA to be deducted without creating a loss on rental property. In most circumstances, a loss on rental property cannot be created or increased by claiming CCA [ITR 1110(11)]. In this situation, the full $16,000 (4%  $400,000) of CCA was restricted to $15,250 so as not to create a loss.

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Introduction to Federal Income Taxation in Canada

Solution 6: Construction Costs The 2023 year can be broken into three different time periods: pre-construction (January 1 to February 14, 45 days); construction (February 15 to October 30, 258 days); post construction (October 31 to December 31, 62 days). The following amounts must be capitalized to the building [ssec. 18(3.1)]:(1) Cost ....................................................................................................................................... $ 1,348,000 Architectural fees .................................................................................................................. 7,200 Engineering fees............................................................................................................. ....... 2,100 Building insurance during construction (61/2 mos.  $450)................................................... 2,925 Property taxes during construction (81/2 mos.  $770) .......................................................... 6,545 Soil testing...................................................................................................................... ....... 1,825 Utilities service connections.................................................................................................. 3,800 Mortgage insurance during construction (8 mos.  $325)..................................................... 2,600 Interest accrued on mortgage during construction (258/365 days  8% of $875,000)............... 49,479 Total cost......................................................................................................................... ...... $ 1,424,474 The following amounts are deductible in computing BDC’s income for 2023: CCA on building Class 1- NRB @ 6% of $1,424,474  1.5 ................................................. $ 128,203 Building insurance after construction (2 mos.  $450) ......................................................... 900 Property taxes after construction (2 mos.  $770)................................................................. 1,540 Mortgage insurance after construction (2 mos.  $325)........................................................ 650 Relocation expenses .............................................................................................................. 34,100 Maintenance from October 31, 2023..................................................................................... 2,500 Utilities from October 31, 2023............................................................................................. 6,300 Landscaping [par. 20(1)(aa)] ................................................................................................ 15,500 Interest accrued on mortgage one month before and two months after construction (93/365 days  8% of $875,000) ....................................................................................... 17,836 Issue costs [par. 20(1)(e)] (1/5  ($18,450 + $58,300))(2) ....................................................... 15,350 CCA on articles of amendment Class 14.1( $1,800 x 1.5 x 5%) ........................................... 135 Total deductible costs............................................................................................................ $ 223,014 —NOTES TO SOLUTION (1) Subsection 20(29) does not apply to allow the deduction of all or some part of the “soft costs” in this case because the building is not being rented to tenants. (2) The issue costs are considered to be long-term financing costs that are not attributable to the period of construction.

Solutions to Chapter 6 Assignment Problems

143

Solution 7: Property Income and Employee Loan Net Income for Tax Purposes Employment income: Salary Deemed interest benefit (Note 1) Income from Employment Property Income: Rental revenues Maintenance expense Utilities expense Interest expense (Note 2) CCA (Note 3) Net rental income Foreign dividends received Add: Withholding tax Gross foreign dividends Interest income bonds Canadian taxable dividend received Add: Gross up at 38% Taxable amount of dividend Net income from property Net income for tax purposes

$95,000 3,000 $98,000 $16,400 ( 5,500) ( 8,200) (3,000) ( 0) $ (300) $18,000 2,000 20,000 5,000 $30,000 11,400 41,400 66,100 $164,100

Notes: 1. Subsection 80.4(1) deems an interest benefit of ($150,000) (2% − 0%). 2.

Section 80.5 and paragraph 20(1)(c) allows interest expense of the actual paid amount at 0% ($0) and the deemed interest benefit included in employment income ($3,000).

CCA allowed is $0. Since the rental property income is already in a loss position no CCA can be claimed. We cannot create/increase a loss with CCA on the rental property.

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Introduction to Federal Income Taxation in Canada

Solution 8: Property Income

Joint bank account (his portion)(1)........................................................................................ Interest on broker account ................................................................................................... Interest on income tax assessment ....................................................................................... Interest on short-term investments(2).................................................................................... Interest on GIC(3) ................................................................................................................. Interest on Government of Canada T-Bills(4) ....................................................................... Dividends from common shares of taxable Canadian corporations ($24,000  1.38)(5) ...... Dividends from common shares in U.S. corporation (gross amount)(6) ............................... Rental loss(7) ........................................................................................................................ Interest on bank line of credit(8) ........................................................................................... Income from property..........................................................................................................

$ 1,500 800 450 0 16,000 991 33,120 20,000 (1,200) (50,000) $ 21,661

—NOTES TO SOLUTION (1) If both John and his spouse contribute capital equally to the bank account, the attribution rules do not apply [sec. 74.1]. (2) Interest is not taxable for 2023 on the term deposit because there is no anniversary date in 2023. The interest will all be taxable when paid in 2024 [ssecs. 12(4), 12(11)]. (3) Interest on an investment contract (the GIC) must be accrued on the anniversary day, which is defined as the day that is one year after the day before the date of issue. The date of issue was November 1, 2022. The day before that day is October 31, 2022. Therefore, the first anniversary day is October 31, 2023 [ssec. 12(11)]. (4) The difference between the face amount and the amount paid ($10,000 – $9,009) is deemed to be interest [ssec. 16(1)]. (5) A dividend tax credit [par. 12(1)(j); ssec. 82(1)] (as discussed in Chapter 10) will be available in the calculation of tax. (6) A foreign tax credit (as discussed in Chapter 10) will be available in the calculation of tax. (7) The calculation of the rental loss is based on the aggregate of the two properties: Property 1 Property 2 Gross rental revenue.................................................................................. $ 30,000 $ 46,000 Utilities...................................................................................................... (5,000) (8,000) Property taxes............................................................................................ (2,400) (3,500) Repairs ...................................................................................................... (1,500) (4,800) Mortgage interest ...................................................................................... (20,000) (32,000) Income/(Loss) before CCA ....................................................................... 1,100 (2,300) Less: CCA — property 1 ($368,209 × .04 = $14,728) ............................ 0 0 CCA — property 2 ($520,225 × .04 = $20,809) ............................ 0 0 Net income/(loss) ...................................................................................... $ 1,100 $ (2,300) The aggregate rental loss before CCA is $1,100 - 2,300 = ($1,200). Since there is an aggregate loss from all rental sources, there is no CCA claim allowed for fiscal 2023. (8) This interest is paid in respect of common shares and thus is incurred for the purpose of earning income. The interest paid on the loan to acquire the automobile is for the purchase of personal use property and thus does not meet the requirements in paragraph 20(1)(c). The interest on the vacant land is not deductible by virtue of subsection 18(2). The land is not used in the course of a business carried on in the particular year by the taxpayer or held primarily for the purpose of gaining or producing income of the taxpayer from the land.

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145

Solution 9: Interest Expense (a) Under paragraph 20(1)(c) of the Act, interest expense can be deducted on debt incurred to earn income. In this instance, Ashley has sold her investments to pay down her mortgage. She then remortgaged the house and reacquired her investments. (b) The accrued interest amount of $262.50 Ashley paid on acquiring the bond will be deductible in the current taxation year [ssec. 20(14)]. This is because Ashley, as the registered bondholder, will receive all the interest due on the bond from the bond issuer. Only the difference represents her real investment income. (c) Under subsection 18(2) of the Act, the land is held primarily to gain or produce income of the taxpayer from the land for the year and therefore, Ashley is eligible to deduct interest expenses and property taxes up to the amount of income received from that vacant land. In this case, she will only be able to deduct $17,500 (seven months × $2,500/month). As this is vacant land used to earn income and not a personal-use property, she will add the non-deductible carrying charges to the adjusted cost base of her capital property, resulting in an adjusted cost base for the land of $478,000 ($450,000 + $45,500 − $17,500).

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Introduction to Federal Income Taxation in Canada

Solution 10: Interest Expense (a) The interest is not deductible [par. 20(1)(c)], unless the gains or losses are treated as business or property income or losses, because of the requirement that funds be borrowed to produce income from business or property. Capital gains are not income from business or property [ssec. 9(3)]. (b) Paragraph 18(11)(b) prohibits a deduction of interest on funds borrowed to invest in an RRSP. (c) Interest on funds borrowed to invest in a fixed-income security is deductible by subparagraph 20(1)(c)(i), which requires that funds be borrowed for the purpose of earning income. An interpretation of the Ludco case suggests that “income” as used here refers to gross income. Refer to Income Tax Folios S3-F6-C1, paragraph 1.27. (d) Interest is deductible even if no dividends are being paid, because there is theoretically always the expectation of a dividend on common shares, even if that dividend is a liquidating dividend on the winding-up of the corporation. Refer to Income Tax Folios S3-F6-C1, paragraph 1.27. (e) Interest expense would be deductible by subparagraph 20(1)(c)(i) on the same basis as for the fixedincome security in part (c), above. Refer to Income Tax Folios S3-F6-C1, paragraph 1.27. (f) Interest expense would be deductible by subparagraph 20(1)(c)(i) on the same basis as for the fixedincome security in part (c), above. Refer to Income Tax Folios S3-F6-C1, paragraph 1.27. (g) Initially, Mindy had borrowed to buy her condominium, which is personal-use property. Since the interest expense is not incurred to earn income, it is not deductible. On the sale of the shares, she uses the funds to pay off the mortgage. She then borrows to purchase 1,000 new shares of International Inc. At this point, the additional borrowed money is directly used to acquire 1,000 shares of International Inc. and the interest will be deductible even though her economic position is identical to what it was immediately before this series of transactions. [Income Tax Folios S3-F6-C1, para. 1.33] (h) Interest on funds borrowed to buy lottery tickets is not deductible, because the lottery winnings are not taxable and, hence, the borrowed funds did not produce income from business or property. However, according to Income Tax Folios, paragraphs 1.35, if the borrowed funds can be traced from a noneligible use (buy lottery tickets) to an eligible use (securities) then the interest will be deductible, since it is the current use that determines the deductibility. (i) Interest on the funds borrowed to buy the common shares is deductible until the shares are sold. Thereafter, the funds are not used to earn income from business or property and, hence, the interest is not deductible.

Solutions to Chapter 6 Assignment Problems

147

Solution 11: Business and Property Income (a) Net income from employment, team salary Net income from proprietorship business Net income from endorsements (business income) Net income from property: Dividends from Canadian corporation Add 38% gross-up Taxable amount Dividends from foreign corporation Interest from Canadian bank One-year anniversary interest accrual on GIC Expenses Interest on loan Net income from property Net income

$150,000 35,000 30,000 $ 7,200 2,736 $ 9,936 7,500 3,000 600 $21,036 ( 4,050) 16,986 $231,986

(b) Basic Tax Planning •

Consider using a deferred-income fund, such as an RRSP, or TFSA for the GICs, and funds held in the bank account. Investigate whether the investment in the foreign corporation might not be better invested in a Canadian corporation because of the dividend tax credit.

•

Pay higher, yet reasonable, compensation to Mary. Mary works 35 hours a week and should at a minimum be paid minimum wage (not $6/hour). A reasonable salary would be similar to what would be paid to a non-related person.

•

Mary has a salary in her own right; consider investing it rather than spending it on family personal needs. This will result in the investment income being taxed in her hands. Trent could pay the family personal needs.

•

Consider incorporating the sporting goods store.

Introduction to Federal Income Taxation in Canada

148

Solution 12: Interest, dividend and rental income Interest earned ($75 x 50%)

37.50

GIC Interest for anniversary date (April 1 to March 31, 2023) ($188 + 95 + 92)

375.00

Dividends ((2,500 x $0.25) x 1.15)

718.75

Scotland dividends - gross amount ($2,340 + $260) Rental Income (note 1)

2,600.00 0.00

Total Property income

3,731.25

Note 1 Rents

#1 $25,800

#2 $18,500

#3 $9,900

Expenses Advertising Property Tax Utilities

(150) (2,750) (3,180)

(175) (2,125) (2,580)

(25) (3,700) 0 (9,625)

$19,720

$13,620

($3,450) (29,890)

Interest Income before CCA CCA (calculation below, Note 2)

Total

$29,890 (29,890) $0

Net rental income

Opening UCC

281,788

323,758

11,272

12,950

Additions CCA at 4%

575,000

CCA at 4% plus the Accelerated Investment Incentive

34,500

Total CCA available Actual CCA claimed UCC at December 31, 2023

$ -

29,890

$281,788

$323,758

$545,110

58,722

At this point, there is more CCA available than can be claimed based on the net rental income before CCA. Total CCA available is $58,722 while the net rental income before CCA is $29,890. We will need to decide on which property to claim the CCA. Without a crystal ball, we must make some assumptions. In this case, we might want to claim CCA on the newer property since it is likely to be kept for a longer period than the older property (although we do not know for sure). Claiming the most CCA on the property that will be held for a longer period will delay any possible recapture for the longest period. Another option would be to spread the CCA across all three properties. For simplicity we have chosen to maximize the CCA on the new property and claim no CCA on properties #1 and #2.

CHAPTER 7

Capital Gains: Personal Solution 1: Stock Transactions Weighted Average Cost Date

Transaction

Jan 15/23 Feb 20/23

Purchase Purchase

April 5/23

Stock dividend

Sept 16/23

Stock split

Nov 30/23

Sale

Dec 12/23

Purchase Superficial loss

Number of Shares

Cost

1200 200 1400 120 1520 1520 3,040 200 2840 200

$ $ $ $ $

3040 Taxable Dividend Stock Dividend Cash Dividend

120 sh x $40 PUC x 1.38 3,040 sh x $10 x 1.38

$ $ $

1. 2. 3. 4.

5. 6.

41,500 7,550 49,050 4,800 53,850 53,850 3,542 50,308 2,725 617 53,650

Adjusted Cost Base

Notes

34.58

35.04

35.43

17.71

17.65

4 5

6,624 41,952 48,576

The ACB after the purchase on February 20th is the weighted average cost of $35.04. The ACB after the stock dividend on April 5th is the weighted average cost of $35.43. The ACB is increased by the increase in paid-up capital as a result of the dividend. The ACB after the stock split on September 16th is the weighted average cost of $17.71. Proceeds = 200 shares  $15 = $3,000 ACB = 200 shares  $17.71 = (3,542) Broker fees (75) Capital loss $(617) Because Rachael effectively bought these shares back within 30 days of the sale the loss is denied as a superficial loss and added back to the cost of the shares. The ACB after the purchase on December 12th and the adjustment for the superficial loss is the weighted average cost of $17.65. The December 15th cash dividend of $30,400 will be grossed-up by 38% ($41,952) and included in her income. The cash dividend does not have any implications on the ACB of the shares.

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Introduction to Federal Income Taxation in Canada

Solution 2: Stock Option—Capital Gain 1.

Calculate benefit for Omar—public company stock option Amount of benefit to report as employment income three years ago (in the year exercised): $1,000 shares  ($35 - $30) = $5,000 Impact on ACB The amount of the employment income reported increases the ACB of the shares. ACB = 1,000  $30 + $5,000 = $35,000. The result is that the ACB of the shares acquired through stock options is equal to the FMV of the shares at the time of exercise. Sale for $45 Proceeds = 1,000 shares  $45 = ACB = (Above) Capital gain

$45,000 35,000 $10,000

Taxable capital gain

$5,000

Total income to report in the year of sale

$5,000

Calculate benefit for Hilda– private company stock option Amount of benefit to report as employment income: $1,000 shares  ($35 - $30) = $5,000 When is this reported? As a private company, the employment benefit of $5,000 is reported in the year the shares are sold. Note that the amount of the total benefit does not change, it is simply the timing of the employment income inclusion that is different between CCPC shares and public company shares. Impact on ACB The amount of the employment income reported will increase the ACB of the shares in the year it is reported. ACB = 1,000  $30 + $5,000 = $35,000 Sale for $45 Proceeds = 1,000 shares  $45 = ACB = Capital gain

$45,000 35,000 $10,000

Taxable capital gain

$5,000

Total income to report in the year of sale

$10,000

The Division C stock option deduction is not included in this analysis, as it is a deduction taken in the calculation of taxable income (Division C). The problem is asking for the amount of income that will be included in each individual’s net income for tax purposes (Division B). The Division C deduction will be dealt with in Chapter 10.

Solutions to Chapter 7 Assignment Problems

Solution 3: Sale of Mutual Fund

2022:

Capital gain allocated ………………………………………………….…… $ 96.37 Taxable capital gain (50%  $96.37).................................................................. $ 48.19 The taxable capital gain of $48.19 must be included in her income for 2022.

2023:

P of D (25 units).............................................................................................. $ 1,000.00 ACB (25 units @ $27.38(1)) ............................................................................... (684.50) CG ………………………………………………………………………….. $ 315.50 TCG (50%  $315.50) ………………………………………………... ..... $ 157.75

— NOTE TO SOLUTION (1) Adjusted cost base of units: 72.788 units ....................................................................................................... $2,000.00 3.774 units @ $25.535 .................................................................................... 96.37 76.562 units ....................................................................................................... $2,096.37

Weighted average: $2,096.37 ÷ 76.562 = $27.38

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Solution 4: Allowable Business Investment Loss Sale

No Sale

Debt

Proceeds

$ 10,000 $

6,000

ACB BIL

100,000 60,000 $ 90,000 $ 54,000

100,000 $ 100,000

60,000 $ 60,000

ABIL

$ 45,000

$ 30,000

Total ABIL

$ 27,000 $72,000

Shares $

50,000

Debt $

$80,000

BIL – ITA 39(1)(c) BIL without disposal – ITA 50(1) Impact of CGE – ITA 39(9) Tax treatment if no sale Debt: For the loss on the debt to be deductible as a BIL, it must have been established to have become a bad debt in the year. Then, Mr. Chu must elect to be deemed to have disposed of it for proceeds of nil and to have reacquired it immediately for a cost of nil. Shares: For the loss on the shares to be deductible as a BIL, the company mush have either gone bankrupt in the year, become insolvent in the year or ceased to carry on business with the expectation of being wound up. Then, Mr. Chu must elect to be deemed to have disposed of it for proceeds of nil and to have reacquired it immediately for a cost of nil. Sale of shares for $10,000 and debt for $6,000: Since the shares and debt are in a “small business corporation”, Mr. Chu will realize an allowable business investment loss of $72,000 that he can deduct against other income [3(d)]. This assumes the purchaser is an arm’s length party. If they are not then the ABIL treatment is not available and the loss will be an allowable capital loss and deductible against taxable capital gains.

Solutions to Chapter 7 Assignment Problems

153

Solution 5: Personal Use and Listed Personal Property

Listed personal property: Oil painting ...................... Rare coin .......................... Bible ................................

Cost

Proceeds

CG (CL)

Taxable amount

$ 2,500 1,400 1,000

$ 1,500 1,000 4,000

$(1,000) (400) 3,000 $ 1,600 (1,200)(3) $ 400

$200

LPP — CL ....................... Personal-use property: Canoe …………………... Antique car(1) .....………... Antique chair(1)......……… Antique table(1) ..……….

$1,000 15,000 1,000 1,500

$ 1,000 10,000 1,200 2,000

Nil Nil(2) 200 500 $700

350 $550

— NOTES TO SOLUTION (1)

Antiques are not listed personal property under the definition in section 54.

(2)

Losses on personal-use property assets are not allowed.

(3)

Listed personal property loss carryovers are netted against capital gains, not taxable capital gains. LPP losses from previous years are the only loss carryovers that are deducted in the calculation of net income for tax purposes.

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Introduction to Federal Income Taxation in Canada

Solution 6: Principal Residence All residences qualify as principal residences according to the definition in section 54 because they are housing units that are ordinarily inhabited by Mr. Hart, a Canadian resident, at any time during the year. The fact that the Florida condominium is outside Canada does not affect its status as a principal residence. The minimum amount of taxable capital gains that Mr. Hart will have to report in 2023 is $26,000 ($10,000 + $16,000 + nil). The calculation of this amount is set out below. P of D ................................. ACB.................................... Gain .................................... Years of ownership............. Gain per year ...................... Optimal allocation of years (see analysis below)...... Principal residence exemption (PRE) .......... Capital gain (Gain - PRE)... Taxable capital gain (1/2 capital gain) ..................

Toronto Home $250,000 (170,000) $ 80,000 8 (2016–2023) $ 10,000 5 (2016–2020)

5 +1

 $80K = $60K

Farm in Quebec $ 148,000 (100,000) $ 48,000 6 (2018–2023) $ 8,000 1 +1

1 (2021) $48K = $16K

Condominium in Florida $ 186,000 (150,000) $ 36,000 3 (2021–2023) $ 12,000 2 (2022-2023)

2 +1

$36K = $36K

$80K - $60K = $20K

$48K - $16K = $32K

$ 36K - $36K = Nil

$ 10,000

$ 16,000

Nil

Analysis Because of the one-plus rule, the maximum number of years that needs to be designated to totally exempt a gain is always one less than the number of years of ownership. For the period in question, there are 8 years that can be designated 2016 to 2023. The years of the residence with the highest gain per year are designated first. The condominium in Florida has the highest gain per year ($12,000 gain per year) and two out of three years are designated in respect of it. We have chosen 2022 and 2023 but the actual years chosen could be any two of 2021, 2022, and 2023. this leaves 2021 to be allocated to one of the other properties. The next residence to look at is the Toronto home, which has been owned since 2016 (eight years), with a gain per year of $10,000, rather than the Quebec farm, which has been owned since 2018 (six years), with a gain per year of $8,000. Initially, it seems to make sense to allocate all of the six remaining years to the Toronto home because it has the higher gain per year. However, because of the one-plus rule, designating one year for the Quebec farm “gets you two,” that is, it shelters two years of gain. The year 2021 is chosen for the Quebec farm. (The year designated could have been one of any of the years of ownership that were left over from the condominium: 2018 to 2021.) The remaining five years (2016 to 20209) shown in the calculation above) are designated in respect of the Toronto home.

Solutions to Chapter 7 Assignment Problems

155

Solution 7: LPP Loss and ABIL Par. 3(a)

Par. 3(b)

Income from non-capital sources (non-negative): Subdivision b — Business .................................................................. — Property................................................................... Net taxable capital gains (non-negative): Subdivision c — LPP(1) ...................................................................... — PUP ......................................................................... — Other .......................................................................

2021

2022

2023

$60,000 2,000 $62,000

$65,000 3,000 $68,000

$70,000 — $70,000

Nil Nil $(1,500) Nil(2)

Nil $ 2,500 3,000 $ 5,500

$62,000

$73,500

$70,000

Nil (1,500)(3) $60,500

Nil Nil $73,500

(1,000) Nil $69,000

500 2,000 (8,000) Nil (2)

Par. 3(d)

Losses from non-capital sources: Property ................................................................................... ABIL........................................................................................

—NOTES TO SOLUTION (1) Listed personal property: 2021 — $5,000 of the $7,000 2022 capital loss applied to 2021 resulting in nil. 2023 — $2,000 of 2022 capital loss applied to 2023 leaving a $500 net taxable capital gain (($3,000 − $2,000)  ½). (2) Paragraph 3(b) does not permit a negative figure; therefore, the 2021 allowable capital loss of $2,500 (½  ($8,000 − $3,000 BIL)) is available as a carryover under Division C. Similarly, $5,500 (i.e., ($16,000  ½ − $500 − $2,000) of 2023 loss is available as a carryover under Division C. (3) 2021 allowable business investment loss of $1,500 (½  $3,000 BIL).

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Introduction to Federal Income Taxation in Canada

Solution 8: Allowable business investment loss Par. 3(a)

2022 2023 Income from non-capital sources (non-negative): Employment income ……………………………………… . $25,000 $30,000 Property income …………………………………………… 10,000 — Business income — other ………………………………….. 8,000 —

Par. 3(b)

$43,000 Net taxable capital gains (non-negative): Taxable capital gain — personal-use property (½  $8,000) …………………..……… $ 4,000 Plus Listed personal property gains ........................... $4,000 Less: LPP loss carryforward — 2019 ............... (1,000) LPP loss carryback — 2023 ..................... (1,500)

$30,000

$1,500 Taxable net gain — ½ thereof ...………………………………..

750

$ 4,750 Public corporation — allowable capital loss …………………… (4,750) — taxable capital gain ...................................................... Par. 3(d)

Nil(1)

$43,000 Losses from non-capital sources: Property loss …………………………………………………… — Business loss …………………………………………………… — Allowable business investment loss.............................................. (3,000)(3) Division B income ........................................................................ $40,000

$ 4,500(2) $34,500 4,000) (9,000) (1,000)(4) $20,500

— NOTES TO SOLUTION (1) Of the $6,000 allowable capital loss (½  $12,000), $1,250 cannot be claimed in 2022 and will be carried back or forward under Division C as a “net capital loss” to be discussed in Chapter 10. (2)

½  $9,000

(3)

½  $6,000

(4)

½  $2,000

Solutions to Chapter 7 Assignment Problems

157

Solution 9: Principal Residence With Change in Use Part (A) — Subsection 45(2) election When Ms. Andrews moves out of the Waterloo home and begins to rent it out, there is a deemed disposition on the change in use. However, if she makes an election under subsection 45(2), then the result is that there is no change in use and the property remains a personal-use property. In addition, paragraph (d) of the definition of a “principal residence” in section 54 provides that it is possible for this property to be designated as her principal residence for up to four additional years even though she is not living there. This would allow her to designate the property as her principal residence for the years 2013–2016 and 2022-2023 based on the years she lived there and for the years 2017–2020 based on the four additional years, for a total designation of 10 years. The only year missing is 2021 and it is protected with the “1+” rule. Gain ($284,000 – $86,000).................................................................................................................... $ 198,000 Exemption(1) .............................................................................................................................................. (198,000) Capital gain ............................................................................................................................................... Nil

Part (B) — No subsection 45(2) election In 2016, when Ms. Andrews moves out of her Waterloo home and begins to rent it to earn income, there is a deemed disposition on the change in use. Since she has been living in the house since she bought it in 2013, she can claim the principal residence exemption on the gain that results from the deemed disposition. By designating the years 2013 to 2015, she can eliminate the full gain as shown below. P of D, deemed 2016 ............................................................................................................................. ACB ............................................................................................................................. ......................... Gain......................................................................................................................... .............................. Exemption(2) ............................................................................................................................. ............. Capital gain ............................................................................................................................. ..............

$ 230,000 (86,000) $ 144,000 (144,000) Nil

In 2022, when she returns to Waterloo and moves back into the house, there is another change in use and a resulting deemed disposition. In this case the principal residence exemption can be claimed for the two years 2016 and 2022, since the house was her principal residence at some point during each of those years. P of D, deemed (2022) .......................................................................................................................... ACB, deemed ............................................................................................................................. ........... Gain......................................................................................................................... .............................. Exemption(3) ............................................................................................................................. ............. Capital gain (2022)....................................................................................................................... .........

$ 294,000 (230,000) $ 64,000 (27,429) $ 36,571

P of D, actual (2023) ............................................................................................................................. ACB ............................................................................................................................. ......................... Capital loss not allowed on PUP ...........................................................................................................

$ 284,000 (294,000) Nil

Comparison: Subsection 45(2) election ...................................................................................................................... Nil No subsection 45(2) election ......................................................................................................................... $ 36,571

Conclusion In summary, by making no elections, she will report a capital gain of $36,571 in 2022 along with any recaptured CCA that also has to be reported. If she had made the subsection 45(3) election in 2022 when the house was changed from income producing to personal-use property, then the capital gain could be deferred and would not have to be reported until the actual disposition in 2023. Since nothing had to be filed with the 2016 tax return to reflect the change in use, the above decisions can be made before filing the 2023 tax return. —NOTES TO SOLUTION (1)

10 + 1  $198,000 = $198,000; designate 2013–2016, 2022, and 2023; and 2017–2020 inclusive.

(2)

3 + 1  $144,000 = $144,000; designate 2013–2015, inclusive.

(3)

2 + 1  $64,000 = $27,429; designate 2016 and 2022.

11 4 7

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Introduction to Federal Income Taxation in Canada

Solution 10: Stock Transactions June 6, 2018: Proceeds of disposition (500 shares @ $3.75) ......................................................................................... $ 1,875 ACB (500 shares @ $4.00(1))............................................................................................... $ 2,000 Commission................................................................................................................... ...... 50 (2,050) Capital loss (superficial loss(2) = $1,875 - $2,050 = $175) ......................................................................... Nil November 5, 2023: Proceeds of disposition (10,000 shares @ $8.50) .................................................................................... $ 85,000 ACB (10,000 shares @ $2.451(3)) ...............................................................................................$ 24,100 Commission................................................................................................................... ...... 650 (24,750) Capital gain......................................................................................................................... ..................... $ 60,250 Taxable capital gain 1/2 ............................................................................................................................ $ 30,125

—NOTES TO SOLUTION (1)

(2) (3)

1,000 shares @ $5.00 ........................................................................... 2,000 shares @ $3.50 ........................................................................... 3,000 Shares reacquired within 30 days. 2,500 shares @ $4.00 ........................................................................... superficial loss............................................................................ 2,000 shares @ $4.00 ........................................................................... 450 shares @ $0.50 (stock dividend)................................................. 4,950 shares @ Nil (stock split, 2:1) .................................................... 2,000 shares @ $6.00 ........................................................................... 1,190 shares @ $1.00 (stock dividend)................................................. 13,090 shares..........................................................................................

* Rounded to two decimal points.

$ 5,000 7,000 $ 12,000

 3,000

= $ 4.00

$10,000 175 8,000 225 Nil 12,000 1,190 $31,590

 13,090

= $2.41*

Solutions to Chapter 7 Assignment Problems

159

Solution 11: Stock Transactions Schvantz Ltd. August 27, 2012 P of D (900 @ $24.50)................................................................................................. ACB (900 @ $28.75)(1)................................................................................................ Selling cost .................................................................................................................. Loss ............................................................................................................................. Superficial loss denied (600/900  $4,585) ................................................................. Capital loss .................................................................................................................. Allowable capital loss (50%  $1,528) ........................................................................

$ 22,050 $25,875 860

(26,735) $ (4,685) 3,123 $ (1,562) $ (781)

A superficial loss results due to the fact that 600 shares were reacquired 30 days after the disposition. The superficial loss will be 600/900  $4,685 = $3,123 and the capital loss will be the balance of $1,562. June 9, 2014 P of D (250 @ $32)...................................................................................................... ACB (250 @ $27.49)(2)................................................................................................ Selling cost .................................................................................................................. Capital gain.................................................................................................................. Taxable capital gain (50%  $855) .............................................................................. December 28, 2023 Transaction does not settle until 2024. Therefore, no disposition until 2024. January 4, 2024 P of D (350 shares @ $39)........................................................................................... ACB (350 shares @ $27.07)(3)..................................................................................... Selling cost .................................................................................................................. Capital gain.................................................................................................................. Taxable capital gain (50%  $3,820) ...........................................................................

8,000

$ $

(7,148) 853 426

$ 6,873 275

$ 13,650 $ 9,475 355 $ $

(9,830) 3,820 1,910

6,400

Shtupp Metals Ltd. October 31, 2012 P of D (200  $32) ....................................................................................................... ACB (200  $36.20)(4) ................................................................................................. Selling cost .................................................................................................................. Capital loss .................................................................................................................. Allowable capital loss (50%  $1,060) ........................................................................ Jun e 30, 2018 P of D (150  $36.50) .................................................................................................. ACB (150  $34.73) .................................................................................................... Selling cost .................................................................................................................. Capital gain.................................................................................................................. Taxable capital gain (50%  $100) ..............................................................................

$ 7,240 220

$ 5,475 $ 5,210 165 $ $

—NOTES TO SOLUTION Schwartz Share Transactions # of shares sold/ purchased

Date of Transaction

[1]

May 24/09

800

25.00

690

Aug. 20/10

1100

30.00

940

Total

1900

[2]

Aug 27/12

(900)

Share price

Brokerage fees

Note

Total Cost

28.75

Per share value (Rounded to 2 decimals)

20,690 33,940

54,630

$ (25,875)

(7,460) $ (1,060) $ (530)

$28.75

5,375 100 50

160

Introduction to Federal Income Taxation in Canada Balance

1000

28,755

Superficial loss

[3]

3,123

Sept 20/12

600

Balance

1600

June 9/14

(250) $

Balance

1350

19.50

400

12,100

27.49

43,978

(6,873)

Aug 20/20 *

270 $

Balance

1620

25.00

37,106 $

$27.49

6,750 43,856

$27.07

* Stock dividend of 20% of existing shares, $1,350 x 20% = 270 shares Shtupp Share Transaction # of shares Note

Date of Transaction

[4]

[5]

Share price

Brokerage fees

Total Cost

$ 35.00

600

$ 18,100

sold/ purchased

June 30/10

500

Oct 31/12

-200 $ 36.20

Balance

300

May 24/16 ** Balance

30 $ 20.00 330

** Stock dividend of 10% of existing shares

Per share value $

36.20

34.73

(7,240) $ 10,860 600 $ 11,460

Solutions to Chapter 7 Assignment Problems

161

Solution 12: Comprehensive • Par. 3(a)

Employment income (see Note (1)) ............................................................................. Property income (see Note (2))....................................................................................

Par. 3(b) Net taxable capital gains (see Note (3)) ....................................................................... Par 3(c) Enhanced CPP ( Income under Division B ......................................................................................................................

$ 85,723 27,689 $ 113,412 88,221 (631) $ 201,002

Note (1) Employment Income Sec. 5 Ssecs. 7(1), (1.1) Ssec. 80.4(1)

Salary — gross........................................................................................... Stock option (see Schedule 1).................................................................... Interest-free loan benefit (see Schedule 2) .................................................

$ 85,000 4,725 198 $ 89,923

Less: Pars. 8(1)(m), 147.2(4)(a) Par. 8(1)(i)

RPP — current service........................................................ Professional fees .................................................................

$ 3,700 500

4,200 $ 85,723

Comments: (a) Income taxes are not deductible [ssec. 8(2)]. (b) CPP contributions and EI premiums are tax credits deductible under Division E. The enhanced CPP is deductible under pargraph 60(e.1) Note (2) Income from Property (A) Dividends $ 920 Dividends from Wealth Inc. ($800  1.15) .................................................... Taxable amount of dividends from Dumark Mutual Fund ................................. 500 (B) Rental properties (see Schedule 3)................................................................................................. (C) Accrued interest (ssec. 20(14)) on Government of Canada Bond (see Schedule 9) ....................... Total income from property ........................................................................................................... Less: Interest expense re: Wealth Co. shares (see Schedule 2) ......................................................

$ 1,420 21,140 5,327 $ 27,887 (198) $ 27,689

Comments: (a) Dividends from Canadian-controlled private corporations resident in Canada are to be included in income [par. 12(1)(j)]. The amount to be included in income is the actual amount of dividends (from income taxed at the low corporate rate) received plus 0.15 of the dividends received [ssec. 82(1)]. Dividends allocated by a mutual fund from dividends that it receives from Canadian-resident public corporations are included in income with a 38% gross-up, as reported on the T3 slip. A dividend tax credit [sec. 121] reduces the tax on dividends received by an individual. (b) Section 80.5 provides that where a benefit is included in income under section 80.4, the amount of the benefit will be regarded as interest paid which might be deductible under paragraph 20(1)(c). Mr. Richmond borrowed funds from his employer to invest in securities. Therefore, a deduction [par. 20(1)(c)] can be taken because the interest expense was incurred for the purpose of earning income from property.

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Note (3) Taxable Capital Gain (Allowable Capital Loss) (A) Listed personal property (see Schedule 4) Painting ($1,500 - $1,000) ....................................................................................................... $ Stamp collection ($1,000 − $1,000) ............................................................................................. $ Less: LPP carryforward (limited to gain - $200 is left on the carryforward) ................................ (B) Personal-use property (see Schedule 4) Antique foot stool .................................................................................................................... (C) Stock options (see Schedule 1) ($9,600  50%) ........................................................................................................................ (D) Rental property (see Schedule 5) ($61,000 50%) ......................................................................................................................... (E) Mutual funds Dumark Mutual Fund (50%  $1,200)..................................................................................... Sale of Dumark units (see Schedule 6) .................................................................................... (F) Government of Canada bonds (see Schedule 7) ($12,000 x 50%) ......................................................................................................................

500 Nil 500 (500) Nil Nil

$ 4,800 30,500 600 321 6,000

(G) Principal residences (see Schedule 8) ($92,000  50%) ......................................................................................................................

46,000 $ 88,221

Schedule 1 — Stock Options Employment income: $ 1,125 1st lot 450 shares  ($10.50 − $8) = ................................................................................................... 3,600 2nd lot 600 shares  ($21 − $15) = .......................................................................................................... $ 4,725 The $100,000 deferral is not available on either lot because the shares are shares in a CCPC. Capital gain: $ 7,200 1st lot 450 shares  ($26.50 − $10.50) =............................................................................................ 2,400 2nd lot 600 shares  ($25 − $21) = .......................................................................................................... $ 9,600

The 1st lot sold by Mr. Richmond will be eligible for a deduction [par. 110(1)(d.1)] equal to ½  $1,125 = $563. The deduction, however, is permitted under Division C, not under Division B and therefore not included in this calculation. The 2nd lot of shares is not eligible for the Division C deduction as they were in the money at grant date and Mr. Richmond did not hold the shares for 24 months. Schedule 2 — Interest-Free Loan Benefit $9,000  (3%  268/365) = .................................................................................................................

$198

Schedule 3 — Rental Properties Rental revenue........................................................................... Recapture (see below) ............................................................... Less: Total expenses ................................................................. CCA (see below) ............................................................. Income (loss)............................................................................. CCA and recapture calculation: UCC — beginning of year............................................... Disposition ...................................................................... CCA — 4% ..................................................................... Recapture......................................................................... UCC — end of year...................................................................

Wealthier St. $ 18,000 — $ 18,000 10,000 1,560 $ 6,440

Richmount St. $ 7,600 15,000 $ 22,600 7,900 — $ 14,700

$ 39,000 — $ 39,000 1,560 — $ 37,440

$ 65,000 80,000 $ (15,000) — 15,000 —

$ 21,140

Solutions to Chapter 7 Assignment Problems

163

Schedule 4 — Personal-Use Property and Listed Personal Property Painting (LPP) Proceeds of disposition..................................................... $ 1,500 ACB ......................................................................................(1,000) Capital gain ...................................................................... $ 500

Antique foot stool (PUP) $ 1,000 (1,100) Nil*

Stamp collection (LPP) $ 1,000 (1,000) Nil

* Losses on personal-use property are denied [spar. 40(2)(g)(iii)].

Schedule 5 — Rental Property Sale Land Proceeds of dispositions Capital cost Selling cost Gain

Land 140,000 100,000 5,040 34,960

Building 110,000 80,000 3,960 26,040

Total 250,000 180,000 9,000 61,000

Schedule 6 — Sale of Dumark units P of D (1,000 units) ............................................................................................................................. $ 12,881 ACB (1,000 units @ $12.240*) ............................................................................................................... (12,240) Capital gain ............................................................................................................................. ............ $ 641 $ 321 TCG (50%  $641)........................................................................................................................ ...... * Adjusted cost base of units: 1,640.824 units ................................................................................................................. 3.845 units @ $12.044 ............................................................................................... 119.358 units @ $12.944 ............................................................................................... 1,764.027

$ 20,000.00 46.31 1,544.97 $21,591.28

Weighted average cost: $21,591.28 ÷ 1,764.027 = $12.240

Schedule 7 — Government of Canada Bonds [ssec. 20(14)] Amount received ............................................................................................................................. .... $ 115,327 Accrued interest received ........................................................................................................................ (5,327) Proceeds of disposition.................................................................................................................. ...... $ 110,000 ACB ....................................................................................................................................................... (98,000) Capital gain ............................................................................................................................. ............ $ 12,000

Schedule 8 — Principal Residence City Home Capital gain per year of ownership Par. 40(2)(b) gain: Proceeds of disposition ACB Selling cost Gain Gain per year

Cottage

$ 350,000 $

95,000 21,000

$234,000 10 years

$ 200,000 $

(116,000) $ 234,000 = $ 23,400 →

15,500 12,000

$172,500 15 years

(27,500) $ 172,500 = $ 11,500

Therefore, Mr. Richmond should assign the maximum designation to the City Home first. Maximum capital gain: Par. 40(2)(b): Gain ............................................................................................................. Exemption....................................................................................................

City Home

Cottage

$ 234,000 (234,000)(1) Nil

$ 172,500 (80,500)(2) $ 92,000

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—NOTES TO SOLUTION (1) Designate 2015–2023 →

1 + 9 years 10 years

(2) Designate 2009–2014 →

1 + 6 years 15 years

 $234,000 = $234,000  $172,500 = $80,500

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Solution 13: Asset Sale 1. Proposed Structure for the Sale All the new assets of Tony's Future Hardware should be transferred by direct sale to Nailem, except the proprietorship's accounts receivable, which should be transferred under a joint election by Tony and Nailem Inc. by virtue of sec. 22 of the Income Tax Act. Transferring the receivables under this section will allow Nailem to deduct a reserve for doubtful debts under par. 20(1)(l) or to write off a bad debt under par. 20(1)(p). Section 22 may be used since Tony is selling all of the property used in his business to Nailem, which is continuing the business. Tony will have to bring the reserve for doubtful debts of $2,000 into his income and will have a business loss of $3,000 on the sale of the accounts receivable ($18,000 + $2,000 - $17,000 FMV). Furthermore, because Tony is disposing of his business, any inventory sold is deemed by virtue of sec. 23 to have been sold in the course of carrying on the business. Thus, the proposed sale proceeds for inventory will result in business income of $13,000 ($48,000 - $35,000). 2. After-Tax Cash Retained by Tony Assets Accounts receivable (Note 1) Inventory (Note 2) Furniture and equipment (Note 3) Computer equipment (Note 4) Land (Note 5) Building (Note 6) Trade payables Goodwill (Note 7) Total cash and income Less: income tax payable, (Note 8)

Proceeds $ 17,000 48,000 11,000 7,000 140,000 260,000 (10,000) 190,000 663,000 $(140,760)

Net after-tax cash

$522,240

Business Income $ (1,000) 13,000 1,000 (1,000)

TCG

60,000 115,000

24,000 -

95,000 $270,000

$ 36,000

Since the net after-tax cash from the sale will be greater than $500,000, Tony will want to accept the offer. Note 1:

Accounts receivable will be transferred by virtue of sec. 22 Therefore, as explained previously, the following will result: Reserve for doubtful debts included in income Business loss on debt ($20,000 − $17,000) Net income inclusion

Note 2:

$ 2,000 (3,000) $ (1,000)

As explained previously, the sale of inventory will be considered business income and, therefore, fully taxable.

Note 3: Class 8 UCC Less:

Note 4: Class 50 UCC Less:

$10,000 lower of: Cost proceeds Recapture

$15,000 11,000

(11,000) $(1,000) $ 8,000

lower of: Cost Proceeds Terminal loss

$18,000 7,000

(7,000) $ 1,000

Note 5: The sale of land will produce a taxable capital gain. Proceeds Adjusted cost base Capital gain Taxable capital gain (50% × $120,000)

$140,000 20,000 $120,000 $ 60,000

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Note 6: The sale of the building will produce recapture and a taxable capital gain. Proceeds Adjusted cost base Capital gain Taxable capital gain (50% × $230,000)

$260,000 30,000 $230,000 $115,000

Class 1 UCC Less: lower of: Cost proceeds Recapture

$ 6,000 $30,000 $198,750

(30,000) $ 24,000

Note 7: The sale of goodwill will cause an inclusion in income. Proceeds Adjusted cost base Capital gain Taxable capital gain (50% × $190,000)

Note 8: Income taxes payable by Tony TCG on sale of business Income from sale of business

$190,000 0 $190,000 $ 95,000

$270,000 36,000

Taxable income from sale of business

$306,000

Tax payable at 46% × $306,000

$140,760

3. When Tony Will Pay Tax on the Sale On the disposition of an unincorporated business, a fiscal period is deemed to end. This would result in Tony having to pay the tax on the estimated taxable income from the period from January 1, 2023 to September 30, 2023 of $40,000 and the income from the sale of $306,000 no later than April 30, 2024.

Solutions to Chapter 7 Assignment Problems

167

Solution 14: Sale of Land and Building, Reserve

Proceeds ACB

Land $ 1,650,000 $ 300,000

Building $ 675,000 $ 600,000

$ 1,350,000

75,000

$ 1,425,000

TCG

$ 675,000

37,500

Reserve Year 1

Lesser of:

Total Opening LOCP

UCC $ 465,000 $ 600,000

Recapture

135,000

712,500

4/5 x $1,425,000

$ 1,140,000

Income - Year 1 Recapture CG

$900k x $1,425k

Reserve

551,612

50% x

873,388

551,612

2,325K

$135,000 $ 1,425,000 $ 436,694 $ 571,694

Year 2

Lesser of:

1 2

3/5 x $1,425,000 $450k x $1,425k

$ $

855,000 275,806

2,325K Year 3

Lesser of:

2/5 x $1,425,000

$ 190,000

$nil x $1,425k 2,325K

Income - Year 2 Reserve Last year This year

$ $

551,612 275,806

50% x

275,806

Income - Year 3 Reserve Last year $ This year $

275,806 -

50% x

275,806

$ 137,903

Total taxable capital gain taken into income

In the year of disposal, the full amount of the taxable capital gain and recapture will be taken into income. A capital gain reserve [40(1)(a)] can then be claimed in year 1 for the proceeds that are not due by the end of the year. No reserve is allowed for recapture. In year 2 the reserve for year 1 is brought into income and a new reserve, if any, may be claimed. In this case, there is no reserve in year 3 since all of the proceeds have either been received or are due. Interest at 3% of the balance owing on the anniversary date of the $900,000 loan would be included in Lev’s income for the year (not shown above).

$ 137,903 $ 712,500

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Solution 15: Dividend in Kind The land can be paid out as a dividend in kind. Company: As a result of transferring the property to the shareholder, the company will have disposed of the land at fair market value with the resulting capital gain of $55,000 and taxable capital gain of $27,500. Adele: Adele will have to report a dividend of $100,000 grossed up as either an eligible dividend at 38% or as a non-eligible dividend at 15%.

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Solution 16: Foreign Exchange Sale of asset P of D — Canadian dollars ($10,000 X $1.34) ....................................................... $ 13,400 ACB — Canadian dollars ...........................................................................................(4,000) CG ……………………………………………………………………………..

$ 9,400

TCG (50%) ……………………………………………………………………

$ 4,700

Currency P of D — Canadian dollars received ..................................................................... $14,500 ACB — Canadian dollars at time of sale ................................................................ (13,400) Gain ………………………………………………………………………….. Exempt portion for an individual taxpayer ………………………………….

$ 1,100 (200)

CG ……………………………………………………………………………

TCG (50%) …………………………………………………………………..

$ 450

900

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Introduction to Federal Income Taxation in Canada

Solution 17: Reserves if Income or Capital Capital Property Assuming that the property sale is determined to be on account of capital, a reserve is available [par. 40(1)(a)(iii)] for that proportion of the gain that is attributable to proceeds not due in the year. This reserve is restricted to a five-year period and on a cumulative basis at least 20% of the gain must be brought into income each year. 2023 Proceeds of disposition .................................................................................................... $ 160,000 Adjusted cost base ............................................................................................................... (4,000) Gain ................................................................................................................................. $ 156,000 Reserve — lesser of: (a) $156,000  $120,000/$160,000 = $117,000 (b) (1/5  $156,000)  (4 - 0) = $124,800 ........................................................................(117,000) Capital gain...................................................................................................................... $ 39,000 Taxable capital gain (50%) .............................................................................................. $ 19,500 2024 Prior year’s reserve .......................................................................................................... $ 117,000 Reserve — lesser of: (a) $156,000  $100,000/$160,000 = $97,500 (b) (1/5  $156,000)  (4 - 1) = $93,600 ........................................................................ (93,600) Capital gain...................................................................................................................... $ 23,400 Taxable capital gain (50%) .............................................................................................. $ 11,700 2025 Prior year’s reserve .......................................................................................................... $ 93,600 Reserve — lesser of: (a) $156,000  $80,000/$160,000 = $78,000 (b) (1/5  $156,000)  (4 - 2) = $62,400 ........................................................................ (62,400) Capital gain...................................................................................................................... $ 31,200 Taxable capital gain (50%) .............................................................................................. $ 15,600 2026 Prior year’s reserve .......................................................................................................... $ 62,400 Reserve — lesser of (a) $156,000  $60,000/$160,000 = $58,500 (b) (1/5  $156,000)  (4 - 3) = $31,200 ........................................................................ (31,200) Capital gain...................................................................................................................... $ 31,200 Taxable capital gain (50%) .............................................................................................. $ 15,600 2027 Prior year’s reserve .......................................................................................................... $ 31,200 Reserve — lesser of (a) $156,000  $40,000/$160,000 = $39,000 (0) (b) (1/5  $156,000)  (4 - 4) = 0 .................................................................................. Capital gain...................................................................................................................... $ 31,200 Taxable capital gain (50%) .............................................................................................. $ 15,600

Note how the capital gain of $156,000 is effectively spread over the five years 2023 to 2027, inclusive [i.e., $39,000 + $23,400 + (31,200  3)]. It is important to note that the entire capital gain will be included in income within 5 years even though the proceeds are not all received. Income Property (Inventory) Assuming that the property sales is determined to be on acount of income, a reserve is available [par. 20(1)(n)] for that proportion of the profit on the sale of land that is attributable to proceeds due after the year. 2023 Sale proceeds ................................................................................................................... $ 160,000 Cost ...................................................................................................................................... (4,000) Profit ...................................................................................................................... .......... $ 156,000 Reserve: $156,000  $120,000/$160,000 = .......................................................................... (117,000) Income ............................................................................................................................. $ 39,000

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2024 Prior year’s reserve .......................................................................................................... $ 117,000 Reserve: $156,000  $100,000/$160,000 = ..........................................................................(97,500) Income ............................................................................................................................. $ 19,500 2025 Prior year’s reserve .......................................................................................................... $ 97,500 Reserve: $156,000  $80,000/$160,000 = ............................................................................ (78,000) Income ............................................................................................................................. $ 19,500 2026 Prior year’s reserve .......................................................................................................... $ 78,000 Reserve: limited by ssec. 20(8) ............................................................................................ (0) Income ............................................................................................................................. $ 78,000

Note how the profit of $156,000 is effectively spread over the four years 2023 to 2026, inclusive [i.e., $39,000 + ($19,500  2) + $78,000]. Summary of Cash Flows Year 2023 2024 2025 2026 2027 2028 2029

Cash received $ 40,000 20,000 20,000 20,000 20,000 20,000 20,000 $ 160,000

Capital property Tax @ 50% Net cash $ (9,750) $ 30,250 (5,850) 14,150 (7,800) 12,200 (7,800) 12,200 (7,800) 12,200 — 20,000 — 20,000 ($ 39,000) $ 121,000

Inventory Tax @ 50% Net cash $ (19,500) $ 20,500 (9,750) 10,250 (9,750) 10,250 (39,000) (19,000) — 20,000 — 20,000 — 20,000 $ (78,000) $ 82,000

In both situations, he will have to include interest income as property income in his net income for tax purposes each year.

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Solution 18: Replacement Property An expropriation of rental property qualifies for subsection 13(4) treatment by virtue of paragraph (a). Income from property of an individual must be reported on a calendar year basis.

2022

2023 2022

UCC at January 1, 2022........................................................................................................ Disposal(1) lesser of: (a) capital cost ............................................ $ 406,000 (b) proceeds ................................................ $ 362,500→ UCC at December 31, 2022.................................................................................................. Recapture.................................................................................................................... .......... UCC at January 1, 2023........................................................................................................ File an amended return for 2022 [subsection 13(4)] as follows: UCC at January 1, 2022........................................................................................................ Deemed disposal [par. 13(4)(c)] lesser of: (a) capital cost ............................................ $ 406,000 (b) proceeds ................................................ $ 362,500→ $ 362,500 reduced by lesser of: (a) normal recapture ($362,500 – $188,500)................ $ 174,000→ (174,000) (b) replacement cost $ 1,276,000

Building Class 1: 4% $ 188,500

(362,500) $ (174,000) 174,000 Nil $

188,500

(188,500)

UCC December 31, 2022......................................................................................................

Nil Building(2) Class 1(Sep.): 4%

2023

2022

Add:

capital cost of new building................................................................ $ 1,276,000 reduced as above [par. 13(4)(c)].............................................................. (174,000) UCC December 31, 2023...................................................................................................... CCA claimed for 2023 @ 4% of [$1,102,000 + 1/2  $1,102,000)] ...................................... UCC January 1, 2024............................................................................................................

$ 1,102,000 $ 1,102,000 (66,120) $ 1,035,880

UCC January 1, 2022............................................................................................................ Less: disposal (proceeds not in excess of cost) .....................................................................

Appliances & fixtures(3) Class 8: 20% $ 7,250 2,600

UCC December 31, 2022...................................................................................................... Terminal loss ........................................................................................................................ 2023

UCC January 1, 2023............................................................................................................ Add: capital cost of new appliances and fixtures.................................................................. UCC December 31, 2023...................................................................................................... CCA claimed for 2023 @ 20% of [$46,400 + (1/2  $46,400)]............................................. UCC January 1, 2024............................................................................................................

$ $

4,650 (4,650) Nil 46,400 46,400 (13,920) $ 32,840

—NOTES TO SOLUTION (1) Income Tax Folio S3-F3-C2, paragraph 1.15 appears to require that even if a replacement property is purchased in the subsequent taxation year before the tax return is due for the year of disposition (i.e., before April 30, 2023 in this case), the recapture must be reported for the year of disposition. Then an amended return can be filed to implement subsection 13(4) when the replacement is purchased within the allowable time limit. (2) Note how the rules [ssec. 13(4)] allow for a replacement with an asset of another class, i.e., a separate class for a rental property costing more than $50,000, in this case. (3) Even if the equipment had been considered part of the involuntary disposition there would not have been any recapture to defer.

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Solution 19: Sale of Building With Terminal Loss Pidgeon Dock Ltd. has sold the building for less than its cost amount, with a concurrent capital gain on the land. When this occurs, subsection 13(21.1) reallocates the proceeds of disposition between the land and the building. Any loss on the building is reduced by the amount of the gain on the land. Deemed proceeds of the building is equal to the lesser of: (a) Total FMV of land and building Deduct the lesser of: i) FMV of land ii) Cost of land amount (a) (b) The greater of: i) FMV of building ii) the lesser of: a) UCC of building b) Capital cost amount (b)

$ 950,000 $350,000 $200,000

$600,000 $650,000 $800,000

$650,000 $ 650,000

Deemed proceeds — building (lesser of (a) and (b)) Deemed proceeds — land ($950,000 − 650,000) The tax implications are: Capital gain on land: Proceeds (deemed) Cost Capital gain Taxable capital gain (50% inclusion rate) Building: UCC at beginning of year Deduct the lesser of: Capital cost Proceeds UCC at end of year

200,000 $ 750,000

$650,000 $300,000 $300,000 (200,000) $ 100,000 $ 50,000 $650,000 $800,000 $650,000 $

650,000 0

No terminal loss arises from the disposition of the building as the deemed proceeds are equal to UCC. The lesser of the capital cost or proceeds on disposition are credited to the UCC pool. In this situation, PD credits the deemed proceeds, which was determined to be the UCC of the building. This results in a UCC balance of zero, with no terminal loss on the building. The land sale results in an overall lower capital gain.

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Solution 20: Sale of Building With Terminal Loss Given that High Towers’ intention is to demolish the building, its fair market value to High Towers is nil. High Towers is effectively paying $1 million to acquire the land on which the building sits. In the absence of a specific provision, Johnny Wong would have a capital gain of $920,000 (i.e., $1,000,000 – $80,000) on the land and a terminal loss on the building of $103,000 (i.e., $140,000 – $37,000). The capital gain is only 50% taxable and the terminal loss could be used to shelter a portion of the taxable capital gain. Therefore, in the absence of a specific provision to prevent such an offset, Johnny’s tax implications would be as follows: Land: P of D..............................................................................................................................................$ 1,000,000 ACB ............................................................................................................................................... (80,000) Capital gain......................................................................................................................... ....... $ 920,000 Taxable capital gain (50%) ........................................................................................................ $ 460,000 Building: P of D............................................................................................................................ ............. Nil UCC.......................................................................................................................... ................. $ (103,000) Terminal loss ............................................................................................................................. $ 103,000 Combined: Taxable capital gain — land ...................................................................................................... $ 460,000 Terminal loss — building ...............................................................................................................(103,000) Net income................................................................................................................... .............. $ 357,000

Subsection 13(21.1) of the Act will, however, require the proceeds of disposition to be allocated between the land and building in such a manner that there is no terminal loss on the building and the capital gain on the land is reduced. This allocation is determined as follows: P of D of building = lesser of: (a) (i) FMV of land and building ...............................................................................................$ 1,000,000 minus (ii) lesser of: ACB of land ..................................................................................... $ 80,000 FMV of land.......................................................................................... $ 1,000,000 lesser amount ................................................................................................................. 80,000 $ 920,000 (b) greater of: (i) FMV of building .................................................................................. Nil (ii) lesser of capital cost ($140,000) and UCC ($103,000) of building $ 103,000 greater amount ........................................................................................................... $ 103,000

Since proceeds of disposition of the building will be deemed to be equal to its UCC of $103,000, there will be no terminal loss. The proceeds of disposition for the land will be deemed to be: (a) P of D of land and building ............................................................................................................$ 1,000,000 minus (b) Deemed P of D of building ............................................................................................................ 103,000 $ 897,000

Therefore, there will be a capital gain of $817,000 (i.e., $897,000 – $80,000) to be reported on the land, 1/2 of which, or $408,500, is the taxable capital gain. Therefore, subsection 13(21.1) results in Johnny having to report $51,500 more income than would otherwise be the case. The effect of paragraph 13(21.1)(a) can be seen from the following comparison: Income effect Taxable capital gain on land........................................................ Terminal loss on building............................................................ Effect on net income ...................................................................

Without par. 13(21.1)(a) $ 460,000 (103,000) $ 357,000

With par. 13(21.1)(a) $ 408,500 Nil $ 408,500

In effect, the terminal loss of $103,000, which is fully deductible, is converted into an amount that is only 1/2 deductible by reducing the gain on the land which is only 50% taxable. Hence, 50% of $103,000 or $51,500 is not deductible.

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Solution 21: Replacement Property This situation involves a voluntary disposition of a former business property in respect of land and building, as well as a disposition of property not eligible for a rollover. Raymond must replace the land and building within one taxation year of the end of the December 31, 2022 year (i.e., the taxation year of the disposition), in order to obtain the benefits of the rollover. 2023 Mar. 1

Dec. 31

2024 Feb.

Dec. 31 Nov.

Replacement

Disposition

replacement period limit (A) 2023 income — Subdivision b Par. 12(1)(d) Sec. 22 Sec. 23 Sec. 13

Sec. 14

Last year’s reserve ............................................................................................. $6,000 – $10,000 ............................................................................................... $5,200 – $7,000 ................................................................................................. Recapture — Class 1 ($62,000 – $28,000)........................................................ — Class 8 ($1,200 – $300)............................................................... — Class 10 ($4,000 – $800)............................................................. 50%  $52,000...................................................................................................

1,300 (4,000) (1,800) 34,000 900 3,200 26,000

Taxable capital gain — Subdivision c Land Building Equipment

— ($120,000 – $65,000) → $55,000  50% ..................................................... — ($170,000 – $62,000) → $108,000  50%.................................................... — Class 8 (($3,000 – $1,200)  50% ................................................................ — Class 10 ........................................................................................................

27,500 54,000 900 Nil $ 142,000

(B) 2023 amended tax return Section 44 election on capital gains TCG on land: Lesser of: (a) $55,000 CG (above) (b) ($120,000 – $105,000) = $15,000 - $15,000  50% .................................. $ 7,500 ACB [par. 44(1)(f)] = $105,000 – ($55,000 – $15,000) = $65,000 TCG on building: Lesser of: (a) $108,000 CG (above) (b) $170,000 – $220,000 = Nil ........................................................................ Nil ACB = $220,000 – ($108,000 – Nil) = $112,000 Note from the capital gain calculation for the building that up to $50,000 (i.e., $220,000 – $170,000) could be added to the proceeds of the building before there is an excess over replacement cost. This determines the room for a reallocation under subsection 44(6). Subsection 13(4) election on recapture Cl. 1: 4% Building: UCC January 1, 2023............................................................................................................... Less: lesser of [par. 13(4)(c)]: P of D......................................................................... $ 170,000 Capital cost ................................................................ 62,000 $ 62,000 reduction [par. 13(4)(d)] which is the lesser of: Less: (a) recapture ............................................................... $ 34,000 (b) replacement cost ................................................... 220,000 34,000 UCC, December 31, 2023............................................................................

$ 28,000

28,000 Nil

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Introduction to Federal Income Taxation in Canada Cl.1: 4% Capital cost of replacement property in 2024: Actual cost ................................................................................................................ $220,000 Less: reduction [par. 44(1)(f) above] ........................................................................ 108,000 $112,000 Less: reduction [par. 13(4)(d) above] ................................................................. 34,000 $ 78,000 UCC, December 31, 2024........................................................................................................ $ 78,000 CCA 2024 (4% x$78,000) ............................................................................................................ (3,120) UCC, January 1, 2025.............................................................................................................. $ 74,880

Buildings used by any person before March 19, 2007 are not eligible for the extra 2% CCA rate for nonresidential buildings [Reg. 1100(1)(a.2), 1101(5b.1), 1104(2)] (C) Using a subsection 44(6) election: Allocate $15,000 of proceeds of disposition on the land to the building. Capital gain — Section 44 election (file an amended return for 2023): The lesser of: (a) P of D................................................................................................. Ssec. 44(6) adjustment ....................................................................... Deemed P of D................................................................................... ACB ................................................................................................... Gain ................................................................................................... (b) Deemed P of D (above)...................................................................... Replacement cost ............................................................................... Excess, if any ..................................................................................... Capital gain (lesser amount) .............................................................................. Adjusted cost base of replacement property [par. 44(1)(f)]: Replacement cost ............................................................................................... Less: deferred capital gain ((a) – (b) above) ...................................................... ACB................................................................................................................... UCC — Subsection 13(4) election (file amended return for 2023):

Land

Building

$ 120,000 (15,000) $ 105,000 (65,000) $ 40,000 $ 105,000 105,000 Nil Nil

$ 170,000 15,000 $ 185,000 (62,000) $123,000 $ 185,000 220,000 Nil Nil

$ 105,000 40,000 $ 65,000

$ 220,000 123,000 $ 97,000

Class 1: 4% UCC — just prior to sale ......................................................................................................... $ 28,000 Reduction [par. 13(4)(c)]: lesser of: (a) cost ($62,000) .................................................................................... $ 62,000 (b) P of D ($170,000) (not adjusted by ssec. 44(6)) Less: the lesser of: (a) recapture ($62,000 – $28,000 = $34,000) .......................................... 34,000 28,000 (b) replacement cost ($220,000) UCC, December 31, 2023 ............................................................................................................ Nil Cl.1: 4% Addition for purchase in 2024: Replacement cost ............................................................................................ $ 220,000 Less: reduction for deferred capital gain [par. 44(1)(f)] .................................. 123,000 Deemed capital cost ................................................................................... $ 97,000 Less: reduction for deferred recapture [par. 13(4)(d)] ..................................... 34,000 UCC.......................................................................................................................... ............... $ 63,000 CCA, 2024 ($63,000  4% )......................................................................................................... (2,520) UCC, January 1, 2025.............................................................................................................. $ 60,480

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Comparison of Part (B) without and Part (C) with subsection 44(6) election: Capital gain — Land ....................................................... — Building ................................................. ACB of replacement property — Land ....................... — Building.................. UCC (before CCA for the year) of replacement building

Without ssec. 44(6) $ 15,000 Nil 65,000 112,000 78,000

With ssec. 44(6) Nil Nil $ 65,000 97,000 63,000

Difference $ 15,000 Nil Nil 15,000 15,000

With a subsection 44(6), the taxpayer would defer an additional $15,000 of capital gain on the land, but the UCC base for CCA on Class 1 would be reduced by $15,000. A present value comparison can be made to evaluate this trade-off. (D) The equipment in Class 8 and Class 10 would be eligible for a section 44 election. The rollover would, therefore, defer $900 and $3,200 of recapture in Class 8 and 10, respectively, and $1,350 of taxable capital gain in Class 8.

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Solution 22: Schedule 1 With Capital Transactions (A) Net income before taxes ...................................................................................................................... $ 900,000 Add: Sec. 3 Book loss on sale of securities ....................................... $ 20,000 Sec. 3 Book loss on sale of trademark ...................................... 10,000 Ssec. 14(1) Recapture (Schedule 1) .................................................. 4,700 Sec. 39 Taxable capital gain on land: 50% of ($150,000 – $120,000) ............................................. 15,000 Taxable capital gain on sale of building 50%of ($120,000 – $100,000) ............................................. 10,000 Par. 18(1)(b) Amortization .................................................................. 80,000 Par. 18(1)(t) Assessment interest........................................................ 1,500 Par. 18(1)(a) Donations....................................................................... 10,000 151,200 $1,051,200 Less: Sec. 3 Book gain on sale of land............................................... $ 50,000 Sec. 3 Book gain on sale of building ........................................ 95,000 Sec. 39 Allowable capital loss on securities: 50%of ($50,000 – $30,000)...................................... 10,000(1) Sec. 50 Allowable capital loss on bad capital debt: 2,500 (50% $5,000).......................................................... Par. 20(1)(a) Capital cost allowance (given)....................................... 100,000 257,500 Net income for income tax purposes ....................................................................................................... $ 793,700 Schedule 1 — Class 14.1 2021 Trademark.................................................................................................................... ....... CCA — 2021 @ (80,000 x 1.5 x 5%)................................ — 2022 @ 5% .......................................................... —.............................................................................. UCC at the end of 2022 (January 1, 2023) 2023 Sale Cost .................. $80,000 P of D ................ 75,000 Recapture ............................................................................................................................. .......

80,000 (6,000) (3,700)

$ 70,300 (75,000) (4,700) 4,700

—NOTES TO SOLUTION (1) The aggregate of taxable capital gains reported in 2023 ($25,000) is in excess of the 2023 allowable capital losses ($12,500). Thus, all the 2023 capital losses can be claimed in 2023. (2) The $14,000 spent on the annual employee dinner-dance is not restricted by the 50% limitation under section 67.1, since the party was for all employees at a particular location providing the number of similar events is limited to six such events per year.

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Solution 23: Replacement Property The following are the issues that arise from the transactions in this case: • insurance proceeds • replacement property rules • equipment lease with option to purchase • business interruption insurance • sale of land with warranty • option to acquire land 1. Insurance proceeds for repairs • Any insurance proceeds used for repairs are included in income [par. 12(1)(f)] to offset the repair expense. • The balance of the insurance proceeds is considered “proceeds of disposition” [ssec. 13(21)] for the equipment. 2. A fire destroyed the building and most of the contents • It was an involuntary disposition since the destruction was caused by a fire. • The income effect will have to be reported in the year in which the proceeds are agreed to, i.e., 2023 (this is the “initial year”). • As a result, they have 24 months from the end of the “initial year” in which to replace the building and equipment, in order to get the benefit of the replacement property rules. • In order to get the replacement property rules, the building and equipment must be replaced within 24 months of the end of 2023, so by the end of 2025. • The equipment qualifies for the replacement property rules since this is an involuntary disposition. • The replacement property must be used in the same or similar business by Holdco or a related person [ssec. 44(5)]. 3. Equipment lease with an option to buy • The equipment lease will probably be an operating lease according to IT-233R. • The option must be exercised by the end of 2025, in order to qualify for the replacement property rules. • Holdings would have to exercise the option under the lease for the property to be replacement property since Holdings is the taxpayer which owned the original property. • If the lease is a capital lease, then it would qualify as a replacement property if Holdings held the lease. o Effects of subsection 13(5.2) not considered (knowledge not required). 4. Business interruption insurance • The business interruption insurance proceeds are included in income under section 9. 5. Sale of land with warranty • Sale of land recognized in July 2023. • Full amount of the proceeds recognized; no reserve is available for the warranty. • Any amount that has to be paid back to the purchaser will be treated as a capital loss under section 42. • The capital gain reserve is only available if part of the proceeds are not yet due. • Ideally, any payments under this warranty would be paid before the three-year carry back for net capital losses expires. 6. Option to acquire land • If Holdings exercises the option to acquire the land then the option price will be added to the cost of the land under subsection 49(3). • If the option is not exercised then the cost of the option will be treated as a capital loss. • Since the original land was not disposed of involuntarily, they only have one year from the end of the initial year in which to exercise the option and replace the land in order to get the replacement property rule.

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Solution 24: Sale of Land With Apple Trees The following represents an outline of how this case could be approached and students need to recognize that at least three, and perhaps as many as four, separate properties are being disposed of. (a) Land: The land represents a non-depreciable capital property with a long-term enduring benefit. Therefore, on disposition a capital gain is recognized. (b) Trees: The trees also represent a non-depreciable capital property with a long-term enduring benefit because the trees bear fruit annually. Likewise, on disposition, a capital gain is recognized. (c) Crop of Apples: The apples are the annual growth from the trees. This annual production is held as inventory until it is sold. All dispositions of inventory result in business income. (d) Something Else?: The portion of the $50,000 that Mac received for “all his hard work over the years”. Assuming the crop value was $15,000, this leaves $35,000 as being for “something else”. But what is it? It can only be one of four things: part of the land/tree asset proceeds, salary or employment or some other kind of income from the developer, an eligible capital receipt, or a non-taxable receipt. It is very unlikely that it is salary or any similar income from the developer as no services were ever provided to the developer, nor did Mac ever have any kind of a business relationship with them. It could be an eligible capital property receipt (section 14), in which case 50% of it would be taxable as farming income. However, this income will be deemed to be a taxable capital gain [ssec. 14(1.1)] eligible for the capital gains exemption (CGE). But it is unclear what “property” was disposed of, i.e., what consideration did the developer receive in exchange for the payment? Therefore, that possibility is also unlikely. It could be part of the proceeds of the land and trees. The view here is that Mac simply negotiated a higher price for the land/trees. Or, and it is quite conceivable, it is not taxable at all as the developer simply gave Mac a gift. Remember, Mac gave nothing to the developer for this extra money. The land deal was negotiated at $400,000, the developer “voluntarily” offered more, to compensate Mac for “his hard work over the years”. All that said, the correct treatment will depend on the wording of the purchase and sale agreement. In all likelihood, it will refer to “land and crops” only, for $450,000 in consideration. This will solidify the $35,000 as being part of the land/tree price. Nonetheless, it’s an interesting question. The “correct” allocation of the proceeds is: Proceeds Less ACB Capital gain Taxable capital gain Apples — business income

Land/Trees $435,000 12,000 $423,000 $211,500

Inventory (Crop) $15,000 N/A $15,000

Since Mac is carrying on a farming business, the taxable capital gains incurred on the disposition of the farmland qualifies for the capital gains exemption. For this purpose, the trees will be considered part of the land. The available capital gains exemption is $500,000 (50% of $1,000,000). Assuming that Mac does not have any current capital losses from any other property, his annual gains limit is $211,500, and the CGE will completely offset his taxable capital gain on the farm. The CGE is allowed in computing taxable income, not net income. The only adjustment the CRA will uncover is the $15,000 business income, as this is the only item Mac did not treat correctly.

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Solution 25: Sale of a Business; Replacement Property Accounts Receivable (a) The allowance for doubtful accounts must be taken into income (par. 12(1)(d)) (b) There will be an allowable capital loss of $1,200, i.e., ½ ($9,600 - $12,000) (c) Joe does not qualify for a sec. 22 election, because the acquirer of the accounts receivable does not propose to continue the business carried on by Joe. Land (a) (b)

There will be a taxable capital gain of $270,000, i.e., 50% ($720,000 - $180,000) An election is available in 2024 to amend his 2023 tax return and defer part of the capital gain and to reduce the adjusted cost base of the replacement property by a similar amount (ssec. 44(1)) since he had acquired a replacement property within the first taxation year after 2023. Capital gain is the lesser of: (a) Proceeds ACB Capital gain (b) Replacement cost Excess, if any

$720,000 180,000 $540,000 Proceeds

$720,000 575,000 $145,000

Taxable capital gain (50%)

$ 72,500

Cost or replacement property

$180,000

($575,000 - ($540,000 - 145,000)) Building (a) There will be a taxable capital gain of $150,000 ((50% x ($420,000 - $120,000))) and recaptured CCA of $66,000 (i.e., ($120,000 - $54,000)) in 2023. (b) An election is available, for the reasons, described above, to amend his 2023 tax return and defer part of the capital gain and all of the recapture with a corresponding reduction of the capital cost of the new building. Capital gain is the lesser of: (a) Proceeds Capital cost Capital gain (b)

$420,000 120,000 $300,000

Proceeds Replacement cost Excess, if any

$420,000 360,000 $ 60,000

Taxable capital gain (50%)

$ 30,000

ACB of replacement (360,000 - (300,000 - 60,000))

$120,000

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Recapture is UCC prior to disposal Less: the lesser of (i) capital cost (ii) proceeds

$ 54,000 $120,000 $420,000

Potential recapture Minus the lesser of: (i) Potential recapture (ii) replacement cost

(66,000)

$ 66,000 $360,000

UCC December 31 as amended

deferred capital gain deferred recapture

$ 66,000 NIL

Capital cost of new building — Class 1 (4% CCA) Replacement cost Less:

120,000

$360,000 $240,000 66,000

306,000

UCC $ 54,000 Capital cost allowance 1. New building is eligible for the accelerated investment incentive in 2024 in Class 1 2. CCA must be prorated to the number of days in operation for 2024 3. CCA rate is 4% because the building acquired is used. Equipment (a) There will be a terminal loss of $12,000 on the sale of the class 8 assets (i.e., 24,000 - 12,000) (b) A capital loss is not permitted on depreciable property Inventory There will be a loss of $1,200 (i.e., $14,400 - 15,600)

CHAPTER 8

Non-Arm’s Length Transfers and Other Special Circumstances Solution 1: Attribution—Spouse, Children The bond would earn $100,000  3% = $3,000 Husband

(1) Loan: Since interest at a commercial rate is not paid, attribution would apply. Her husband would not report the $3,000, but instead Donna would report it on her return. Result: she pays the tax and her husband keeps the $3,000. (2) Gift: Since this is a gift for no consideration, attribution would apply. Her husband would not report the $3,000, but instead Donna would report it on her return. Result: she pays the tax and her husband keeps the $3,000. Transferor – Donna

Husband

Attribution

Loan To spouse @ 0% interest

She reports $3,000 She pays the tax

He earns $3,000 – attributed to Donna He keeps the cash

FMV consideration? Debt – interest at prescribed rate paid? Spouse – elect out of rollover? Marriage breakdown & apart?

Gift To spouse

She reports $3,000 She pays the tax

He earns $3,000 – attributed to Donna He keeps the cash

FMV consideration? Debt – interest at prescribed rate paid? Spouse – elect out of rollover? Marriage breakdown & apart?

15-Year-Old Daughter

(3) Loan: Since interest at a commercial rate is not paid and her daughter is a minor, attribution would apply. Her daughter would not report the $3,000, but instead Donna would report it on her return. Result: she pays the tax and her 15-year-old daughter keeps the $3,000. (4) Gift: Since this is a gift for no consideration and her daughter is a minor attribution would apply. Her daughter would not report the $3,000, but instead Donna would report it on her return. Result: she pays the tax and her 15-year-old daughter keeps the $3,000.

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Introduction to Federal Income Taxation in Canada Transferor – Donna

Daughter – 15

Attribution

Loan To minor @ 0% interest

She reports $3,000 She pays the tax

She earns $3,000 – attributed to Donna She keeps the cash

FMV consideration? Debt – interest at prescribed rate paid? Spouse – elect out of rollover? Marriage breakdown & apart?

Gift To minor

She reports $3,000 She pays the tax

She earns $3,000 – attributed to Donna She keeps the cash

FMV consideration? Debt – interest at prescribed rate paid? Spouse – elect out of rollover? Marriage breakdown & apart?

25-Year-Old Daughter

(6) Loan: Although interest at a commercial rate is not paid, her daughter is not a minor, so attribution would not apply. Donna would not report the $3,000, but instead her daughter would report it on her return. Result: her daughter pays the tax and keeps the $3,000. (7) Gift: Although this is a gift for no consideration, her daughter is not a minor, so attribution would not apply. Donna would not report the $3,000, but instead her daughter would report it on her return. Result: her daughter pays the tax and keeps the $3,000. Transferor – Donna

Daughter – 25

Loan To adult @ 0%

No tax effect Income shifted

She earns $3,000 Reports income Pays the tax

Gift To adult

No tax effect Income shifted

She earns $3,000 Reports income Pays the tax

Attribution However, if one of the main reasons for the loan is to reduce or avoid tax then attribution. [ssec. 56(4.1)]

Benefit of attribution if it works Donna Don Danielle Susan

Tax Bracket 53% 41% 25% —

Savings 12%  $3,000 = $360 28%  $3,000 = $840 53%  $3,000 = $1,590

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Solution 2: Attribution (a) Mr. Lee must include the dividend in his income, since the attribution rules will apply. The amount to be included in Mr. Lee’s income is $6,900 ($5,000 + 38% gross-up). He will also be eligible for the dividend tax credit. (b) As Carey turned 18 in the year, subsection 74.1(2) will not apply to attribute any of the income back to Ellen. All of the income would be taxed in Carey’s hands.

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Solution 3: Business and Property Income, Attribution (a) Net income from employment, team salary Net income from proprietorship business Net income from endorsements (business income) Net income from property: Dividends from Canadian corporation Add 38% gross-up Taxable amount Dividends from foreign corporation Interest from Canadian bank One-year anniversary interest accrual on GIC (attributed to John)

$190,000 45,000 31,000 $ 7,200 2,736 $ 9,936 8,000 6,950 600 $25,486

Expenses Interest on loan Net income from property Net income

( 4,500) 20,986 $286,986

(b) Basic Tax Planning • • • • • •

Consider using a deferred-income fund, such as an RRSP, for the GICs. Investigate whether the investment in the foreign corporation might not be better invested in a Canadian corporation because of the dividend tax credit. Pay higher, yet reasonable, compensation to Kate to split more income with John. To be deductible, salary must be reasonable given the work she is doing. Kate has a salary in her own right; consider investing it rather than spending it on family personal needs. This will result in the investment income being taxed in her hands. Consider incorporating the sporting goods store. Consider setting up a tax-free savings account.

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Solutions to Chapter 8 Assignment Problems

Solution 4: Interest Versus Dividend and Attribution (A) Dividend Fund: Dividend Income (3% of $200,000)........................................................................... Add: gross-up of 38% of dividend .............................................................................

$ 6,000 2,280

Grossed-up dividend subject to tax ............................................................................ Federal and provincial tax on grossed-up dividend @ 53%....................................... Less: dividend tax credit (assumes provincial and federal total the gross-up) ........... Net tax payable .......................................................................................................... After-tax dividend ($6,000 – $2,108).........................................................................

$ 8,280 $ 4,388 (2,280) $ 2,108 $ 3,892

Income Fund: Interest income (4% of $200,000).............................................................................. Federal and provincial tax payable @ 53%................................................................ After-tax interest ($8,000 – $4,000)...........................................................................

$ 8,000 $ 4,240 $ 3,760

The difference between the two is $3,892 – $3,760 = $132. As a percentage of the $200,000 principal invested, this difference is marginal (less than 1% of the principal invested), so non-tax factors may affect the decision. (B) Putting the investment in the name of the daughter would be of no advantage in the holding period envisaged: — this would be considered as a transfer of the property subject to the income attribution rules [ssec. 74.1(2)]; — the effect would be to require that the investment income be included in the income of the father until the daughter reaches the age of 18 years; — since the holding period is expected to be until 2024, the daughter who is presently eight years old will not reach 18 in the holding period. (C) Subsection 74.5(2) would exempt this loan with interest at the prescribed rate from attribution in subsection 74.1(1): — the wife must pay interest which will be income to him and will reduce or eliminate any income splitting benefit on a fixed-income security; — would be a good strategy if substantial capital gains were expected.

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Solution 5: Non-Arm’s Length Transactions, Attribution Gift to Husband For the gift to the husband we must look at two scenarios: using the automatic interspousal rollover or electing out of the automatic rollover provisions.

Automatic Rollover

Donna

Husband

Attribution

Proceeds = ACB – no gain or loss to Donna

Her husband receives the shares at an ACB of $70,000

Attribution?

She will pay tax on any future CG/CL

When he disposes of the shares, any capital gain or loss will be attributed back to Donna, since they did not elect out of the rollover and she did not receive fair market value consideration form him

She will pay tax on any future dividends

Any dividends received on the shares will be attributed back to Donna as well He will keep the cash Election out of Rollover – FMV

1,000 shares  (proceeds $100 – ACB $70) = CG $30,000; TCG $15,000

Her husband receives the shares at an ACB of $100,000 or the FMV at the time of the transfer

Donna will report a TCG of $15,000.

Since there was no consideration for the transfer, any capital gain or loss on the sale of these shares by her husband will be attributed back to Donna

She will pay tax on any future CG/CL

Yes – transferred property to spouse

Exception? No – did not elect out of rollover and the husband did not pay FMV consideration Conclusion: Attribution will apply. Attribution? Yes – transferred property to spouse

Exception? She will pay tax on any future dividends

Since there was no consideration for the transfer, any dividends received on the shares will be attributed back to Donna as well

No – the husband did not pay FMV consideration

He will keep the cash

Conclusion: Attribution will apply.

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Solutions to Chapter 8 Assignment Problems Gift to 15-year-old son Donna

Son

Attribution

1,000 shares  (proceeds $100 – ACB $70) = CG $30,000; TCG $15,000

Her son receives the shares at an ACB of $100,000 or the FMV at the time of the transfer

Attribution?

Donna will report a TCG of $15,000. She will not pay tax on any future CG/CL

Yes – transfer to related minor

Any capital gain or loss on the sale of these shares by her son will not be attributed back to Donna Exception?

She will pay tax on any future dividends received before her son turns 18

Since there was no consideration for the transfer, any dividends received on the shares will be attributed back to Donna until the year in which her son turns 18 and is no longer a minor

No – Son did not pay FMV consideration Conclusion: Attribution will apply.

Gift to 25-year-old daughter Donna

Daughter

Attribution

1,000 shares  (proceeds $100 – ACB $70) = CG $30,000; TCG $15,000

Her daughter receives the shares at an ACB of $100,000 or the FMV at the time of the transfer

Attribution?

Donna will report a TCG of $15,000 She will not pay tax on any future CG/CL

No – she is over 18 and it is a gift

Any capital gain or loss on the sale of these shares by her daughter will not be attributed back to Donna Exception?

She will not pay tax on any future dividends

Since her daughter is over 17 and is no longer a minor, any dividends received on the shares will not be attributed back to Donna

N/A Conclusion: Attribution will not apply.

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Solution 6: Non-Arm’s Length Transactions, Attribution Sell the shares to her husband 1. Sell the shares to her husband for cash of $50,000 Automatic rollover – Proceeds = ACB – no gain or loss to Katie Her husband receives the shares at an ACB of $35,000 even though he paid $50,000 for the shares. When he disposes of the shares, any capital gain or loss will be attributed back to Katie, since they did not elect out of the rollover. Any dividends received on the shares will be attributed back to Katie as well. Elect out of Section 73(1) – Proceeds $50,000 – ACB $35,000 = CG $15,000; TCG $7,500 Katie will report a TCG of $7,500 in the year of transfer. Her husband receives the shares at an ACB of $50,000. Since there is full consideration for the transfer, any capital gain or loss on the sale of these shares by her husband will not be attributed back to Katie, and any dividends received on the shares will not be attributed back to Katie either. 2.

Sell the shares to her husband for a non-interest bearing note of $50,000 Automatic rollover – Proceeds = ACB – no gain or loss to Katie Her husband receives the shares at an ACB of $35,000. When he disposes of the shares, any capital gain or loss will be attributed back to Katie, since they did not elect out of the rollover and the consideration was not equal to the fair market value of the shares. A non-interest bearing note for $50,000 has a fair market value of less than its face value. Any dividends received on the shares will be attributed back to Katie as well and will be grossed up by 38%. Elect out of Section 73(1) – Proceeds $50,000 – ACB $35,000 = CG $15,000; TCG $7,500 Katie will report a TCG of $7,500. Her husband receives the shares at an ACB of $50,000. Since there was no interest charged on the note, any capital gain or loss on the sale of these shares by her husband will be attributed back to Katie. Since there was no interest charged on the note, any dividends received on the shares will be attributed back to Katie as well and will be grossed up by 38%.

Sell the shares to her husband for cash of $40,000. Automatic rollover – Proceeds = ACB – no gain or loss to Katie Her husband receives the shares at an ACB of $35,000. When he disposes of the shares, any capital gain or loss will be attributed back to Katie, since they did not elect out of the rollover and the consideration was not equal to the fair market value of the shares. Any dividends received on the shares will be attributed back to Katie as well and will be grossed up by 38%.

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Elect out of Section 73(1) – Proceeds $50,000 – ACB $35,000 = CG $15,000; TCG $7,500 Katie will report a TCG of $7,500. She is deemed to have disposed of the shares at fair market value, since she and her husband are not dealing at arm’s length. Her husband receives the shares at an ACB of $40,000, which is what he paid for them. This will result in double tax, since both he and Katie will pay tax on the $10,000 between $40,000 and $50,000. Since fair market value was not received, any capital gain or loss on the sale of these shares by her husband will be attributed back to Katie. Since fair market value was not received, any dividends received on the shares will be attributed back to Katie as well.

Sell the shares to her 25 year-old daughter 1. Sell the shares to her 25-year-old daughter for cash of $50,000 Proceeds $50,000 – ACB $35,000 = CG $15,000; TCG $7,500 Katie will report a TCG of $7,500. Her daughter receives the shares at an ACB of $50,000. Any capital gain or loss on the sale of these shares by her daughter will not be attributed back to Katie. Since her daughter is over 17 and is no longer a minor, any dividends received on the shares will not be attributed back to Katie. Any dividends received will be grossed up by 38%. 2.

Sell the shares to her 25-year old for a non-interest bearing note of $50,000 Proceeds $50,000 – ACB $35,000 = CG $15,000; TCG $7,500 Katie will report a TCG of $7,500. Her daughter receives the shares at an ACB of $50,000. Any capital gain or loss on the sale of these shares by her daughter will not be attributed back to Katie. Since her daughter is over 17 and is no longer a minor, any dividends received on the shares will not be attributed back to Katie unless the purpose of the transaction is to split income. Any dividends received will be grossed up by 38%.

Sell the shares to her 25-year-old daughter for cash of $40,000. Proceeds $50,000 – ACB $35,000 = CG $15,000; TCG $7,500 Katie will report a TCG of $7,500. Her daughter receives the shares at an ACB of $40,000. This will result in double tax, since both he and Katie will pay tax on the $10,000 between $40,000 and $50,000. Any capital gain or loss on the sale of these shares by her daughter will not be attributed back to Katie. Since her daughter is over 17 and no longer a minor, any dividends received on the shares will not be attributed back to Katie unless the purpose of the transaction is to split income. Any dividends received will be grossed up by 38%.

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Solution 7: Transfer of Property on Divorce Property transferred as a result of the breakdown of a marriage is treated the same way as the transfer of property between spouses living together, i.e., either an automatic rollover or an election out of the rollover. [ssec. 73(1)] Automatic rollover – Proceeds = ACB – no gain or loss to Sally Harry receives the shares at an ACB of $12,500. When he disposes of the shares any capital gain or loss will not be attributed back to Sally since the shares were transferred as a result of the breakdown of the marriage. [ssec. 74.5(3)] Any dividends received on the shares will not be attributed back to Sally since the shares were transferred as a result of the breakdown of the marriage. [ssec. 74.5(3)] As a result, Harry and Sally will each share the tax on the accrued gain. Election – Proceeds $20,000 – ACB $12,500 = CG $7,500; TCG $3,750 Sally will report a TCG of $3,750. Harry receives the shares at an ACB of $20,000 or the FMV at the time of the transfer. There will not be any attribution back to Sally since the shares were transferred as a result of the breakdown of the marriage. However, from an equity point of view the election is not “fair”, since Sally will end up paying tax on the full amount of the accrued gain. So, while the proceeds are shared equally the tax liability is not.

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Solutions to Chapter 8 Assignment Problems

Solution 8: Related, Affiliated, Arm’s Length Mr. Grand 100%

Mrs. Grand 100%

Father Inc.

Mother Inc.

Related [ssec. 251(2)] Mr. Grand is related to Father Inc. because he controls it [spar. 251(2)(b)(i)] Mrs. Grand is related to Mother Inc. because she controls it [spar. 251(2)(b)(i)] Mr. and Mrs. Grand are related to each other by marriage [spar. 251(2)(a)] Mr. Grand is related to Mother Inc. because he is related to the person (his wife) who controls Mother Inc. [spar. 251(2)(b)(iii)] Mrs. Grand is related to Father Inc. because she is related to the person (her husband) who controls Father Inc. [spar. 251(2)(b)(iii)] Father Inc. and Mother Inc. are related because the individuals who control them are related. [spar. 251(2)(c)(ii)] Mr. and Mrs. Grand are related to Noah, since he is their son [par. 251(2)(a)] Noah is related to Father Inc. and Mother Inc., since he is related to his parents who control the companies [spar. 251(2)(b)(iii)] Affiliated [ssec. 251.1(1)] Mr. Grand is affiliated with Father Inc. because he controls it [spar. 251.1(1)(b)(i)] Mrs. Grand is affiliated with Mother Inc. because she controls it [spar. 251.1(1)(b)(i)] Mr. and Mrs. Grand are affiliated with each other by marriage [ssec. 251.1(1)(a)] Mr. Grand is affiliated with Mother Inc. because he his wife controls it [spar. 251.1(1)(b)(i)] Mrs. Grand is affiliated with Father Inc. because her husband controls it [spar. 251.1(1)(b)(i)] Father Inc. and Mother Inc. are affiliated because the individuals who control them are affiliated. [spar. 251.1(1)(c)(i)] Mr. and Mrs. Grand are not affiliated with Noah [ssec. 251.1(1)] Arm’s length [ssec. 251(1)] Since all of the parties are related, none of them deal at arm’s length. [par. 251(1)(a)]

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Solution 9: Non-Arm’s Length Purchase of Rental Property As Roxanne acquired the property in a non-arm’s length transaction, her cost for CCA purposes is reduced by the amount specified in paragraph 13(7)(e). Brother’s cost Brother’s proceeds Brother’s cost Roxanne’s cost for CCA purposes

$350,000 $ 600,000 350,000 $ 250,000 × 50%

125,000 $475,000

The condominium is a Class 1 asset. Since the capital cost of the property is greater than $50,000, it must be put into its own separate CCA class. The maximum CCA that Roxanne may claim in her first year is: Class 1-4% Capital cost of additions Less CCA ($475,000 × 4%) (see Notes) UCC at end of year

$ 475,000 2,250 ** $472,750

Notes: The accelearted investment incentive does not apply [Reg. 1100(2.2)] since she acquired the property from a non-arm’s length person. **CCA at 4% = $19,000, but Roxanne cannot create or increase a rental loss by claiming CCA on her rental property. As her rental income for the year is 1/4 × $9,000 = $2,250, this is the maximum CCA available. As this is income from property and not income from a business, the CCA is not prorated by the number of days she owned/operated the property.

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Solutions to Chapter 8 Assignment Problems

Solution 10: CCPC Stock Option With Attribution A summary of the specific income implications of the above transactions is set out below. Any transfer of the shares received under the stock option, whether in the form of a gift, a sale for cash or a sale in exchange for a note, is a disposition of the shares for tax purposes. Thus, by virtue of subsections 7(1) and 7(1.1), Madame Martel must include the employment income in 2022, the year of sale, because the employer is a CCPC, the difference between the exercise/option price and the fair market value at the date the option is exercised. However, she will have an offsetting deduction under Division C [par. 110(1)(d)] in 2022 because the fair market value of the shares was equal to the exercise price at the grant date. $ 90,000 Employment Income ($35 – $20)  6,000 shares................................................. $ 45,000 Division C deduction (1/2  $90,000) ................................................................... ACB of shares to Madame Martel ($35  6,000) .......................................................$ 210,000

The net effect of the above is the inclusion in 2022 of an amount equivalent to the one-half taxable portion of a capital gain. Because the word “transfer” in sections 74.1, 74.2, and 69 includes either a gift or a sale, these sections apply to all three proposed transactions. 1. Gift

Implications to Madame Martel Proceeds(a) ...................................... ACB................................................ Capital Gain .................................... ACB to recipient(b) ................................. Attribution.............................................. Dividends........................................ Capital gains ................................... Double Tax Potential..............................

Transferee 15-year-old Spouse— child ssec. 73(1)

Spouse—no ssec. 73(1)

$ 84,000 (70,000) $ 14,000 $ 84,000

$ 70,000 (70,000) $ 0 $ 70,000

$ 84,000 (70,000) $ 14,000 $ 84,000

No No(e) No

No(j) No(e) No

Yes(c) Yes(f) No

Yes(c),(d) Yes(f),(d) No

Sale for cash of $20 per share

Implications to Madame Martel Proceeds(g)....................................... ACB................................................ Capital Gain .................................... ACB to recipient(h) ................................. Attribution.............................................. Dividends........................................ Capital gains ................................... Double Tax Potential..............................

21-year-old child

Transferee 15-year-old Spouse— child ssec. 73(1)

Spouse—no ssec. 73(1)

$ 84,000 (70,000) $ 14,000 $ 40,000

$ 70,000 (70,000) $ 0 $ 70,000

$ 84,000 (70,000) $ 14,000 $ 40,000

No No(e) Yes

No(j) No(e) Yes

Yes(c) Yes(f) No

Yes(c),(d) Yes(f),(d) Yes

Sale for note receivable of $42 per share with no interest (present value is $25 per share)

21-year-old child

Transferee 15-year-old Spouse— child ssec. 73(1)

Spouse—no ssec. 73(1)

$ 84,000 (70,000) $ 14,000 $ 50,000

$ 70,000 (70,000) $ 0 $ 70,000

$ 84,000 (70,000) $ 14,000 $ 50,000

Yes(i) No(c) Yes

No(j) No(e) Yes

Yes(c) Yes(f) No

Yes(c),(d) Yes(f),(d) Yes

200

Introduction to Federal Income Taxation in Canada

—NOTES TO SOLUTION (a) The proceeds of disposition to the children are deemed to equal fair market value [par. 69(1)(c)]. In the absence of any election filed by Madame Martel, the proceeds of disposition on the gift to the spouse equal Madame Martel’s ACB [ssec. 73(1)]. If Madame Martel elects for subsection 73(1) not to apply to the transfer then the proceeds of disposition to the spouse are fair market value [par. 69(1)(c)]. (b) The ACB of a gift is fair market value [par. 69(1)(c)] for the children or the spouse if Madame Martel elects for section 73 not to apply. The ACB of a gift to the spouse is equal to Madame Martel’s ACB [ssec. 73(1)] in the absence of any election to ignore subsection 73(1). (c) Attribution will occur on the transfer to the spouse since the acquisition price is less than the fair market value [par. 74.5(1)(a)]. Where spouses are living apart by reason of a breakdown of their marriage, there is an exemption from section 74.1 [par. 74.5(3)(a)]. Income earned on income previously attributed back (e.g. second generation income) is not subject to the attribution rules because the income previously attributed is not included in the definition of substituted property in subsection 248(5). (d) If Madame Martel elects not to have subsection 73(1) apply, the attribution rule will still apply since the fair market value of the consideration (gift — nil; cash sale of $20; note payable for $42 per share without interest) is less than the fair market value of the transferred shares ($42) [par. 74.5(1)(a)]. (e) There is no capital gain attribution in respect of children (except where farming property was transferred under sec. 75.1). (f) When her spouse disposes of the shares, the resulting gain or loss would be attributed back to Madame Martel if she is still married to her spouse and they are living together [sec. 74.2]. However, where the spouses are living apart by reason of a breakdown of their marriage, an exemption from section 74.2 is provided if a joint election is filed with the tax return of the transferor spouse in the first year in which the above conditions apply [par. 74.5(3)(b)]. (g) The proceeds to the children are deemed to equal fair market value [spar. 69(1)(b)(i)]. In the absence of any election filed by Madame Martel, the proceeds of disposition on a sale for cash or a note equal Madame Martel’s ACB [ssec. 73(1)]. If Madame Martel elects for subsection 73(1) not to apply to the sale then the proceeds of disposition are fair market value [spar. 69(1)(b)(i)]. (h) The ACB of a sale at less than fair market value ($20 cash or $42 note with no interest  $42) is not affected by section 69. Section 69 provides only for an adjustment to the transferor’s proceeds of disposition on a transfer at less than the fair market value — not to the transferee’s cost. Thus the ACB is the amount paid — $20 per share/$25 present value of the note (for the children or the spouse if Madame Martel elects for section 73 not to apply). If section 73 applies to the sale to the spouse then the ACB to the spouse is equal to Madame Martel’s ACB. (i) Since this transaction involves indebtedness between related parties, ssec. 56(4.1) applies to cause attribution of income from property (dividend income in this case) for the 21-year-old child. Note that par. 56(4.1)(b) requires that “one of the main reasons” for the transfer of the shares to the 21-year-old “was to reduce or avoid tax” by effectively transferring taxation of the income from the shares to the 21year-old. This test is met in this particular situation. (j) The dividends received by the 15-year-old child are subject to the income-splitting tax, and therefore, will not be subject to the attribution rules. The income splitting tax stops at age 18. The effect of the income splitting tax is, in essence, the same as the attribution rules where the transferor is in the top federal tax bracket.

Solutions to Chapter 8 Assignment Problems

201

Solution 11: Death of a Taxpayer Estate At the time of death there is a deemed disposition of all capital property at fair market value. The exception is for assets left to a surviving spouse where the proceeds are deemed to be the deceased’s ACB resulting in an automatic rollover. However, an election can be made to have the proceeds be fair market value. Shares left to spouse: Automatic rollover: Proceeds ($20,000) = ACB ($20,000) = no gain or loss [70(6)] in the deceased taxpayer’s final return. ACB to spouse = $20/share which is equivalent to the ACB of the transferring spouse. Elect out of Section 73(1): Shares are disposed of at FMV: 500 shares  (proceeds ($50) – ACB ($20)) = CG $15,000; TCG $7,500 [70(6.2)] ACB to spouse = $50/share Note: the election can be made on any number of shares from 1 to 500, if there is a need to create a specific TCG in the estate to use up net or non-capital losses, tax credits, or low rates of tax. Shares left to daughter: No rollover is available for assets left to her daughter. There is an automatic deemed disposition at fair market value. [70(5)] 500 shares  (proceeds ($50) – ACB ($20)) = CG $15,000; TCG $7,500 ACB to daughter = $50/share Results to estate: Either a TCG $15,000 or up to a TCG of $30,000 will be reported, depending on whether they elect not to roll some or all of the shares to the surviving spouse. Spouse Automatic rollover—her ACB will be equal to the proceeds in the estate, i.e., the same as Brandon’s ACB of $20/share. Election—her ACB will be equal to the proceeds in the estate, i.e., fair market value of $50 per share. Daughter Her ACB will be equal to the proceeds in the estate, i.e., fair market value of $50 per share.

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Introduction to Federal Income Taxation in Canada

Solution 12: Becoming Resident and Non-Resident Stella [ssec. 128.1(1)] On entering Canada, Stella is deemed to have disposed of and reacquired the shares at fair market value. As a result, her adjusted cost base is $40,000, not the original cost of $25,000. If she sells the shares for $50,000, she will have a capital gain of $10,000 and a taxable capital gain of $5,000. Proceeds = Fair market value $50,000 Cost = FMV on becoming resident 40,000 Capital gain $10,000 TCG $ 5,000 The gain that accrued up to the time of becoming a resident will be taxed under the tax rules of Greece. There was a deemed acquisition at fair market value when she became a resident of Canada.

Harry [ssec. 128.1(4)] On leaving Canada, Harry is deemed to have disposed of and reacquired the shares at fair market value of $40,000. As a result, he will have to report a capital gain of $15,000 and a taxable capital gain of $7,500 this year. Any gain or loss in value after he leaves Canada will not be taxed in Canada, so a disposition for $50,000 will be taxed under the rules of England. Proceeds = Fair market value Cost Capital gain Taxable capital gain

$40,000 25,000 $15,000 $ 7,500

203

Solutions to Chapter 8 Assignment Problems

Solution 13: Death of a Taxpayer Income on Final Return In the absence of any elections, Mary’s minimum income/taxable capital gains are calculated as follows: Asset Toronto rental land(1).............................................. Toronto rental building(1)........................................ Stratford rental land(2)............................................. Stratford rental building(3) ...................................... CBV shares(4) ......................................................... View Canada shares(5) ............................................ Totals......................................................................

Recapture n/a — n/a $ 23,000 n/a n/a $ 23,000

Taxable capital gain — — $ 10,000 14,000 — (15,000) $ 9,000

—NOTES TO SOLUTION (1) The Toronto rental building transfers to Mary’s spouse per spar. 70(6)(d)(i) at the lesser of: (i) capital cost ............................................................ $ 55,000 and (ii) UCC .................................................................. $ 15,000 The lesser is.............................................................. $ 15,000 Proceeds ................................................................... Capital cost............................................................... Capital gain/loss ....................................................... Opening UCC.................................................................................................. Less: lesser of (i) capital cost............................................................... $55,000 (ii) proceeds ......................................................... $15,000 Recapture.........................................................................................................

$ 15,000 (55,000) $ 0 $ 15,000

(15,000) 0

The Toronto rental land transfers to Mary’s spouse at its ACB [spar. 70(6)(d)(ii)]. Therefore, there is no capital gain/loss on the transfer of the Toronto rental land. (2) The Stratford rental land transfers to Margaret at its fair market value [par. 70(5)(a)]. This results in the following capital gain: Proceeds ................... Adjusted cost base.... Capital gain ............. Taxable capital gain

$ 45,000 (25,000) $ 20,000 $ 10,000

(50%)

(3) The Stratford rental building transfers to Margaret at its fair market value [par. 70(5)(a)]. This results in the following capital gain and recapture: Proceeds ................... $ 93,000 Capital cost............... (65,000) Capital gain .............. $ 28,000 Taxable capital gain $ 14,000 (50%) Opening UCC................................................... Less: lesser of (i) capital cost........ $ 65,000 (ii) proceeds .......... $ 93,000 Recapture..........................................................

$ 42,000

(65,000) $ 23,000

(4) The CBV shares transfer to Mary’s spouse at ACB [spar. 70(6)(d)(ii)]. Therefore, no gain or loss is recognized. (5) The View Canada shares transfer to Margaret at fair market value [par. 70(5)(a)]. Mary’s adjusted cost base in these shares is equal to the fair market value as of the date she inherited the shares from her father — $180,000 per paragraph 70(5)(a). This results in a capital loss calculated as follows: Proceeds ....................................... $ 150,000 Adjusted cost base ............................. (180,000) Capital loss ........................................ $ (30,000) Allowable capital loss .................. $ (15,000)

(50%)

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Introduction to Federal Income Taxation in Canada

Cost to Beneficiaries The cost amounts of the inherited assets to the respective beneficiaries are set out below. Mary’s Spouse Asset Toronto rental land(1) ............................................................................... Toronto rental building(2) — Class 3 ....................................................... CBV Shares(3) .......................................................................................... Margaret Asset Stratford rental land(4).............................................................................. Stratford rental building(5) — Class 1 ...................................................... View Canada shares(4) .............................................................................

Capital Cost/ACB $ 40,000 55,000 500,000

UCC N/A $ 15,000 N/A

Capital Cost/ACB $ 45,000 93,000 150,000

UCC N/A $ 93,000 N/A

—NOTES TO SOLUTION (1) Beneficiary spouse acquires non-depreciable capital property at adjusted cost base [spar. 70(6)(d)(ii)]. (2) Beneficiary spouse acquires depreciable property at a cost amount equal to the proceeds to the deceased taxpayer [spar. 70(6)(d)(i)]. The capital cost of depreciable property acquired by a spouse is equal to the capital cost to the deceased taxpayer [par. 70(6)(e), spar. 70(5)(c)(i)]. Note that Mary’s spouse is not subject to the halfyear rule in computing CCA on the Toronto rental building in the year he inherits the asset [Reg. 1100(2)(h)]. Note also that the Toronto rental building is deemed to be a Class 3 asset to Mary’s spouse [Reg. 1102(14)(d)]. (3) These shares had an adjusted cost base to Mary of $500,000 [spar. 70(5)(a)]. On transfer to Mary’s spouse, these shares are acquired by the spouse at this adjusted cost base [spar. 70(6)(d)(ii)]. (4) Any beneficiary other than a spouse (or spousal trust) acquires non-depreciable capital property at fair market value [par. 70(5)(b)]. (5) Any beneficiary other than a spouse (or spousal trust) acquires depreciable property at its fair market value [par. 70(5)(b)]. Note that paragraph 13(7)(e) contains an exception for transfers as a result of the death of the transferor and thus the UCC for Mary’s daughter will be the full $93,000. Note that Mary’s daughter is not subject to the half-year rule or the accelerated investment incentive in computing CCA on the Stratford rental building in the year she inherits the asset [Reg. 1100(2)(h)].

205

Solutions to Chapter 8 Assignment Problems

Solution 14: Going Non-Resident Classification of Properties and Taxable Capital Gains (Losses)

Household furniture Skis, etc. Rights to season tickets Paintings Chevrolet Fishing lodge ABC shares Total capital gain Taxable capital gain Business loan

Property Type PUP PUP PUP LPP PUP PUP ordinary

BIL

Proceeds $20,000 1,000 4,000 2,400 3,600 45,000 46,000

ACB Disposal $35,000 1,200 3,500 1,900 12,000 31,000 20,000

Disposition Costs $ 800 0 0 120 350 4,500 200

$ 8,000

Gain (Loss) $ 0 0 500 380 0 9,500 25,800 $36,180 $18,090 $ (8,000)

Notes:

Gain on personal residence is exempt as principal residence.

Losses from the disposition of personal-use property are not deductible.

We assume that the fishing lodge cannot be designated as Billy’s principal residence.

The BIL will qualify as an ABIL and can be deducted against any other source of income. Computation of Net Income Paragraph 3(a) Paragraph 3(b) Paragraph 3(d) Net income for tax purposes

Employment income Taxable capital gains ABIL

$48,000 18,090 (4,000) $62,090

206

Introduction to Federal Income Taxation in Canada

Solution 15: Going Non-Resident Theresa should be advised that, upon becoming a non-resident, she is deemed to have disposed of each property that she owned, except for the following: • real property situated in Canada, Canadian resource properties, and timber resource properties; • capital property used in, and eligible capital property in respect of, a business that she carried on through a permanent establishment in Canada, and the inventory of the business; • “excluded rights and interests” (defined in subsection 128.1(10)); • if she was resident in Canada for 60 months or less out of the last 120 months, property that she owned when she last moved to Canada, or property inherited during the period of residency; and • property in respect of which she, upon subsequently returning to reside in Canada, makes an election to “unwind” the deemed disposition.

Treatment of Real Property In light of the above, Theresa should reconsider her decision to dispose of her real property. Unless she actually disposes of it, she will not incur any tax liability in regard to it upon emigrating. Obviously, if she has to liquidate some of her real property assets, making use of the principal residence exemption should be considered. If she disposes of her real property, the tax consequences will be as follows. Years owned Capital gain: Downtown townhouse (2011) Cottage (2012)

13 12

Gain/year $320,000 − 130,000 = $190,000 $270,000 − 55,000 = $215,000

$14,615 $17,917

A married couple can have only one principal residence. For the years during which both properties were owned, it would be possible to designate the cottage as the principal residence since it has the highest gain per year. However, one year should be moved from the cottage to the townhouse to take advantage of the 1+ rule.

Rental Property Since the gain on the sale of land and building must be reported separately, the legal and disposition costs should be prorated between the land and the building accordingly. The legal expenses incurred at the time of purchase would be prorated based on cost and the disposition costs would be prorated based on proceeds. Land proceeds ACB (includes $25/$105 of $3,000 legal expenses) Disposition expenses ($20,000 × 150/250) Capital gain Taxable capital gain

$150,000 (25,714) (12,000) $112,286 $ 56,143

Since the building has appreciated, there will be recaptured CCA. The capital cost of the building is $105,000 – 25,000 + (3,000 (80/105)) = $82,286. Building proceeds ACB (includes $80/$105 of $3,000 legal expenses) Disposition costs ($20,000 × 100/250) Capital gain Taxable capital gain Recaptured CCA ($82,286 − 30,000)

$100,000 (82,286) (8,000) 9,714 $ 4,857 $ 52,286

Treatment of Stocks and Bonds and Other Assets These assets are not exempted; accordingly, there will be a deemed capital gain as follows: • Publicly traded shares — $50,000 ($190,000 - $140,000) • Province of Alberta bond — $10,000 ($110,000 - $100,000) • Piano — $2,000 ($10,000 - $2,000) Total capital gain: $62,000; total taxable capital gain: $31,000.

Posting Security Where an individual has a deemed capital gain upon emigrating, he or she has the option of posting adequate security with the CRA and deferring the payment of the tax (without interest) until the property is actually sold. Security is not required for the first $100,000 of capital gains resulting from the deemed disposition rule. Accordingly, if Theresa were to retain her real property assets, she could emigrate without immediate tax liability.

CHAPTER 9

Other Sources of Income and Deductions in Computing Income Solution 1: Moving Expenses Net employment income in new location ($5,600 + $4,000) ................................. $ 9,600 Moving Expenses: Moving costs ……………………………………………….. $ 3,100 Air transportation ………………………………………….. 3,000 15 Hotel and Meals ($2,500 x /20) …………………………. 1,875 Storage fees ………………………………………………… 1,250 Lease cancellation fee ……………………………………… 1,200 Legal fees + taxes for new residence ………………………. N/A (10,425) Carryforward of moving expenses to following year ……… $ 825

ITA: 62(3)(f)

Eligible moving expenses incurred in the year are $10,425. However, the maximum deduction is limited to net employment income of $9,600 and $825 is carried forward and available for a deduction in the following year. Note that the legal fees incurred on the purchase of the new residence are not deductible because a former residence was not sold as a result of the move.

207

ITA: 62(3)(f)

Introduction to Federal Income Taxation in Canada

208 Solution 2: Child Care Expenses

This problem situation does not involve a single parent attending a qualifying education program or both parents attending a qualifying education program at the same time, as the legislation requires. Therefore, the limits for these situations are not applicable. Cathy can claim the child care deduction even though she is the higher income spouse because Charles was a student in full-time attendance at a designated educational institution.

ITA: 63(2.2)

Cathy’s maximum deduction is the lesser of: (A) the least of: (i) amount paid in the year ($200 × 52) ............................. $10,400 (ii) 1 child × $5,000 = $5,000 2 children × $8,000 = $16,000...................................... $21,000 (iii) 2/3 × earned income (2/3 × ($47,000 + $4,000)) ............. $34,000 Least amount .......................................................................... $10,400

ITA: 63

(B) the sum of: (i) $200 × 2 = $400 (ii) $125 × 1 = 125 $525 × 30 weeks =

ITA: 63(2.3)

$15,750

Lesser amount ........................................................................ $10,400 Charles’ maximum deduction is the least of: (i) $200 × 52 weeks = $10,400 (ii) 1 child × $5,000 = $5,000 2 children × $8,000 = $16,000 ......................................... $21,000 (iii) 2/3 × earned income ($23,850)(1) = $15,900

ITA: 63

}

minus amount deducted by Cathy .................................................................................. . $

$10,400

10,400 $0

— NOTE TO SOLUTION (1) Earned income Gross salary............................ $23,000 Taxable benefits …………... 850 Scholarship (fully exempt) $0 $23,850 Note that earned income for child care expenses is defined differently than earned income for a registered retirement savings plan. [ITA: 63(3), 146(1)]

Solutions to Chapter 9 Assignment Problems

209

Solution 3: Spousal Support Payments The $200 monthly payments made for Ursalla's support prior to November 1st are income to Ursalla and deductions to Uriah as long as the agreement provides for the payments being considered as part of the agreement and the agreement makes a specific reference to subsection 56.1(3). The payments of $200 for November and December are income to Ursalla and deductions to Uriah. [ITA: 56(1)(b), 60(b)] The mortgage payments of $400 would qualify as income to Ursalla and deductions for Uriah since they are considered to be a third-party support payment , because the payment is under a written agreement for the maintenance of a former spouse.. [ITA: 56.1(2), 56(1)(b), 60(b), 60.1(2)] The $700 monthly support payments for the children and the medical expense payments are neither income to Ursalla nor deductions for Uriah, since they are child support amounts. [ITA: 56.1(4)]

210

Introduction to Federal Income Taxation in Canada

Solution 4: Transfer of RRSP on Divorce For the property in Richard’s RRSP to be transferred to Liz tax deferred, it must meet the following conditions: [s.146(16)] 1.

It must be made under a decree, order, or judgment of a competent tribunal or under a written separation agreement;

The transfer has to be made directly from the annuitant's un-matured RRSP to Liz’s RRSP, RRIF, or RPP; and

Richard and Liz must be living separate and apart.

If these conditions are met, then neither of them will have to take the $100,000 into income. Also, future withdrawals from this RRSP will be included in Liz’s income.

Solutions to Chapter 9 Assignment Problems

211

Solution 5: RRSP

Earned income Salary Rental income Spousal Support Loss from partnership

$ 18% of earned income Unused RRSP deduction room: lesser of 1. RRSP limit 2. 18% of prior year earned income Therefore, unused RRSP deduction room Pension adjustment Unused deduction from previous year Unused deduction room available for the year (assuming that there was no unused RRSP contributions carried forward from the prior year)

2021

2022

2023

130,000 $ 7,000 10,000 (30,000) 117,000 $ 21,060 $

135,000 18,000 10,000 (20,000) 143,000 25,740

29,210

30,780

21,060

25,740

21,060 (4,000) —

17,060

25,740 (7,000) 17,060

35,800

As per subsection 146(5), the maximum RRSP contribution that Diana can deduct for 2023 is the lesser of: (i) actual contribution within 60 days after year end (ii) RRSP deduction limit

$10,000 $35,800

Therefore, the maximum RRSP deduction in 2023 taxation year is $10,000. She could contribute an additional $25,800 to her RRSP before March 1, 2024 and deduct the amount on her 2023 tax return.

Introduction to Federal Income Taxation in Canada

212 Solution 6: RRSP vs. TFSA (A) Future Value of the investment (i) Tax-Free Savings Account:

The contribution to the TFSA is not deductible for tax purposes. As a result, the after-tax income available to invest is lower than for an RRSP contribution and is calculated for each taxpayer below. Future withdrawals and the investment income earned on the invested amount is not taxable. Note: The $4,500 is immediately taxable to the individual at his or her current marginal tax rate. Taxpayer A: After-tax amount invested = $4,500 (1 - 0.45) FV of investment = $2,475 (1 + 0.08)10 Taxpayer B: After-tax amount invested = $4,500 (1 - 0.40) FV of investment $2,700 (1 + 0.08)10 Taxpayer C: After-tax amount invested = $4,500 (1 - 0.27) FV of investment = $3,285 (1 + 0.08)10

= =

$2,475 $35,854

per year

= =

$2,700 $39,114

per year

= =

$3,285 $47,588

per year

(ii) RRSP contribution: The contribution to the RRSP is deductible for tax purposes. As result, the full amount is available to invest for each taxpayer. Investment income earned on the invested amount is not taxable. The original contribution is taxable at the withdrawal date only (in 10 years). Each taxpayer will accumulate the same amount over the 10-year period as their original contribution and their marginal tax rate at Year 10 are the same. Taxpayers A, B, and C: FV of investment = $4,500 (1.08)10 = $65,190 After-tax cash = $65,190 (1 - 0.4) = $39,114 (B) As shown in the above calculations, Taxpayer A should definitely contribute to an RRSP because his or her after-tax accumulation in an RRSP is greater than what would be accumulated in a savings account. Taxpayer B is indifferent between the two alternatives as the after-tax accumulation on both is equal. This individual could wait until his/her income is higher and, thus, the marginal tax rate is higher, before contributing to an RRSP. Taxpayer C should use the TFSA, as the current marginal tax rate of 27% is much less than the tax rate on withdrawal of 40%. Other considerations when deciding between an RRSP and TFSA include the likely length of investment and purpose of the investment of the funds. RRSP contribution room is not re-established when funds are withdrawn. Ideally, RRSP investments should remain in the RRSP until needed for retirement savings. Shorter term investments are generally more beneficially accumulated within a TFSA. Furthermore, it should be noted that both spouses even where one is not working accumulate TFSA room.

Solutions to Chapter 9 Assignment Problems

213

Solution 7: RRSP (A) Since Mrs. Rui withdrew $6,000 from her RRSP in 2023, Mr. Rui must include in income the lesser of $6,000 and the sum of the amounts paid by Mr. Rui as premiums to her RRSP in 2023, 2022, and 2021 [ssec. 146(8.3)]. — The lesser amount is $4,000, the sum of the amounts paid by him in those three years. (B) Mr. Rui can deduct a $9,880 RRSP contribution in 2023 [par. 60(i)] (lesser of 18% of $66,000 = $11,880 or $30,780) less 2022 PA of $7,000 plus unused RRSP deduction room of $5,000. — Since he has already made a $2,000 contribution to Mrs. Rui’s plan, he should make an additional contribution of $7,880. (C) Since Mr. Rui has earned income in 2023 of $52,300,(1) his tax-deductible RRSP contribution for 2024 is $8,814 (the lesser of 18% of his 2023 earned income of $52,300 and $31,560) less his 2023 PA of $600. (D) Because Mr. Rui turns 71 in 2024: — Unless he buys an RRSP annuity or RRIF by December 31, 2024, his entire RRSP will be included in his 2024 income. — 2024 will be the last year in which he can make his annual contribution to his own RRSP. — Mr. Rui may continue to make an annual contribution to his spouse’s RRSP (subject to his earned income limitation) until the end of the year in which Mrs. Rui turns 71. —NOTE TO SOLUTION (1) His 2023 earned income is computed as follows [ssec. 146(1)]: Employment income......................... RPP contribution .............................. Farming income (business)............... Rental income................................... Royalty income ................................ Total .................................................

$ 7,000 300 20,000 10,800 14,200 $ 52,300

Introduction to Federal Income Taxation in Canada

214 Solution 8: Moving Expenses

The move from Halifax to Toronto is an eligible relocation for purposes of a moving deduction expense. The relocation was made to enable George to be employed in Toronto, the move was within Canada and he moved 40 kilometres closer to the new work location. The deductible moving expenses for George’s personal tax returns in 2023 and 2024 are calculated below.

Deductible Moving Expenses Par. 62(3)(a )

Par. 62(3)(b )

Travel expenses:(1) Food, 7 days @ $100 (vs. $69 x 2 x 7 x = $966) Accommodation, 7 days @ $80 Vehicle expenses, including gasoline ($0.55 x 2,000 km) Transporting household effects Storage

Staying near new residence:(2) Staying in Toronto prior to possession but after closing of new home: Food, 11 days @ $100 (vs. $69 x 2 x 11 = $1,518) Accommodation, 11 days @ $80 Total 2023 deductible moving expenses paid in 2023

966 560 1,100 $ 6,200 250

2,626 6,450

Par. 62(3)(c )

Par. 62(3)(e )

1,518 880

2,398 $ 11,474

(A)

Selling costs of old residence:(3)

Legal fees — old home New residence — legal fees — land transfer tax Total 2023 deductible moving expenses paid in 2024 Par. 62(3)(f )

Total deductible moving expenses (sum of (A) and (B))

$ 2,800 1,000 $ $

2,000 3,800 5,800

(B)

$ 17,274

Deduction for Moving Expenses: 2023: Paragraph 4.16 of Tax Folio S1-F3-C4 states that “an individual may not deduct moving expenses until they are paid.” Any moving expenses that were paid in 2024 would be known at the time of filing the 2023 tax returns. Like most expenditures made by individuals, which are only deductible at the time of payment, the moving expenses paid for in 2024 would be eligible for deduction in 2024 (to the extent of income earned at the new location), because they were incurred in that year. The moving allowance of $9,350 ($10,000 less the first $650) must be included in George’s income from employment in 2023 [par. 6(1)(b)]. Since this is his only income in the new work location for the year, he can deduct $9,350 of the moving expenses in 2023. 2024: George or Sue can claim the balance of $7,924 against 2024 income earned in Toronto.(4) Since George will be in a higher tax bracket it will be preferable for George to claim the deduction.

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215

Loss Reimbursement Where the employee has begun employment at the new work location, the employee is required to include in 2024 income, the year of receipt [ssec. 6(20)] one-half of the amount in excess of $15,000 paid in respect of a decrease in value of the employee’s residence. In this case, the income inclusion for the loss reimbursement would be $2,500 (i.e., 1/2  ($20,000 - $15,000)). Note that the $27,000 reimbursement was $20,000 for the loss the other $7,000 was for the real estate commission. —NOTES TO SOLUTION (1) Seven days of travel (between Halifax and Toronto) do not seem unreasonable, since they experienced bad weather delays and their new home was not ready in any case. If they had reached Toronto in, say, 2 days, they would have incurred similar costs of meals and accommodation near their new residence and would have qualified for a deduction [par. 62(3)(c)] for up to a total of 15 days. Paragraph 4.22(a) of Tax Folio S1-F3-C4 indicates that eligible moving expenses include: • travelling costs, including reasonable amounts for meals and lodging, in the course of moving the taxpayer and members of the household. • unreceipted maximum (by the CRA administrative practice) $23 per meal per person $69 per day per person $69  2  7 = $966 • but reasonable receipted amounts higher (2) The week on the house-hunting trip prior to the purchase (closing) of the new residence would not be allowed [Tax Folio S1-F3-C4, par. 4.22(f)]. The 11 days spent near the new residence result in deductible expenditures [par. 62(3)(c)].

Paragraph 4.22(a) and (c) of Tax Folio S1-F3-C4 indicates that eligible moving expenses include: • costs of up to 15 days for temporary board and lodging near either residence. • unreceipted maximum (by the CRA administrative practice) $69 per day  2 persons  11 days = $1,518 • but reasonable receipted amounts higher (3) The selling costs of the old residence may be deducted as a moving expense or a cost of the disposition in arriving at the capital gain or loss [pars. 4.22(e) and 4.29 of Tax Folio S1-F3-C4]. However, since NorthAm Co. is reimbursing the loss and real estate commission but not legal costs, only the legal costs were included as moving expenses. (4) Any moving expenses otherwise deductible that were not deductible by virtue of this section in the preceding year are deductible in the year following the move [par. 62(1)(d)].

Introduction to Federal Income Taxation in Canada

216 Solution 9: Child Care Expenses

[Note to instructors salary was updated from $53,000 to $74,000; Len’s business income was updated to $137,000 from $120,000] (A) Child care deduction calculation Salary and taxable benefits............................................................................................. Business income............................................................................................................. Earned income [sec. 63] .................................................................................................

Nina $ 74,000 $ 74,000

Len $ 137,000 $ 137,000

Since Len has the higher net income ($136,000), his claim for child care expenses is limited [ssec. 63(2)] to the lesser of: (a) $13,800, being the least of: (i) Eligible child care expenses ($250  50 + ($125  2  4 weeks(1)) + $300(2)) $ 10,000 (ii) $5,000  2 children .................................................................................. 16,000 $8,000  2 children .................................................................................. (iii) 2/3  earned income ($137,000)……………………………………… (b) the sum of: $ 3,250 (i) 2  $125  13 weeks ................................................................................ 5,200 (ii) 2  $200  13 weeks ................................................................................

$ 13,800 $ 26,000 $91,333

8,450

Len’s deduction is the lesser amount: $8,450. Nina’s claim for child care expenses is limited [ssec. 63(1)] to the least of: (a) Eligible child care expenses (as above)………………………………….. (b) $5,000  2 children .......................................................................................... $8,000  2 children .......................................................................................... (c) 2/3  earned income ($74,000) (2/3  $74,000)……………………………

$ 13,800 $ 10,000 16,000

$ 26,000 $ 49,333

Nina’s deduction is: The least amount………………………………………………………… Minus Len’s deduction………………………………………………….. Nina’s deduction…………………………………………………………

$ 13,800 8,450 $ 5,350

Note that the sum of the two deductions is equal to the amount paid with the camp limitation. (B) Child care deduction while a student If Nina went to school part-time, Len could deduct a more limited amount: [($200  2 children) + ($125  2 children)]  4 months during which child care expenses incurred = Nina’s claim would be for the remaining amount: $13,800 - $2,600 = $11,200.

$ 2,600

—NOTES TO SOLUTION (1) The deduction for the overnight camp for Trevor and James is restricted to $125 per week each [ssec. 63(3)]. (2) Since Lindsay is not under age 18, payments made to her constitute eligible ‘‘child care expenses’’ [ssec. 63(3)]. Note also that she is not an eligible child for the purposes of part (ii) of the calculation.

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Solution 10: Comprehensive [Note to instructors earned income updated to $134,000 from $120,000] Subdivision d Spar. 56(1)(a)(ii) Subdivision e Par. 60(b) Ssec. 60.1(2) Par. 60(i)

Severance.................................................................................................................

$41,538

Support paid to husband per agreement ................................................................... Rental payments(1) ................................................................................................... RRSP — ssec. 146(5) lesser of: $................................................................................... $ 30,780

(2,000) (3,000)

18% of earned income of previous year (18% of $134,000)..............................

Par. 60(o) Sec. 62

Sec. 63

$ 24,120

less: pension adjustment of previous year ......................................................... Legal fees on appeal of tax assessment........................ Moving expenses: travelling costs [pars. 62(3)(a) and (c)]: — vehicle expenses, including gasoline ($0.575  120 km) — hotel (near new residence) — meals (near new residence) (flat rate: 2 days  $69  2) ....... transportation of household effects [par. 62(3)(b)] ............................ selling costs on old residence [par. 62(3)(e)] ..................................... costs on purchase of new residence [par. 62(3)(f)] ............................

(9,500)

(1,200)

69 200 276 600 13,050 4,100

Child care expense — least of amount paid [$8,976 + (2  $125) + 720] ..................................

9,946

$5,000  1 child (7 years or older) .............................................

5,000

⅔  earned income (see Schedule 1) ⅔  $165,743 ............................................................................. Total Subdivisions d and e

Total Subdivisions a, b, and c Total Division B income

(14,620)

(18,295)

$ 110,495

(5,000) $

(2,577)

158,488 $ 155,911

Items not used in calculations Direct transfer of lump-sum of $210,000 out of her RPP to an RRSP is exempt income [sec. 147.3]. RRSP overcontribution of $1,380, calculated as follows, will not result in a penalty of 1% per month since it is below the $2,000 threshold. Also, the contribution was made in 2024 and can be used against 2024 contribution room: Contributions made in 2023 and 2024 in respect of 2023 ................................................................. $ 16,000 Deductible amounts in respect of 2023 (2023 RRSP room): Excess ...................................................................................................................... Allowable excess not subject to penalty.......................................................................... Overcontribution subject to penalty ................................................................................

(14,620) 1,380 (1,380) $ 0

Legal fees for representation during separation proceedings to establish a requirement to pay support is a capital expenditure. Costs of house-hunting trip are not deductible under sec. 63. Tuition and transportation are not child care expenses [par. 63(3)(d)]; maximum deductible weekly fee for YMCA overnight summer camp is $125 [spar. 63(3)(c)(i)].

Introduction to Federal Income Taxation in Canada

218 Schedule 1 Earned income [ssec. 63(3)]:

Salary [par. 63(3)(a)]........................................................................................................................... .. $ 96,000 Salary [par. 63(3)(a)]........................................................................................................................... .. 60,000 Section 6 taxable benefits [par. 63(3)(b)] .............................................................................................. 1,743 Consulting income [par. 63(3)(c)] ............................................................................................................. 8,000 $ 165,743

—NOTES TO SOLUTION (1) As long as the agreement specifically refers to ssec. 60.1(2).

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219

Solution 11: Calculate income, provide advice Sibbald’s net income for tax purposes would be calculated as follows: Employment income: Gross salary (subsection 5(1)) Director’s fees (paragraph 6(1)(c)) Association fees (paragraph 8(1)(i)) Property income: T-bill interest Other income: RRSP withdrawal (400 × $20) (subsection 56(1)) Net income for tax purposes

$ 48,000 600 (280) 3,200 8,000 $

59,520

Notes: 1. The cost of uniforms is non-deductible as an employment expense. 2. Parking expenses are personal and are also not deductible. 3. In accordance with paragraph 18(11)(b), interest on funds borrowed to make RRSP contributions is not deductible. Tax planning opportunities: 1. In the future, Sibbald should consider funding any household purchases by making a withdrawal from her T-bill account rather than her RRSP. A T-bill withdrawal of $8,000 would have no effect on taxable income in the year of withdrawal, while any amount withdrawn from an RRSP is fully taxable. In addition, $8,000 left in an RRSP would compound annually on a pre-tax basis, while investments outside of the plan accumulate at a much lower after-tax rate of return. Furthermore, RRSP contribution room is is not replenished when funds are withdrawn as they would be for TFSA withdrawals. 2. Assuming that Sibbald will continue to invest in both shares and T-bills, it is be preferable to hold T-bills within her RRSP or a TFSA where the investment income is earned tax free. If TFSA room is not available, shares are better held in unregistered accounts outside of an RRSP as any associated gains realized on shares held in an RRSP are fully taxable as income in the year of withdrawal. However, if the same shares were held personally, any gains would receive preferential tax treatment. For example, dividend income is eligible for a dividend tax credit, and only one-half of capital gains are taxable. 3. It would also be beneficial for Sibbald to pay off her RRSP loan as quickly as possible considering that the related interest expense is not deductible. In the future, if Sibbald needs to borrow money, she should consider only doing so to purchase investments held outside of an RRSP or TFSA. As the investments would be purchased for the purpose of earning property income, any interest expense related to the loan would be fully deductible. 4. Any investments held outside the RRSP should be invested in Sibbald’s TFSA if room is available. This will ensure that investment income earned on the investments is not subject to tax. These funds could be used for household purchases when needed and TFSA room would be replenished in the year after the withdrawal.

Introduction to Federal Income Taxation in Canada

220 Solution 12: Comprehensive Part (a): Business income (Schedule 1) Rental loss (Schedule 2) Total income Subdivision e deductions: Child care expenses (Schedule 4) Moving expenses Net income for tax purposes

$61,500 (1,125) $60,375 (9,600) (1,900) $48,875

Mariah should be registered for HST, charge and remit HST on her consulting fees. She could also claim input tax credits for her HST on deductible business expenses.

Schedule 1 — Business income Fees received Deduct: Salaries and benefits Office Interest expense Courses Insurance Capital cost allowance Office equipment (Schedule 3) Automobile expenses Operating expense Capital cost allowance (Schedule 3) Less: 50% personal use Net business income

$145,000 $55,500 1,200 10,500 1,400 5,000

(7,100) $ 1,000 6,000 $ 7,000 (3,500)

Schedule 2 — Rental income from office building Rent revenue Deduct: Interest Operating expense Capital cost allowance (Schedule 3) Rental income Net rental loss (loss shared 50/50) Mariah Sister

Mariah is not required to register for HST for the commercial rental as she will be considered a small supplier.

Schedule 3 — Capital Cost Allowance

(73,600)

$ 24,000 (6,250) (20,000) 0 ($ 2,250) ($ 1,125) (1,125) ($ 2,250)

(3,500) $ 60,800

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221

Accelerated inv. incen. adj. UCC before CCA CCA — current year Immediate expensing Total CCA - current year

Business Class 10.1: Class 8: 30% 20% $ 20,000 $ 30,500 — $ 20,000 $ 30,500 20,000 30,500 (6,000) (6,100) (1,000) (6,000) (7,100)

Accelerated inv. incen. adj. UCC Dec. 31 current year

UCC Dec. 31 prior year Additions — current year

8,000 $

16,300

Property Class 1: Class 8: 4% 20% — — $ 500,000 $ 3,000 $ 500,000 $ 3,000

—

$ 500,000 $

—

3,000

Mariah cannot claim any CCA on the rental property since there is a rental loss before capital cost allowance (ITR 1100(11)).

Introduction to Federal Income Taxation in Canada

222

Schedule 4 — Childcare expenses deduct the least of: The actual amount Allowable (2 × $8,000) ⅔ earned income ($60,800 × ⅔) The least of the three amounts is

$ 9,600 $16,000 $40,533 $ 9,600

*Note that the $20,000 removed from the RRSP as part of the homebuyer plan is not included in income but is required to be paid back over a maximum of 15 years. Payments would begin in the second calendar after the current year. Part (b): Mariah’s claim for moving expenses may or may not be allowed. Only an eligible relocation qualifies for moving expenses. To quote the definition of “eligible relocation” at subsection 248(1), the first qualification is “the relocation occurs to enable the taxpayer to carry on a business at a location in Canada”. The question is unclear as to whether Mariah can meet the “enables” requirement. She was already carrying on her consulting business and its location did not change. Perhaps though, it was moved in a previous year (we don’t know). Would she have been “unable” to carry on the consulting business if she had not moved?

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Solution 13: Comprehensive Paragraph 3(a): Income Sec. 5 Sec. 5 Par. 6(1)(a )

Employment Income — Subdivision a Salary — gross Commission income Christmas present, including HST — (>$500)

Par. 6(1)(k )

Fitness Club(1) Car benefit: $0.33 x 10,000 km

Par. 6(1)(e )

(10,000/20,004) x 2/3 x $18,400 (2)

Par. 6(1)(a )

$ 150,000 30,000 350 1,300 $

3,300

8,465 11,765 (2,400)

less: payroll deduction Par. 8(1)(f ), 67.1 Par. 8(1)(m )

Salesperson's expenses (50% x $8,300) RPP

9,365 $ 191,015 (4,150) (6,000) $ 180,865

Par. 12(1)(c ) Par. 12(1)(j ) Par. 12(1)(k ) Ssec. 74.1(2) Par. 20(1)(bb ) Par. 20(1)(c ) Par. 56(1)(d )

Property Income — Subdivision b Interest Dividends — taxable Canadian corporations grossed up @ 38% Dividend — U.S. corporation (Cdn$) Bonds —minors: (2 x $120) Less: Investment counsellor's fee Interest — shares Other income — Subdivision d Annuity

Paragraph 3(b): Taxable Capital Gain — Subdivision c House: P of D ($188,000 + $12,000) ACB SC Gain Exempt portion 1 + 12(3) 14 Capital gain

1,800

10,350 800 240 13,190

1,100 850

1,950

11,240 2,000

$ 200,000 $

90,000 12,000

(102,000) 98,000

$ x

$ 98,000 $

(91,000) 7,000

TCG ( 1/2 x $7,000) Total income [pars. 3(a ) and (b )]

3,500 $ 197,605

Paragraph 3(c): Deductions — Subdivision e Par. 60(a )

Capital portion of annuity

Par. 60(i )

RRSP

Par. 60(e.1)

Enhanced CPP contribution

Paragraph 3(d): Losses Rental loss Partnership loss Division B income

650 14,000 (4) 631

3,500 3,200

$ (15,281) $ 182,324

(6,700) $ 175,624

—NOTES TO SOLUTION (1) The membership in the Fitness Club paid by Clothes to You Ltd. will be a taxable benefit [par. 6(1)(a)] unless Ms. Sui can demonstrate that the primary benefit was to Clothes to You Ltd. and not to herself and only if the membership agreement is with the employer and not the employee and the facility or membership is available to all employees.

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224

(2) A standby charge reduction is available since the business usage was more than 50%, i.e., 75%. Note that the election [par. 6(1)(k)] of reporting the operating cost benefit as ½ of the standby charge is available, because the car is driven primarily for business. However, the election is not beneficial, because it results in an operating cost benefit of $3,066 (i.e., 1/2  $6,132 which is greater than the benefit based on personal kilometres driven. (3) Years designated — house 2012–2023 = 12 years (no need to designate cottage for 2012 with 1 + rule and therefore designating the house for that year. 2010 and 2011 were designated to the cottage). (4) RRSP Contribution Lesser of

(a)

18%  $170,000 = $30,600

(b)

dollar limit: $30,780

$30,600 - $7,000 = $23,600 Of the $14,000 contribution in 2023, all is deductible under paragraph 60(i). The remaining $9,600 may be carried forward as unused deduction room available (added to any unused balance from future years) for contributions in a future taxation year. Other: •

The Private Health Insurance premium paid by Clothes to You Ltd. is not a taxable benefit due to the exception [spar. 6(1)(a)(i)].

•

The unexercised stock options will not trigger any tax effect in the year [sec. 7]. Any tax impact will occur in a subsequent year depending on other facts.

•

The Employment Insurance premiums and Base Canada Pension Plan contributions would generate a tax credit [Division E, sec. 118.7 of the Act] with the exception of the $631 of enhanced contribution to CPP which is included as a deduction above

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225

Solution 14: Becoming a Resident – Moving & Child Care Expenses Ed’s income for tax purposes in Canada would be calculated as follows: Employment income: Gross salary (Note 1) Moving expenses (Note 2) Child care expenses (Note 3) Income for tax purposes

$ 72,000 — 6,800 $ 65,200

Notes: 1.

Ed is only a Canadian resident since the time he entered Canada on a permanent basis. Accordingly, his England earnings are not relevant for Canadian tax purposes.

In accordance with subsection 62(1), moving expenses are only deductible if a taxpayer moves from a residence within Canada. In this case, Ed cannot deduct his moving expenses since he moved from a residence outside of Canada. It is not an eligible relocation.

In most situations where there is more than one “supporting person”, childcare expenses must be claimed by the taxpayer with the lower income. However, as Laura is in full-time attendance at school, Ed may claim the childcare deduction. Ed’s deduction would be limited to the least of: (a) amount paid (5 months × $1,360)

$6,800

(b) $5,000 per eligible child 7 or older (3 × $5,000)

$15,000

(c)

/3 of earned income ($72,000 × 2/3)

(d) $125 per eligible child 7 or older multiplied by the 20 weeks (estimated at 5 months × 4). Laura was in full-time attendance at school ($125 × 3 × 20)

$48,000

$7,500

Laura’s scholarship income of $2,500 will be fully exempt, so her income is zero.

Introduction to Federal Income Taxation in Canada

226 Solution 15: Comprehensive Par. 3(a )

Par. 3(b ) Par. 3(c )

Belleville employment $ 85,000.00 Windsor employment 5,000.00 Stock option (800 x ($25 – $17)) 6,400.00 Moving allowance (1) 7,350.00 Dividends (1.38 x $9,058) 12,500.00 Legal fees incurred to establish support payments (administrative practice*) (3,200.00) TCG ( 1/2 x ($180,000 – $60,000)) 60,000.00 Moving expenses (2) (6,258.00) RRSP (3) (9,900.00) CPP enhanced contribution deduction (631.00) Accounting fees (400.00) Childcare expenses (4) (3,000.00) Net income $ 152,861.00

(1) Moving Allowance - $8,000-$650= $7,350 [Up to $650 of moving allowance is tax free] (2) Moving Expenses Allowable expenses [$5,950 – $75 + ($0.575 x 600 km) – $100 + ($69 x 2)] $ 6,258 Income from new employer: Salary $ 5,000 Allowance 8,000 $ 13,000 (3) RRSP Lesser of: 18% x 2022 earned income ($55,000) RRSP dollar limit

$ $

9,900 30,780 $

9,900

$ $ $

8,000 69,167 3,000

18,750 $

103,750

(3) Child Care Expenses $8,000 x 1 child (< 7 yrs) 2/3 x earned income ($103,750) Expenses incurred Earned income: Salary Stock option Moving allowance

Omit (1) (2) (3) (4)

$ 5,000 6,400 7,350

85,000

Apartment hunting costs are not allowable moving expenses. Food and clothing for the child do not qualify for child care expenses. Income tax withheld of $11,000 will be applied in calculating taxes payable.. Stock option deduction of one-half of stock option benefit is a Division C deduction.

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(5) The base CPP and EI premiums and charitable donations are eligible for Division E tax credits, while the enhanced CPP contribution is deducted above. (6) The dividends are eligible for a dividend tax credit. (7) Child support receipts are not included.

ITTN #24 suggests that these fees can be deducted from investment income, like interest and carrying charges.

Introduction to Federal Income Taxation in Canada

228

Solution 16: Reassessment (a) Cam’s revised business income: Consulting income net of expenses as reported

$ 28,000

Add nanny’s salary (see below)

12,000

Add cost of car expensed (see below)

7,200

Less CCA allowed for property designated for immediate expensing in 2023(see below)

(7,200)

Revised business income

$ 40,000

Child Care Expenses The situation presented in this case is similar to the Supreme Court of Canada case, Symes v. The Queen. In this particular case, the Court overturned an earlier judgment that allowed a lawyer to deduct the actual cost of a nanny’s salary against self-employment income. The Court ruled, in effect, that child care expenses are nondeductible personal or living expenses and may only be deducted as allowed under the Act’s provisions. Cam’s deduction is limited to $10,000, which is the least of the following amounts: (i) the actual amount $12,000 (ii) $5,000 per eligible child (2 × $5,000) = $10,000 (iii) 2/3 of his earned income (2/3 × $40,000) = $26,667 RRSP Withdrawals A withdrawal of funds from an RRSP must be included in income in the year of withdrawal in accordance with paragraph 56(1)(h). Accordingly, Cam must report the gross amount of his RRSP withdrawal as another income inclusion under subdivision d. The 20% tax withheld at source will be deducted from taxes payable to arrive at his net refund or balance owing. Support Receipts Generally, an amount received from an ex-spouse for support is taxable under paragraph 56(1)(b). However, the definition of “support amount” at section 56.1 requires that the amount be receivable on a periodic basis. Lumpsum payments that are settlements are not taxable (nor deductible). Cam should file a notice of objection in respect to this part of the assessment if the amounts are periodic in nature. Capital Cost of Vehicle Paragraph 18(1)(b) specifically denies a deduction for an expenditure on account of capital. Cam cannot deduct the cost of the new vehicle from his consulting income, regardless of what portion of it was used for business purposes. However, he is allowed to deduct capital cost allowance in accordance with paragraph 20(1)(a). The new vehicle would be eligible for immediate expensing if the property is designated starting January 1, 2022. The maximum CCA that Cam may claim is as follows: $18,000 × 40% (business use) = $7,200 Taxable Dividends Under paragraph 82(1)(b), dividends from a taxable Canadian corporation (CCPC) have to be grossed-up by 15% when reported as income. Cam will be entitled to a dividend tax credit against his tax liability, and it’s assumed that the CRA allowed this on assessment.

Solutions to Chapter 9 Assignment Problems (b) Income For Tax Purposes Based on our above analysis, Cam’s revised net income for tax purposes would be calculated as follows: Business income (as above) RRSP withdrawal (subsection 56(1)) Dividends (as grossed-up) Child care deduction Net income for tax purposes

40,00 12,000 1,725 (10,000) $ 43,725

229

Introduction to Federal Income Taxation in Canada

230 Solution 17: Retirement Package

Memo to Myron Van Doulis There are three issues to be considered. First, there are different severance packages available that need to be analyzed from an after-tax cash flow perspective. Second, the issue of emigration and the transfer of assets to a tax haven must be examined. It is important to look at how the CRA will assess residency and also look at the income tax consequences of emigration. The last issue to be considered is the CRA’s assessment of the capital losses from trading options. Severance Packages Option 1: If the entire $80,000 retirement allowance is contributed to an RRSP, it will earn income tax-free. There will be no tax payable until it is withdrawn in 20 years at the estimated marginal tax rate in that year of 40%. The future value of the sum will be: $80,000 (1 + 0.05)20 (1 - 0.4) = $127,358 The cash payment of $40,000 will be taxed immediately in income at Myron’s current tax rate of 50%. If this is reinvested in GICs, the after-tax interest rate is used to determine the future value of the cash: (1 - 0.5) (40,000) (1 + 0.04 (1 - 0.5))20 = $129,719 The total future value of this option is $157,077 [127,358+129,719 – 80,000-20,000]. Option 2: If shares are received, the FMV of the benefit received must be included in employment income. This means that extra funds must be available to meet the cash requirement of the income tax that results from the receipt of the shares. The FMV of the shares is $8 × 12,000 = $96,000. With the current income tax rate of 50%, there will be an extra $48,000 of income tax owed. Thus, only $48,000 is left, assuming 6,000 shares are sold to pay the tax. The future value of the shares considering 4% growth and 5% dividends is: FMV of shares less: tax @ 50% Balance to hold Future value of shares 48,000 (1.04)20 less tax on capital gain (105,174 - 48,000) × 50% × 0.4 Future value of dividend annuity [$48,000 (0.05) (1 − t) ×( (1.02)20 – 1)] ÷ 0.02 =

$96,000 (48,000) $48,000 105,174 (11,435) 93,739 $40,236

t = tax rate on Canadian public corporation dividends, assuming that the combined federal and provincial dividend tax credit equals the gross-up of 38% = approximately 31%.

Note: This equation represents the annual dividend (5% of $48,000) multiplied by the after-tax rate (adjusted for the dividend tax credit) accumulated at 2% (4% × regular tax rate of 50%). The total value of this option is $93,739 + $40,236 = $135,975. Other aspects that should be considered are the inherent flexibility of an RRSP and the opportunity for withdrawal at any time. With respect to the securities, there is the inherent risk associated with an investment in securities. Emigration The determination of residency is based on the facts of the situation. The factors the court considers include regularity and length of visits, the ties in Canada and other jurisdictions (or the motive for being present or absent), ownership of a dwelling in Canada on a long-term basis, the residences of the spouse and children, memberships of social club, banking privileges, health care and car registrations, business and employment ties to Canada, and the general routine of the individual’s life. They would also look to see if you became a resident in another country. In this situation, the courts would look at the fact that the children remain in Canada and that Jennifer would be present in Canada with strong ties to the country. This includes her employment ties with the software publishing company. With no real ties to the tax-haven country — or any other country — the motive for being absent from Canada appears only to be tax motivated. Also, the ownership of a house would be considered. Even though the house is rented through the foreign corporation, this situation could possibly be defined as tax avoidance, the deliberate planning of events and transactions to circumvent the law with the intent of reducing taxes payable. The courts look at the economic substance of the situation and not the legal form. Tax avoidance is a civil wrongdoing.

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231

The facts of this situation suggest that you will not have broken primary residential ties and will be considered a factual resident of Canada for tax purposes and would subsequently be subject to Canadian tax on your worldwide income. To avoid being taxed as a resident, it is important to sever the continuing state of the relationship with Canada. If you were a non-resident, if you visit Canada for 183 days or more during the year you will be deemed a resident of Canada throughout the year and will be taxable on worldwide income. As a non-resident, you would be taxed on your Canadian-source income. The severance pay would be included in income in the year it was received and taxed accordingly. Also, you will be deemed to have disposed of all property except for taxable Canadian property at fair market value immediately prior to ceasing residence. Any capital gains and losses must be reported in income on the last tax return for the period prior to departure. Taxable Canadian property includes real property, other capital property, shares in a private corporation and ownership of 25% of shares of any class in a Canadian public corporation if the value of the shares is derived from real property. However, it is possible to elect to treat all capital properties as not having been disposed of at the time you cease to be a resident. This requires acceptable security to be left with the CRA as collateral. If the election were not taken, the tax effects of the deemed disposition would be: Speculative stocks

Deemed adjusted cost base = FMV Cost Capital loss Allowable capital loss (50%)

$ 4,000 95,000 $91,000 $45,500

The RRSP is not subject to the deemed disposition, and there would be no capital loss or gain to account for on the T-Bills and bonds. Assessment of Capital Loss from Trading Options Income earned as a result of trading in the options and derivatives markets could be considered business income, and not be given capital treatment, if you were able to establish a business approach to the activity. Factors would include capital invested and/or borrowed, time spent, experience and knowledge, frequency of trades, and similar factors. Given that you reported the previous year’s gain as capital, it is extremely unlikely that, now that you’ve incurred losses, you will be allowed business treatment rather than capital treatment. You can object to the reassessment but, in my opinion, your objection to the measurement will most likely be unsuccessful.

CHAPTER 10

Computation of Taxable Income and Taxes Payable for Individuals Solution 1: Dependent Credit

ITA: 118(1)(a) ITA: 118(1)(b)

ITA: 118(1)(b)(i) ITA: 118(1)(b)(ii) ITA: 118(1)(b.1)

(B) In 2023, Jack and Jill could each claim a basic personal tax credit. Neither is eligible for the equivalent-to-married tax credit. — NOTES TO SOLUTION (1) All income of a spouse during the year of marriage is used in determining a spousal tax credit. [ITA: 118(1)(a)(ii)] (2)

Jack does not have the option of claiming either of the children as ETM since they were not related to nor living with him at the time during the year that he was single. [ITA: 118(1)(b)] (3)

Jill has the option of claiming either Jack (however, his income is too high in this fact situation) or one of her children as ETM since she falls into both paragraphs. It would appear that Jack and Jill cannot both claim each other at the same time according to a court decision which determined that spouses cannot simultaneously support each other. (See The Queen v. Robichaud, 83 DTC 5265 (F.C.T.D.).) [ITA: 118(1)(a), 118(1)(b); IT-513R, par. 27]

231

232 Solution 2: Tuition Credit

Introduction to Federal Income Taxation in Canada

(A) Division B and taxable income .......................................................................... Federal tax @ 15% of $5,000 ......................................................................... Less: basic personal tax credit ........................................................................ Federal tax payable ......................................................................................... Credits available for transfer: Tuition fee tax credit (15% of $1,800) ......................................................

$5,000 $ 750 (2,250) Nil $ 270

Amount deductible by qualified transferee: Lesser of: (a) $750 (b) student’s tuition fee credit — $270 Less: amount of tax credit required to reduce student’s tax payable to nil .................... Net amount deductible by transferee ..............................................................................

}

$ 270

Nil $ 270

Note that the Employment Insurance premium and CPP contribution tax credits cannot be transferred. (B) If Sammy was married, his wife could deduct the $270 in tuition fee tax credit, ITA: 118.7 tax credits, since Sammy’s federal tax, after his personal tax credit, is nil. Sammy’s parent or grandparent can deduct all or some part of the $270 as a tax credit, if Sammy so designates.

Solutions to Chapter 10 Assignment Problems

233

Solution 3: Exempt income, Non-capital loss Paragraph 3(a) Sources of income Sections 5–8 Employment income Sections 9–20 Property income Paragraph 3(b) Taxable capital gains: Gain on ABC shares ($1,200 × 50%) Section 3 Net income for tax purposes

$7,000 800 600 $8,400

The lottery winnings and the inheritance funds are not included in the computation of net income because these are windfall gains outside the concept of income sourcing. (b) Section 111 Subsection 2(2)

Net income for tax purposes per paragraph (a) Loss carryforward Non-capital loss carryforward Taxable income

$8,400 (3,000) $5,400

Introduction to Federal Income Taxation in Canada

234

Solution 4: Income and Taxable Income, Ordering Rules 2021

(A) Income from non-capital sources: Employment income .................................................. Property income......................................................... Total par. 3(a) income................................................ Par. 3(b): Net taxable capital gains: Taxable capital gains.................................................. Allowable capital losses............................................. Total par. 3(b) income................................................ Par. 3(c): Par. 3(a) + par. 3(b) ................................................... Par. 3(d): Losses from non-capital sources and ABIL: Property loss .............................................................. ABIL.......................................................................... Division B income ......................................................................... (B) Deduct: Net capital losses from 2018 (see Schedule 1below)...... Net capital losses from 2022 (see Schedule 1, below).... Taxable income .............................................................................

2022

2023

Par. 3(a):

75,000 Nil 75,000

80,000 3,000 83,000

72,000 (9,000) 63,000 138,000

Nil (11,250) Nil $ 83,000

(4,000) (18,000) $ 116,000 (21,000) (11,250) $ 83,750

Nil (27,000) $ 56,000 Nil Nil $ 56,000

(6,000) Nil $ 124,000 Nil Nil $ 124,000

$ $ $ $

90,000 Nil 90,000

80,000 (40,000) $ 40,000 $ 130,000

Schedule 1 (I) Net capital losses — Pars. 111(1)(b) and 111(8)(a) 2021

(II)

2022

2023

Ref.

Lesser of: (i) Net TCGs for the year........

$ 63,000

Nil

$ 40,000

Par. 3(b)

(ii) Total net CLs .................... Lesser amount.........................

$ 21,000 $ 21,000

Nil Nil

(II)

Loss continuity schedule Net CL ..................................................................................

2017 $ 21,000

2021 $ 11,250

Total $ 32,250

Ref.

Utilized in 2021 ................................................................ Available in 2023 .............................................................

(21,000) Nil

(11,250) Nil

(32,250) Nil

(I)

2023

Ref.

Schedule 1 (I) Net capital losses — Pars. 111(1)(b) and 111(8)(a) 2021 Lesser of: (i) Net TCGs for the year. (ii) Total net CLs ………….. Lesser amount ……………..

$ $

2022

63,000 21,000

Nil Nil $

$ 40,000 Nil

21,000

(II) Loss continuity schedule Net CL ……………………………………………………………………………………………………………………… Utilized in 2021 ……………………………………………………………………………………………………….. Available in 2023 ……………………………………………………………………………………………………..

Nil

Par. 3(b) (II) Nil

2018 2022 Total 21,000 $ 11,250 $ 32,250 (21,000) (11,250) (32,250) Nil Nil Nil

Ref. (I)

Solutions to Chapter 10 Assignment Problems

235

Solution 5: Credits

—NOTES TO SOLUTION (1) The dividend income would be attributed back to Mrs. Plant [ssec. 74.1(1)] but not the interest on the already attributed dividends [IT-511R, par. 6]. The worker’s compensation payments are included in Mr. Plant’s net income but not in his taxable income [pars. 56(1)(v), 110(1)(f)]. The amount of Mr. Plant's impairment credit transfer is computed as follows: Impairment credit base Less: Mr. Plant's Part I tax (taxable income < personal credit base) Minus: Part I tax in excess of disability credit

$9,428 $ nil nil

nil $9,428

(2) The $7,000 social assistance payments are included in Amanda’s net income but excluded from her taxable income [pars. 56(1)(u), 110(1)(f)]. A Canada caregiver credit is available for Amanda, due to her infirmity. The Canada caregiver credit is $7,525, since Amanda’s income does not exceed the $18,783 threshold. Her impairment and tuition credits can be transferred because her taxable income of nil does not exceed the basic personal amount of $15,000. The amount of the tuition transfer is computed as follows:

Lesser of: (a) Maximum amount of transfer (15% of $5,000)........................................................ (b) Tuition fee................................................................................ $ 300

750

300  .15 =

The credit base of $300 can be transferred.

Introduction to Federal Income Taxation in Canada

236 (3) Joan’s Taxable Income:

Employment income.................................................................................................................. $ Scholarship (exempt) ..................................................................................................................... $ Moving to university* ............................................................................................. $ Nil Moving from university........................................................................................... 150 Net income and taxable income................................................................................................. $

4,200 Nil 4,200 150 4,050

* Limited by scholarship income.

Joan will have no tax to pay because her basic personal amount of $15,000 exceeds her taxable income. Therefore, all of the tuition tax credit will be available to transfer to Mrs. Plant. The transfer is computed as follows: Lesser of: (a) Maximum amount of transfer (15% of $5,000)........................................................ (b) Tuition fee................................................................................ $ 3,000

750

$ 3,000  .15 =

450

The base of $3,000 can be transferred.

Solutions to Chapter 10 Assignment Problems

237

Solution 6: Wholly Dependent Person (Equivalent to Married) Credit Each of Angelina and Romeo has a right to claim the eligible dependant tax credit as each is a single parent who supports a child under the age of 18, in a self-contained domestic establishment. However, under paragraph 118(4)(b) it is provided that not more than one person is entitled to that tax credit in respect to the same person. Paragraph 118(4)(b) goes on to provide that the two entitled persons must agree which of them is to make the claim and that if they cannot agree, no person is entitled to that particular credit. Angelina and Romeo should agree as to which of them will claim Maria for the eligible dependent credit. It is not in either of their interests to disagree. The tax credit has the same value to either of them (assuming each has sufficient taxable income).

Introduction to Federal Income Taxation in Canada 238 Solution 7: Credits—Single Parent, Infirm Child Mrs. Jackson’s Non-refundable Tax Credit related to Rachel

Par. 118(1)(b) Par. 118(1)(d)

Married equivalent tax credit(1) .................................................. $ 15,000 Canada caregiver …………………………………………………………………… 2,499

Sec. 118.3

Disability tax credit transferred from a dependant(2) ……………

Sec. 118.2

9,428

(3)

Medical expense …………………………………………… $ 10,000 Less lesser of: (a) Limit: $2,635 (b) 3% of Rachel’s net income (nil) = Nil Lesser amount …………………………………………………. Nil Total tax credit base ……………………………………………………………… $ Total non-refundable tax credits related to Rachel ……………… $

10,000 36,927 x 15% 5,539

—NOTES TO SOLUTION (1) Wholly Dependent Person (Married equivalent) tax credit [par. 118(1)(b)]. An individual who, at any time in the year, is single, widowed, divorced or separated may be entitled to claim the married equivalent tax credit if the individual, at that time, maintained (either alone or jointly) and lived in a self-contained domestic establishment and supported therein a person who is: (a) a resident of Canada, except where the claim is in respect of the individual’s child; (b) wholly dependent for support on the individual or the individual and any other person or persons who jointly maintained the self-contained domestic establishment; (c) related to the individual; and (d) under 18 years of age or wholly dependent by reason of mental or physical infirmity, except where the claim is in respect of the individual’s parent or grandparent. Since Rachel is severely mentally handicapped and is supported by Mrs. Jackson, Mrs. Jackson will be able to claim the tax credit in 2022. She will also be able to claim the Canada Caregiver credit in the amount of $2,499 as Rachel is 18 years of age or older and dependent because of mental and physical infirmity. The lower threshold applies because the equivalent to married credit is claimed for Rachel. (2) Impairment tax credit [sec. 118.3] — Rachel has a severe and prolonged mental or physical impairment which caused her to be markedly restricted in her basic activities of daily living. As well, her impairment has lasted for a continuous period of at least 12 months. Therefore, Rachel qualifies for the impairment tax credit. The certificate of a medical doctor attesting to the impairment as described in paragraph 118.3(1)(a.2) must be filed [par. 118.3(1)(b)]. Since Rachel has no income and, therefore, no use for the impairment tax credit, the amount can be transferred to Mrs. Jackson, because Rachael is a dependant of Mrs. Jackson [ssec. 118.3(2)]. Note: If a medical expense tax credit was being claimed for full-time attendant care under 118.2(1)(b), the impairment tax credit would not be available. Either the medical expense tax credit for full-time attendant care could be taken or the impairment tax credit could be claimed, but not both. In this case the full-time attendant care is claimed as a medical expense tax credit under 118.2(1)(b.1) which has a $10,000 limit. The impairment tax credit is allowed in that case. (3) Medical expense credit [sec. 118.2] — Medical expenses which have been incurred by the taxpayer, by the taxpayer’s spouse, or by persons whom the taxpayer is entitled to claim as dependants may be claimed by the taxpayer. Therefore, Mrs. Jackson may claim medical expenses incurred for Rachael. A supporting person may claim as a medical expense the remuneration of a full-time attendant or the expenses for full-time care in a nursing home under 118.2(1)(b). However, if a medical expense claim is made for full-time attendant care under this paragraph, the impairment tax credit may not be claimed. In this case the attendant care is not for a full-time attendant.

Solutions to Chapter 10 Assignment Problems 239 A medical expense credit for part-time attendant care is instead available under paragraph 118.2(1)(b), provided the total expenses for such care for the year do not exceed $10,000 (or $20,000 in the year of death). In this case, the impairment credit may be claimed. The care must be provided for a patient who is eligible for the $9,428 impairment amount (although someone else may actually claim the impairment amount under the transfer rules), and this credit is not available if any expense is deducted from the disabled person’s income for attendant care. Rachel would qualify for the impairment tax credit. Therefore, Mrs. Jackson can claim $10,000 for purposes of the medical expense tax credit.

240 Solution 8: Medical Expenses

Introduction to Federal Income Taxation in Canada

All of the medical expenses incurred or expected to be incurred qualify for the credit [ssec. 118.2(2) and Reg. 5700]. Note also that the refundable medical expense supplement is not available in the case of the Jennings, because their adjusted income, that is, Mr. Jennings’ Division B income of $65,000 is above the income level of $58,944 where the supplement is fully eroded. Mr. Jennings does not have enough medical expenses in 2023 ($1,485) to exceed the lesser of $2,479 and 3% of his Division B income ($1,650 = 3% of $55,000) for 2023 [ssec. 118.2(1)]. Mr. Jennings can claim his 19-year-old son’s medical expenses if his son is dependent upon him for support [ssec. 118(6)]. The Jennings should incur as many of the medical expenses as they can before June 2024. This period will give them the largest dollar amount of medical expenses to be claimed on their 2024 tax return. If Mr. Jennings chose the 12-month period ending May 31, 2024 and paid for all of the expenses anticipated in 2024 by that date, his medical expenses in 2023 would be computed as: 2023 — June........................................................................................................... $ 1,150 2024

— July.................................................................................................................. 300 — February................................................................................................. 2,550 — March.............................................................................................................. 2,700 — by May 31 ($750 + $450 + $375 + $1,050).......................................................... 2,625

Total (including $2,700 + $750 = $3,450 re: older son) ..............................................

9,325

Note that the anticipated expenses must not only be paid for, but the services must be received, by May 31, 2024, in this case. Prepaid expenses for services not received are not deductible for the period ending May 31, 2024, in this case. The medical expenses incurred for his oldest son are $3,450 ($2,700 + $750). Mr. Jennings 2024 medical expense tax credit can be computed as follows: A [(B – C) + D] where A = 15% B = $9,325 – $3,450 = $5,875 C = lesser of: (a) limit: $2,635 (b) 3% of $55,000 = $1,650 = $1,650 D = $3,210 D = E – F = $3,450 – lesser of: (a) $2,635 (b) 3% of $8,000 = $240 =$3,450 – $240 =$3,210

The credit is: 15% of [($5,875 – $1,650) + $3,210] = $1,115.

Solutions to Chapter 10 Assignment Problems

Solution 9: Dividend Election

241

Introduction to Federal Income Taxation in Canada 242 Solution 10: Credits For U.S. University Tuition Fees Per paragraph 118.5(1)(c), Pamela can claim a federal credit of 15% the tuition fees in calculating her tax payable under Part I. The criteria she must satisfy are: 1)

she resided in Canada throughout the year near the Canada–U.S. border;

she was a student at a U.S. educational institution that is a university providing courses at a post-secondary level (she is taking a Masters degree);

she commuted to the U.S.;

the fees exceed $100; and

she paid the fees herself, i.e., they were not paid on her behalf by an employer.

Income Tax Folio S1-F2-C2, paragraphs 2.13 and 2.15, provides additional information for Pamela.

Solutions to Chapter 10 Assignment Problems

243

Solution 11: Credits For U.S. and Canadian Universities Tuition fees which qualify for a tax credit (A) Only the academic portion of the tuition fee and ancillary fees levied on all students is allowed for tax purposes as reflected by the official receipt for tax purposes. Normally, student union and athletic fees will be excluded. (B) The tuition fees for Harvard University, except for July and August 2022, qualify for a tax credit [par. 118.5(1)(b)], since the courses lead to a degree and exceeded 13 weeks. The July–August 2022 course does not qualify since Stuart is not in full-time attendance during July and August (paragraph 118.5(1)(b)). The re-read fee also qualifies [Income Tax Folio S1-F2-C2]. (C) The tuition fee for the University of Toronto taxation course would also qualify as a deduction [par. 118.5(1)(a)]. The CRA’s assessing policy is that, “If you [Universal Exports Inc.] operate a post-secondary scholarship or bursary program for the family members of your employees, do not include the amount in your employee’s income. Instead, report the FMV as a scholarship on a T4A slip for the family member.”1 Stuart would not have to report the scholarship income and he could claim the tuition credit. (D) The fitness course taken at a local secondary school would not qualify for either the tuition or the fitness credits. Allowable tuition fee credit: Qualified tuition fees must be paid in respect of the year to provide a tax credit for the year. Therefore, if the fees for a full academic year (fall and winter terms) are paid in, say, September of that year, they would provide a tax credit for the year to which the fees relate [Income Tax Folio S1-F2-C2 par. 2.31]. Note that the tuition fee tax credit can be transferred to a spouse, a parent or a grandparent. Alternatively, it can be carried forward indefinitely by the student.

www.cra-arc.gc.ca/tx/bsnss/tpcs/pyrll/bnfts/dctn/ttn-eng.html

244

Introduction to Federal Income Taxation in Canada

Solution 12: Pension vs. Dividends, OAS Claw Back

(2) Alan: [$8,396− 0.15 ($98,309− $42,335)] × 0.15 = $429 Clare: [$8,396– 0.15 ($98,309 – $42,355)] × 0.15 = $225 (3) Alan pays less personal income tax because of the lower marginal tax rate applicable to non-eligible dividends. Also, the corporation which Alan’s son manages would have likely paid corporate income tax on its earnings prior to the payment of dividends. Neither Clare nor Alan will be subject to minimum tax.

Solutions to Chapter 10 Assignment Problems

245

Solution 13: Minimum Tax

Thus, minimum tax adds $21,196 ($24,120 – $2,924) to his federal tax. The $21,196 is available as a carryforward to the next seven years to reduce the excess of regular tax over minimum tax in those years. She does not have an EI credit since we have assumed that she would not pay any EI as the owner of the company. However, it is possible that she would qualify for specified EI benefits, so she should be encouraged to apply for coverage, if the benefits would apply in her case.

Introduction to Federal Income Taxation in Canada

246

Solution 14: Stock Option—Division C Deduction 1.

Calculate benefit – public company stock option Three years ago – when option was exercised Employment income:

1,000 shares x ($35 - $30) =

$5,000

Division C deduction:

$5,000 x 50% = $2,500 [this deduction is available, since the exercise price was not less than the FMV at the time the option was granted]

(2,500)

Taxable income Impact on ACB:

$2,500 ACB = 1,000 x $30 + $5,000 = $35,000 [The amount of the employment income reported increases the ACB of the shares to reflect the tax-paid cost of the shares.]

2023 – Sale for $45 Proceeds = 1,000 shares x $45 = ACB = Capital gain

$45,000 35,000 $10,000

Taxable capital gain

$5,000

Total income to report in 2023

$5,000

Taxable income for all years Employment – Division C – three years ago 2023 taxable income Impact on taxable income Economic gain = 1,000 shares x ($45 - $30) =

$2,500 5,000 $7,500 $15,000

Calculate benefit – CCPC company stock option Three years ago – when option was exercised No income would have been reported when the option was exercised. As a CCPC the benefit is reported in the year the option shares are sold. 2023 – Sale for $45 Employment income:

$1,000 shares x ($35 - $30) = $5,000

Division C deduction:

$5,000 x 50% = $2,500 [this deduction is available, since either the exercise price was not less than the FMV at the time the option was granted or the shares are held for more than two years]

When is this reported?

As a private company, the employment benefit of $5,000 is reported in the year the shares are sold, i.e., in 2023

Impact on ACB:

ACB = 1,000 x $30 + $5,000 = $35,000 [The amount of the employment income reported will increase the ACB of the shares in the year it is reported to reflect the tax-paid cost of the shares.]

Solutions to Chapter 10 Assignment Problems Sale for $45

247

Proceeds = 1,000 shares x $45 = ACB = Capital gain

$45,000 35,000 $10,000

Taxable capital gain

$5,000

Taxable income for all years Employment – 2023 TCG – 2023 Division C deduction – 2023 Impact on taxable income Economic gain = 1,000 shares x ($45 - $30) =

$5,000 5,000 (2,500) $7,500 $15,000

Comparison The total amount and nature of the income does not change between a public company and a CCPC. However, the timing of the recognition of the employment income is different.

248 Solution 15: Loss Carryover

Introduction to Federal Income Taxation in Canada

Income for the Year 3(a)

Employment, including stock option Property Net TCG ($15,000 - $20,000)

3(b) 3(c) 3(d) Losses: Business Income for the year Division C: stock option deduction Taxable income

$45,000 1,150 $46,150 (60,000) (2,500) $ -

Non-Capital Losses Loss for the year from business Stock option deduction Less: Employment income Stock option benefit Dividends – grossed up Net TCG Non-capital loss for the year

$60,000 2,500 40,000 5,000 1,150 -

$62,500

(46,150) $16,350

This is available to be carried back 3 years and forward 20 years to reduce income from any source in those years.

Net Capital Losses Allowable capital losses in the year Taxable capital gains in the year Net capital loss for the year

$20,000 (15,000) $5,000

This is available to be carried back three years and forward indefinitely to reduce net taxable capital gains in those years.

Solutions to Chapter 10 Assignment Problems

249

Solution 16: Allowable Business Investment Loss Income for the Year 3(a) 3(b) 3(c) 3(d)

Employment, including stock option Property Net TCG

Losses: Business ABIL Income for the year Division C: stock option deduction Taxable income

$45,000 1,150 15,000 $61,150 (60,000) (20,000) (2,500) $ -

Non-Capital Losses – 2023 Loss for the year from business Allowable business investment loss Stock option deduction Less: Employment income Stock option benefit Dividends – grossed up TCG Non-capital loss for the year

$60,000 20,000 2,500 40,000 5,000 1,150 15,000

$82,500

(61,150) $21,350

This is available to be carried back 3 years and forward 20 years to reduce income from any source in those years. Net Capital Losses – 2023 Allowable capital losses in the year Taxable capital gains in the year Net capital loss for the year

$ nil (15,000) $ nil

ABIL Notice that the ABIL has become part of the non-capital loss and can be applied against any source of income in the back 3, forward 20-year, carry-over period. The ABIL will remain in this non-capital loss category until it is either applied against income in the carry-over period or 10 years has elapsed. If the 10-year period expires first, then the remaining ABIL becomes a net capital loss in that year and can be carried forward indefinitely.

Introduction to Federal Income Taxation in Canada 250 Solution 17: Marginal Tax Rates For each of the following types of income, the marginal tax rate for individuals in the top tax bracket has been calculated:

This reinforces the concept that the nature of the income determines the amount of tax that is paid.

Solutions to Chapter 10 Assignment Problems

251

Solution 18: Pension Splitting Harry and Shia are both retired. They have the following income: Assuming they DO NOT split any of the pension income

1. Assuming they do not split any of the pension income Harry Shia Company pension $ 120,000 $ CPP 12,100 6,000 OAS 8,251 8,251 RRIF 12,000 OAS repayment (8,016) $ 132,335 $ 26,251 Federal tax @ 15% Federal tax on $106,718 Federal tax on $25,617 @ 26% Tax on OAS Personal credit Pension credit Age credit

$ 3,938 $ 18,942 6,660 8,251 (2,250) (300) -

(2,250) (300) (1,259)

$ 31,303 $

128

$31,432

Notes: 1) OAS Tax/Repayment

Therefore, the full amount has to be repaid and is deductible in arriving at taxable income.

Introduction to Federal Income Taxation in Canada

252 2)

Age Credit

2. Harry and Shia are both retired. They have the following income: Assuming they DO split the pension income

Notes: 1)

OAS Tax/Repayment

Solutions to Chapter 10 Assignment Problems 2)

Age Credit

Their position has improved by $9,760 ($31,432-$21,672) by splitting income in retirement.

253

Introduction to Federal Income Taxation in Canada 254 Solution 19: Income, Ordering Rules

Paragraph 3(a) Paragraph 3(b) Paragraph 3(c) Paragraph 3(d )

Paragraph 3(e ) Section 3 Section 111 Subsection 2(2)

Sources of income (loss) Employment income Income from property (Note 1) Taxable capital gains (Note 2) Subdivision e deductions (RRSP) Losses Business loss Rental property ($25,000 − $31,000) Allowable business investment loss CCP enhanced contribution deduction Net income for tax purposes Net capital loss carryforward Taxable income

$120,000 24,000 0 (1,000) (7,500) (6,000) (6,000)

( 19,500) (631) $122,869 (3,000) 0* $122,869

* Not useable, as no net taxable capital gains in year. Note 1:

Net income from property: Interest income Rental income from joint ownership

$ 9,000 15,000 $24,000

Note 2: Taxable Capital Gains Capital gain on sale of shares (.5 × 10,000) $ 5,000 Allowable capital loss (11,000 − 6,000 ABIL) (5,000)** Net taxable capital gain $ 0 ** As these are described as “allowable”, they are already stated at the appropriate 50% figure.

Solutions to Chapter 10 Assignment Problems

255

Solution 20: Income and Taxable Income, Ordering Rules [Note to instructors Employment income changed from $72,000 to $89,000] Employment income — per T4s ...................................................................... — ssec. 7(1) benefit (2,000 shares  ($10−$4) ............. — interest benefit on loan [ssec. 80.4(1)](1) ................... Property income — Interest net of carrying charges(2) ........................................ Par. 3(a)............................................................................................................... Taxable capital gains(3) [par. 3(b)].......................................................................

$ 89,000 12,000 252

$ 101,252 4,000 $ 105,252 4,950

CPP enhanced contribution deduction………………………………………….. Par. 3(c) and total Division B income .................................................................

(461) $ 109,741

Division C deductions: Par. 110(1)(d) Employee stock option deduction(4) ...............................................................

Par. 111(1)(b) Par. 111(1)(a)

Net capital losses(5) ........................................................................................ Non-capital losses(6) .......................................................................................

Total Division C deductions...................................................................................................... Taxable income (equal to non-refundable credits) (7) ................................................................

6,000 4,950 78,298

$ $

89,248 20,493

—NOTES TO SOLUTION (1) Interest on all loans subject to subsection 80.4(1) computed at the prescribed rate on each loan and debt for the period in the year during which it was outstanding (less amounts actually paid, if applicable). [$100,000  92 days/365  1%] (2) Property income is equal to the property income earned less the expenses incurred to earn the property income. [$5,000 – $1,000] (3) Taxable capital gain = 1/2 of the capital gain. [$9,900  1/2] (4) Deduction [par. 110(1)(d)] will be equal to 1/2 of the benefit inclusion [ssec. 7(1)], since exercise price is greater than or equal to the fair market value on the grant date. (1/2  $12,000) (5) Net capital losses applied are restricted to the net taxable capital gains ($4,950). (6) Non-capital losses carryforward from 2022........................................................................ $ 78,000 Non-capital losses applied from: — 2017.............................................. $ 24,000 — 2018.............................................. 26,000 — 2021.............................................. 12,734 62,734 Non-capital loss carryforward to 2023 (from 2021 balance) .............................................. $ 15,266 Note that less than the maximum non-capital loss carryforward is claimed in order to leave taxable income to offset the personal and employment tax credit bases for the year. Other credits that could be offset, in this particular case, if less than the maximum non-capital losses are claimed, include the CPP and EI credits. These types of credits will vary in other cases. The point here is to consider these options to claiming maximum noncaptial losses. (7)

Introduction to Federal Income Taxation in Canada 256 Solution 21: Income and Taxable Income, Ordering Rules

—NOTES TO SOLUTION (1) Listed personal property:

2022

$6,000 – $5,000 (carried forward from 2017 [sec. 41]) → $1,000  1/2 = $500

(2) Personal-use property losses denied. (3) Other capital property — 2023

$ 22,500 Allowable capital losses (1/2  $45,000) .............................................................................. Less: allowable business investment loss applied in par. 3(d) (1/2  $24,000) ......................... (12,000) $ 10,500 Amount which can be applied under par. 3(b) ......................................................................... 10,125 Balance which can be carried forward or backward as a net capital loss ............................. $ 375

(4)

(a) RRSP contribution deduction for 2022 would be limited by the lesser of: (i) 18% of 2021 earned income ($33,250) = $5,985 (ii) $29,210 Lesser amount ...................................................................................................... $ Minus the pension adjustment for 2021 ...........................................................................

5,985 Nil

Solutions to Chapter 10 Assignment Problems

257

Net contribution limit................................................................................................... Unused RRSP contribution room to be carried forward ($5,985 – $1,000) .................

$ $

5,985 4,985

(i) 18% of 2022 earned income (see below: $42,000) = $5,220 (ii) $30,780 Lesser amount ...................................................................................................... Minus the pension adjustment for 2022 ................................................................... Unused RRSP deduction room ....................................................................................

7,560 Nil 4,985

Total available .............................................................................................................

12,545

(b) RRSP deduction for 2023 would be limited to the lesser of:

2023 RRSP deduction limited to $3,000 contribution. $9,545 of unused room will remain at the end of 2023. Earned income for 2022 would be: $ 60,000 Employment income ............................................................................................ Business loss ........................................................................................................ (14,000) Rental income .................................................................................................. 3,000 Deductible support payments ............................................................................... (7,000) Earned income ................................................................................................. $ 42,000

(5) Net capital losses

2022

2023

Lesser of: (i) Net TCGs for the year.................................

4,500

(ii) Total adjusted net CLs* ..............................

25,000

Lesser amount..................................................... * Net capital loss continuity schedule.

4,500

Net CL ............................................................................. Utilized in 2022............................................................. Available in 2023 .......................................................... Net CL realized in 2023................................................. Total available in 2023 .................................................. Utilized in 2023............................................................. Available in 2024 ..........................................................

Nil $

Nil

2020 $ 25,000 (4,500) $ $ $

20,500

20,500 20,500 Nil 20,500

$ $ $

2023 N/A N/A

C/F Total $ 25,000 ( 4,500)

N/A 375 375 Nil 375

$ 20,500 $ 375 $ 20,875 Nil $ 20,875

(7) In each of 2022 and 2023, sufficient taxable income has been left to utilize the basic personal and employment tax credits as well as CPP and EI.

258

Introduction to Federal Income Taxation in Canada

Solutions to Chapter 10 Assignment Problems

Solution 22: Income and Taxable Income, Ordering Rules

259

The tax liability is due April 30th. The tax return is due June 15th.

231

Introduction to Federal Income Taxation in Canada

232

Solution 23: Subdivision e Deductions, Taxable Income For an Individual; Personal Tax PART 1 Subdivision e Deductions in Computing Income 1. Maintenance Payments — Paragraphs 60(b) and (c) Monthly payments are made pursuant to a court order Payments to apartment owner are considered to be an allowance

$ 8,000 4,709

$12,709

2. Registered Retirement Savings Plan Contributions — Paragraph 60(i) Maximum contribution for 2023 would be the lesser of: (a) $30,780 - $5,000 (PA) $ 25,780 (b) 18% of his earned income in 2021 - PA (18% × (75,550 + 8,500 - 4,500 - 13,000) - 5,000) (18% × 66,550) - 5,000

$ 6,979

6,979

Note that any portion of the RRSP contribution not deducted in 2023 may be carried forward to 2024. A nondeductible overcontribution of $2,000 total at any time is allowed without penalty. 3. Direct Transfer of Superannuation Benefits to RRSP — Subsection 147.3(4) Not deductible, but no inclusion of amount transferred 4. Transfer of Retiring Allowance — Paragraph 60(j.1) The maximum deductible amount Mr. Leaving may designate under par. 60(j.1) is the lesser of: (a) $2,000 × 12* $1,500 × (5* - 0)** = (b) total RRSP premium contribution Maximum designated amount under par. 60(j.1) would be

$24,000 7,500

$31,500 $70,000 31,500

Since the legislation only refers to years, not full years, it is reasonable to assume part years would qualify. However, only pre-1996 years qualify. ** Formula is as follows: $1,500 times the number of years, prior to 1989, employed by the particular or related employer minus the equivalent number of vested years prior to 1989. 5. Expense of Objection or Appeal — Paragraph 60(o) Note: legal fees for representation in Family Court are personal expenses and are not deductible. 6. CPP Enhanced Contribution Deduction

1,250

Total subdivision e deductions in computing income

$53,061

631

Solutions to Chapter 10 Assignment Problems

233

PART 2 Calculate Mr. Leaving's Taxable Income Subdivision a — income from employment Subdivision b — income from business and property Subdivision c — taxable capital gains Subdivision d — other sources of income: Spar. 56(1)(a)(ii) retiring allowance

$ 70,450 5,600 11,500 60,000 $147,550 (53,061) 94,489

Subdivision e — deductions in computing income Division B income Division C Par. 111(1)(b) and 111(1.1) Net Capital losses (11,466) Taxable income

(11,466) $ 83,023

PART 3 Federal Taxes Payable

83,023

Federal tax on first

53,359

8,004

on next

29,664 @ 20.5%

6,081

83,023

14,085

Less: (1) Total non-refundable tax credits Basic personal

15,000

Equivalent to married amount for youngest child

15,000

Canada employment credit

1,368

CPP contributions – maximum

3,123

EI premiums – maximum

1,002

Tuition fees amount transferred from 18-year-old, Scott*

5,000 40,493 × 15% (6,074)

Charitable donations On the first

200 x 15%

On the next

1,050 x 29%

305

(335)

(2) Federal dividend tax credit 6/11 × gross up ( 6/11 x $344) ($1,250 - $1,250/1.38 = $344)

(188)

Basic and total federal tax

* Tuition fees available to student Scott's taxable income Less: basic personal amount Unused portion available for transfer Maximum transfer

7,489

(13,808)

$ 6,000 $ 2,500 Nil $ 6,000 $ 5,000

CHAPTER 11

Computation of Taxable Income and Tax After General Reductions for Corporations Solution 1: Taxable Income Par. 3(a)

Income from business ........................ Income from property ........................

Par. 3(b)

Taxable capital gains.......................... Allowable capital losses .....................

2020 54,000 42,500 $ 96,500 11,000 (2,000) $

$ $

2021 32,000 22,500 54,500 2,500 (2,500)

2022 $ $

2023 62,500 10,500 $ 73,000 9,000 Nil

0 18,000 18,000 5,000 (3,500)

19,500 n/a (75,000) 0 — 0

— — 0 (1,500)

(3,000) (13,000) $ 55,500 (500) $ 55,000 (24,750) $ 30,250

(1)

Par. 3(c) Par. 3(d)

ABIL .................................................. Business loss ...................................... Income from Division B..................... Inter-company dividends....................

Par. 3(e) Sec. 112 Sec. 110.1

Par. 111(1)(b)

Charitable donations:(2) Carryover .................................... Current ........................................ Net capital losses(3).............................

Par. 111(1)(a) Non-capital losses(4) ........................... Taxable income ..................................................................

$ 105,500 (3,750) n/a $ 101,750 (42,500) $ 59,250

54,500 n/a n/a $ 54,500 (22,500) $ 32,000

n/a (23,000) $ 36,250 (9,000) $ 27,250 (27,250) 0

— (9,000) $ 23,000 — $ 23,000 (23,000) 0

0 — 0

82,000 n/a n/a $ 82,000 (10,500) $ 71,500

—NOTES TO SOLUTION (1) (2)

A maximum of $2,500 can be deducted in 2021. Charitable donations: 2020: Lesser of:

2021: Lesser of:

2022: Lesser of:

2023: Lesser of:

(a) 75% of $101,750 = $76,313 (b) $23,000 Carryforward: $0 (a) 75% of $54,500 = $40,875 (b) $9,000 Carryforward: $0 (a) 75% of Nil = $0 (b) $3,000 Carryforward: $3,000 (a) 75% of $82,000 = $61,500 (b) $3,000 + $13,000 = $16,000 Carryforward: $0

(3) Net capital losses 2017 net capital loss.............................................................................................................. $ 9,000 Net capital loss deducted in 2020 to the extent of net taxable capital gains ..................................... (9,000) 0 2021 net capital loss not utilized............................................................................................ $ 2,000 2022 net capital loss deducted to the extent of net taxable capital gains .......................................... (1,500) $ 500 2023 remaining net capital loss deducted in 2023 to the extent of net taxable capital gains............. (500) Available for carryforward .............................................................................................................. 0

263

Introduction to Federal Income Taxation in Canada

264 (4) Non-capital losses

Par. 3(d) Loss from business in 2022............................................................. $ 75,000 Dividends deducted under section 112 ................................................... 18,000 Add: net capital loss deducted ................................................................................................... Less: par. 3(c): par. 3(a) dividends .................................................................... $ par. 3(b) taxable capital gain .........................................................

$ $

93,000 1,500 94,500

19,500 75,000

18,000 1,500

Losses utilized: 2020 carryback ..................................................................... $ 27,250 2021 carryback ..................................................................... 23,000 2023 carryforward ........................................................................ 24,750 Closing balance .........................................................................................................................

75,000 0

Solutions to Chapter 11 Assignment Problems

265

Solution 2: Permanent Establishment [Reference: Chicago Blower (Canada) Ltd. v. M.N.R., 66 DTC 471 (T.A.B.)]

(ii) (B)

(A) Facts fall within Regulation 400(2)(b) (i) the company carried on business in each province through an agent, — the agent was established in a particular place, clearly identified to the public, — occupied building with various warehouse facilities, — the agent had general authority to contract, — the agent had a stock of merchandise from which he filled orders, — the exception to this was on orders for larger fans, — thus, the condition was met at least in part, therefore, the company does have a “permanent establishment” in the provinces indicated. This conclusion differs from that in the Sunbeam case which can be distinguished on its facts, (i) in the Sunbeam case, the taxpayer’s representatives in Quebec did not have authority to make contracts on the company’s behalf, (ii) there was no telephone listing in the company’s name and that name did not appear on any business signs.

Solution 3: Income From Business With SR&ED (Note to instructors – Net income for tax purposes before R&D changed from $615,000 to $657,000) Net income for tax purposes before R&D ...................... Add: Amount booked for salaries .................................... Amount booked for operating costs of lab.............. Investment tax credits on salaries(3) ........................ Investment tax credits on operating costs of lab(3) .. Deduct:(4) 100% of lab salaries................................................ 100% of lab operating costs.................................... Net income for tax purposes ...........................................

2023 657,000(1)

2024

Reference (2)

85,000 34,000 15,000 6,000 (100,000) (40,000) $ 636,000

Par. 12(1)(v) same as above Par. 37(1)(a) Par. 37(1)(a)

—NOTES TO SOLUTION (1) The amortization has already been added back in arriving at this number. CCA on the lab machinery and equipment and the building has been deducted in the calculation of this amount. (2) We can only determine the impact of the year 2023 R&D expenditures on the year 2024 income. We do not know any further details of the income for tax purposes for the year 2024, as this is yet to be determined. (3) In reality, a pool of R&D expenditures would be created in the year 2023 and include all of the amounts deducted above. This pool will be reduced to 0 to the extent that all of the year 2023 eligible expenditures on R&D are in fact claimed on the tax return. This pool will increase in 2024 by any R&D expenditures made in that year and eligible for deduction under section 37. The balance in this pool will then be reduced in 2024 by the investment tax credits (in total $21,000, i.e., 15% of ($100,000 + $40,000)) claimed in the preceding year (2023) thus resulting in a smaller pool of available deduction in the year 2024. (4) The lab machinery and equipment and the building are not eligible for the 100% write-off since they are not current, as required by paragraph 37(1)(a).

Introduction to Federal Income Taxation in Canada

266 Solution 4: Tax Payable, ITC (A) The maximum investment tax credit is 15%  $2,200,000 = $330,000

(B) Income before sec. 37 deduction............................................................................... $ 3,200,000 Section 37 deduction ..................................................................................................... (2,200,000) Income and taxable income....................................................................................... $ 1,000,000 Net tax 15% .............................................................................................................. $ 150,000 Investment tax credit .................................................................................................... (150,000) Net federal tax payable under Part I ............................................................................. 0 (C) The remaining investment tax credit of $180,000 (i.e., $330,000 – $150,000) may be carried back three and forward 20 taxation years. (D) Section 37 SR&ED expenditures in first year........................................................... $ 2,200,000 Section 37 deduction in first year .................................................................................. (2,200,000) Balance at the beginning of the second year ............................................................. 0 Less: ITC claim for first year .................................................................................... (150,000) Recapture in second year [par. 12(1)(t)] ....................................................................... 150,000 Balance after recapture ................................................................................................. 0 If no further SR&ED expenditures are made in the following year, the income inclusion would be $150,000 [par. 12(1)(t)].

Solutions to Chapter 11 Assignment Problems

267

Solution 5: Schedule 1 Reconciliation and Taxable Income Net income before income taxes ......................................................................................................... Add: Loss on the sale of investment [ssec. 9(3)] ...................................................... $ 10,000 Amortization [par. 18(1)(b)] ............................................................................ 114,900 Interest on income tax payments [par. 18(1)(t)]............................................... 435 Club dues [par. 18(1)(l)] .................................................................................. 1,750 Political contributions [par. 18(1)(n)] .............................................................. 2,500 Charitable donations [par. 18(1)(a)] ................................................................ 22,500 Property tax on vacant land [ssec. 18(2)]......................................................... 3,000 Life insurance premium [pars. 18(1)(a), (b), (c)] ................................................. 1,950 Subtotal............................................................................................................ Deduct: Capital cost allowance [par. 20(1)(a)].......................................................... $ 159,500 Gain on sale of land [ssec. 9(3)] ...................................................................... 126,200 Add: Taxable capital gain on business land [sec. 38]: 50% ($200,000 – $73,800). $ Allowable capital loss on investments [sec. 38]: 50%  ($75,000 – $85,000): Net income under Division B ...................................................................................... Less Division C deductions: Charitable donations [sec. 110.1]......................................................................... $ Dividends [sec. 112] ............................................................................................ Non-capital loss [par. 111(1)(b)] ......................................................................... Net capital loss [par. 111(1)(a)]: .............................................................................. Taxable income ...........................................................................................................

The following items are treated the same for tax and accounting: (a) Landscaping costs [par. 20(1)(aa)]; (b) Site investigation fees [par. 20(1)(dd)]; (c) Dividends from taxable Canadian corporations [par. 12(1)(j)].

342,000

157,035 499,035

(285,700) $ 213,335

63,100 (5,000) $

58,100 271,435

(209,600) 61,835

22,500 64,300 72,800 50,000

Introduction to Federal Income Taxation in Canada

268

Solution 6: Tax Payable—Provincial Allocation Income under Division B from consulting business ................................................................... Canadian investment royalty income.......................................................................................... U.K. non-foreign affiliate dividend income................................................................................ Taxable dividend received from non-connected Canadian corporations .................................... Taxable capital gains .................................................................................................................. Income under Division B............................................................................................................ Deduct: Charitable donations (not exceeding 75%  $306,000 = $229,500).................................... Canadian dividends received ............................................................................................... 2017 net capital loss (limited to taxable capital gains of $7,000) ........................................ Taxable income....................................................................................................................... ....

$ 263,000 11,000 20,000 5,000 7,000 $ 306,000

Basic federal tax at 38% of $194,000 ......................................................................................... Deduct: Abatement from federal tax (see Schedule 1) ............................................................... Net .............................................................................................................................................. Deduct: Non-business foreign tax credit (see Schedule 2)................................................................ Business foreign tax credit (see Schedule 3) ....................................................................... General rate reduction (13% of $194,000) .......................................................................... Part I tax payable (federal).......................................................................................................... Provincial tax: British Columbia 10% of $77,600 ....................................................................................... Alberta rate 10% of $58,200................................................................................................ Total tax.......................................................................................................................... ............

(100,000) (5,000) (7,000) $ 194,000 73,720 (13,580) $ 60,140 (2,376) (16,497) (25,220) $ 16,047

7,760 5,820 29,627

Schedule 1: Abatement from federal tax B.C. $3,000K 30% $500K 50%

Gross revenues...................................... % gr. revenues (1)................................. Salaries and wages................................ % S&W (2) ........................................... (1) + (2) .................................................

Alberta $3,000K 30% $300K 30%

40% 30% 2 Abatement: 10% of 70% of $194,000 = $13,580 Allocation of income to: B.C. 40%  $194,000 = $77,600 Alberta 30%  $194,000 = $58,200

Total Cdn. $6,000K 60% $800K 80%

U.S. $4,000K 40% $200K 20%

Total $10,000K 100% $1,000K 100%

70%

30%

100%

Schedule 2: Non-business foreign tax credit (U.K. income) Lesser of: (i) tax paid (ii)

income from U.K. income less dividends and net capital loss carryover $20,000 $306,000−$5,000−$7,000

$20,000/$294,000

Lesser amount is $2,376.

$ 3,000

tax otherwise payable after abatement minus general tax reduction (60,140 – $25,220)

× $34,920 =.....................................................................

$ 2,376

Solutions to Chapter 11 Assignment Problems

269

Schedule 3: Business foreign tax credit (U.S. income) Least of: (i) tax paid and unused credit ($16,000 + $3,000) ..................................................................... $ 19,000 tax otherwise payable before abatement income from U.S. (ii) × minus general tax income less dividends and net capital loss carryover reduction $100,000 $306,000−$5,000−$7,000

$100,000 $294,000

× ($73,720 – $25,220) ×

$48,500 = ................................................................

$ 16,497

(iii) tax otherwise payable before abatement minus general rate reduction less nonbusiness tax credit ($73,720 – $25,220– $2,376) .................................................................. $ 46,124 Least amount is $16,497.

Introduction to Federal Income Taxation in Canada

270 Solution 7: Tax Payable

Income under Division B: Operating profits ......................................................................................................................... Dividends from taxable Canadian corporations .......................................................................... Canadian investment income (i.e., interest income).................................................................... Foreign investment income ($61,000 + $10,000) ....................................................................... Add: donations.................................................................................................................... ...... Division B income ...................................................................................................................... Less: Division C deductions: Taxable dividends deductible under sec. 112.......................................................... $ 60,000 Donations (max. 75% of $673,255 = $504,941) ..................................................... 9,755 Non-capital losses ....................................................................................................... 255,545 Taxable income .................................................................................................................................. Federal tax (38% of $347,955) ........................................................................................................... Federal abatement (10% of $347,955)................................................................................................ Federal tax after abatement................................................................................................................. Less: Foreign non-business tax credit(1)....................................................................... 6,043 General rate reduction (13% of $347,955) .............................................................. 45,234 Part I federal tax payable .................................................................................................................... New Brunswick tax @ 11% of $347,955 ........................................................................................... Total tax liability ................................................................................................................................

—NOTE TO SOLUTION (1) Foreign non-business tax credit Lesser of: (i) Amount paid ......................................................................................................... (ii)

$71,000 $673,255−$60,000

× ($97,427 − $45,234)...............................................................

$ 480,000 60,000 52,500 71,000 $ 663,500 9,755 $ 673,255

(325,300) $ 347,955 $ 132,223 (34,796) $ 97,427 (50,976) 46,151 38,275 $ 84,426 $

10,000

6,043

Solutions to Chapter 11 Assignment Problems

271

Solution 8: Tax Payable Net income under Division B ................................................................................................... $ 2,097,000 Division C deductions: Dividends from taxable Canadian corporations................................. (15,000) (50,000) Charitable donations (max. 75%  $2,097,000) ................................ Net capital losses ............................................................................... (6,000) Non-capital losses .................................................................................. (60,000) Taxable income....................................................................................................................... .. $ 1,966,000 Tax @ 38%.......................................................................................................................... ..... $ 747,080 Federal abatement (10%  $1,966,000) ......................................................................................... (196,600) $ 550,480 General rate reduction (13% of $1,966,000) .................................................................................. (255,580) Federal tax before investment tax credit ................................................................................... $ 294,900 Investment tax credit(1) ................................................................................................................................................................................ (22,500) Federal Part I tax payable ......................................................................................................... $ 272,400 —NOTES TO SOLUTION (1) Investment tax credit: 15%  $150,000 = $22,500 The ITC claimed and used against federal tax in 2023 will be included in income in 2024 [par. 12(1)(t)].

CHAPTER 12

Integration for Business and Investment Income of the Private Corporation Solution 1: Corporate Tax Rates Comparison of corporate tax rates for active business income earned by a Canadian public company, a CCPC with active business income below $500,000 and a CCPC with active business income above $500,000.

Active Business Income Cdn Public Employment Business Property Net TCG OI/OD ABIL Div B Div C Donations Dividends Net CL Non CL Taxable Corporate Basic Abatement SBD M&P RDTOH FTC Gen ART Part IV Federal Provincial

CCPC <500 >500

38% (10%)

38% (10%) (19%)

38% (10%)

(13%)

15% 12%

9% 4%

15% 12%

27%

13%

27%

273

274

Introduction to Federal Income Taxation in Canada

Assuming a provincial corporate tax rate on active business income over $500,000 in a CCPC is the same as for a public company of 12%. For ABI under $500,000 the provincial tax rate would include a provincial small business deduction. The CCPC with income below $500,000 benefits from the small business deduction at both the federal and provincial levels unless the small business deduction limit is clawed back (because of taxable capital or passive income levels of the associated group for the preceding taxation year end). Corporations with zero-emission manufacturing profits are eligible for a 50% rate reduction of the above noted federal tax rates.

Solutions to Chapter 12 Assignment Problems

275

Solution 2: Explain Small Business Deduction Small business deduction = 19% of the least of: a. b.

Net Canadian active business income (plus specified partnership and corporate income) Taxable income less; i. Foreign source investment income (100/28 x non-business FTC) ii. Foreign source business income (4 x business FTC) iii. Taxable income exempt from Part I Business limit ($500,000 – portion allocated to associated companies) Small Business Deduction = 19% x least of: a. Net Canadian ABI b. Taxable income less i. 100/28 x non-business FTC ii. 4 x business FTC iii. Exempt income c.

$ 600,000 300,000 -

Business limit SBD @ 19%

$ 300,000 $ 200,000

Least

$ 38,000

There must be Division C deductions (such as loss carry overs) that reduced taxable income below ABI. The business limit of $500,000 is being shared among associated corporations (or has been clawed back because of the taxable capital and passive income of the associated group of companies for the prior year). 1.

What is the purpose behind the small business deduction? The purpose of the small business deduction is to help Canadian-controlled private corporations retain capital to expand their active business. This is done by providing an 19% tax credit (reduction) for active business income earned in Canada.

Is this deduction a savings or a deferral? Explain This is a tax deferral. The tax is deferred until this retained income is paid out to the shareholders as a dividend and personal tax is paid. The theory of integration is that an individual would be in the same position whether they earned the business income directly or through a corporation.

The purpose behind the components of the calculation. a.

Canadian active business income

This is an incentive for active business earned in Canada.

Taxable income less:

If taxable income is reduced by loss carry-overs then the incentive is only on Canadian active business income that is actually taxable.

(this should represent taxable income earned in Canada) i.

Foreign investment income (formula)

This eliminates non-Canadian investment income that has been taxed in Canada.

ii.

Foreign business income (formula)

This eliminates non-Canadian business income that is taxed in Canada.

Introduction to Federal Income Taxation in Canada

276 iii.

Taxable income exempt from Part I tax c. Business limit of $500,000 less any relevant clawback reduction.

This eliminates items that are included in taxable income but not subject to tax. This is the limit on the base for the credit. After this the corporation is assumed to be large enough to expand without the government’s help.

The purpose behind the associated company rules. To avoid having taxpayers multiplying the small business deduction by incorporating new companies as soon as they reach the $500,000 business limit, the rules cause all “associated” companies to share one small business deduction. The rules are complex, since taxpayers and their advisers have been creative in finding ways to multiply the deduction.

If income is over the annual business limit should the company declare a bonus to reduce the income back down to the annual business limit? Corporate tax rate on: Income below $500,000 Income above $500,000 Personal tax rate (marginal) on: Salary/bonus Dividends – not eligible (<$500,000) Dividends – eligible (>$500,000)

13% 28%

50% 42.5% 31%

If a bonus is declared to reduce corporate income to $200,000, then the combined personal and corporate tax rate on this bonus is 50%, since there is no tax in the corporation. Quantitative analysis: Step 1: − A bonus of $100,000 is needed to reduce taxable income down to the business limit. Step 2: − The personal tax on a $100,000 bonus will be $50,000 leaving $50,000 in cash to the individual. Step 3: − If the income is left in the corporation, it will pay tax at 28% resulting in GRIP that can paid as a dividend that will be taxed at 31% in the hands of an individual shareholder (the dividend can be designated as eligible from the company’s GRIP). − −

The $100,000 left in the company will be taxed at 28% leaving $72,000 in after-tax cash. A dividend of $72,000 paid to an individual shareholder will be taxed at 31% leaving $49,680 of cash in the hands of the individual shareholder. Conclusion − The after-tax cash of $49,680 after paying the dividend is slightly smaller than the $50,000 that the shareholder would have by paying a bonus. A tax savings results because the corporate rate is higher than the rate of perfect integration of 27.5%. Each province has provincial personal and corporate tax rates that will give different answers to this question.

Solutions to Chapter 12 Assignment Problems

277

Solution 3: Explain Dividends

Public

3(a) Div C

Canadian dividend

Division C deduction

Private

100,000

(100,000)

Taxable income

Part I tax

Part IV tax payable (38 1/3%)

Eligible RDTOH Eligible Dividend needed for full refund

($38,330/.3833)

38,330

100,000

Note: The Part IV tax above is calculated assuming that the two corporations are not connected (i.e. the dividends are portfolio dividends) Explain how dividend income is taxed in a corporation. 1.

Why are dividends deductible under Division C? −

Dividends are paid out of after-tax income of a corporation. Where that income has been taxed in Canada at the corporate level, it would be unfair to tax them again at the normal corporate tax rates at the corporate level.

−

Dividends will be taxed at the next level when they are paid out to individual shareholders.

What is the purpose of Part IV tax? Is it a permanent or temporary tax? Who does it apply to? −

It applies to private corporations – for this course CCPCs.

−

Part IV is a temporary tax designed to remove the incentive to have an investment holding company receive an individual’s dividend income to defer the personal tax.

−

Corporations receiving eligible and non-eligible Canadian dividends from non-connected corporation will pay Part IV tax at 38 1/3%.

−

Corporations receiving eligible and non-eligible Canadian dividends from connected corporations will pay Part IV tax based on the RDTOH refund the paying corporation receives as a result of paying a taxable dividend.

Why might there be Part IV tax on dividends from connected corporations? −

If the payer company receives a “dividend refund”, then the recipient company will have to pay its share of that refund as a Part IV tax. This prevents companies from “stacking” companies to get a dividend refund without having an individual shareholder pay tax on the dividend.

Introduction to Federal Income Taxation in Canada

278 4.

What is the purpose behind the Refundable Dividend Tax On Hand (RDTOH)? −

This account accumulates the Part IV tax and the Refundable Portion of Part I tax that will be refunded to the corporation when the dividend income and investment income are flowed through to the shareholders as a dividend.

−

Each private company is required to track their eligible RDTOH and non-eligible RDTOH. A payment of a taxable non-eligible dividend will first result in a refund of the balance of the noneligible RDTOH. A payment of a taxable eligible dividend x 38 1/3% will result in a refund of the balance in the eligible RDTOH account. An eligible dividend will not result in a refund of noneligible RDTOH. A non-eligible dividend can result in a refund of eligible RDTOH once the noneligible RDTOH is exhausted.

Why doesn’t Part IV tax apply to public companies? −

Public companies are generally not controlled by an individual who has transferred his or her investments into the public company in order to defer tax.

How does the Dividend Refund fit in? −

This completes the story of the temporary tax

−

When a taxable dividend is paid, the company gets a dividend refund and the individual shareholder pays the tax.

−

Example: A private company receives a $1,000 dividend from a public company and pays Part IV tax of $383. Then this private company pays a $1,000 dividend to its shareholders and receives a dividend refund of $383. The public company dividend has been flowed through the private company without any permanent tax until the individual shareholder is taxed on receipt of the dividend. As long as the $1,000 dividend is an eligible dividend, the Part IV tax will be included in eligible RDTOH.

−

A payment of a taxable non-eligible dividend will first result in a refund of the balance of the noneligible RDTOH. To the extent that the taxable non-eligible dividend x 38 1/3% exceeds the balance in the non-eligible RDTOH account, the corporation may receive a refund from its eligible RDTOH account. An eligible dividend paid to the shareholders will result in only a refund of eligible RDTOH.

Solutions to Chapter 12 Assignment Problems

279

Solution 4: Explain Investment Income Public 3(a)

Interest

3(b)

TCG(50% x $40,000)

Taxable income Part I tax

38%

Abatement

10%

ART

10.67%

General rate reduction

13%

Provincial (assumed)

12%

CCPC

10,000 $

10,000

20,000

30,000 $

30,000

11,400 $

11,400

(3,000)

(3,000) 3,200

(3,900) $

3,600

8,100 $

15,200

Non-eligible RDTOH

30.67%

9,200

Dividend needed for full refund

38.33%

24,000

Cash available after refund Explain how investment income, other than dividends is taxed in a public corporation. -

The 15% federal corporate tax rate applies to all investment income earned by a public corporation. The concept of refundable taxes does not apply.

Explain how investment income, other than dividends, is taxed in a CCPC. 1.

What type of income is included in Aggregate Investment Income (“AII”)? [129(4)] − − −

How is AII calculated? − − −

Property income such as interest, rent, royalties Taxable capital gains Dividends

Property income such as interest, rent, royalties less losses from property Taxable capital gains less: allowable capital losses and net capital losses claimed Dividends less: dividends deducted under Division C

What is the purpose behind the Additional Refundable Tax (“ART”)? [123.3] −

− −

When the corporate tax rates on investment income in private companies became lower than the top personal tax rate on investment income, there was an incentive for individuals to transfer their investments to a closely-held corporation where the investment income could be taxed at a lower rate and tax on the individual shareholder could be deferred. The ART at 10 2/3% was meant to reduce this incentive by raising the corporate tax rate above the personal tax rate. 10 2/3% x lesser of: i. AII ii. Taxable income – SBD amount

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What is the purpose behind the Refundable Dividend Tax on Hand (RDTOH)? [129(3)] Non-eligible RDTOH −

Non-eligible RDTOH is an account that accumulates a portion of the Part I tax and the full amount of the ART so it can be refunded to the corporation when a dividend is paid to the shareholders. Part I 20% ART 10 ⅔% Total 30 ⅔% Corporate tax = 38% - 10% + 10 2/3% + 12% provincial = 50 ⅔% Dividend refund 30 ⅔% Net 20% 20% was the theoretical rate for perfect integration using the former 25% gross-up and tax credit rate. However, now the perfect integration rate is 13% using the 15% gross-up and tax credit rate in effect for these dividends. As a result, there is a tax cost to incorporating investment income.

Eligible RDTOH The eligible RDTOH is an account that accumulates Part IV tax related to the receipt of either eligible dividends or non-eligible dividends resulting in a refund of eligible RDTOH. The account captures the tax until dividends are paid to a shareholder of a corporation. o Part IV tax on eligible dividends from non-connected corporations o Part IV tax on eligible and non-eligible dividends from connected corporations where the connected corporation received a dividend refund from eligible RDTOH. o Last year’s closing eligible RDTOH less: dividend refund for preceding year −

A payment of taxable non-eligible dividends will first result in a refund of the balance of the non-eligible RDTOH. To the extent that the taxable non- eligible dividend x 38 1/3% exceeds the balance in the noneligible RDTOH account, the corporation may receive a refund from its eligible RDTOH account i.e. the noneligible RDTOH balance must be fully refunded. Eligible dividends will result in a refund of eligible RDTOH. The dividend refund for a particular year will be equal to the total of three amounts:

(1) The lessor of: • •

38 1/3% of all eligible dividends it paid in the year, and Its eligible RDTOH balance at the end of the year

Plus

(2) The lessor of: • •

38 1/3% of all non-eligible dividends it paid in the year, and Its non-eligible RDTOH balance at the end of the year

Plus

(3) Either (*) •

If 38 1/3% of all non-eligible dividends it paid in the year exceeds its non-eligible RDTOH balance at the end of the year, the lesser of • The amount of the excess, and • The amount by which its eligible RDTOH balance at the end of the year exceeds the amount in (1), if any. • In any other case, $0. (*) When a non-eligible dividend is paid, this calculation requires that a private corporation obtain a refund from its non-eligible RDTOH balance first before it can access the balance in the eligible RDTOH.

Solutions to Chapter 12 Assignment Problems

Why don’t ART and RDTOH apply to public companies? −

281

Public companies are generally not controlled by an individual who will transfer his or her investments into the public company in order to defer tax.

How does the Dividend Refund fit in? [129(1)] − − −

This completes the story of the refundable tax When a dividend is paid, the company gets a dividend refund to provide enough cash to pay a dividend sufficient to generate the refund. Example: A private company earns $1,000 of investment income and pays Part I tax and ART of $507 of which $307 goes into the non-eligible RDTOH. Then this private company pays an $800 non-eligible dividend to its shareholders and receives a dividend refund of $307. The investment income has been flowed through the private company with a 20% corporate tax rate.

− Investment income Part I tax ART Non-eligible RDTOH and dividend refund ($800 x 30.67%) After-tax cash and dividend to individual shareholder Gross-up (15%) Grossed-up dividend

$1,000 (400) (107) 307 800 120 $920

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Solution 5: Personal Services Business

Corporate Active Business Income

Corporation Personal Service Income

Income

Expenses allowed if incurred to earn income

Expenses limited to those available to an employee

Tax payable

Eligible for the small business deduction.

Not eligible for either the small business deduction or the general rate reduction.

Basic Abatement Federal rate Small business deduction General rate reduction Provincial (assumed) Total

38% (10) 28 (19) 4 13%

Basic Abatement Federal rate Additional tax on PSB

38% (10) 28 5

Small business deduction General rate reduction Provincial (assumed) Total

12 45%

What is the purpose behind taxing “personal services business” income differently? − −

The government does not want individuals to incorporate their employment income to take advantage of the small business deduction or other corporate incentives. They also don’t want an incorporated employee to be able to deduct expenses that they could not deduct as an individual earning employment income.

To determine the true implications, one should compare the calculation of income and tax payable between an individual earning employment income and a corporation earning personal services business income.

Income Tax owing (45%) after tax income Individual Income Dividence received Tax rate applicable Tax owing After tax cash

Corporate personal service income $ 100,000 45,000 55,000

$ $ $

55,000 31% 17,050 37,950

Individual income

$100,000 50% 50000 $50,000

Solutions to Chapter 12 Assignment Problems

283

Solution 6: Corporate Tax – Public vs. CCPC Assess the Situation 1.

Draw a diagram identifying stakeholders

John Robinson

Resident of Saint John, NB

100% First Gear

Identify the relationships among the stakeholders, e.g., related, affiliated, associated, connected −

−

John owns 100% of First Gear so the two are related and affiliated

Identify the profile of each stakeholder, e.g., tax features, risk profile −

December 31 year end

John Robinson o

Owns First Gear

Since he lives in Saint John assume he is a Canadian resident

He is in the top tax bracket

First Gear o

Since we assumed that John is a Canadian resident then First Gear will be a CCPC

December 31 year end

Its provincial tax rate is 4% on income eligible for the SBD and 12% on other income

Understand the decision maker and their objectives −

John is the owner of First Gear and wants information on how the different types of income in the corporation are taxed

−

He also wants you to calculate his corporate tax liability and offer any advice you consider appropriate related to refundable tax

Identify the relevant past transactions/events or planned future transactions/events and create a timeline. −

December 31, 2023 year end calculation of corporate tax

Introduction to Federal Income Taxation in Canada

284 Identify the issues 1.

Identify all of the major tax issues and any non-tax issues −

Explain: − The different types of income earned by the corporation − The taxation of each type of income and the corporate tax rates for a CCPC on the different types of income − Refundable taxes

−

Calculate federal and provincial tax − Identify the different tax components that need to be calculated − Calculate the tax, non-eligible and eligible RDTOH balances − Calculate dividend needed to clear RDTOH − Advise on items including any refundable tax

Identify missing information or assumptions made −

None identified

Analyze the Issues 1. Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act Explain how different types of income are taxed As shown on the schedule of “effective tax rates” below, the Canadian ABI eligible for the small business deduction will have an effective tax rate of 13% (38% - 10% - 19% + 4%). Income above the small business deduction will have an effective tax rate of 27% (38%-10%-13%+12%) The portfolio dividends will not be subject to Part I tax since the dividends are deducted under Division C. Instead, as portfolio dividends, they are subject to Part IV tax at 38 ⅓% which will be added to NERDTOH. The interest income is part of AII and will be taxed initially at 50.67% with 30.67% of refundable Part 1 tax going into RDTOH and being refundable when sufficient dividends are paid.

Explain refundable taxes (Qualitative) -

NERDTOH o o o o o o o

Captures refundable Part I tax (and Part IV tax on non-eligible dividends received by the corporation) Can be refunded when corporation pays out non-eligible dividends Ensures integration of tax on incorporated investment income High rate of tax applies to prevent deferral opportunity Refund results in 20% corporate rate paid when investment income is paid-out as a dividend. Non-eligible dividends are subject to 42.5% marginal tax rate in highest bracket. Overall tax cost to incorporating investment income.

ERDTOH o o o o o o

Captures Part IV tax on eligible dividends received by the corporation Can be refunded when company pays out either eligible or non-eligible dividends. Must exhaust NERDTOH first to get a refund from a non-eligible dividend. Ensure integration of tax on incorporated portfolio dividends Refund results in $0 corporate tax rate when dividend is flowed through to the shareholder. Eligible dividend subject to 31% highest marginal tax rate.

Solutions to Chapter 12 Assignment Problems

285

Calculate corporate tax As shown on the schedule “corporate tax payable” below, the federal and provincial tax payable is $230,156 which is made up of Part IV tax of $32,583, federal Part I tax of $122,753 and provincial tax of $74,820. Of this, $70,457 is refundable when a dividend of $183,800 is paid. The GRR is applicable in this case. Due to the high level of passive income, the SBD limit is completely eliminated. We have assumed that investment income earned in the prior year is the same as the amount

earned in the current year.

John’s Personal Situation Dividend refund in the corporation – 38 ⅓% x dividends paid Dividend tax rate to John Eligible dividend 31% (1.38 x .50 - .38) Non-eligible dividend 42.5% (1.15 x .50 - .15) Since some of the dividend is eligible and come from Canadian public company dividends received by First Gear there will be a GRIP balance. The rest of the dividend ($98,800) is a non-eligible dividend. In addition to the eligible dividends, $500,000 of the active income was not eligible for the SBD and therefore taxed at a higher rate. The GRIP balance would include: Eligible dividends received

$ 85,000

72% x $500,000

360,000

GRIP balance

$445,000

Personal tax: Dividend paid

$183,800

Eligible dividend

85,000

x 31.0% =

$26,350

$ 98,800

x 42.5% =

41,990

Non-eligible dividend

$68,340 If the company pays a dividend of $183,800 it will generate a dividend refund of $70,457. This will result in a net cost to the corporation of $113,343 (183,800 – 70,457). John will pay personal tax of $68,340 leaving him with $115,460 ($183,800 – $68,340) to invest. The difference is a net savings to John/First Gear of $2,116. First Gear

John

Eligible dividend paid/received Dividend refund Tax paid

$85,000 (32,583)

$85,000

Non-eligible dividend paid/received Dividend refund Tax paid

98,800 (37,873)

(26,350)

Benefit (Cost)

$6,233

98,800 (41,990)

(4,117) $2,116

An option is to only pay out the eligible dividend of $85,000, since the personal tax rate of 31% is lower than the dividend refund rate, and defer the non eligible dividend of $98,800 where the personal tax rate is 42.5%, which is higher than the dividend refund rate of 38.33%. If the company pays a non eligible dividend of $98,800 it will generate a dividend refund to First Gear of $37,873 and personal tax of $41,990 resulting in a net cost of $4,117.

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286

This may be viewed as a small cost to pay to get the cash from the government as a tax refund and out of the corporation and available to invest personally where the tax rates on investment income earned personally are less than the tax rates in the corporation.

2. Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format

Effective Tax Rates ABI

AII Cdn

Div B

500,000 (1)

123,500

Cdn Dividends Conn Port 85,000

Dividends 500,000

123,500

(85,000) -

Div C Taxable income Corporate Tax Basic Abatement ART Deduct SBD GRR Part I tax payable Part IV tax payable Less: Dividend Refund ITC

% 38.00 (10.00)

Cdn

% 38.00 (10.00) 10.67

(0) (13) 15.00

38.67

Provincial tax payable

12.00

Total tax payable RDTOH

25.00

50.67 (30.67)

Net TCG Total 708,500 (85,000) 623,500 %

38.3 (38.3)

0 (38.3)

Solutions to Chapter 12 Assignment Problems

287

Corporate Tax Payable

Analysis of Income

AII ABI

Property

Cdn

Dividends - Corp Cdn Conn

Div B Div C

500,000

123,500

Port

TOTAL

85,000

$ 708,500

Dividends

(85,000)

Taxable income

623,500

Calculation of Corporate Tax

Basic

38%

236,930

Abatement

10%

(62,350)

Schedule

13,173

Additional refundable tax

187,753 Deduct:

Small business deduction

Schedule

General rate reduction

Schedule

(65,000)

Part I tax payable

$ 122,753

Part IV tax payable Less:

32,583

Dividend refund

Schedule

Total federal tax payable

$ 155,336

Provincial tax payable ABI <$500,000

Other

12%

74,820

Total tax payable

74,820

$ 230,156

(1) The level of investment income in the prior year (assumed to be the same as this year) would reduce the small business deduction to zero. The solution assumes that the province implemented the federal passive income tax measures that affected the federal small business deduction, therefore the small business deduction is clawed back at the same rate as it is federally. Some provinces, such as Ontario and New Brunswick are not clawing back the small business deduction based on passive income (i.e. they are calculating the small business deduction as if the claw back does not apply).

Introduction to Federal Income Taxation in Canada

288 Schedules to Corporate Tax Calculation Schedules AII

Sum of: Property income

$ 123,500

Dividend income

85,000

Net TCG Div C - dividends

(85,000)

Div C - net CL

ART

SBD

10 2/3% x lesser of:

$ 13,173

1. AII

123,500

2. TI - SBD amount

623,500

19% x least of:

1. Cdn ABI

500,000

2. TI

623,500

13% x total of: 1. TI

65,000

623,500

2. SBD amount 3. AII

0 (1)

3. Business Limit GRR

$ 123,500

(0) (123,500) 500,000

Refundable Part I

Part IV

RDTOH

Least of:

$ 37,873

1. 30 2/3% x AII

37,873

2. 30 2/3% x (TI-SBD amt)

191,207

3. Part I tax

122,753

Sum of: 38 1/3% x portfolio dividend

32,583

% x connected dividend refund

Sum of:

Eligible

32,583 Non-eligible

Opening balance Less prior year dividend refund Part IV tax

32,583

Refundable Part I (above) Balance at end of year

37,873 $ 32,583

$ 37,873

(1) For CCPCs with passive investment income in excess of $150,000 in the prior year, the small business deduction

will be completely eliminated. Assuming the AAII in the prior year is the same as the current year, AAII would be $208,500 ($123,500+85,000 portfolio dividends) which completely eliminates the SBD.

Solutions to Chapter 12 Assignment Problems

Dividend Refund Lesser of: 1. 38 1/3% x eligible dividend paid 2. ERDTOH balance Plus Lesser of: 1. 38 1/3% of non-eligible dividends paid 2. NERDTOH balance Plus lesser of; 1. Excess 38 1/3% of non-eligible dividends p Less: NERDTOH

289 32 32,583 32,583

2. Remaining ERDTOH Total Dividend Refun Eligible Divid Non Eligi Total 3. Identify risks including missing information, assumptions, and uncertain research positions No assumptions or risks were identified 4.

Reach a conclusion on each issue If the company pays a dividend of $183,800 it will generate a dividend refund to First Gear of $70,457 and personal tax of $68,340 resulting in a net benefit of $2,116. If the company only pays out the eligible dividend of $85,000 (the personal tax rate of 31% is lower than the dividend refund rate) it will generate a dividend refund to First Gear from its Eligible RDTOH account of $32,583 and personal tax of $26,350 resulting in a net benefit of $6,233. If the company only pays a non-eligible dividend of $98,800 it will generate a dividend refund to First Gear from its non-eligible RDTOH of $37,873 and personal tax of $41,990 resulting in a net cost of $4,117.

Evaluate the strengths/weaknesses/risks of your conclusions None identified

Advise/Recommend Advise your decision maker, integrating your conclusions on each of the issues with the client’s objectives, giving priority to the most important issues John will have to choose between two options: 1.

John could have the company pay total dividends of $183,800 ($85,000 eligible and the balance non-eligible) to generate a dividend refund of $70,457 with John paying personal tax of $68,340. The net savings are 2,116.

Introduction to Federal Income Taxation in Canada

290 2.

Alternatively, John could have the company pay only an eligible dividend of $85,000 to generate a dividend refund of $32,584 from its eligible RDTOH and personal tax of $26,350 resulting in a net benefit of $6,233. This option avoids the payment of a non-eligible dividend where there is a net cost.

Solutions to Chapter 12 Assignment Problems

291

Solution 7: Part IV Tax Paragraph 186(1)(b) requires that Part IV tax be calculated as follows: $ 90,000 x $18,000 = $13,500 $120,000 Ex Ltd. must own 75% of Little Ex Ltd. since it received $90,000 of the $120,000 dividend. Ex Ltd is therefore a connected corporation. Little Ex Ltd. received a dividend refund of $18,000 on the dividend paid of $120,000. Ex Ltd. must pay Part IV tax equal to its share of the dividend refund or 75% x $18,000. The Part IV tax would be added to Ex Ltd.’s non-eligible RDTOH account.

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Introduction to Federal Income Taxation in Canada

Solution 8: RDTOH, Dividend Refund (Note to instructors ABI was increased from $85,000 to $97,000) (A) Computation of Taxable Income Net income for income tax purposes …………………………………..…… Deduct: taxable dividends ................................................................... $18,750 non-capital losses................................................................... 40,000 net capital losses ($52,000 limited to TCG)......................... 37,500 Taxable income ……………………………………………………………… Part I Tax on Taxable Income Tax @ 38% of $102,000 ……………………………………………………… Deduct: federal tax abatement (10% of $102,000) …………………………… Net ……………………………………………………………………………. Additional refundable tax (ART) — 102/3% of lesser of: (a) AII ($37,500 + $45,000 + $18,750 − $37,500 − $18,750) = $45,000 (b) TI − SBD income amount ($102,000 − $97,000) = $5,000 Deduct: small business deduction (see Schedule 1) .......................... $18,430 General rate reduction ....................................................... $0 Part I tax payable (federal) ………………………………………………… Part IV tax payable ($18,750 x 38 1/3%)………………………………... Dividend refund…………………………………………………………... Provincial tax: (4% x $97,000) + (12% x (102,000 – 97,000))1…………….. Total tax payable …………………………………………………………...

$198,250

96,250 $ 102,000 $ 38,760 10,200 $ 28,560

533 $29,093 $ 18,430 $ $10,663 7,187 (8,720) 4,480 $ 13,610

Schedule 1: Small Business Deduction (I) Income from active business ………………………………………………. $ 97,000 (II)Taxable income (no foreign tax credits) …………………………………… $ 102,000 (III)Business limit ................................................................................................... $243,750 19% of the least of amounts (I), (II), and (III) ……………………………… $ 18,430 CCPCs (and their associated corporations) with significant investment income in the prior taxation year will have a reduction in their small business deduction limit. For CCPCs with passive investment income in excess of $50,000 in the prior taxation year, the small business deduction will be reduced by $5 for every $1 of investment income over $50,000. Specifically, the small business deduction (SBD) limit will be reduced on a straight-line basis for CCPCs (with associated companies) having between $50,000 and $150,000 in investment income, and completely eliminated if passive investment income is greater than $150,000 (for the associated group). Assuming the prior year’s AAII is the same as the current year AAII would be calculated as follows: Taxable capital gains Less current year allowable capital losses Portfolio dividends Interest income Total adjusted AII

$37,500 $0 18,750 45,000 $101,250

The adjusted AII is $101,250 therefore the SBD limit will be affected. The reduction to the small business limit is:

Note: the solution assumes that the province implemented the federal passive income tax measures that affected the federal small business deduction, therefore the small business deduction is clawed back at the same rate as it is federally. Some provinces, such as Ontario and New Brunswick are not clawing back the small business deduction based on passive income (i.e. they are calculating the small business deduction as if the claw back does not apply).

Solutions to Chapter 12 Assignment Problems

293

Reduction in SBD limit AAII less base AAII in excess

101,250 50,000 51,250

Reduction in SBD limit

x $5

256,250

The $500,000 SBD limit for 2023 would be $243,750 ($500,000 – 256,250). (B) Refundable Portion of Part I Tax Least of: (a) 302/3% x aggregate investment income (302/3% x ($45,000 + $37,500 + $18,750 − $37,500 − $18,750)) ………………………..

$ 13,800

(b) Taxable income .................................................................. $ 102,000

Less: Amount eligible for the SBD .................................... (97,000) 302/3% x $5,000

= $ 1,533

$ 10,663

Refundable portion of Part I tax — the least amount ………………………..

$ 1,533

Part IV Tax on Taxable Dividends Received Taxable dividends subject to Part IV tax x 38.33% ($18,750 x 38.33%) …… Deduct: non-capital loss claimed for Part IV x 38.33% (all claimed under Part I) Tax …………………………………………………………………………..

$ 7,187 $0 $ 7,187 Eligible RDTOH

RDTOH and Dividend refund Opening balance as of January 1, 2023 Refundable Part I tax Part IV tax on portfolio dividends @

Noneligible RDTOH $

1,533

38 1/3%

Balance at the end of December 31, 2023 - prior to refund

7,187 $

7,187

1,533

Dividend refund is equal to the total of three amounts: 1. The lesser of: • •

38 1/3% x total of all eligible dividends paid in the year Its eligible RDTOH balance at the end of the year

$0 7,187

plus 2. The lesser of: •

38 1/3% x total of all non- eligible dividends paid in the year

•

Its non-eligible RDTOH balance at the end of the year

$ 43,125 1,533

plus 3. either: • if 38 1/3% of non-eligible dividends is in excess of non-eligible RDTOH at the end of the year, the lesser of: • the amount in excess • the amount by which it eligible RDTOH balance at the end of the year exceeds the amount in 1, if any •

in any other case, nil

$ 41,592 7,187 $ 7,187

294 The total dividend refund is

Introduction to Federal Income Taxation in Canada $ 8,720

Solutions to Chapter 12 Assignment Problems

295

Solution 9: Active Business vs. Property Income [Note: The facts of this case are those of The Queen v. Cadboro Bay Holdings Ltd., 77 DTC 5115 (F.C.T.D.). However, the legislation, under which the case was decided, did not contain a definition of active business or specified investment business.] Under the current legislation, an “active business” [ssec. 125(7)] is any business other than a “specified investment business” [ssec. 125(7)] or a “personal services business” [ssec. 125(7)]. As a result, if a business is not a specified investment business or a personal services business, it is an active business. Consider the definition of “specified investment business.” It is a business other than a business carried on by a credit union. This case does not involve a credit union. The business of leasing property other than real property, i.e., the leasing of movable property, is not a specified investment business. However, the facts of this case indicate the leasing of real property, i.e., land and buildings in a small shopping centre. This activity fits the definition of a specified investment business. Furthermore, the principal purpose of the business is to derive income from rents. Since the facts of the case do not indicate that there are more than five full-time employees of the taxpayer corporation, the exception in paragraph (a) of the definition in subsection 125(7) is not met. Since there is no indication of an associated corporation providing services to the taxpayer corporation that would otherwise be performed by more than five full-time employees of the taxpayer corporation, the exception in paragraph (b) of the definition in subsection 125(7) is not met. It can be concluded that the taxpayer corporation is carrying on a specified investment business. It is not carrying on a personal services business because it is not reasonable to regard the principal officer of the taxpayer corporation who negotiated the leases as an employee of the persons to whom the taxpayer corporation provided services.

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Introduction to Federal Income Taxation in Canada

Solution 10: Associated Corporations (A) Leah Ltd. and Elaine Ltd. are associated because Leah Ltd. controls Elaine Ltd. [par. 256(1)(a)]. (B) Abigail Ltd. and Ethan Ltd. are associated because they are controlled by the same person [par. 256(1)(b)]. (C) Clare Ltd. and Philip Ltd. are associated because they are controlled by the same group of persons, namely, Ms. Irene and Mr. Mordechai [par. 256(1)(b)]. (D) Jay Ltd. is considered to be controlled by the group, Mrs. Lyn and Mrs. Sarah [spar. 256(1.2)(b)(i)]. Then paragraph 256(1)(b) applies to associate the corporations, despite the fact that Mrs. Lyn controls Jay Ltd. [spar. 256(1.2)(b)(ii)]. (E) Stan Ltd. and Jonathan Ltd. are associated because they are controlled by the same group of persons, namely Janna Ltd. and Rayna Ltd. [par. 256(1)(b)]. (F) Rick Ltd. and Daniel Ltd. are associated because each company is controlled by one person and the person who controls Rick Ltd. is related [par. 251(6)(a)] to the person who controls Daniel Ltd. and that person owns not less than 25% of the shares, other than of a specified class, of each corporation [par. 256(1)(c)]. (G) Gord Ltd. and Rebecca Ltd. are associated because Gord Ltd. is controlled by one person, Mr. Joshua, and he is related to each member of a group of persons (Mr. Joshua [ssec. 256(1.5)] and Ms. Dahlia [par. 252(2)(b) or 251(6)(b)] that controlled Rebecca Ltd. Mr. Joshua owns not less than 25% of the issued shares, other than of a specified class, of the other corporation [par. 256(1)(d)]. By the same rules, Rosalyn Ltd. and Rebecca Ltd. are associated. Therefore, Gord Ltd. and Rosalyn Ltd. are associated, unless Rebecca Ltd. elects not to be associated with Gord Ltd. and Rosalyn Ltd. [ssec. 256(2)]. The election has the dual effect of denying Rebecca Ltd. the small business deduction and dissociating Gord Ltd. and Rosalyn Ltd. for purposes of section 125 only (the small business deduction) and only for the election year. If an election is made, it must be made annually to apply in a particular taxation year. (H) Mrs. Yael controls Benjamin Ltd. Mrs. Yael controls, indirectly, 25% of the shares of Livi Ltd. through her holdings of Benjamin Ltd. shares. She also controls another 30% of the shares of Livi Ltd. directly, thereby controlling a total of 55% of the shares of Livi Ltd. Therefore, Benjamin Ltd. and Livi Ltd. are associated [par. 256(1)(b)]. Association is also possible because Mrs. Yael controls Benjamin Ltd. and she is related to the group of persons (Benjamin Ltd. [spar. 251(2)(b)(i)] and herself [ssec. 256(1.5)]) that controls Livi Ltd. and she owns not less than 25% of the shares, other than shares of a specified class, of the other corporation [par. 256(1)(d)]. (I) The corporations are associated [par. 256(1)(b)] because Ms. Daniella is deemed [par. 256(1.4)(a)] to be in the same position as if she owned the shares on which she holds an option. Therefore, she controls Ava Ltd. in addition to controlling Elizabeth Ltd. (J) Since both corporations are controlled by groups, paragraph 256(1)(e) is the only possible set of conditions for association. Isabelle Ltd. is controlled by a related group consisting of Mr. and Mrs. Jonathan who are related by marriage [par. 251(6)(b)]. Maya Ltd. is also controlled by a related group consisting of any three of the three brothers and one sister who are related by blood [par. 251(6)(a)]. Each of Mr. and Mrs. Jonathan is related to each of the brothers and the sister. Mr. Jonathan is related by blood to his brothers and sister. Mrs. Jonathan is related to her brothers-in-law and sister-in-law [pars. 251(6)(a) and 252(2)(b) or (c) or par. 251(6)(b)]. Mr. Jonathan, who is a member of both related groups, owns in respect of the other corporation not less than 25% of the shares, other than of a specified class. Therefore, all conditions for association are met.

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297

Solution 11: Associated Corporations (A) A Ltd. and B Ltd. are associated [par. 256(1)(b)]. They are both controlled by the same group, i.e., Rachel and Monica. Rachel and Monica may be considered as a group controlling B Ltd., even though Rachel controls B Ltd. on her own also [spars. 256(1.2)(b)(i) and (ii)]. (B) A Ltd. and B Ltd. are associated [par. 256(1)(c)]. A Ltd. is controlled by Charlie. B Ltd. is controlled by Claudia. Charlie and Claudia are related. Charlie owns in respect of each of A Ltd. and B Ltd. not less than 25% of the issued shares of any class, other than a specified class. Charlie is deemed to own 80% of 40% = 32% of the shares of B Ltd. [par. 256(1.2)(d)]. (C) A Ltd. and B Ltd. are associated [par. 256(1)(d)]. B Ltd. is controlled by Bert. Bert is related to each member of a group of persons that control A Ltd. Bert owns not less than 25% of the issued common shares of A Ltd. Bert is deemed to own 1/3 of 100% = 33.3% of the shares of A Ltd. [par. 256(1.2)(e)]. (D) A Ltd. and C Ltd. are associated [par. 256(1)(d)]. A Ltd. is controlled by Anne. Anne is related to each member of a group of persons that control C Ltd. Anne owns not less than 25% of the issued common shares of C Ltd. Anne is deemed to own 100% of 40% = 40% of the shares of C Ltd. [par. 256(1.2)(d)]. B Ltd. and C Ltd. are associated [par. 256(1)(d)]. B Ltd. is controlled by Barbara. Barbara is related to each member of a group of persons that control C Ltd. Barbara owns not less than 25% of the issued common shares of C Ltd. Barbara is deemed to own 100% of 40% = 40% of the shares of C Ltd. [par. 256(1.2)(d)]. Since A Ltd. and B Ltd. are not associated by any other provision, subsection 256(2) deems them to be associated because of their common association with C Ltd. However, if C Ltd. elects not to be associated with A Ltd. and B Ltd., then C Ltd. will be deemed to have a business limit of nil and A Ltd. and B Ltd. will not be associated for purpose of section 125. Nevertheless, C Ltd. will continue to be associated with both A Ltd. and B Ltd., separately. (E) A Ltd. and B Ltd. are associated [par. 256(1)(b)]. They are both controlled by the same group, i.e., Brandon and Claire. Brandon and Claire may be considered as a group controlling B Ltd., even though Claire controls B Ltd. on her own also [spars. 256(1.2)(b)(i) and (ii)]. B Ltd. and C Ltd. are associated [par. 256(1)(b)]. They are both controlled by Claire. Since A Ltd. and C Ltd. are not associated by any other provision, subsection 256(2) deems them to be associated because of their common association with B Ltd. However, if B Ltd. elects, then B Ltd. will be deemed to have a business limit of nil for the purpose of section 125. Nevertheless, C Ltd. will continue to be associated with both A Ltd. and B Ltd., separately. (F) A Ltd. and B Ltd. are not associated, since the conditions of paragraph 256(1)(e) cannot be met. A Ltd. and B Ltd. are not controlled by one person but by groups of unrelated persons. Valerie and her two nieces are not related for tax purposes [sec. 251]. Dilon and his nephew also are not related for tax purposes [sec. 251]. Therefore, A Ltd. and B Ltd. are not associated under the technical rules in section 256. However, careful consideration should be given to a possible assessment under the anti-avoidance provision [ssec. 256(2.1)]. (G) Each of the corporations is controlled by a person; F Ltd. is controlled by Father and S Ltd. is controlled by Sean. Father and Sean are related. Father is deemed to own 100%  30% = 30% of the issued preferred shares of S Ltd. [par. 256(1.2)(d)]. However, the preferred shares are shares of a specified class [ssec. 256(1.1)]. Therefore, the preferred shares do not count towards the 25% ownership required for the corporations to be associated. Where shares are owned by a child under age 18, for the purpose of determining associated corporations, the shares are deemed to be owned by the parent unless it can reasonably be considered that the child manages the business and affairs of the corporation and does so without a significant degree of influence by the parent [ssec. 256(1.3)]. Therefore, it is likely the Father will be deemed to own the 100% of the common shares of S Ltd. which are owned by Sean. Therefore, F Ltd. and S Ltd. will be associated [par. 256(1)(b)] as both corporations are controlled by the same person.

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Solution 12: Tax Payable (Note to instructors Canadian investment income was increased from $17,000 to $24,000.)

Part I tax payable: Taxable income

$323,000

Tax at 38% of $323,000

$122,740

Deduct: Federal abatement (10% of $323,000)

32,300

Net

$90,440

Additional refundable tax – 10 2/3% of lesser of: (a) AII ($24,000 - $2,000)

$22,000

(b) TI – income eligible for SBD (Schedule 1) ($323,000 – $320,000)

$3,000

10 2/3 % of 3,000

320

Total

$90,760

Small Business Deduction

($60,800)

General Rate Reduction

Part 1 Tax Payable

$29,960

Schedule 1: Small business deduction 18% of lesser of: (a) Income from an active business

$320,000

(b) Taxable income

$323,000

$500,000

Less: ($11,900,000 - $10,000,000) 40,000,000 19% of least:

x $500,000

23,750

$320,000

$476,250 $60,800

For CCPCs with passive investment income in excess of $50,000 in the prior year, the small business deduction is reduced by $5 for every $1 of investment income over $50,000. The reduction to the SBD limit will be the greater of: • The reduction based on capital (as calculated above) and • The reduction based on Adjusted AII We have assumed investment income earned in the prior year is the same as the amount earned in the current year. In this case, the adjusted AII is below the $50,000 threshold therefore reduction based on adjusted AII would be $0. The adjustment based on taxable capital is the greater of the two amounts and will be used to reduce the income eligible for the SBD. Schedule 2: General reduction Taxable income ............................................................................. Less: income eligible for SBD .....................................................

$316,000 $320,000

Solutions to Chapter 12 Assignment Problems AII .................................................................................... Net ................................................................................................ 13% of $0 = $0

299 15,000

335,000 $ 0

Introduction to Federal Income Taxation in Canada

300 Solution 13: Tax Payable Analysis of Division B Income

Source Cdn. business ................ Dividend........................ Rental ............................ Interest........................... Royalty .......................... Net taxable capital gains Division B income.........

ABI Cdn. For’n. 159,000

PSB

Investment Cdn. For’n.

Dividend Conn. Port.

Total 159,000 8,000 115,000 15,000 1,000 9,000 $ 307,000

$ 8,000

$ 159,000

$115,000 15,000 1,000 9,000 $140,000

$ 8,000

Income under Division B ...............................................................................................................................$ 307,000 Deduct: Charitable donations ($60,000 + $10,000 carryforward; not exceeding 75%  $307,000 = $230,250) (70,000) Dividends received ............................................................................................................................ (8,000) 2017 net capital loss ($10,000; but limited to taxable capital gains of $9,000) ...................................... (9,000) Taxable income ............................................................................................................................. .......... $ 220,000 Basic federal tax at 38% of $220,000...................................................................................................... $ 83,600 Deduct: Federal abatement (10% of $220,000) ........................................................................................... (22,000) Net.......................................................................................................................... ................................. Additional refundable tax (ART): 10⅔% of the lesser of: (a) Aggregate investment income ($140,000+$8,000– $9,000-$8,000) ............ (b) Taxable income – SBD eligible income ($220,000 – $50,000.....................

13,973

220,000

(181,000) 39,000

(9,500) (5,070) $ 61,003

22,400 83,403

50,000

131,000 net ....................................................................................................................... 13% of $80,000...................................................................................................

$ 220,000

(c) Business limit(1) ........................................................................................... $ 50,000 19% of $50,000...................................................................................................................... ...... General rate reduction* ............................................................................................................................. .. Part I tax payable (federal) .......................................................................................................................... Provincial tax: @ 4% of $ 50,000……………………………………………………… $ 2,000 0 @ 12% of $170,000 …………………………………………………… 20,400. 22,400(2) Total tax.................................................................................................................... ................................... * General tax reduction: taxable income .................................................................................................. less: income eligible for the small business deduction ...................................... AII............................................................................................................

61,600

$ 131,000 $ 170,000

Lesser amount  10⅔% ($131,000  10⅔%)...................................................................................... Deduct: Small business deduction = 19% of least of : (a) Canadian-source active business income ..................................................... $ 159,000 (b) Taxable income....................................................................

$ 5,070

(1) For CCPCs (and all their associated companies) with passive investment income in excess of $150,000 in the prior taxation year, the entire small business deduction will be eliminated. The legislation defines the adjusted aggregate investment income (AAII) for the purposes of the SBD. Assuming the current year investment income is the same as in the prior year, the AAII would be calculated as follows:

Solutions to Chapter 12 Assignment Problems

301

Taxable capital gains (non-active) Interest income Royalty income Rental income Total AAII

$ 9,000 15,000 1,000 115,000 $140,000

The AAII is $140,000 therefore the SBD limit will be affected. The reduction to the small business limit is: Reduction in SBD limit AAII less base AAII in excess Reduction in SBD limit

140,000 50,000 90,000 x $5

450,000

The SBD limit for 2023 would be $50,000 ($500,000 – 450,000). (2) Note: the solution assumes that the province implemented the federal passive income tax measures that

affected the federal small business deduction, therefore the small business deduction is clawed back at the same rate as it is federally. Some provinces, such as Ontario and New Brunswick are not clawing back the small business deduction based on passive income (i.e. they are calculating the small business deduction as if the claw back does not apply).

Introduction to Federal Income Taxation in Canada

302 Solution 14: Dividend Refund (A) Dividend refund:

Refundable Portion of Part I is least of: (a) 30 2/3% of AII (30 2/3% of $45,000) (b) Taxable income Less: amount eligible for SBD 30 2/3% of (c) Part I tax Least of

$ 13,800 $200,000 170,000(1) $ 30,000

9,200 26,900 $

9,200

Part IV Tax on Taxable Dividends Received Taxable not connected dividends subject to Part IV tax x 38.33% ($20,000 x 38.33%) 5,000 x 80% Taxable connected dividends

7,667 4,000

Part IV Tax …………………………………………………………………………..

RDTOH and Dividend refund Opening balance as of January 1, 2023

11,667

Eligible RDTOH

Noneligible RDTOH

$ 12,000

Less Dividend Refund from 2022

(4,000)

Refundable Part I tax Part IV tax on portfolio dividends @ Part IV tax on Connected corporations

9,200 38.33%

7,667 4,000

Balance at the end of December 31, 2023 - prior to refund

11,667

$ 17,200

Balance at the end of December 31, 2023

11,667

$ 17,200

Dividend refund is equal to the total of three amounts: 1. The lesser of: 38 1/3% x total of all eligible dividends paid in the year Its eligible RDTOH balance at the end of the year

$0 $

11,667

plus

2. The lesser of: - 38 1/3% x total of all non- eligible dividends ($60,000) paid in the year

- Its non-eligible RDTOH balance at the end of the year

23,000 17,200

plus

$ 17,200

3. either: - if 38 1/3% of non-eligible dividends is in excess of non-eligible RDTOH at the end of the year, the lesser of: - the amount in excess ($23,000 – 17,200) - the amount by which the eligible RDTOH balance at the end of the year exceeds the amount in 1, if any

5,800 11,667

- in any other case, $0 The total dividend refund is

5.800 $ 23,000

The eligible and non-eligible RDTOH balances at December 31, 2023 are $5,867 ($11,667 – 5,800) and $0 respectively. The $24,000 eligible dividend paid in 2024 will result in a refund of eligible RDTOH on the 2024 corporate tax return.

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303

Notes: (1)

Small business deduction 19% of least of: (a) Active business income (Canadian-source)

$ 170,000

(b) Taxable income

200,000

400,000 (2) 170,000

$ 32,300

(2) Adjusted AII for SBD Taxable capital gains (non-active)

30,000

Interest income

20,000

Dividend

20,000

AAII

70,000

Reduction in SBD limit AAII

70,000

less base

50,000

AAII in excess

20,000

Reduction in SBD limit SBD limit

x $5

100,000

400,000

Introduction to Federal Income Taxation in Canada

304 Solution 15: Comprehensive Analysis of Division B Income

Source Distributing........................ Dividend............................ Net taxable capital gains.... Royalties............................ Recapture........................... Rental ................................ Interest — A/R .................. Division B income.............

ABI Cdn. $ 220,000

Investment Cdn.

Dividend Conn.

Port. $

$ 11,000

$ 20,000

$ 11,000

$ 20,000

$ 17,000 9,000 4,000 14,000 5,000 $ 229,000

$ 40,000

Total 220,000 31,000 17,000 9,000 4,000 14,000 5,000 300,000

(A) Part I Tax on Taxable Income Taxable income ............................................................................................................................. ...... Tax @ 38% of taxable income (38% of $226,000).............................................................................. Less: Abatement 10% of $226,000..................................................................................................................... . Basic tax net of tax abatement ............................................................................................................ Additional refundable tax: 102/3% of lesser of: (a) Aggregate investment income ($17,000+$9,000+$14,000 + $31,000– $ 33,000 $7,000 -$31,000).................................................................................................. (b) Taxable income – SBD income amount ($226,000 – $226,000) ................. $ 0 Deduct: Small business deduction (see Schedule 1).................................................. $ 42,940 General reduction (see Schedule 2).............................................................. $0 Part I tax payable (federal) .................................................................................................................. Provincial tax @ 4% of $226,000 ..................................................................................... $. 9,040 @ 12% of $0………………………………………………………….. $ 0 Total tax.......................................................................................................................... ..................... Summary of tax: Part I tax payable (federal and provincial) ................................................................................... Part IV tax payable (see separate calculation in Part B) .............................................................. Dividend refund (see separate calculation in Part B) ................................................................... Net tax payable ............................................................................................................................

$ $

226,000 85,880

22,600 63,280

(42,940) 20,340

9,040 29,380

29,380 10,417 (10,417) $ 29,380

Schedule 1: Small Business Deduction1 Income from active business carried on in Canada .................................................................... $ 229,000 Taxable income.................................................................................................... $ 226,000 Business limit ........................................................................................................................... $ 450,000 Deduction: 19% of $226,000 ..................................................................................................... $ 42,940 1 For CCPCs (and all their associated companies) with passive investment income in excess of $150,000 in the prior year, the entire small business deduction will be eliminated. The legislation defines the adjusted aggregate investment income (AAII) for the purposes of the SBD. Assuming the current year investment income is the same as in the prior year, the AAII would be calculated as follows: Adjusted AII for SBD taxable capital gains (non-active) Royalty income Rental income Portfolio dividends AAII Reduction in SBD limit AAII less base AAII in excess Reduction in SBD limit x $5 SBD limit

17,000 9,000 14,000 20,000 60,000

$ $

60,000 50,000 10,000 50,000 450,000

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305

Schedule 2: General Reduction taxable income ..................................................................... $ 226,000 less: income eligible for the small business deduction ...... $ 226,000 AII 0 (226,000) net ......................................................................................... $ $0 13% of $0 ............................................................................................................................. .....

(B) Refundable Dividend Tax on Hand, December 31, 2023 and Dividend Refund Refundable portion of Part I tax Least of: (a) 30 2/3% of AII (30 2/3% of $33,000)

$10,120

(b) Taxable income Less: amount eligible for SBD 30 2/3% of (c) Part I tax Refundable portion of Part I tax-

$ 226,000 $

226,000 0

0 20,340 $0

Part IV Tax on Taxable Dividends Received Taxable dividends subject to Part IV tax x 38.33% ($20,000 x 38.33%) Connected dividends (100% subsidiary)

7,667 2,750

Part IV Tax

$ 10,417 Eligible RDTOH

Opening balance as of January 1, 2023

Non-eligible RDTOH

Refundable Part I tax Part IV tax on connected corporation Part IV tax on portfolio dividends @ 38 1/3% Balance at the end of December 31, 2023 - prior to refund

0 2,750

x $20,000

7,667 $ 7,667

$ 2,750

Dividend refund is equal to the total of three amounts: 1. The lesser of: 38 1/3% x total of all eligible dividends paid in the year Its eligible RDTOH balance at the end of the year plus 2. The lesser of: - 38 1/3% x total of all non- eligible dividends paid ($72,000) in the year - Its non-eligible RDTOH balance at the end of the year plus

$ 7,667 $

$27,600 2,750 $2,750

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306

3. either: - if 38 1/3% of non-eligible dividends is in excess of non-eligible RDTOH at the end of the year, the lesser of: - the amount in excess (27,600 – 2,750) - the amount by which it eligible RDTOH balance at the end of the year exceeds the amount in 1, if any

24,850 7,667

- in any other case, $0

$ 7,667

The total dividend refund is

$10,417

Solutions to Chapter 12 Assignment Problems

307

Solution 16: Find the Errors (1) Net income is incorrect. — Capital losses on depreciable property are not recognized. Therefore, the taxable capital gain should be $12,000  1/2 = $6,000. (2) Taxable income is incorrect. — The dividends from the foreign corporations should not be deducted. — Verify that charitable donations are limited to 75% of Division B net income. — Net capital losses should be limited to taxable capital gains. (3) The basic federal tax rate is 38%, not 40%. (4) Abatement: — The abatement should be subtracted from tax otherwise payable, not added. (5) Additional refundable tax: — Since Tek has aggregate investment income made up of the bond interest ($20,000) and the taxable capital gain ($6,000) which is fully offset by the net capital loss and foreign dividends which are not deductible under Division C ($12,000), — Thus additional refundable tax should be calculated (6) Foreign tax credits: — The denominator of the formula for the foreign non-business tax credit should be “net income under Division B minus dividends from taxable Canadian corporations and net capital losses deducted in the computation of taxable income.” — Tax otherwise payable for the foreign non-business tax credit is the basic tax – the abatement (7) Small business deduction: — Interest on the overdue accounts receivable should be included in the active business income (ancillary). ABI should be ($341,500 + 5,000 = $346,500) — Item (b) should be taxable income reduced by 100/28  foreign non-business tax credit. — Adjusted aggregate investment income (AAII) for the prior year should be calculated to ensure the small business deduction (SBD) isn’t reduced. If the AAII in the prior year for the CCPC and its associated group is greater than $150,000, there entire SBD will be eliminated. (8) Investment tax credits of $50,000  35% = $17,500 should be claimed with respect to the SR&ED expenditures. (9) The 13% general tax reduction should be recalculated, since the GRR is only available on taxable income in excess of the total income eligible for the small business deduction and aggregate investment income.

Introduction to Federal Income Taxation in Canada

308

Solution 17: Identify Types of Income Carl

Vince

100%

Compunet AII

ABI

Vitamins PSBI

ABI Services

100% Warehouse Divs Mindblasters ABI Warehouse

Types of Income: Compunet has three sources of income: (a) personal services business income (PSBI), (b) aggregate investment income (AII), and (c) active business income (ABI).

Computer Consulting Services: The computer consulting fee earned from Vitamins Inc. is personal service business income. It meets all the tests [ssec. 125(7)] as outlined below: (a) Compunet is in the business of providing computer consulting services; (b) Carl who performs the services on behalf of Compunet is a specified shareholder, since he owns not less than 10% of the issued shares [ssec. 248(1)]; (c) Sulee who also performs services on behalf of Compunet is related to Carl; (d) both Carl and Sulee would reasonably be regarded as employees of Vitamins Inc. but for the existence of Compunet (refer to the three tests used in Chapter 3 to determine whether they would be regarded as employees); (e) Compunet does not employ more than five full-time employees in the computer consulting business; and (f) Compunet and Vitamins Inc. are not associated corporations. Personal services business income is taxed at full corporate rates plus 5% with no general rate reduction under Part I. Deductions from this source of income are restricted [par. 18(1)(p)].

Rental Income: Rent received from Vitamins Inc. is property income. Rent received from Mindblasters is deemed by subsection 129(6) to be active business income, since it is deductible in computing the active business income of an associated corporation. Compunet controls Mindblasters and thus the two are associated [par. 256(1)(a)]. Property income is taxed initially at full corporate rates. It is also subject to 10 2/3% additional tax on investment income. 302/3% of the property income is added to Compunet’s non-eligible refundable dividend tax on hand (RDTOH). The non-eligible RDTOH is refunded to Compunet, upon the payment of non-eligible dividends to Carl, at a rate of 38 1/3% of taxable dividends paid. The active business income is eligible for the small business deduction under subsection 125(1), to the extent of the portion of the $500,000 business limit allocated to Compunet. Mindblasters and Compunet, being associated corporations, must share the business limit. The active business income in excess of Compunet’s allocation of the business limit is taxed at full corporate rates. It is also important to note that there may be an erosion of the SBD if the associated group has excessive passive income, such as the rental income discussed above. For the associated group of CCPCs with passive investment income in excess of $150,000, the entire small business deduction will be eliminated.

Solutions to Chapter 12 Assignment Problems

309

Dividend Income: Dividends received from Mindblasters is property income. Taxable dividends received from taxable Canadian corporations are deducted in the computation of taxable income [sec. 112] and thus are not subject to tax under Part I. Such dividends are not included in investment income and thus are not subject to the additional 102/3% tax. Dividends received by private corporations are generally subject to Part IV tax. The Part IV tax rate is 381/3%. The Part IV tax is added to Compunet’s RDTOH (either eligible or non-eligible) and refunded upon the payment of dividends as discussed above. Mindblasters is connected with Compunet [par. 186(4)(a)]. Because of this, the dividends received will be subject to Part IV tax to the extent the payment thereof results in Mindblasters receiving a dividend refund. As Mindblasters earns active business income only, it will not receive a dividend refund. Thus the dividends received by Compunet will not be subject to Part IV tax. In other words, they will be received tax-free and will not have any impact on Compunet’s RDTOH.

Introduction to Federal Income Taxation in Canada

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Solution 18: Identify Types of Income Association Lemon Ltd. and Rental are associated, since Les has de jure control of both corporations (i.e., 100% of the shares). [par. 256(1)(b)] Lemon Ltd. and Cheap are also associated since Les has de jure control of both corporations (i.e., 100% of Lemon Ltd. and 55% of Cheap: 25 shares directly and 30 shares indirectly through his 100% ownership of Lemon Ltd.). [pars. 256(1)(b) and (1.2)(d)] Cheap and Rental would also be associated on the same basis as Lemon Ltd. and Cheap as described above. Note that in both association situations with Cheap, the basis could also be paragraph 256(1)(d), since Cheap is controlled by a related group, either Les, Lucy and Lemon Ltd. or Les and Lemon Ltd., and since Les meets the 25% cross-ownership test. Since Lemon Ltd., Rental, and Cheap are all associated, they must share the business limit for the small business deduction. [ssec. 125(3)] Sources of Income and Federal Tax Rates Toys-4-U Ltd. Active business income Federal tax rate: ≤ $500,000 → 9%(1) > $500,000 → 15%(2)

Lemon Ltd. The income from Toys-4-U Ltd. is from personal services business [ssec. 125(7)] because: (a) Les can reasonably be considered to be an employee of Toys-4-U Ltd., since he was a former vicepresident of administration and finance and is now performing similar services; (b) Les is a specified shareholder, since he owns not less than 10% of the outstanding shares of Lemon Ltd. and related corporations [ssec. 248(1)]; (c) Lemon Ltd. does not have more than five full-time employees; and (d) Lemon Ltd. and Toys-4-U Ltd. are not associated. The tax consequences are: (a) Federal tax rate for this source of income is 33%.(3) (b) Deductions from this source of income are restricted [par. 18(1)(p)] to: (i) salary, wages and other remuneration paid to the incorporated employee (i.e., Les Lemon); (ii) benefits or allowances for the incorporated employee; (iii) legal expenses paid by Lemon Ltd. in collecting the management fees from Toys-4-U Ltd.; and (iv) contractual expenses of the incorporated employee which are incurred in respect of the negotiating of contracts or the selling of property, similar to paragraph 8(1)(f). If Les negotiates contracts for Toys-4-U Ltd., the rent paid to Rental may be deductible. The management fees from the associated corporations would be active business income by virtue of the associated corporation exception in the definition of a “personal services business” [ssec. 125(7)]. The federal tax rate would be 9% or 15%, as calculated in notes (1) and (2), below, depending on whether any of the business limit has been allocated to Lemon Ltd. Cheap Leasing Ltd. Cheap’s income from the leasing business (80%) is active business income, since the specified investment business definition excludes property income derived from the leasing of movable property. The federal tax rate would be either 9% or 15% depending on the allocation of the business limit. The interest income received from Toys-4-U Ltd. would be property income subject to federal tax at 28.0% plus the additional refundable tax of 10 2/3% initially, with a refund of 302/3% of the income based on 38 1/3% of dividends paid. It is also important to note that there may be an erosion of the SBD if the associated group has excessive passive income. For the associated group of CCPCs with passive investment income in excess of $150,000, the entire small business deduction will be eliminated.

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Rental Ltd. The rental income appears to be property income and not active business income, since Rental is not actively engaged in the rental operations. The federal tax would be at 28.0% plus the additional refundable tax of 10 2/3% subject to a 302/3% refund based on 38 1/3% of dividends paid. However, some of the rental income would be deemed to be active business income, since some of this income was deducted from the active business income of an associated corporation, Cheap Leasing Ltd. [ssec. 129(6)] Cheap Leasing Ltd. (80% of 25%) .............................................................................................. 20%

Note that the rental income from Lemon Ltd. was not deducted from ABI of Lemon Ltd., since Lemon Ltd. has only PSB income. Hence, the deeming rule does not apply and that rental income is income from property for Rental Ltd.

The federal rate of tax would be the same as discussed above.

—NOTES TO SOLUTION (1) 38% – 10% – 19% (2) 38% – 10% – 13% (3) 38% – 10% + 5%

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Solution 19: Incorporating Investments Investment income received directly Interest income (8% of $200,000).................................................... Grossed-up dividend (5% of $550,000  1.15) ................................ Taxable capital gain (10.5% of $550,000  1/2) ……………………………… Incremental income and taxable income .......................................... Other income Taxable income Federal tax on taxable income:......................................................... $18,898 on $106,500 Less: dividend tax credit (9/13  15% of 5% of $550,000)

16,000 31,625 28,875 76,500 30,000 $106,500

18,898

(5,227) 13,671

9,070 22.501

$2,856 2,371

other personal tax credits.................................... Basic federal tax............................................................................... Provincial tax on $106,500 ......................................................................... less: personal tax credits....................................................... dividend tax credit (4/13  15% of 5% of $550,000) ..... Total tax payable..............................................................................

$11,713 1,640 1,269

Investment income received through a corporation: (i) Corporation Interest income........................................................... Dividend income (5% of $550,000) ........................... Taxable capital gain ................................................... Corporation income.................................................... Less: intercorporate dividends [sec. 112] ................... Taxable income .......................................................... Corporation federal and provincial tax @ 40%.......... Part IV tax @ 38⅓% of $27,500 ................................ Additional refundable tax (10⅔%  ($16,000 + $28,875)).................................. Total tax ............................................................................................ Corporation retention (excluding non-taxable portion of capital gain which can be distributed tax-free) ..................................... Potentially refundable tax: Refundable Part I tax (30⅔% of ($16,000 + $28,875))......................... Refundable Part IV tax (shares of nonconnected corporation)....................................... Potentially available for taxable dividend (non-eligible) ..................

Tax @ 40% $

$ $

16,000 27,500 28,875 72,375 27,500 44,875 17,950 10,542

72,375

4,787 (33,279)

39,096

24,304 63,400

72,910

18,162

(8,955) 9,207

6,716 15,923

22,501

8,975 15,923 24,898 2,397(1)

13,762 10,542

(ii) Shareholder

Grossed-up dividend from corporation ($63,400  1.15).................. Federal tax on income from grossed-up dividend + $30,000 ($102,910); $18,162 Less: dividend tax credit (9/13  15% of $63,400) ...... other personal tax credits.................................... Basic federal tax................................................................................ Provincial tax $5,336 on first $53,359 + 12% on remainder .......................... less: personal tax credits.......................................................... dividend tax credit (4/13  15% of $63,400)..................... Total tax payable...............................................................................................

6,584 2,371

$11,282 (1,640) (2,926)

Comparison of taxes: Investment income received directly........................................................ Investment income received through corporation: Corporate tax.............................................................. Less: refund to corporation ........................................ Individual tax ................................................................................... Total tax ........................................................................................... Tax cost of using corporation...........................................................................

33,279 24,304

$ $

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Other considerations: Advantages of incorporating — • Estate planning considerations: • Possible income splitting by having his wife and adult children subscribe for the shares of the investment company if they have their own source of capital to buy the shares. [taking into consideration the implications of TOSI and corporate attribution] Disadvantages of incorporating — • Initial prepayment of tax: Tax on corporate income ............................................................. Tax on individual’s $30,000 of existing income [$7,500(2) – ($2,371 + $1,650)]

$ Less: tax on total income received directly .................................. Prepayment through corporation..................................................

33,279 3,489 36,768 22,501 14,267

• Administrative costs of a corporation; • Corporate losses not available to shareholder to offset personal income. —NOTES TO SOLUTION 3– 30 /3%) is in excess of 13% using the 15% gross-up on dividends paid. The 13% tax rate is the perfect integration rate. (2) $7,500 of tax on $30,000 @ 25% (combined federal @15% and provincial @ 10%). (1) Note how there is a tax cost when the combined net corporate rate of tax at 20% (i.e., 40% + 10 2/

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Solution 20: Association P. Holdings Inc. and Peter's Manufacturing Inc. Associated under par. 256(1)(d). Peter: directly controls P. Holdings Inc.; is related to each member of a group of persons (Peter, Elle, and John) that controls Peter's Manufacturing Inc.; and owns 25% (i.e., "not less than 25%") of the issued shares of Peter's Manufacturing Inc.

P. Holdings Inc. and Susybea Ltd. Associated under par. 256(1)(a). P. Holdings Inc. is deemed to control Susubea Ltd. since it owns preferred shares having a fair market value greater than 50% of the fair value of all outstanding shares. Therefore, the two are associated as one controls the other. [Also associated under par. 256(1)(b), par. 256(1)(c), and par. 256(1)(d). Any one reason would have received full marks.]

Peter's Manufacturing Inc. and Susubea Ltd. Associated by par. 256(1)(d). Peter indirectly controls Susybea Ltd., and he is related to each member of a group of persons that controls Peter's Manufacturing Inc. of which Peter owns at least 25%. [Also associated under par. 256(1)(e).] Note: ssec. 256(2) does not apply, since the companies are associated by rules in ssec. 256(1). This is in accordance with par. 256(2)(a).

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Solution 21: Errors in RDTOH Calculation (A) Draft Memorandum To: Tax File From: New CPA This memorandum explains the errors in the calculation of Aggregate Investment Income and Refundable Part I Tax. Aggregate Investment Income • • • • •

•

Net TCGs for the disposition of equipment and securities is correctly included in AII. The company does not appear to have used net CLS which would reduce the inclusion Property income correctly includes bond interest including bond interest from connected corporations Dividends deductible in computing taxable income are excluded i.e. the $39K Interest on term deposits. - Property income does not include income that is “incident to or pertains to an active business carried on by it” . Rental income from warehouse. - Property income does not include in income “from property used or held principally for the purpose of gaining or producing income from an AB carried on by it. Profit on sale of land not used in the business. Could be either business income or capital gain. Need to review badges of trade & obtain more information on primary/secondary intent when acquired. Assumed business income for quantitative analysis.

Refundable Portion of Part 1 Tax • • •

Need to confirm $94,136 is the income eligible for the small business deduction Need to confirm $350,000 is taxable income Need to confirm Part 1 tax is $107,406. RDTOH balances are split into NERDTOH and ERDTOH. Refundable Part I tax goes into NERDTOH. There will also be Part IV tax that will go into ERDTOH

(B) Recalculate Aggregate Investment Income and Refundable Part 1 Tax.

Aggregate Investment Income - Revised Net TCG for the year Equipment Securities

8,000 13,000

21,000

Property Income Eligible dividends from non-connected taxable Cdn corps Interest - bonds of connected corps Bond interest

39,000 16,000 9,350

Division C Deduction dividends Total

(39,000) 46,350

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Refundable Portion of Part I Tax - Revised Least of; 1. 30.67% x AII 2. 30.67% x ($350,000-94,136) - verify 3. Part I tax - verify

14,214 78,473 107,406

Note that adjusted aggregate investment income would be above $50,000

(C) Recalculate Eligible RDTOH and Non-eligible RDTOH balance assuming that the beginning balance is $0. Non-Eligible RDTOH Refundable portion of Part 1 Tax

14,214

Eligible RDTOH Part IV Tax on Eligible Dividend 39K x 38.33%

14,950

(D) Determine the dividend refund if an eligible dividend of $20,000 and a non-eligible dividend of $45,000 had been paid during the year.

If the company paid: Eligible dividend Non-eligible dividend

Dividend refund would be: Lesser of: i) 38 1/3% x eligible dividends ii) Eligible RDTOH

20,000 45,000

7,667 14,950 $

7,667

17,250 14,214

14,214

3,036 7,283

3,036

Plus Lesser of: i) 38 1/3% x non-eligible dividends ii) Non-eligible RDTOH Plus Lesser of: i) 38 1/3% of non-eligible dividend less non-eligible RDTOH ii) Eligible RDTOH remaining ( $14,950 -7,667) Total dividend refund Eligible RDTOH balance after refund (14,950-7,667-3,036) Non Eligible RDTOH balance after refund (14,214 -14,214)

$ 24,917 4,247 -

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Solution 22: SR&ED (A) Qualifying SR&ED Expenditures [ssec.37(8)] Current expenditures: Salaries for research technicians and assistants ......................................................... Salary for Natalia ($80,000  25%) ........................................................................... Bonus for Natalia [ssec. 37(9)] .................................................................................. Materials consumed ................................................................................................... Supplies consumed .................................................................................................... Actual overhead expenses (using proxy method) ...................................................... Total SR&ED expenditures ..............................................................................................

600,000 20,000 0 200,000 40,000 0 860,000

The overhead expense related to the SR&ED has not been included as the actual amount is unknown. The overhead would be deducted in the computation of income as an ordinary expense. The difference is the limited period of carryforward for ordinary expenses (i.e., 20 years for non-capital losses), as compared to the indefinite carryover for the SR&ED expenditure pool. (B) ITCs and Refundable ITCs Nature Current.................................................................. .............................................................................. PPA (below)(treated as a current expense) ...........

Amount 860,000

ITC rate 35%

ITC $ 301,000

338,250

35%

118,388

Refundable ITC (100%) $ 301,000 (100%)

$ 1,198,250

118,388 $ 419,388

Since NAL does not expect to have taxable income this year, it can apply for a refund of the ITCs. Alternatively, the ITCs may be carried back and applied to reduce federal tax payable in any of the three preceding years or carried forward and applied to reduce federal tax in any of the 20 subsequent years. ITCs that are deducted or refunded in the year must be included in income for the following year in respect of current SR&ED expenditures [par. 12(1)(t)]. Prescribed Proxy Amount (PPA) [Reg. 2900(4)] (covered in Chapter 11) Salary for research technicians & assistants ........................................................................ $ 600,000 15,000(1) Salary for Natalia for time spent on SR&ED (25%  $60,000) ............................................... $ 615,000  55% $ 338,250

The PPA cannot exceed $500,000, the overhead expenses [Reg. 2900(6)]. —NOTE TO SOLUTION (1) Regulation 2900(7) limits the amount included in respect of salary of an employee who owns 10% or more of the shares (a specified employee) to the lesser of: (a) 75% of Natalia’s salary $80,000 = $60,000, and (b) 2.5  2023 CPP maximum pensionable earnings = 2.5  $66,600 = $166,500.

Introduction to Federal Income Taxation in Canada

318 Solution 23: Incorporate or Not DRAFT MEMO To: From: Re:

Susan Taylor Staff Accountant Incorporation Enquiries

In response to your enquiries relating to the proposed incorporation of both the investment holding company (High Income Limited), as well as the scarf retail business, please find below a detailed analysis of the tax consequences of incorporation as well as a discussion of some pertinent related tax issues. In addition, I have provided advice on some of the quantitative and qualitative pros and cons of incorporation that should be considered when deciding upon the right form of organization for your business(es). High Income Limited •

The ultimate effect of incorporating your investment portfolio is a tax cost (relative to earning the income directly) on both the interest income and the capital gain, and no cost or benefit relating to either received in dividends from public companies.

•

Additionally, income earned by High Income Limited from GIC interest, portfolio dividends, and capital gains would need to be paid out to you in the year to avoid a prepayment on taxes on this income.

•

The tax liability on the dividends received from the connected corporation Stage can be deferred by leaving the dividends in High Income Limited.

•

This indicates that if you intend to keep the money for reinvestment in the company, there is a prepayment of taxes on all of the sources of income except the Stage dividends. Further, from a tax perspective, there is no benefit to earning income from those sources. See Schedule 1 for detailed calculations. o Based on the tax cost and the potential for a prepayment of taxes on all the sources of investment income, except the Stage dividends, it is advised that you should not incorporate the investments in an investment holding company. If distribution is delayed, the prepayment of taxes would magnify the tax cost of incorporation due to the opportunity cost of using those prepaid taxes for a more productive purpose. In addition, it is important to note that incorporation is also costly (for example, legal and accounting fees). o If dividends are paid from Stage then the holding company will receive the dividend without either Part I or Part IV tax. If no dividends are paid from High Income Limited then tax can be deferred indefinitely or until dividends are paid out to you personally as part of your compensation planning.

• The tax system in Canada has rules, such as the Additional Refundable Tax on Aggregate Investment Income (e.g., interest income, the taxable portion of capital gains), and the Part IV tax on certain dividend income, to discourage the deferral of taxes on investment income earned in a corporation. • If incorporated, High Income Limited (HIL) would be considered to be carrying on a “specified investment business” (SIB) under the definition of that term in subsection 125(7) of the Act. This means that the investment income earned by the company would not be considered active business income (ABI) and would, therefore, be ineligible for the small business deduction normally allowed to Canadian-controlled private corporations (CCPC) on their first $500,000 of ABI. (A)

Incorporation of investment income

The following is a description of the effects of incorporation on the four different types of income: GIC Interest & Capital Gains • When received by a corporation, ½ of the capital gain would be put into a capital dividend account and would not be subject to tax. This mirrors the treatment of a capital gain received by an individual (only ½ taxable). Capital dividends could then be issued to you from this account tax-free after filing the proper election. • The taxable portion of the capital gain and the GIC interest would then be pooled together as “aggregate investment income” (AII). They would both be initially taxed at 52⅔% (38% basic federal rate less the 10% federal abatement plus the 10⅔ additional refundable tax plus the assumed 14% provincial rate). Of this, 30⅔% is a refundable portion that goes into the Refundable Dividend Tax on Hand account to be refunded when dividends are paid out to you. When dividends are paid out eventually, for each dollar of taxable dividends, the company receives 38.33% as a dividend refund.

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• Upon paying this income to you in the form of dividends, the corporation is refunded a portion of the taxes at a rate of 30⅔% of the income, resulting in an ultimate corporate tax rate of 22% (52⅔% - 30⅔%) on this income. • There is a small tax prepayment (no deferral benefit) because earning this type of income directly is taxed at 50%, while it would be taxed at 52⅔% if earned by a corporation. • The refundable tax mechanism ensures that the total tax paid by the corporation on the income and you on the dividends will be similar in amount to the tax that you would pay earning the investment income personally. However, because integration is imperfect for incorporated investment income, there is a tax cost overall to earning this type of income in a corporation. • Since the investment income is ultimately taxed at 22% (higher than 13% needed for perfect integration), there will be a tax cost in using the corporation to earn investment income. • Dividends paid out of the investment income of CCPCs are not considered “eligible dividends” and are subject to the 15% gross-up to arrive at the total amount taxable at your marginal tax rate. A federal and provincial dividend tax credit (approximately the amount of tax paid at the corporate level) will apply to reduce the personal taxes payable. Dividends Portfolio investment in public corporation shares • The $10,000 dividend received from the publicly traded company is subject to Part IV tax at 38⅓%. This tax takes away the advantage of tax deferral. In fact, when compared to a situation where you receive these dividends directly (taxed at 31%), earning this income through the holding company results in a tax prepayment of 7 1/3%. • The Part IV will be added to the eligible Refundable Dividend Tax on Hand (RDTOH) and refunded at 38.33% of taxable dividends paid to Susan. • This dividend received from the publicly traded company is considered to be an “eligible dividend” for tax purposes and will be added to the General Rate Income Pool (GRIP) of the corporation. When you receive dividends from this account, you must include in your income a 38% gross up to arrive at the taxable amount and you are eligible to deduct a dividend tax credit. The effective tax rate on dividends from GRIP is about 31% in the top combined federal and provincial personal tax bracket. Investment in 40% common shares of Stage • The holding company does not pay tax on the dividends received from Stage because dividends are exempt from Part I tax and there is no Part IV tax since the two corporations are connected. • Since this dividend comes out of the after-tax earnings of Stage, which has been taxed at 14% (all income earned by Stage is subject to the small business deduction), this dividend will be a non-eligible dividend and is therefore subject to the 15% gross-up when received by you personally and a dividend tax credit can be claimed. You will pay a 42.5% effective tax rate on dividends from LRIP. • Since the holding company does not pay tax on dividends received from a connected corporation for which the connected corporation did not receive a dividend refund, the tax liability can be deferred indefinitely while the dividends are left in the holding company. For this reason, it is advisable to receive this source of income through High Income Limited. The benefit of having a holding company is discussed earlier in this memo. However, you should be aware that High Income Limited will not be able to claim the capital gains deduction when it sells the Stage shares in the future. If you expect Stage to increase in value significantly then you should consider not holding these shares in High Income Limited. (B)

Incorporation of the Scarf Retail Business

• If the scarf business were to be incorporated, the corporation would be a Canadian-controlled private corporation earning active business income. • The effective total federal and provincial tax rate after claiming the small business deduction would be 14%. Compared to the 50% total personal tax rate (your current personal tax rate), there is a tax cost of $1,100 as well as a deferral of $73,100 in tax payable. See Schedule 2 for a detailed calculation. o Based on this information, it is recommended that the scarf retail business be incorporated to take advantage of the tax deferral opportunities. • If incorporated, the scarf retail business would be considered to be a CCPC eligible for a small business rate of 14% on the first $500,000 of active business income (38% basic federal rate less the 10% federal abatement less the 19% federal small business deduction plus the assumed 5% net provincial rate after provincial small

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business deduction). Since the business would not meet the definition of a specified investment business or a personal services business [ssec. 125(7)] all $200,000 of taxable income would be considered to be from an “active business”. o Note that excess passive income in associated corporations may reduce the small business deduction which would increase the overall tax on active business income in the corporation. For CCPCs with passive investment income in excess of $50,000, the small business deduction will be reduced by $5 for every $1 of investment income over $50,000, with the small business deduction being eliminated when the adjusted aggregate investment income is greater than $150,000. Adjusted aggregate investment income is calculated for an associated group, which would include the holding company. It would be important to keep the level of investment income below the $50,000 threshold.

• When paid to you, the $172,000 in non-eligible dividends would be grossed up by 15% to arrive at the taxable amount in your hands. The federal and provincial dividend tax credits which combined are equal to the amount of the gross-up are then deducted to arrive at the taxes payable by you. (C) Discussion of Pros and Cons of Incorporation Advantages • The most obvious qualitative benefit of incorporation is the limited liability offered to shareholders unless personal properties are pledged to financing sources. Shareholders of a corporation are only liable to creditors up to the amount of their investment in the business unless another arrangement is agreed to by both parties. • Directors of the corporation can still be held personally liable for certain required payments, such as employee source deductions and GST/HST when they are judged not to have exercised due care in making all necessary remittances but they are not held personally liable for unpaid Part I tax. • The creation of a separate legal entity (the corporation) allows for a number of benefits relating to the continuity of the business beyond the life or involvement of the owner as well as in the transferability of ownership. • Another advantage of the corporate form of ownership is the greater ability to regulate income flows to the individual by paying a regular salary or a bonus payment from the corporation. The bonus payment is fully deductible, as long as it is paid to the individual within 179 days of the end of the year in which it was accrued. • Incorporation allows for the deferral of income tax on business income in situations where the applicable corporate tax rate is lower than that for the individual. For example, business income eligible for the small business deduction or for other business income where the individual is in a higher tax bracket. • In certain provinces and territories, incorporation may be a benefit to a business involved in manufacturing and processing as they can be eligible for a provincial or territorial rate reduction on M&P income not otherwise eligible for the small business deduction. • There are potential tax savings through income splitting (subject to attribution and TOSI rules) by allowing non-minor family members to purchase shares in the company. • For situations where a combined corporate tax rate of less than 13% applies (not in this case), incorporation provides tax savings compared to earning income directly by an individual. • The ability to sell shares in the corporation makes it potentially easier to acquire financing. • Shareholders are allowed to deduct for tax purposes the interest on funds borrowed to invest in the common shares of the corporation. • An enhanced investment tax credit of 20% is available for scientific research and experimental development expenditures, subject to certain restrictions, for CCPCs that is not available to unincorporated businesses. • Shareholders can use the capital gains exemption to shelter up to $971,190 for 2023 of the capital gain on disposing of their qualifying shares in a “small business corporation” as defined in subsection 248(1) of the ITA. o Further to this, capital losses that result from the disposition of qualified small business corporation shares are treated as business investment losses (BIL). The allowable portion of these losses (ABILs) can be deducted against all sources of income. o Any amount of capital gains deduction in used prior years is deducted from the BIL before calculating the ABIL and a portion of the disallowed amount — based on the capital gains inclusion rate in the year the deduction took place — is added to the regular allowable capital losses for the year.

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Disadvantages • A major disadvantage to the individual is the loss of business and investment losses available to offset the individual's other sources of income. • Incorporation can result in a net tax cost on business income if corporate tax rates are greater than 13% (as in this case). • Incorporation results in a prepayment of taxes on income for which the individual is subject to a lower marginal tax rate than the corporation. For example, investment income earned through a corporation which is subject to the additional refundable tax or the Part IV tax, or business income not eligible for the small business deduction where the individual is in a lower tax bracket. • The requirement to collect and remit source deductions as well as the other time and money costs related to the creation and maintenance of the corporation. • Corporations are subject to provincial payroll and capital taxes. Schedule 1 – Tax consequences of incorporating High Income Limited GIC Interest

High Income Limited Income Tax @ 52⅔% on investment income [Part I] Tax @ 38⅓% on portfolio dividends [Part IV]

Dividends Public company Stage

Capital Gains NonTaxable taxable 10,000 10,0001

5,000

10,000

20,000

(2,633)

(3,833)

2,367

6,167

20,000

4,733

Refund on payment of dividend: @ 30⅔% of investment income @ 38⅓% of portfolio dividends

1,533 -

3,833

3,067 -

Available for payment of dividend

3,900

10,000

20,000

7,800

3,900

10,000

20,000

7,800

585

3,800

3,000

1,170

Income for taxes

4,485

13,800

23,000

8,970

Tax @ 50% Less: eligible dividend tax credit (6/11 Fed & 5/11 assumed Prov) non-eligible dividend tax credit (assume 9/13 Fed & 4/13 assumed Prov)

2,243

6,900

11,500

4,485

(3,800)

(585) 1,658

3,100

(3,000) 8,500

(1,170) 3,315

High Income Limited (net after refund) Susan Total

1,100 1,658 2,758

3,100 3,100

8,500 8,500

2,200 3,315 5,515

Tax paid on equivalent amount of income if received directly by Susan (a)

2,500

3,1002

8,500

5,000

515

Susan (assumes 50% combined rate) Dividend received Gross-up (38% on eligible dividends 15% on other-than-eligible dividends)

Net tax paid

(5,267)

Summary of tax paid

Cost /(Benefit) of incorporation

258

322 Tax paid by High Income Limited before paying dividend (b) Deferral / (prepayment) of tax through High Income Limited (a)-(b)

Introduction to Federal Income Taxation in Canada

2,633

3,833

5,267

(133)

(733)

8,500

(267)

1 - This amount would be added to the corporations capital dividend account and can be distributed to Susan tax-free after filing an election 2 - The calculation would be identical to the one presented above where dividends flow to Susan through the corporation.

Schedule 2 - Tax consequences of incorporating the scarf retail business Corporation Income from active business Corporate tax (@ 14%) Available for dividend Susan Dividend Add: gross up (15%) Income subject to tax Personal tax before credit (@ 50%) Dividend tax credit (assume equal to gross up) Net tax Add: tax paid by corporation Total tax Tax on income if unincorporated (50% of $200,000) Tax cost/(savings) of incorporation Tax deferral/(prepayment) available through incorporation ((B) – (A))

$200,000 (28,000) $172,000 $172,000 25,800 $197,800 98,900 (25,800) 73,100 28,000 $ 101,100 $ 100,000 $1,100 $ 72,000

(A) (B)

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Solution 24: Share Ownership The main issue in this case is whether the companies are associated. 1. Shareholder agreements • The mandatory buyout “option” on retirement will cause the buyout to have been deemed to have taken place for purposes of the associated company rules. [IT-64R (cancelled) 4; ssec. 256(1.4)] 2. Holdco and Sales Co. • Mickey and Joe are not related. • Holdco and Sales should be associated only by the buy/sell provisions of the shareholder agreement [par. 256(1)(a)]. • If Joe owns another company, then that company may be associated with Sales Co. and, therefore, associated with all the other companies by subsection 256(2). • The preference shares are specified shares [ssec. 256(1.1)] and should not cause any association of companies. • Need to consider de facto control [ssec. 256(5.1)(5.11)]. 3. Retail One Inc. and Retail Two Inc. • Holdco and Fred are a group which controls both companies so Retail One and Retail Two are associated [par. 256(1)(b)]. 4. Holdco and Retail One • Holdco and Retail One are associated because one controls the other [par. 256(1)(a)]. 5. Holdco and Retail Two • Holdco and Retail Two are associated since they are both associated with Retail One [ssec. 256(2)]. However, they can elect and make no allocation of the business limit to Retail One so that it is not eligible for the Small Business Deduction. 6. Sales and Retail One • Sales and Retail One are associated since they are both controlled by Holdco as a result of Holdco controlling sales through the buy/sell provisions. 7. Ours Inc. and Mine Inc. • Nicki is deemed to own 60% of Ours Inc. o therefore, the cross-ownership test is met and they are associated [par. 256(1)(d)]. 8. Trust • Each of the children is deemed to own the shares of Kids are Fun Inc. [par. 256(1.2)(f)]. • Each of Mickey and Nicki are deemed to own the shares of the children [ssec. 256(1.3)]. • With that deemed ownership by each of the parents, Kids are Fun Inc. will be associated with all of Mickey’s companies and Nicki’s companies.

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Solution 25: Comprehensive Corporate Tax using Problem Solving Process for Tax A)

Assess the Situation

Stakeholders

Caroline

Jeff

ACB $500 50% CS

50% CS

ACB $500

Jets Traders Ltd. (Jets)

100%

Sports Freaks Ltd (SFI)

Relationships a. Jeff and Caroline • related through marriage b.

• affiliated through marriage Jeff/Caroline and Jets • related because Jeff/Caroline is part of a related group controlling the corporation,

• affiliated because Jeff/Caroline is part of an affiliated group controlling the corporation. Jeff/Caroline and SFI • related because Jeff controls SFL • related because Caroline is related to Jeff who controls SFL

• affiliated because Caroline is the spouse of Jeff who controls SFL Jets and SFL • related because Jeff controls SFL and is related to himself and Caroline who controls Jets as an related group. • affiliated because Jeff controls SFL and is affiliated with himself and Caroline who controls Jets as an affiliated group. • associated because Jeff controls SFL and is related to each member of a group who controls Jets and Jeff owns not less than 25% of the issued shares of a class of Jets (not a specified class of shares).

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Tax Profile a. Jeff – Individual, 36, salary and dividends b. Caroline – Individual, 35, salary and dividends c. 2 Children - minors d. Jet Traders/Sports Freaks Ltd. Canadian-controlled private corporation.

•

Private corporation

•

Canadian corporation

•

Not controlled directly or indirectly in any manner whatever (de facto control) by non-resident persons or public corporations

•

No shares listed on a designated stock exchange

•

SFI does not have passive income

• Jets – large distribution business with passive income Jets tax balances: NCL, NERDTOH, RDTOH, GRIP, Taxable capital

Client/Objectives Client: Jeff Objectives: Determine when his corporate tax/HST filings and payments are required. Identify information he needs to provide for returns and real estate sale. Determine tax treatment and HST considerations re: real estate sale. Determine Schedule 1, Division C deductions and SBD availability (partner’s request). Understand the tax treatment of types of income Jets earns/tax rate. Understand the impact of the dividend payments to Jeff/Caroline in 2023 Determine after-tax cash from dividends. Future dividend planning (identified by partner) Determine entries to book tax provision. Timeline/Key Transactions 2007 – Incorporation Jets 2019 – Class 8 property acquired $152,500 2020 – real estate purchase $150K 2023 – real estate sale $455K 2023 – sale of Class 8 equipment sold $175,500 2023 – sale of Class 14.1 franchise $330K December 31, 2023 Year End Now – January 15, 2024 Future – dividends likely B) Identify the Issues 1) 2) 3) 4)

Identification of types of income, type of tax, tax rate applicable to income earned by the corporation. Tax/HST treatment of the land disposition. Identify Schedule 1/Division C adjustments Availability of Small Business Deduction (considering clawbacks)

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326 5)

Tax treatment of dividend payments (past and future) a. Dividend refund/refundable taxes/RDTOH balances i. Corporate impact ii. Personal tax treatment to Jeff/Caroline (Marginal tax rates to Jeff/Caroline & after-tax cash) iii. Future dividend planning b. Future dividend planning (Impact (benefit) of paying eligible vs. non-eligible dividends). Financial reporting entries/Tax/HST filing & payment requirements

C) Analyze the Issues Issue 1 - Identification of types of income, type of tax, tax rate applicable to income earned by the corporation. •

Profit from business operations is active business income earned in Canada from the distribution business. The company has a PE in Manitoba sells into Ontario. The SBD if available can be applied which would reduce the federal tax rate to 9%. Without the SBD the GRR will apply and reduce the federal tax rate to 15%.

•

Royalty income and interest on long term bonds is property income included in aggregate investment income. Refundable taxes apply.

•

Interest on accounts receivable is incidental to active business income and therefore is treated as ABI

•

Rental income is property income unless characterized as business income i.e. a rental business. In either case it is included in aggregate investment income unless a rental business has more than 5 full-time employees.

•

Dividends are from non-connected corporations and are subject to Part IV tax. A Division C deduction ensure Part 1 tax does not apply to dividends from Canadian corporations.

•

Gain on the sale of the land investment can either be business income and included in ABI or a capital gain, 50% of which is included in AII. See Issue 2 below for an analysis of the treatment. Income Type

Type of Tax

Tax Rate

Profit from distribution business

ABI

Part I

9% (38-10-19) SBD 15%(38-10-13) no SBD

Royalty income

AII

Part I including ART

38.67% (38-10+10.67)

Interest on outstanding accounts receivable

ABI

Part I

9% (38-10-19)

Rental income

AII

Part I including ART

38.67% (38-10+10.67)

Interest income from fiveyear bonds

AII

Part I including ART

38.67% (38-10+10.67)

Dividend on public company share investment

AII (Portfolio)

Part IV

38.33%

Information requirements; •

Determine whether there is a PE in Ontario. The company has a warehouse in Ontario but is rented to a third party. Should discuss with the client whether there are activities/employees in Ontario. Conclusion: The CCPC has both ABI and AII and dividends subject to Part IV tax. Refundable taxes will need to be considered.

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Issue 2 - Tax/HST treatment of the land disposition. •

We need to determine if the disposition results in a capital gain or business income.

•

The badges of trade based on case law should be considered to assess whether there was primary or secondary intent to hold the property as a capital property when acquired

•

The property was held for 3 years and there is no indication of it being used for any purpose.

•

The disposition has no relationship to Jets business.

•

The intended use was for a potential warehouse expansion. This needs to be investigated. Is there any documentation available to support this as the primary intention? Eg. expansion drawings etc.

•

The business does not appear to habitually enter into real estate transactions

•

Appears likely that at least a secondary intention to resell for a profit could be argued due to bargain price paid. Was that a signficant motivation when it was acquired?

•

Should find out the zoned use of the property.

•

Was it a financed purchase? Doesn’t appear to be as there is no loan interest on the P&L

•

The company should be registered for GST (Manitoba has a 5% GST)

•

Real estate sales to a registrant require the purchaser to self-assess the GST and claim an ITC if eligible. Information requirements; •

Obtain information on the primary intention for the use of the property when the real estate was acquired and any secondary intention to resell for a profit. This should be well documented to support the treatment on the return.

•

The land sale agreement should be reviewed to review the clauses impacting the the collection/remittance of GST, ensure that the purchaser was a registrant and self-assessed the GST.

• Interest/property tax that should be added to ACB? Conclusion: It would be better to treat the disposition of the land as a capital disposition as only 50% of the capital gain will be taxed and 30.67% of the taxable capital gain will be refundable Part 1 tax to be refunded when non-eligible dividends are paid out. [vs. 100% taxable at 9% federal rate if SBD applies or 15% federal rate if no SBD available] We should collect information and document support for treatment as a capital disposition and discuss potential risk of reassessment with Jeff. Capital gains treatment will impact SBD availability in 2024. SBD limit will be fully clawed back for 2024 Issue 3 - Identify Schedule 1/Division C adjustments The following Schedule 1 adjustments can be identified from the information provided. The calculation starts with net income after tax and requires the following adjustments to determine Division B income. We are assuming that the land disposition will be treated as capital (can be supported). Schedule 1 Adjustments Net Income per F/Ss Addback; Tax Provision Depreciation Donations TCG Land TCG PPE Recapture Deduct; CCA (info needed) Gain on sale of land Gain on sale of PPE Division B

1,020,000

214,000 95,000 12,500 152,500 63,000 32,500

305,000 126,000 1,158,500

Introduction to Federal Income Taxation in Canada

328 Schedule 8 (Information needed) UCC 145,000 202,000

Class 8 Class 14.1

LCP Recapture 152,500 -7,500 227,000 -25,000

Taxable Capital Gains Equipment

Franchise

Land

175,500 152,500 23,000 11,500

330,000 227,000 103,000 51,500

455,000 150,000 305,000 152,500

PofD ACB CG TCG

Information Requirements o o

Ending UCC balances from 2022 return and all 2023 additions, dispositions to be able to calculate CCA. Detailed breakdown of administrative expenses to determine if there are non-deductible expenses that need to be added back on Schedule 1 eg. M&E

The following Division C deductions can be identified from the information provided Division C Deductions Net capital losses (sufficient TCGs) Charitable donations (including CF) Dividends

14,500 not discretionary 12,500 not discretionary 9,000

Issue 4 - Availability of Small Business Deduction in 2023 and 2024 2023 • • • • •

The small business deduction limit for 2023 is impacted by passive investment income for 2022 Passive investment income includes TCGs from the disposition of non-active capital properties, property income and dividends from non-connected corporations. The following calculation using the financial statements for 2022 identified property income and dividends from connected corporations totalling $76,500 resulting in a partial clawback in the SBD limit for 2023. SFL (an associated company) does not have passive investment income to impact the calculation. The following is the calculation of adjusted aggregate investment income for 2023;

Solutions to Chapter 12 Assignment Problems

329

2024 •

The small business deduction limit for 2024 is impacted by passive investment income for 2024

•

Only TCGs from the sale of land is included in AAII (non-active) if treated as a disposition of capital property.

•

The TCGs on the equipment and franchise are from the disposition of active capital assets.

•

Dividends are included because they are from non-connected corporations.

•

Net capital losses are not deducted in calculating AAII.

•

The following is the calculation of adjusted aggregate investment income for 2024. Column A assumes TCG treatment for the land disposition. Column B assumes business income treatment for the land disposition;

TCGs Royalties Rental income Interest Dividends Less:Dividends Net CLs AAII Clawback (AAII - $50,000)*5 SBD Remaining ($500,000 - Clawback)

AAII for 2024 AAII for 2024 (A) (B) 152,500 15,000 15,000 36,500 36,500 10,000 10,000 9,000 9,000 223,000 70,500

223,000

70,500

865,000

102,500 397,500

Information Requirements: It would useful to obtain forecasted income information for 2024 to be able to assess the impact of the 2024 small business deduction clawback. Conclusion: The available SBD limit for the 2023 tax return for Jets is $367,500. $50,000 of the SBD limit could be allocated to SFL as the SBD must be shared among associated corporations. The available SBD limit for the

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Introduction to Federal Income Taxation in Canada

2024 tax return for Jets is dependant on the characterization of the disposition of the land for tax purposes. The SBD limit is completely eliminated if the land disposition is a capital disposition.

Solutions to Chapter 12 Assignment Problems

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Issue 5 - Tax treatment of dividend payments/dividend tax planning 1) Dividend refund/refundable taxes •

The non-eligible dividend payments during the year of $165,000 ($45K x 3 + $30K) will result in a refund of NERDTOH

•

Refundable Part I tax on Jet’s AII for the year will be added to the NERDTOH account for the year.

•

Part IV Tax on the dividends from non-connected companies will be added to the ERDTOH account for the year. As no eligible dividends were paid, there will not be refund of ERDTOH.

•

As the NERDTOH is not fully exhausted (as calculated below), a refund of ERDTOH will not result.

•

The opening balance of Non-eligible RDTOH is $2,000

•

The rental income of the warehouse does not appear to be supportable as incidental to active business income and would be treated as property income.

•

The following is the calculation of AII for 2023 assuming the disposition of the land is treated as a capital disposition;

TCGs Royalties Rental Income Interest Dividends Less: Dividends Net CLs AII

AAII for 2023 215,500 15,000 36,500 10,000 9,000 286,000 (9,000) (14,500) 262,500

•

Refundable Part 1 Tax on AII of $262,500 x 30.67% will be equal to $80,500

•

The dividend refund of Non-eligible RDTOH will be ; Lesser of; 1) 38.33% of 165,000 = $63,249 2) ($80,500 + $2,000) = $82,500

Conclusion: The 2023 dividends will result in a refund of NERDTOH of $63,249. After the dividend refund the company will have an NERDTOH balance of $19,251 and a ERDTOH of $9,200 [$3,450 + $5,750]. The January, 2024 non-eligible dividend will result in a further refund of NERDTOH. 2)

Marginal tax rates to Jeff/Caroline & after-tax cash from dividends •

Jeff has employment income of $100,000 for 2023. Additional income will fall primarily into the 41% tax bracket.

•

Caroline has employment income of $50,000 for 2023. Additional income will fall primarily into the 32.5% tax bracket.

•

The marginal tax rates applying to the next dollar of income received as dividends is as follows; Jeff $100,000 salary plus $82,500 ($165,000 dividends/2) = $182,500 32.2% (.41 x 1.15 - .15) up to $165,430

Introduction to Federal Income Taxation in Canada

332 37.9% (.46 x 1.15 - .15) up to $235,675

Caroline $50,000 salary plus $82,500 = $132,500 22.4% (.325x1.15-.15) up to $106,717 32.2% (.41x1.15 - .15) up to $165,430 3)

Dividend Planning • •

Part IV Tax on the dividends from non-connected companies will be added to the ERDTOH account for the year. As no eligible dividends were paid, there will not be a refund of ERDTOH. The Part IV Tax on the $9,000 dividend at 38.33% is $3,450 and the opening balance of ERDTOH is $5,750.

•

An eligible dividend should have been designated from GRIP for $24,000 to obtain a refund of the $9,200 of eligible RDTOH.

•

A marginal rate of 25.5% (.46x1.38-.38) would have applied to Jeff’s $12,000 dividend (savings of $1,488 (37.9%-25.5%)x12,000 for Jeff)

•

A marginal rate of 18.6% (.41x1.38-.38) would have applied to Caroline’s $12,000 dividend (savings of $1,632 (32.2%-18.6%)x12,000 for Caroline).

Conclusions: Taking into account the marginal tax rates applicable to the dividends received, the after tax cash Jeff will receive is $50,196 = $82,500 – $32,304 ($392x22.4% + $50,195x.322 + $42,355x.379). The after tax cash Caroline will receive is $56,906 = $82,500 – $25,594 ( $197x .138+ $50,195x.224 $11,244 + $44,483x.322($14,323)) For 2023, an eligible dividend of $24,000 could have been paid and would have been subject to a lower personal marginal tax rate when received by Jeff & Caroline. See recommendations below for future dividend planning. Issue 6 - Financial reporting entries, Tax/HST filing & payment requirements •

The tax entries that should be made in the financial statements for the tax provision using the taxes payable method of financial reporting for income taxes.

•

Assumes that dividends are likely to be paid in the future which appears to be the case.

DR Tax Payable $214,000 CR Tax Provision $214,000 Reverses booked provision DR Tax Provision DR Retained Earnings [$3,450+$80,500-$63,249] $20,701 CR Tax Payable Current year tax provision

$249,299 $270,000

•

The 2023 HST return must be filed and the payment made by March 31, 2024 because the company has revenues of $1.5M or less)

•

Quarterly instalments would have been required for 2023 as it is likely that the net tax for 2022 was $3,000 or more.

•

Corporate return is due June 30, 2024.

•

Corporate tax payable March 31, 2024 if SBD is claimed on the 2023 or 2022 tax returns and taxable income of the associated group of companies was less than the SBD limit for 2022. Otherwise February 28, 2024

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Information required: We will need a breakdown of the administrative expenses to determine the adjustments needed to prepare the HST return. We also need to know how much the company paid in instalments during 2023. Need copies of the 2022 tax returns for the companies to determine tax payment due date. Advise/Recommend Summary of Tax Planning Recommendations Further information and a review of available documentation regarding the land disposition is needed to determine a supportable tax position in regards to reporting the disposition of land on the 2023 tax return. Forecasted financial information for 2024 would be useful to assist in the analysis of the impact on the 2024 tax liability of Jets. Position for TCG treatment should be well documented. Tax planning to reduce the level of passive income in Jets should be considered to maximize the tax deferral/minimize tax in Jets for future years. Earning property income in a corporation is not tax effective (there is an overall tax cost to earning AII even after the income is distributed as a dividend and a dividend refund received). Jeff should consider whether the bonds, franchise rights and public company shares should be held personally instead of in the corporation. In the future, where the company has a GRIP balance and ERDTOH, eligible dividends should be paid/designated from GRIP to obtain a refund of ERDTOH and minimize personal tax for Jeff and Caroline.

CHAPTER 13 Shareholder-Manager Remuneration and Tax Planning for the Owner-Manager

Solution 1 – Salary vs Dividends

Assess the Situation Establish the facts 1. Draw a diagram identifying all stakeholders and their relationships, e.g. corporate org charts.

Jamal Uppal 100%

Father (CPA) Salary or Dividend?

Tax Intel Ltd 2. Identify the relationships among the shareholders e.g. related, affiliated, associated, connected a. Jamal controls Tax Intel Ltd. and is related and affiliated b. Jamal’s father – related/non-arm’s length to Jamal, related/non-arm’s length to Tax Intel Ltd. 3. Identify the profile of each stakeholder e.g. tax features, risk profile a. Jamal i. Canadian resident ii. Individual iii. No income other than from company b. Tax Intel Ltd. i. CCPC ii. Varying amounts of income in the question

4. Understand the client/decision maker and their objectives Jamal wants to receive all of the $50K of business income for 2023 as salary or dividends Jamal wants to increase salary to $180K for 2024 Jamal wants to pay his father $40K for 2024 Jamal wants to retain $435K in the corporation for reinvestment for 2024 333

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Wants to understand the pros/cons of bonus vs dividends Wants to know if it is better to retain all of the after-tax income in the corporation. 5. Identify the relevant past transaction/events or planned future transactions/events and create a timeline. − 2023- salary of $50,000 or dividends of after-tax profit of corporation − 2024 – possible bonus or dividends to bring after-tax cash in the company to $435,000, salary increase to $180,000

Identify the Issues 1. Identify all of the major tax issues and any non-tax issues a. How should Jamal take compensation out of the company? −

Salary vs. dividends for 2023

−

Bonus vs. dividends for 2024 or retain in corporation

b. Tax treatment of $40,000 salary to father in 2024

Analyze the Issues A. How should Jamal take compensation out of the company? a. Salary vs. dividends for 2023 Jamal just started earning income from his business. He is expecting to have sufficient profits to pay himself a $50,000 of salary. This is his only source of income. Would you prefer to receive your compensation as $30,000 of salary or a dividend of the after-tax profit? The below calculation compares salary of $50,000 without considering payroll deductions to dividend payments of after-tax corporate income of $43,500.

Solutions to Chapter 13 Assignment Problems

Corporation Business Income Salary Taxable Income Corporate Tax (13%) Dividend (Non-eligible) After-tax Cash Shareholder Salary Dividend Gross Up (15%) Taxable Income Tax Credits Basic Personal Employment Dividend Tax Credit Tax Payable After-tax Cash

335

Salary

Dividend

50,000 (50,000) -

50,000 50,000 (6,500) 43,500 -

50,000

50,000 12,500 1 2

(3,750) (342)

8,408 41,592

Tax cost - dividend

43,500 6,525 50,025 12,506 (3,750) (6,525) 2,231 41,269 323

1.$15,000 x 25% 2. $1,368 x 25% 3. (9/13+4/13) x $6,525 The salary option is marginally better without considering CPP contributions. Other considerations:

−

Salary has the corporate and personal CPP contributions and the related deduction/credit to be considered. The employee and employer CPP contributions on $50,000 of salary would be $2,767 ($50,000-$3,500) x 5.95% each for the year. The employer portion of $2,767 would be deductible by the corporation. The employee portion of $2,302 ($50,000-$3,500) x 4.95% would result in a personal tax credit of $575 plus a deduction for the enhanced CPP amount for the employee of $465. Note that the company would need to come up with $2,767 less the tax saved through the tax deduction to pay the employer portion of the CPP

−

T4 reporting

−

RRSP Room - $50,000 of salary creates $9,000 of RRSP contribution room for Jamal that he can take advantage of in 2024.

−

Child Care Deduction. Unlikely a consideration for Jamal.

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B. Bonus vs. dividends for 2024 or retain in corporation For 2024, Jamal’s company is projected to make $600,000 after the salary payments of $220,000. Should he declare a bonus of $100,000 to leave $435,000 in the company? Should he pay a dividend equal to the amount needed to bring the corporate cash to $435,000? Should he leave the funds in the corporation for reinvestment?

Retain Corporation Business Income Bonus Taxable Income Corporate Tax Dividend (Eligible) After-tax Cash Shareholder Salary Bonus Dividend (Eligible) Gross Up (38%) Taxable Income Personal Tax Credits Basic Personal Dividend Tax Credit Tax Payable After-tax Cash

600,000

$100K Bonus $73K Dividend

600,000 (92,000)

600,000 (100,000) 500,000 (65,000)

508,000

435,000

180,000

180,000 100,000

600,000 600,000 (92,000) (73,000) 435,000

180,000 73,000 27,740 280,740 109,599

180,000 61,455

280,000 109,229

(3,673)

(3,380)

57,782 122,218

105,849 174,152

(3,380) (27,740) 78,479 174,522

Total After-tax Cash (A+B)

630,218

609,152

609,522

Total Tax Paid (C+D)

149,782

170,849

170,479

3 4

D B

1. 13% for the first $500K eligible for the small business deduction. 27% for income above the small business deduction. 2. Dividend is designated as an eligible dividend paid from the GRIP. The company has $73,000 of income not eligible for the small business deduction that would become GRIP. 3. The basic personal credit base is fully clawed down where income is above the highest tax bracket. It is partially clawed down when the income is in the 4th highest tax bracket.

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4. [6/11+5/11] x $27,740 Jamal would be indifferent between the bonus and dividend options because there is close to perfect integration. However, the most cash is preserved by leaving the money in the corporation, as he would be deferring the second level of tax and distributions as salary or dividends to the shareholder. There is a tax deferral benefit of that can be reinvested in the corporation $100,000 x (marginal tax rate on $100K(at 46% & 50%) - 27% corporate tax rate)

Other considerations: −

Does Jamal need the cash, personally or in the company?

−

CPP, RRSP room and EI for the child care deduction are already maximized through your salary.

Tax treatment of $40,000 salary to father in 2024 As long as the salary is reasonable for the work performed it is a deductible expense to the corporation. Payroll withholdings are required. As well a T4 slip must be issued to the father by February 28, 2025.

Advise/recommend For 2023, Jamal should pay salary to create RRSP contribution room that he can take advantage of in 2024. However, the CPP employer and employee payroll costs should be discussed with him. For 2024, if Jamal does not need the cash personally from the year end bonus or dividend he would be best to retain the funds in the corporation to take advantage of a tax deferral. Even if the funds are not needed in the business and were invested in property income earning investments there would not be sufficient passive income to impact the small business deduction limit for the corporation. The QSBC status of the corporation should be considered if Jamal has plans to sell the shares of the company in the future.

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Introduction to Federal Income Taxation in Canada

Solution 2: GAAR The following attempts to apply the logic represented in Exhibit 13-10. The particular application of the logic and the conclusions reached are a matter of judgment, in the absence of interpretation of the law by the courts. (1) (a) Does any other provision of the Act or other rule of law apply to stop the taxpayer from achieving the intended advantage? ......................................... (b) Does the transaction result, directly or indirectly, in a tax benefit, as defined in ssec. 245(1), i.e., a reduction, avoidance or deferral of tax or an increase in a refund? .............................................. (c) Is the transaction part of a series of transactions which would result, directly or indirectly, in a tax benefit? .................................................................. (e) Can it reasonably be considered that the transaction would result, directly or indirectly, in a misuse of the provisions of the Act or an abuse having regard to the provisions of the Act read as a whole? .................................................................

(2) (3) (4) (5) (answers should be read down the columns)

No(1)

No(6)

No(11)

No(13)

No(18)

Yes(2)

Yes(7)

Maybe(12)

Yes(14)

Maybe(19)

Yes(3)

Yes(8)

Maybe

Yes(15)

Maybe

Yes(5)

No(10)

Maybe

No(17)

Maybe

—NOTES TO SOLUTION (1) The contribution and the withdrawal are specifically permitted under the Act. (2) A deferral of tax will be achieved with the contribution and, depending upon the marginal tax rate in the year of withdrawal, there may be a tax saving. (3) Since each transaction hinges on the other, these transactions could be considered a series. However, since the answer to (b) was yes, then (d) can be addressed directly after (b). (4) It may be possible to argue that the contribution was made for bona fide reasons, but an unanticipated need for cash necessitated the withdrawal. This argument is not likely to be successful when the withdrawal follows the contribution within a short period of time or when the same transactions are repeated over a period of years. (5) Each transaction is specifically permitted under the Act. However, there may be a misuse of these provisions or an abuse of the Act read as a whole. In paragraph 5 of Information Circular 88-2, the CRA states that “transactions that rely on specific provisions, whether incentive provisions or otherwise, for their tax consequences, or on general rules of the Act can be negated if these consequences are so inconsistent with the general scheme of the Act that they cannot have been within the contemplation of Parliament.” In this case, it can be argued that the RRSP provisions were intended to allow for a sheltered funding of retirement using the deferral mechanism of a deduction or contribution and taxation on withdrawal and that the quick withdrawal is an abuse. On the other hand, what was accomplished in this case was a one-year deferral of income and a deferral of income is contemplated by the scheme of the Act pertaining to an RRSP. (6) A gift to a spouse that does not result in the funds producing income from property is not subject to the attribution rules. The use of the gift to pay tax would not be considered to produce income from property. (7) The fact that second generation income generated by the loan is not taxed to the husband reduces his tax. (8) The cash gift to pay the taxes resulted in the wife having more cash to reinvest which would create more second-generation income. However, since the answer to (b) was yes, then (d) can be addressed directly after (b). (9) It may be possible to argue that the loan was primarily for a bona fide business, investment or family purpose, as indicated in paragraph 4 of Information Circular 88-2. However, facts must show that a tax benefit was not the primary purpose of the transaction.

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339

(10) IT-511R suggests, in paragraph 6, that compound interest, i.e., income on attributed income or “secondgeneration” income is not subject to income attribution. The CRA, thereby, suggests that this transaction is not a misuse or abuse of provisions of the Act. As a result, the GAAR should not apply. (11) The attribution rules only apply to transfers between individuals or between an individual and a corporation. (12) There may be no tax benefit from this transaction. The loan capital was paid from earnings of Wells Ltd. that had been taxed. That capital will earn income in Stieb Ltd. that will be taxed at the corporate rate applicable to the type of income generated. On the other hand, it might be possible to argue that the surplus in Wells Ltd. would otherwise have been distributed to Mrs. Hogart in the form of dividends which would have been taxed. Then, if she loaned the funds to Stieb Ltd., an attribution rule applicable to loans by individuals to a corporation i.e. corporate attribution (see Chapter 15) would have applied. Note that TOSI would apply to dividends paid from Stieb ltd. to the minor children and possibly also Mr. Hogart unless they meet the definition of an excluded amount. If so, the income splitting benefit to the transaction would be negated. (13) As long as the sale of the investments was at fair market value, then the Act has no prohibition on this transaction. The borrowing to purchase investments is specifically contemplated in paragraph 20(1)(c). (14) What was non-deductible interest is now technically tax-deductible. (15) See (14), above. (16) Having borrowed to purchase the house rather than to finance the investments initially, the restructuring of the debt could be regarded as a transaction to obtain the tax benefit of interest deductibility. (17) There is no misuse of provisions or an abuse of the Act read as a whole. Underlying tax policy allows the deduction of interest on funds borrowed to produce income from property. This series of transactions does not contravene that policy. Therefore, following common law guidelines for the interpretation of the GAAR, as applied in the OSFC case (2002 DTC 6742 (FCA) and applied, with approval, by the Supreme Court of Canada in subsequent cases), it can be concluded that there has been no misuse or abuse in this situation. (18) Subsection 56(4.1) only deals with individuals. (19) Case similar to situation (3). See Note (12). In this case, if the statement that the loan was made to avoid subsection 56(4.1) is taken literally, then there may be a misuse or an abuse in answer to (e). Note that TOSI could apply to dividends paid from Vancouver Hockey Puck Ltd., to the adult child unless they meet the definition of an excluded amount. If so, the income splitting benefit would be negated. The March 28, 2023 Federal Budget includes proposed amendments to the GAAR legislation in the ITA to clarify the intended application of the provision, lower the threshold for the determination of an avoidance transaction and require the application of an economic substance test when determining whether there is a misuse of the provisions or abuse of the ITA as a whole has occurred. The amendments also impose a penalty of 25% of the tax benefit resulting from the transaction subject to GAAR.

Solution 3: GAAR This problem is meant to bring out the CRA’s stated position on these issues as provided in Information Circular 88-2. In particular, this question addresses the issue of what the CRA views as a misuse of the provisions of the Act or an abuse having regard to the provisions of the Act read as a whole. (1) Paragraph 11 states that “there is nothing in section 125 (which provides for the small business deduction) or elsewhere in the Act that prohibits an individual from incorporating his or her business. The incorporation is consistent with the Act read as a whole and, therefore, subsection 245(2) would not apply to the transfer of the business to the corporation.” (2) Paragraph 17 states that “there is no provision in the Act requiring a salary to be paid in these or any other circumstances and the failure to pay a salary is therefore not contrary to the scheme of the Act read as a whole. Subsection 245(2) would not apply to deem a salary to be paid by the corporation or received by the individual.” (3) Paragraph 19 states that “the borrowing by the parent corporation is for the purpose of gaining or producing income as required by paragraph 20(1)(c) of the Act, and subsection 245(2) would, therefore, not apply.” (4) Paragraph 5 of Supplement 1 states that “the Explanatory Notes to Draft Legislation and Regulations Relating to Income Tax Reform issued by the Minister of Finance in June 1988 state that the transfer of income between related corporations that is accomplished using transactions that are legally effective would not usually result in a misuse of the provisions of the Act or an abuse of the Act read as a whole. The transactions between

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Profitco and Lossco, which are related corporations, would not therefore be considered an abuse of the Act read as a whole. This interpretation does not address the deductibility of interest payable by Profitco to its bank or to Lossco. Such interest will be deductible pursuant to paragraph 20(1)(c) of the Act provided that Profitco acquires the shares of Lossco for the purpose of earning income from the shares.” (5) Paragraph 14 states that “as the transfer of shares to the Newco is part of an arrangement undertaken to avoid the tax required by Part IV of the Act to be paid in respect of dividends received on portfolio shares, the transfer of the shares would be a misuse of a provision of the Act or an abuse of the Act read as a whole, and subsection 245(2) would be applied.” (6) Paragraph 24 states that “as the interposition of the intermediary is made solely to enable the owner of the property to defer recognition of the gain, the sale of the real property to the intermediary would be subject to subsection 245(2).” The March 28, 2023 Federal Budget includes proposed amendments to the GAAR legislation in the ITA to clarify the intended application of the provision, lower the threshold for the determination of an avoidance transaction and require the application of an economic substance test when determining whether there is a misuse of the provisions or abuse of the ITA as a whole has occurred. The amendments also impose a penalty of 25% of the tax benefit resulting from the transaction subject to GAAR.

Solutions to Chapter 13 Assignment Problems

341

Solution 4: Shareholder Benefit Assess the Situation 1.

Draw a diagram identifying all stakeholders, e.g., corporate org chart

Mia

PYU pays $2,000 monthly rent on her condo

100% Pump You Up Daughter (Mimi) – university student 2.

Identify the relationships among the stakeholders e.g. related, affiliated, associated, connected −

−

She is related to, and affiliated with, and non-arm’s length with the corporation

−

Daughter (Mimi) – related and non arm’s length with Mia and Pump You Up

Identify the profile of each stakeholder, e.g., tax features, risk profile −

Since Mia owns 100% of Pump You Up:

Mia −

Very little information

−

Mia is the sole shareholder and president (employee)

−

Mimi

−

Attending university – likely 17 or 18

Understand the decision maker and their objectives −

Mia is your client

−

Objectives:

−

There is an agreement that the company will pay rent on her apartment

−

Mia would like you to explain the tax consequences to Mia, Mimi and the company of the company transferring funds to her daughter for her tuition, paying for company-owned life insurance, paying for rent.

Identify the relevant past transaction/events or planned future transactions/events and create a timeline −

Past transactions – payment to Mimi for tuition, payment of life insurance premiums

−

Future transaction – next month is when PYU will start to pay the rent

−

There is time to amend the plan re: rent

Identify the Issues 1.

Identify all of the major tax issues and any non-tax issues −

Issue 1: Do the payments result in a benefit to Mia or Mimi? 1.

−

Discuss whether there is an employment benefit or shareholder benefit resulting from the following payments; rent, life insurance premiums, payment to Mimi

Issue 2: Are the payments deductible to the corporation?

Introduction to Federal Income Taxation in Canada

342 1. −

Discuss the deductibility of the payments to the corporation

Issue 3: Are there any HST considerations (not asked for in the problem) 1.

Discuss whether there are any input tax credits available, remittances required of the corporation.

Analyze the Major Issues 1.

Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act

Issue 1: Do the payments result in a taxable benefit to Mia or Mimi? Discuss whether there is an employment benefit or shareholder benefit resulting from the following payments; rent, life insurance premiums, payment to Mimi. Shareholder Benefit – Subsection 15(1) Does s. 15(1) apply?

−

Mia is a shareholder

−

She received a benefit from the company for payment of condo fees. Yes, s. 15(1) applies.

−

She received a benefit from the company for the payment to the daughter for her tuition. This would be a benefit conferred on Mia because of 15(1) & 56(2) – indirect payment Yes 15(1) applies.

She is not considered to have received a benefit for the life insurance premiums as the policyholder and beneficiary for the insurance is the company. No 15(1) does not apply (CRA’s administrative policy)

Benefits conferred on a shareholder by a corporation [ssec. 15(1)] are: −

Included in the shareholder’s income and

−

Are not deductible to the corporation.

There are a few specific exceptions in 15(1), but they relate to the disposition or acquisition of additional shares, none of which is applicable to this particular case.

Employment Benefit The benefits could not be considered an employee benefit, which would be included in employment income [par. 6(1)(a)], because the rental payment by the corporation and the tuition payment for her daughter would both be made because of Mia’s capacity as a shareholder. There is no evidence to support the argument that the corporation offers similar arrangements to other non-related employees. Life insurance premiums to a group term life insurance policy are fully taxable to an employee under subsection 6(4). This is not a group term policy. Life insurance premiums paid for life insurance that is not a group term policy would be a taxable benefit under 6(1)(a) if paid for Mia, she (or a family member) was the beneficiary of the life insurance and the insurance was paid in her capacity as an employee. Conclusion: Shareholder benefit of $2,000 per month for the rent and $9,000 of the tuition payment will be taxable to Mia in the year the payments were made. Life insurance premiums paid by the company will not result in a benefit/income inclusions to Mia.

Issue 2: Are the payments deductible to the corporation? Deductibility to Pump You Up Ltd.

Solutions to Chapter 13 Assignment Problems

343

Paragraph 18(1)(a) In addition to the amount being taxable to Mia, the amounts would not be deductible for tax purposes to Pump You Up Ltd. An expense is not deductible unless it was incurred for the purpose of earning income from the business. In this case, it is clear that there is no such purpose for either the rent or the tuition payments. Life insurance premiums paid by a corporation for a shareholder where the company is the policyholder and beneficiary are not deductible to the corporation unless the life insurance policy is collateral for a loan under 20(1)(e.2). [Note that life insurance premiums paid by a corporation for a shareholder where the shareholder is the policyholder and beneficiary, are paid for in the shareholder’s capacity as an employee and that are a reasonable business expense would be deductible to the corporation. This life insurance policy is a key person policy where the company is the policyholder and beneficiary] Conclusion: If Pump You Up Ltd. pays the rent for the condominium, Mia will be required to include a benefit from the corporation in her income and Pump You Up Ltd will not be able to deduct the expense. The same applies for the tuition payment to Mimi. The life insurance premiums are not taxable to Mia. They could only be deducted under 20(1)(e.2) if the policy was collateral for a loan.

Issue 3: Are there any HST considerations (not asked for in the problem) HST is not paid on long term residential rentals, or on life insurance premiums (financial institutions are exempt). No HST considerations.

Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format −

Identify risks including missing information, assumptions and uncertain research positions −

None needed

None identified

Reach a conclusion on each issue -

Shareholder benefit of $2,000 a month for the rent and $9,000 for the tuition payment will be taxable to Mia in the year the payments are made. Life insurance premiums paid by the company will not result in a benefit/income inclusion to Mia.

−

No HST considerations as HST is not paid on long term residential rentals i.e. exempt supply, universities are exempt and financial institutions are exempt.

Evaluate the strengths/weaknesses/risks of your conclusions −

Little risk as this would be consistent with CRA standard assessment

Advise/Recommend Advise the decision maker, integrating your conclusions on each of the issues with the client’s objectives, giving priority to the most important issues

Introduction to Federal Income Taxation in Canada

344 Alternative Plan

Instead of having the company pay the rent on the condo, Mia should consider receiving additional salary or a bonus to cover the rental cost. As long as the additional remuneration is reasonable, the amounts will be deductible by the corporation. The income to Mia would be the same. −

This recommendation will avoid double tax.

For Mimi, if she works for the company during weekends/summer, reasonable amounts could be paid to her for her work and would be deductible to the corporation and would be subject to little tax because of the basic personal amount credit and low graduated tax rates. Mimi could use the after-tax amounts to pay for her tuition.

Solutions to Chapter 13 Assignment Problems

345

Solution 5: Shareholder Loans Benefit on share purchase loan As there are bona fide arrangements in place for repayment of the share purchase loan within a reasonable time, and the loan is one of those within the exceptions to 15(2) in subsection 15(2.4), the loan amount is not included in Kristie’s income. Interest benefit under section 80.4 Year 1

Year 2

Year 3

$150,000 × 2% × 275/365 = Less actual interest paid at 1% × 275/365 Taxable benefit $125,000 × 2% Less actual interest paid at 1% Taxable benefit $100,000 × 2% Less actual interest paid at 1% Taxable benefit

$2,260 1,130 $1,130 $2,500 1,250 $1,250 $2,000 1,000 $1,000

Under section 80.5, the taxable benefit is deemed to be interest paid for the purposes of paragraph 20(1)(c). As the loan is for investment purposes, the actual interest paid, plus the taxable benefit interest, is deductible by Kristie in determining her income for tax purposes. Benefit on the other loan As the loan for the motor home and boat is not within one of the exceptions provided for at subsection 15(2), and it was not repaid within one year after the Year 1 fiscal year end, it is fully included in Kristie’s Year 1 income. No imputed interest benefit applies to this loan as subsection 80.4(3) exempts any loan included in income from the imputed interest benefit. In Year 3, Kristie will be able to deduct the $25,000 she repaid as a deduction under paragraph 20(1)(j).

Introduction to Federal Income Taxation in Canada

346 Solution 6: Shareholder Loans

Note to Instructors: The facts of the case have been revised as follows: The housing loan was increased from $250K to $300K repayable over 30 years.

Assess the Situation 1.

Draw a diagram identifying all stakeholders, e.g., corporate org charts

1. Joe (Son) Cdn resident employee

related Mr. Scott – President connected Cdn resident employee

related 5%

95% related affiliated

Skies Limited CCPC

Harry VP Sales not related

December 31 yr end

Identify the relationships among the stakeholders, e.g., related, affiliated, associated, connected − Mr. Scott – controls Skies o

As a result, he is related to and affiliated with Skies

− Mr. Scott and son are related but not affiliated o

As a result, Joe (son) is also related to Skies

Mr. Scott and Joe are “connected” for purposes of s. 15(2) (NAL)

− Harry is not related to or affiliated with any of Mr. Scott, Joe or Skies.

Solutions to Chapter 13 Assignment Problems 3.

Identify the profile of each stakeholder, e.g., tax features, risk profile −

−

Mr. Scott o

Individual

Resident of Canada

Owns 95% of Skies

Employee of Skies (President)

Joe (Son) o

Individual

Resident of Canada

Owns 5% of Skies

Employee of Skies

Skies Limited o

−

CCPC since controlled by Canadian residents

Harry o

Individual resident in Canada

Employee of Skies (VP Sales)

Understand the decision maker and their objectives −

Mr. Scott is the decision maker

−

He would like to understand the tax implications to him, Joe, Harry and Skies Ltd. of the shareholder loans

Identify the relevant past transaction/events or planned future transactions/events and create a timeline

Mr. Scott received a loan to buy a house on June 1, 2023 i. $300,000 @ 1% ii. Repay over 30 years @ $10,000/year Harry received a loan to buy a car on June 1, 2023 i. $24,000 @ 0% ii. Repay over 5 years @ $4,800/year Joe received a loan to buy shares on August 1, 2023 i. $18,000 @ 0% ii. Repay over 10 years @ $1,800/year

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348 Timeline: June 1 300K loan to Mr. Scott 24K loan to Harry

Aug 1 $18K loan to Joe

June 1 $10K repayment

Aug 1 $1,800 repayment

31-May $4,800 repaymt

2023

2024 Now - February 2024

Identify the Issues 1.

Identify all of the major tax issues and any non-tax issues Issue 1 Tax treatment of loans to shareholders & employees Loans to shareholders can be an alternative form of compensation and a way to receive the cash without paying personal tax. There are rules in place to deal with whether the principal should be included in the shareholder’s income or whether there should be a deemed interest benefit. 1) 2) 3) 4)

Tax treatment of loan to Mr. Scott for $300K to purchase a house. Tax treatment of loan to Harry for $24K to purchase a car. Tax treatment of loan to Joe for $18K to purchase unissued shares of Skies Ltd. Tax implications to Skies Ltd.

For each of the above 1) to 3) (Qualitative); a. Does 15(2) apply to include the loan in the recipient’s income in 2023 b. If so, is there an exception applicable? Was the loan received by virtue of employment or shareholding? c. If there is no 15(2) inclusion, is there an interest benefit under 80.4? a. Calculate the benefit (Quantitative) d. If there is an interest benefit, can the recipient deduct the benefit?

Identify missing information or assumptions made −

None

Analyze the Issues 1.

Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act

Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format Determine whether s. 15(2) applies −

Since both Mr. Scott and Joe are shareholders and received a loan then s. 15(2) will apply

−

Harry is not a shareholder or connected with a shareholder. As a result, 15(2) does not apply.

Is an exception to 15(2) available? Identify the factors for determining whether a loan is received by virtue of employment or shareholding

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349

Capacity Issue: Employee vs. Shareholder [15(2.4)(e)] S. 15(2) only requires that the individual actually be a shareholder for its provisions to apply. To meet the exception in 15(2.4)(e) the person must have received the loan because of “the employee’s employment and not because of any person’s shareholdings”.

To receive a loan by virtue of employment −

Other unrelated employees are also entitled to receive this type of loan under these conditions

−

Other unrelated employees have actually received these loans

−

Did the person receive the loan “in his capacity as” or “because they were” an employee?

To receive a loan by virtue of shareholding −

Did the person receive the loan “in his capacity as” or “because they were” a shareholder?

1) Tax treatment of loan to Mr. Scott for $300K 1% to purchase a house. Does 15(2) apply? Yes. Mr Scott is a shareholder. 20(1)(j) deduction $10K on 2024 return. Received by virtue of employment or shareholding? By virtue of shareholding. As a result 15(2.4)(e) is not met and the only exemption is 15(2.6) 1. Need to determine if similar loans are available to arm’s length employees. Does not appear to be the case as the employee loan plan is only for loans up to $25,000 i.e. not similar. 2. Loan to Harry is to an arm’s length employee (and possibly others under the loan plan) but loan not similar. This loan is significantly larger than loans available under the plan. Is there an exception applicable? Won’t be repaid by December 31, 2024. 15(2.6) is not met. If no 15(2), is there an interest benefit under 80.4? • No interest benefit unless repaid by December 31, 2024 If repaid, interest benefit will not be based on lesser of 4% rate when loan received and quarterly prescribed rates because loan is not received by virtue of employment (interest rate is higher than quarterly rates anyways). If, the loan is argued to have been received by virtue of being an employee (rather than a shareholder) then subsection 80.4(1) would apply to impute an interest benefit for 2023 computed as follows: −

lesser of [80.4(4)]: 1. interest at the prescribed rate in effect during the quarterly period in the year the loan was outstanding, and 2. interest at the prescribed rate in effect at the time the loan was made.

• this “lesser of” choice can be made on a quarter-by-quarter comparison of interest rates. • Reduce by actual 1% paid if paid within 30 days of the end of the year. Calculate the benefit (Quantitative) N/A If there is an interest benefit, can the recipient deduct the benefit? No deduction Conclusion: 15(2) inclusion on 2023 return for $290,000 ($300,000 less $10,000 repayments within 1 year of end of the taxation year end of the company). Future repayments are deductible under 20(1)(j) in the year of repayment.

Notes to analysis of the home purchase loan to Mr. Scott: If the loan principal is taken into income, then the subsection 80.4(2) interest benefit that may have been included on the 2023 return will be reversed;

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Interest Benefit: 30/365 x 4% x $300,000 + 184/365 x 3% x $300,000 = $986 + $4,537 = $5,523 Less: Interest Paid: 214/365 x 1% x $300,000 = $1,759 Net Benefit = $3,764 − −

while section 80.5 deems this interest benefit to be interest paid pursuant to a legal obligation to pay interest, it is not deductible, because the purpose of the loan was not to produce income [par. 20(1)(c)]

Received by virtue of employment or shareholding and risk of reassessment −

Mr. Scott is president so he is an employee; he is also a shareholder

−

The tax impact is smaller if he receives the loan by virtue of employment as only the interest benefit is included in income.

−

If the loan is treated as received by virtue of employment then there would be a high probability of reassessment

−

Strong support for treating the loan as received by virtue of shareholding. This has a low risk of reassessment

2) Tax treatment of loan to Harry for $24K 0% to purchase a car. Does 15(2) apply? No. Harry is not a shareholder, not connected with a shareholder Received by virtue of employment or shareholding? N/A Is there an exception applicable? N/A If no 15(2), is there an interest benefit under 80.4? • Interest benefit 80.4(1), Deemed paid 80.5 Calculate the benefit (Quantitative) Since the loan was received by virtue of being an employee subsection 80.4(1) applies to impute an interest benefit for 2023 computed as follows: 2023 $24K [4%x30/365] +$24K [3% x 92/365] + $24K [3%x92/365] = $442 2024 $24K [2%x150/365] + $19,200[2%x215/365] = 423 − If there is an interest benefit, can the recipient deduct the benefit? The employment use portion is deductible against any commission income earned by Harry [8(1)(f), (j)], because the purpose of the loan was to produce income [par. 20(1)(c)]. $442 x 70% (employment mileage/total mileage) = $309 Conclusion: 15(2) N/A. Interest benefit on 2023 and future returns. 8(1)(f)(j) deduction on 2023 and future returns.

−

3) Tax treatment of loan to Joe for 0% $180K to purchase unissued shares of Skies Ltd.

Does 15(2) apply? Yes. Joe is a shareholder. Received by virtue of employment or shareholding? By virtue of employment. Joe appears to have received the loan in his capacity as an employee per 15(2.4)(e).Similar loans are available to arm’s length employees up to $25,000 for any purpose. Loan to Harry who is to an arm’s length employee for a similar amount.

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351

Is there an exception applicable? Won’t be repaid by December 31, 2024 Loan is to a specified employee (Mr. Scott is a specified shareholder (owns not less than 10% of shares of the company and Joe is non-arm’s length with Mr. Scott). Specified employee/shareholder definitions in 248(1) Not Met Loan was used to purchase unissued shares of the corporation. Bona fide repayment terms to repay the loan over 10 years (Is 10 years a reasonable repayment term?) Met Paragraphs 15(2.4)(c) and (f) would exclude the principal amount of this loan from income because of its purpose (to purchase unissued shares of the corporation) and because bona fide arrangements were made, when the loan was granted, for repayment within a reasonable time. If no 15(2), is there an interest benefit under 80.4? • Interest benefit • Calculate interest on balance outstanding at quarterly prescribed rates Calculate the benefit (Quantitative) There would be no subsection 15(2) inclusion, but subsection 80.4(1) would apply to impute an interest benefit to the son for 2023, computed as follows: 2023

153*/365  .03  $18,000 =

226

2024 212/365 x .2% x $18,000 + 153/365 x 2% x $16,200 = $345 If there is an interest benefit, can the recipient deduct the benefit? Yes Section 80.5 deems this imputed interest to be interest paid pursuant to a legal obligation and, therefore, it will be deductible, since the shares can be expected to produce income from property [20(1)(c)(i)]. * The day on which the loan is granted is counted, but the last day of the loan is not counted, under normal commercial practice followed by the CRA.

Conclusion: No 15(2) inclusion on 2023 return. Interest benefit under subsection 80.4(1) on 2023 and future returns. Notes to analysis of the share purchase loan to Joe

Risk of reassessment −

Joe is vice president so he is an employee; he is also a shareholder

−

The tax impact is smaller if he receives the loan by virtue of employment

−

If the loan is treated as received by virtue of employment, then there could be a possibility of reassessment as it may be unlikely that other arm’s length employees could use loans under the plan to receive shares of the company. [ although the plan does say the loans can be used for any purpose]

−

The loan amount is low and within the $25K limit under the employee loan plan. There is a low risk of reassessment

− Skies Limited treatment of the loans −

Regardless of how the loans to Joe and Mr. Scott are treated for tax purposes, it would be accounted for as a related party transaction (ASPE 3840) and disclosed on the balance sheet.

−

Regardless of how the loan to Harry is treated for tax purposes, it would be accounted for as a loan to an employee and disclosed on the balance sheet.

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352

−

No interest is reported in Skies since none is charged on Joe or Harry’s loans.

−

The interest income is accrued annually on Mr. Scott’s loan. It would be property income included in aggregate investment income of Skies Limited.

−

For any deemed interest benefit on loans received by virtue of employment the benefit will need to be reported on the T4 of the employee.

−

For any deemed interest benefit on loans received by virtue of shareholding the benefit will need to be reported on the T5 of the shareholder.

Identify risks including missing information, assumptions and uncertain research positions −

Reach a conclusion on each issue −

None identified

Refer to notes above

Evaluate the strengths/weaknesses/risks of your conclusions −

High chance of reassessment if Mr. Scott treats the loan as received by virtue of employment and does not include the loan in income.

−

Low chance of reassessment if Joe treats the loan as received by virtue of employment and does not include the loan in income.

Advise/Recommend Advise the decision maker, integrating your conclusions on each of the issues with their objectives, giving priority to the most important issues Home Purchase Loan to Mr. Scott −

Likely to be loan by virtue of shareholding

−

Must be repaid by December 31, 2024 or loan principal must be included in Mr. Scott’s income in 2023

−

The deemed interest benefit may have been included in Mr. Scott’s income in 2023. This should be reversed if the principal is required to be taken into income. Ultimately, no deemed interest benefit if loan principal taken into income

−

Deductions to Mr. Scott when loan is repaid

−

Recommend: Mr. Scott repay the loan by December 31, 2024 to avoid the income inclusion

−

Interest benefit on 2023 return will be $3,764 calculated above. 2024 interest benefit [$300K x 2%]x151/365 +$290Kx2%x214/365 – [$300K x 1%x151/365] - $300K x 1% x 214/365 = $2,941. Ensure he pays the interest within 30 days of year end. Will need to get a mortgage from the bank to repay or pay salary/dividends from the company to repay the loan.

− − −

Car Purchase Loan to Harry −

Loan by virtue of employment

−

A deemed interest benefit must be included in Harry’s income in 2023 and future years.

Share Purchase Loan to Joe −

Loan by virtue of employment

−

The deemed interest benefit must be included in Joe’s income in 2023 and future years. Interest benefit on 2023 return will be [$18K x 3% x 61/365 + $18K x 3% 92/365] = $226. 2024 $18K x 2% x 212/365 + $16,200 x 2% x 153/365 = $345

Solutions to Chapter 13 Assignment Problems −

Recommend: Document support for 15(2.4) exception. Claim offsetting deduction 20(1)(c) of $226 2023, $345 2024.

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Introduction to Federal Income Taxation in Canada

354 Solution 7: Shareholder Loans

(A) Subsection 15(2): By virtue of shareholding Since Stuart is a shareholder, subsection 15(2) will apply to include the $100,000 in his 2023 income, unless one of the three exceptions are met (i.e., either subsection 15(2.3), 15(2.4), or 15(2.6)). — The only exception that can apply is subsection 15(2.6) — that is, repayment of the loan within one year of the end of the taxation year in which the loan was made (December 31, 2024 deadline). — The other two exception tests do not apply: — subsection 15(2.3) does not apply since lending money is not Stuart Publishing’s ordinary business; and — paragraph 15(2.4)(b) does not apply because: — even though the loan was made to purchase a house and Stuart is an employee, it is not reasonable to conclude that he received the loan because of his employment since it is not a company policy to make such loans to employees and no other loans have been made to employees on similar conditions [paragraph 15(2.4)(e)]. Conclusion: The $100,000 principal amount of the loan (less the repayment made before December 31, 2024) will, therefore, be included in Stuart’s income in 2023 unless the full amount is repaid by December 31, 2024 [ssecs. 15(2), (2.6)]. — If the $100,000 is included in income in 2023 under subsection 15(2), the $20,000 repayment on May 1, 2024 will be deductible in 2024 [par. 20(1)(j)]. Administratively, the net amount can be included on the 2023 return. Recommendation: Repay the $100,000 loan by December 31, 2024. Section 80.4 Interest benefit On December 31, 2023, it is not known whether the one-year condition will be met, because Stuart has until December 31, 2024 to repay the loan. As a result, Stuart could exclude the loan from his income for 2023. Since the loan is received by virtue of Stuart’s shareholding, the interest benefit is computed under the rules in subsection 80.4(2) and included in Stuart’s income from property [ssec. 15(9)]. — The interest benefit in 2023 is: May to June: 61/365  $100,000  4% ................. July to Sept.: 92/365  $100,000  5% ................. Oct. to Dec.: 92/365  $100,000  4%..................

668 1,260 1,008 $ 2,936

Conclusion: If the principal amount of the loan is included in income under subsection 15(2) (because the loan is not repaid by December 31, 2024), there will be no interest benefit from the loan [par. 80.4(3)(b)]. — the 2023 return would be initially filed to include the $2,937 interest benefit, — the 2023 return will have to be amended to include the loan and remove the interest benefit, — the 2024 situation will be known before the 2024 return has to be filed. (B) Subsection 15(2): By virtue of employment The subsection 15(2.4) employee exception test applies because: — the loan is used to purchase a dwelling for Stuart’s inhabitation [par. 15(2.4)(b)]; — Note that one of the three purpose tests in paragraph 15(2.4)(b), (c), or (d) must apply, since Stuart meets the definition of a specified employee in subsection 248(1), that is, because he is a majority shareholder; he owns more than 10% of the shares; — it is reasonable to conclude that Stuart received the loan by virtue of employment since it is a company policy to make such loans to employees and other loans have been made to employees on similar conditions [par. 15(2.4)(e)]; — there are bona fide arrangements (made at the time of loan) for repayment within a reasonable time and the loan is not a series of loans and repayments [par. 15(2.4)(e)]; — a mortgage would qualify as a bona fide arrangement because taking back a mortgage as security is normal commercial practice for a housing loan; and — a five-year term with annual repayments of 1/5 each year is reasonable (perhaps more than reasonable) compared to commercial practice.

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Conclusion: Since the subsection 15(2.4) exception test is met, Stuart will have no subsection 15(2) inclusion in income. Section 80.4: Interest benefit Since subsection 15(2) does not apply, Stuart will report an interest benefit. Since the loan is made by virtue of employment, the interest benefit will be calculated under subsection 80.4(1) and included in employment income under subsection 6(9). Since the loan is calculated under subsection 80.4(1) and it is for the purchase of a home, it will qualify as a home purchase loan [par. 80.4(7)(a)], which means that, for the entire five-year term, the 4% prescribed rate effective in May 1, 2023 can be used to compute the benefit if it is lower than the prescribed rate in effect in that particular quarter [ssec. 80.4(4)]. In this case, the prescribed rate is lower than the prescribed rate in the third quarter by 1%. — The subsection 80.4(1) interest benefit for 2023 is: May to June: 61/365  $100,000  4% ................... July to Sept.: 92/365  $100,000  4% ................... Oct. to Dec.: 92/365  $100,000  4%....................

668 1,008 1,008 2,684

— The subsection 80.4(1) interest benefit in 2024 is based on the 4% prescribed interest rate when the loan was granted, since it is less than the 5% rate in effect for that year: Jan. to Apr: $100,000  4%...................................................... May to Dec: $80,000x4%......................................................... 2,148

1,315

(C) Subsection 15(2): By virtue of employment Since Stuart now owns less than 10% of the shares of Sunshine Publishing Limited, he is no longer a specified employee [par. 15(2.4)(a)]. His loan, therefore, does not have to meet any purpose test [par. 15(2.4)(b), (c), or (d)] in order to be exempt from subsection 15(2) as long as it meets the conditions in paragraphs 15(2.4)(e) and (f). Therefore subsection 15(2) does not apply to include Stuart’s loan to purchase a rental property in his 2023 income. Section 80.4: Interest benefit Subsections 80.4(1) and 6(9) apply because the loan received is received by virtue of employment; the interest benefit is therefore included as employment income. However, the loan cannot be a home purchase loan because it is a loan to buy a rental property. The amount of the subsection 80.4(1) benefit is, therefore, the same as the amount of the subsection 80.4(2) benefit: $2,936 in 2023 (Part (A)), and $4,329 in 2024 [$100,000x5%x120/365+$80,000x5%x245/365].

These imputed interest benefits are deemed to be interest paid [sec. 80.5]. Therefore, the interest may be deducted from rental income [par. 20(1)(c)].

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Solution 8: Incorporation, Compensation Note to Instructors: Personal credits have been increased to $2,500 federal and $1,700 provincial

(A) Income earned directly Personal tax Business income Tax on 1st Balance at 41% Less: federal personal tax credits Less: Provincial personal tax credits Total personal tax

150,000 $106,717 $43,283

30,681 17,746

Income earned through corporation Corporate tax Business income before salary Salary Taxable income Combined Federal and Provincial Tax @ 12%  $100,000 After-tax retained earnings Personal tax Salary received Tax on 1st $50,000 Balance at 32.5% Less: Federal personal tax credits Less: Provincial personal tax credit Total personal tax (B) Tax deferral on $88,000 in after-tax retained earnings Salary Dividend Gross Up (15%) Taxable income Tax on 1st $106,717 Balance at 41% $44,483 Less: Federal personal tax credit Less: Provincial personal credit Dividend Tax Credit (assumed equal to gross up) Total tax Less tax paid on $50,000 salary (above) Amount of personal tax deferred until payment of dividend

48,427 (2,500) (1,700) 44,227

150,000 (50,000) 100,000 (12,000) 88,000 50,000 12,500 (2,500) (1,700) 8,300

50,000 88,000 13,200 151,200 $30,681 18,238

48,919 (2,500) (1,700) (13,200) 31,519 (8,300) 23,219

Note that if Nancy received the dividend today, she would pay $708 less tax (see below) than if she earned the income directly (or received a $150,000 salary from her company). There is close to perfect integration of personal and corporate taxes, i.e., a small tax saving when the combined federal provincial corporate tax rate is 12% which is below the perfect integration rate of 13%. The $708 tax saving is in addition to the tax deferral benefit of incorporation of $23,219. Therefore, Nancy benefits from both a tax deferral and future tax savings through incorporating the income. Note that payroll deductions (CPP) will offset the tax savings but result in a future source of retirement income.

Solutions to Chapter 13 Assignment Problems Comparison Personal tax paid now on $150,000 Tax paid now if incorporated Corporate tax Personal tax on $50,000 salary Tax paid later on dividend Tax cost (savings) of incorporation ($44,227 - $43,519)

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44,227 12,000 8,300 20,300 23,219 43,519 (708)

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Solution 9: Incorporation, Compensation Note to Instructors: The facts of the case have been revised as follows: Corporate provincial tax rate has been reduced to 3% resulting in a combined rate of 12%. Personal credits have been increased to $7,900 federal/provincial including the spousal credit.

Assess the Situation 1. Draw a diagram identifying stakeholders Mrs. Edwards (49)

Mrs Edwards

Proprietorship

Corporation

Mr. Edwards – 50 doesn’t work Child – 16 high school Child – 19 university

2. Identify the relationships among the stakeholders, e.g., related, affiliated, associated, connected Mrs Edwards will control her corporation. Related/affiliated/NAL Mr Edwards – related/affiliated/NAL with Mrs. Edwards and corporation Mrs. Edwards controls.

Solutions to Chapter 13 Assignment Problems

3. Identify the profile of each stakeholder, e.g., tax features, risk profile Business – Ms Edwards sole proprietor, business income $310K on individual’s tax return, taxed at graduated tax rates. Personal credits of $7,900. Corporation – CCPC, $310K ABI eligible for SBD, 12% tax rate Children – 1 minor child Mr Edwards does not work.

4. Understand the decision maker and their objectives Decision maker – Mrs. Edwards Objectives – • Incorporate her business. • Receive $120K salary to pay for personal expenses. • Reinvest in the business. • Understand how much of 2023 tax she will pay if she incorporates. • Possibly income split with family members

5. Identify the relevant past transactions/events or planned future transactions/events and create a timeline. Future – Incorporation, salary or dividend payments

359

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Identify the issues Issue 1: Should Mrs. Edwards incorporate her business? Qualitative: Discuss benefits/cons to incorporation. Quantitative: Calculate tax deferral benefit, tax cost/savings to incorporation A) Calculate tax unincorporated vs. incorporated with $120K salary

What is the purpose of this calculation? What are you trying to show the client? B) Calculate tax deferral benefit of incorporation of the income.

What is the benefit of the tax deferral to Ms. Edwards and her business? C) Calculate tax cost/savings of incorporation once income fully distributed to

Ms Edwards. What is the purpose of this calculation? What are you trying to show the client? Issue 2: Should Mrs. Edwards split income with her family members? If so how? Qualitative: Discuss income splitting options available and potential tax consequences What is the objective in splitting income?

Analysis: Issue 1: Should Mrs. Edwards incorporate her business? Qualitative: Discuss benefits/cons to incorporation. Benefits to incorporating? Limited liability, use of the capital gains exemption in the future, tax deferral benefit because of low corporate tax rates Cons to incorporating? Incorporation costs, ongoing admin/filing costs, more difficult to access funds

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Quantitative: Calculate tax unincorporated vs. incorporated with $120K salary

Unincorporated Earned Directly Business income (A) Personal Tax Tax on 1st Balance @50% Credits Tax (B) After - tax personal cash (A-B)

310,000 235,675 74,325

87,066 37,163

124,229 (7,900) 116,329 193,672

Incorporated

Corporate Tax Business income before salary Salary Paid Taxable Income Corporate Tax 12% (38%-10%-19%+3%) After- Tax Retained Earnings Personal Tax Salary (A) Personal Tax Tax on 1st Balance @41% Credits Tax (B) After-tax personal cash (A-B)

310,000 (120,000) 190,000 (22,800) 167,200 120,000 106,717 13,283

30,681 5,446

Total after-tax cash

A) Calculate tax deferral benefit of incorporation of the income. Tax deferred of $65,301 ($258,973-$193,672) Is this a tax saving? Why is this deferred tax? What allows her to defer the tax? Conclusion:

36,127 (7,900) 28,227 91,773 258,973

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Mrs Edwards can defer $65,301 of tax by incorporating her business income because she doesn’t need all of the after-tax income for her personal use (only $120K). She can use the deferred amount to reinvest in the business.

B) Calculate tax cost/savings of incorporation once income fully distributed to Ms Edwards. Unincorporated Business income (A) Personal Tax Tax on 1st Balance @50% Credits Tax (B) After - tax personal cash (A-B)

310,000 235,675 74,325

87,066 37,163

124,229 (7,900) 116,329 193,672

Incorporated Business Income Salary Paid Taxable Income Corporate Tax Available for a Dividend

310,000 (120,000) 190,000 (22,800) 167,200

Salary Dividend Gross Up (15%) Taxable Income

120,000 167,200 25,080 312,280

Personal Tax Tax on 1st Balance @50% Personal Credits Dividend Tax Credit Total Tax After-tax Cash

Tax saved = $1,140 [194,812-193,672]

235,675 76,605

87,066 38,303

125,369 (7,900) (25,080) 92,389 194,812

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Note that the clawback of the basic personal amount credit is not reflected in the calculation. The clawback would reduce the credit to $3,380 from $3,750 for 2023 where taxable income exceeds the highest tax bracket of $235,675. Conclusion: Small tax savings at a corporate rate of 12% results of $1,140. [Note that there could be tax savings if dividends are paid in a year when taxed in a lower tax bracket (pay dividends over time in lower brackets) or could be paid to family members in lower tax brackets.] Recommendation: Mrs. Edwards should incorporate to take advantage of the significant tax deferral $65,301. She can time future dividend distributions to save tax by taking advantage of lower tax brackets.

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Part D) Income Splitting Suggestions Can Ms. Edwards split income with her husband and/or children through dividends or salary? What is the benefit to doing so? See Paragraph 13,270. Framework What is Split Income? Taxable dividends received from a private company When does the tax apply? Dividend is not an excluded amount. Dividend is coming from a “related business” How does it impact the individual’s personal return? High rate of tax 50% and DTC available Why does TOSI exist? Limits opportunities to split income with family members who have little involvement/investment in the business. Prevents splitting of income of professional corporations/service businesses. Who will it impact? Minors (almost always) – TOSI generally applies to all dividends from private companies Age 18 to 24 (likely) – TOSI applies unless actively engaged in the business OR made an investment in capital of the corporation (safe harbour or reasonable return on arm’s length capital (investment of own funds)). Age 25 and older (possibly) – TOSI applies unless actively engaged in the business OR made an investment in capital of the corporation (reasonable return) or own 10% of the votes and value of the corporation (not if the shares are shares of professional corporations, corporations with service businesses (90% test), or holding companies (advanced)) Age 65 and older spouse (usually not) – depends whether spouse (65 or older) would be subject to TOSI

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Qualitative Mrs. Edwards could potentially split income with her husband and children if they own shares in the company or through the payment of salaries. Spousal RRSPs could also be considered Option 1: Have Mr. Edwards/children own shares and receive dividends TOSI needs to be considered. If TOSI applies then there is no benefit to be gained. However there may be other benefits to family members owning shares e.g. future use of the capital gains exemption. TOSI Analysis Mr. Edwards/children – specified individuals (resident in Canada), minor child has a parent resident in Canada Split income – taxable dividends from private corporations Derived from a related business – a business carried on by Ms. Edwards (a source individual) and a business of a corporation where a source individual owns shares worth 10% of the value of the corporation. Child age 16 – Under 18 years old - Dividends will not be an excluded amount Child age 19 – Age 18 to 24 years old -

Dividends will be an excluded amount if; o From an excluded business – actively engaged in the business ▪ The child works at least 20 hours a week during the part of the year the business operates (unlikely) o A safe harbour capital return = 4% of FMV of property contributed (prescribed rate for 1st quarter of 2023) o A reasonable return on arm’s length capital – a question of fact, child needs to have own funds to contribute to the corporation Mr. Edwards – Over 25 years old - Dividends will be an excluded amount if; o From an excluded business – actively engaged in the business ▪ works at least 20 hours a week during the part of the year the business operates (possible) o Shares are excluded shares = must hold 10% of votes and value, the company is not a service business or professional corporation or a holding company with 90% or more of income derived from a related business.

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o A reasonable return – a question of fact, based on property contributed, risks assumed, work performed etc. Conclusion: If Mr Edwards has his own funds available to invest in at least 10% of the common shares of the company (possible on incorporation) or will be working at least 20 hours per week during business operations there will be no opportunity to split income through dividends as TOSI will apply. It may be advantageous for family members to hold separate classes of shares to multiply the future use of the capital gains exemption. Option 2: Pay salaries to family members -

Must be reasonable Consider what an arm’s length employee would receive for the same position Because of the basic personal amount and Canada employment credit, at least $16,368 ($15,000+$1,368) can be earned tax free for 2023 and the amount received in excess of the basic personal amount up to $53,359 for 2023 is taxed at an assumed combined federal/personal tax rate of 25% (other credits may be available eg. CPP/EI) Ms. Edwards would lose married tax credit $15,000 x 25% = $3,750

Option 3: Spousal RRSP -

Ms. Edwards can contribute to spousal RRSP Withdrawals taxed at Mr Edwards lower graduated tax rates in future when he retires. Ms. Edward’s RRSP contribution room is impacted by her own and spousal RRSP contributions Must be in plan 2 years before withdrawal to avoid the attribution of the withdrawals to Ms. Edwards.

Recommendations: Split income with family members through salary payments to extent feasible and supportable. Discuss having Mr. Edwards be issued shares of the corporation on incorporation and work in the business at least 20 hours a week during the year so he could be paid dividends. If TOSI doesn’t apply, it is possible to pay up to $27,270 of dividends tax free to Mr. Edwards after the basic personal amount and dividend tax credit are applied (refer to Exhibit 13-8)

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Solution 10: Salary/Dividend Planning Note to Instructors: The facts of the case have been revised as follows: Personal credits have been increased to $7,842.

Under Option 1, if a salary of $66,600 is paid to maximize her CPP contribution then, based on the assumption given, her RRSP contribution will be $11,988. In order for her to have $75,000 before tax she will need to pay a dividend of $8,400 ($75,000–$66,600).

Ms Kroneman Salary CPP Deduction (Enhanced) RRSP Dividend Gross Up (15%) Taxable Income

Option 1 66,600 (631) (11,988) 8,400 1,260 63,641

Option 2 75,000 (631) (13,500)

Federal and Provincial Tax DTC (Assumed equal to gross up) Credits CPP credit Total tax paid After-tax cash CPP withheld/remitted

16,682 (1,260) (7,842) (781) 6,799 56,213 (3,754) 52,459 11,988 64,447

15,781 (7,842) (781) 7,158 54,342 (3,754) 50,588 13,500 64,088

RRSPs Total Personal Cash & Investments (A)

60,869

Federal and Provincial Tax: Option 1 13,340 + (63,64153,359)*.325 Option 2 13,340 + (60,869--53,359)*.325 CPP Credit: 3,123*.25 CPP Deduction: $3,754-$3,123

This compensation plan will result in the following cash available in the company for future dividends.

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Corporation Corporate Income Salary CPP Corporate Tax (12%) Dividend After-tax cash (B)

Option 1 140,000 (66,600) (3,754) 69,646 (8,357) (8,400) 52,888

Option 2 140,000 (75,000) (3,754) 61,246 (7,349) 53,896

Overall Funds Available (A+B)

117,335

117,984

Because the corporate rate is 12% generally there is a small tax saving to the payment of dividends relative to salary (13% is the rate of perfect integration). However, because salary results in a higher RRSP contribution room, overall Option 2 will be preferred and will result in a lower personal tax liability. Ms Kroneman is $649 better off ($117,984 - $117,335) with Option 2. Option 1 – Ms. Kroneman will have $52,459 available to pay for her personal expenses which is $1,871 more than Option 2. This is the result of the dividend tax credit and therefore lower personal marginal tax rate on dividends. However, she will have $1,512 less available in RRSP contribution room for 2024. The company will have $1,008 less available to invest in the business because dividends are not deductible. Option 2 – Ms. Kroneman will have $50,588 available to pay for her personal expenses but $1,512 more available in RRSP contribution room for 2024. This is due to the higher personal marginal tax rate applicable to salary over dividends. The company will have $1,008 more to invest in the business because salary is deductible. Conclusion: If $50,588 of after-tax cash is sufficient for Ms. Kroneman to pay for her personal living expenses, Option 2 is preferable. Option 2 also provides Ms. Kroneman with greater retirement savings over Option 1.

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Solution 11: Owner/Manager Advice This case deals primarily with the integration concept and secondarily with the attribution rules and TOSI. 1. Incorporate • Integration—should John continue to use a proprietorship or should he incorporate. • Consider whether he will have more cash left if he flows his income through a corporation or continues to use a proprietorship—this will determine the tax savings. As long as the combined corporate federal and provincial tax rates are close to the rates at which perfect integration results i.e. 13% (for income eligible for the small business deduction) tax savings will be negligible. •

•

Consider whether there will be more cash left if he earns the income in a corporation and then does not pay the dividend versus earning it in the proprietorship—this will determine the tax deferral. John can receive a tax deferral of the difference between the effective personal tax rate applying to his income (calculated using graduated tax rates; 25%, 32.5%, 41%, 46%, 50%) and the low corporate rate applying when income is eligible for the small business deduction. A significant tax deferral is available if he retains the business income in the corporation. To maximize the debt repayment, they will need to leave cash in the company to pay off the debt with income taxed at the low corporate rate. More after-tax cash will be available for repayments if the debt is held in the corporation. In order to buy the property, it will be cheaper to buy it with after-tax dollars earned in the corporation.

2. Attribution rules • Loans from a spouse are subject to the attribution rules [ssec. 74.1(1)] but if interest is charged at least at the prescribed rate (and paid within 30 days of the end of each year), then the exception in subsection 74.5(2) should apply. • Once the business is transferred to a corporation then the loan from Alison will be to the corporation. There may be corporate attribution [ssec. 74.4(2)] on the loan to the corporation but these rules will not apply if the corporation is a small business corporation. If it is not an SBC, then the deemed interest benefit will be reduced by the interest paid on this loan. [Refer to Chapter 15 for information on corporate attribution.] 3. Tax on Split Income • Income in respect of a debt obligation of a private corporation is subject to TOSI unless it meets the definition of an excluded amount. • Interest income earned by Alison on her loan to the business is income from a “related business”. • A related business is a business carried on by a related person (source individual) or a business of a corporation of which a source individual owns 10% of the FMV of all if the issued and outstanding shares of the corporation. •

If the interest is considered to be a “reasonable return” in regard to property contributed including the cash loaned to the business then it will be an excluded amount and not subject to TOSI.

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Solution 12: Tax Planning, GAAR Tax Avoidance, Aggressive Tax Planning and Effective Tax Planning Tax avoidance and aggressive tax planning relies on a strict interpretation of the legislation in the Income Tax Act (ITA). Effective tax planning considers the wording of the legislation in light of the object and spirit of the ITA. Individuals who plan their affairs using schemes to avoid tax hope to avoid paying taxes in the short term by, perhaps, circumventing the actual intent of the legislation. They do this by focusing on the exact legal wording of the Act. GAAR applies where abusive tax avoidance has taken place as opposed to aggressive tax planning. GAAR applies because there has been a misuse or abuse of the provisions of the ITA. Aggressive tax planning where GAAR is not applicable is tax planning that a court determines is legal, where there is no abuse or misuse of the provisions of the ITA. Such aggressive tax planning may instead be addressed through legislative amendments by the Department of Finance. This creates more legislation and adds to the complexity of the expanding Income Tax Act. In contrast, effective tax planning looks at the overall intent of the legislation and works within the conceptual framework to decrease the overall taxes paid over a multi-period timeframe. The transactions are planned within the object and spirit of the Act. Change in Tax Minimization Objective Charles needs to change his objective of tax minimization through circumventing the intent of the legislation. The Income Tax Act and the courts focus on the concepts of business purpose and substance over form. This is evidenced by the general anti-avoidance rule (section 245), which nullifies any transaction that provides a tax benefit that is not for a bona fide purpose and where there is a misuse or abuse of the provisions of the ITA. As well, the courts rule against transactions the economic substance of which does not fit within the language and purpose of the legislation (see Stubart Investments Ltd. v. The Queen, 84 DTC 6305 (S.C.C.)). If GAAR is successfully applied, Charles will have to repay the tax benefits he has construed and inevitably change his attitude towards tax planning if he hopes to decrease the overall taxes he pays in the future. When considering a tax planning strategy, Charles should consider the following potential consequences of CRA challenging an aggressive tax plan or abusive tax avoidance subject to GAAR; 1) 2) 3) 4)

The cost of the plan and its implementation. Potential costs of challenging reassessments (professional representation). Interest on unpaid tax should the objection be unsuccessful. The impact of uncertain tax positions on audited financial statements of the company.

Avoiding the Application of the GAAR By applying the concept of substance over form, taxpayers can focus on the legislative intent underlying tax rules. By doing such, they focus on effective tax planning rather than pure tax minimization. This ensures that transactions will not be reversed by the anti-avoidance provision of section 245, nor will the taxpayer be guilty of tax avoidance or tax evasion. In addition, taxpayers will enhance their ability to interpret tax rules, predict future tax changes, and achieve a broader understanding of the underlying tax principles. The March 28, 2023 Federal Budget includes proposed amendments to the GAAR legislation in the ITA to clarify the intended application of the provision, lower the threshold for the determination of an avoidance transaction and require the application of an economic substance test when determining whether there is a misuse of the provisions or abuse of the ITA as a whole has occurred. The amendments also impose a penalty of 25% of the tax benefit resulting from the transaction subject to GAAR.

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Solution 13: Purchase of a business, compensation Assess the Situation Draw a diagram identifying all stakeholders and their relationships, e.g., corporate org charts Roger

Related/affiliated

Samantha

Unrelated

Retired Dentist

2 Children (14, 17) Related

Greene Dentist

Greene Dentist Clinic

Potential CCPC

Greene Dentist

FMV $950K

Potential Proprietorship

Identify the relationships among the stakeholders e.g. related, affiliated, associated, connected −

Roger and Samantha are related (NAL) and affiliated by marriage

−

Roger and Samantha are not related to the vendor (Mr. Vander)

−

A corporation will be related (NAL) and affiliated with Roger and Samantha

−

Samantha is affiliated/related because she controls

−

Roger is related/affiliated because he is related/affiliated with Samantha who will control

−

Children –Related (NAL) to parents and Samantha’s company (Samantha controls)

−

Retired dentist – not related

Identify the profile of each stakeholder, e.g., tax features, risk profile −

Samantha – Canadian resident, dentist, 2021 RRSP room fully utilized

−

Roger - Canadian resident, employee, earns $150K/year

−

Proprietorship – FMV $950,000, Business income of $300K would be taxed on Samantha’s T1

−

Greene Dentist Clinic– CCPC, ABI eligible for SBD, can choose year end

−

Children Mark (14) and Hilary (17) – minors

−

Vendor (Mr. Vanderstam) – selling assets for $950K (inventory, equipment, leaseholds, goodwill)

Understand the decision maker and their objectives −

Purchase dental practice personally or in a corporation & advice on structuring the purchase, summarize tax non-tax benefits (partner request)

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Understand responsibilities for employees

−

Understand compensation if incorporate/plan cash flow/propose options (partner request)

−

Prioritize retirement savings/maximize RRSP contributions

−

Live on Roger’s income/Roger would have no ownership in dental practice

−

Use Samantha’s income to reinvest in dental practice (leasehold improvements/equipment), make loan repayments, retirement savings, mortgage repayments, other savings.

−

Determine how much tax depreciation she can claim in first year

−

Determine if she can repay loan faster if incorporates and how quickly

−

Repay loan asap and eliminate personal guarantee

−

Hire Hilary part-time & help with vehicle purchase/university living costs

−

Identify income splitting opportunities

Identify the relevant past transaction/events or planned future transactions/events and create a timeline −

2006 – Samantha graduated as dentist

−

February 2023 – maxed out RRSPs

−

September 30th 2023– today

−

Future - Before November 1st – Samantha or corporation borrows $950,000

−

Future – Before November 1st – Samantha may incorporate

−

November 1st, 2023 - assets of the dentist practice are to be purchased.

−

October 31, 2024 – First repayment of the bank loan

−

Identify the Issues Identify all of the major tax issues and any non-tax issues

Issue 1: Should Samantha purchase the practice personally or incorporate? Discuss considerations if Samantha buys the practice personally vs. using a corporation Quantitative: Calculate tax deferral benefit of incorporation.

Issue 2: If Samantha incorporates how would she be compensated? Options? Discuss tax and non-tax considerations of potential compensation options if business income is incorporated.

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Quantitative: Calculate after-tax cash to corporation/shareholder of proposed compensation options Issue 3: Income splitting/funding Hilary’s car and living expenses from business profits Discuss income splitting options/tax treatment of loans or the payment of expenses for Hilary.

Issue 4: Tax/HST Filing obligations/responsibilities re: employees Discuss income tax/HST return filing/payment requirements & payroll withholding obligations.

Issue 5: Tax Treatment of Assets Purchased Discuss income tax (tax depreciation available) and HST treatment of assets purchased

Analyze the Major Issues 1. Identify and perform the qualitative and quantitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act Issue 1: Should Samantha purchase the practice personally or incorporate? Option 1 – Proprietorship a) Qualitative considerations if Samantha buys the practice personally •

$300K of income taxed at graduated rates

•

Interest on loan deductible 20(1)(c)

•

She pays both employee and employer portion of CPP (2023 $3,754x2)

•

RRSP Room is lesser of 18% of prior year’s earned income and limit for the year.

•

For 2023, room is lesser of 18% of prior year’s (2022) earned income of $120,000 and limit of $30,780 or $21,600. Contribute by end of February, 2024

•

For 2024, room is lesser of 18% of 2023 earned income and limit of $31,560. Contribute approximately $27,000 by end of February, 2025 (see calc below).

•

Future years, she will have $300,000 of earned income and can contribute to the maximum available room.

•

Cash easily accessible

•

Less filing/admin cost

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b) Calculate after-tax cash if operate as a proprietorship

The below calculation determines the annual tax that would be paid if Samantha purchases the dental practice personally and operates it as a sole proprietorship. If Samantha operates as a sole proprietorship, the bank debt would be held personally.

2024 Greene Dental

Purchase Personally Proprietorship

Business Income (A) RRSP Deduction (2024) (B) Taxable Income

300,000 (27,000) 273,000

Tax Basic Personal Net Tax (C)

105,728 (3,380) 102,348

After-tax Cash (A-B-C) Repay Debt

170,652 (95,000) 75,652

RRSP Balance

27,000

Additional Repayments

75,652

Repayment Time

5.57

Assumption: We have assumed an RRSP contribution of $27,000 for 2024. If her salary for 2023 is $120,000 x 10/12 and business income is $300,000x2/12 her earned income will be $150,000. 18% of $150,000 will be $27,000 [ less than $31,560 max limit for 2024]. Conclusion: Samantha will have $75,652 of cash available after tax to make additional repayments on the $950K loan, repay the mortgage on the house and/or reinvest in the business. Could repay $950K loan in 5.6 years if the extra after-tax cash is used to repay the loan.

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Option 2 – Corporation a. Qualitative considerations if Samantha buys practice with a corporation. •

Significant tax deferral benefit comparing 13% corporate rate to personal rates of 25% to 50%

•

Professional/legal liability protection once personal guarantee is gone.

•

More after-tax cash is available to repay the bank loan held in the corporation.

•

Samantha will only pay tax personally on income received as salary or dividend

•

She can choose how much salary to take to create room for RRSP contributions/ensure CPP available in retirement

•

She can choose type/timing of compensation – divs/salary

•

Tax deferral available through choice of year end after June 30th

•

Interest on loan deductible 20(1)(c)

•

Close to perfect integration with a combined corporate rate of 13% on income eligible for the small business deduction results in no tax savings or cost to incorporating business income.

•

Incorporation costs

•

Tax filing/payroll costs (CPP) if salary is paid

•

Funds are less accessible as can only remove as salary, dividends or as a shareholder loan/advance.

Quantitative: i. Calculate tax deferral benefit of incorporation (Calculate after-tax cash if incorporate) If she incorporates, the bank debt would be held in the corporation and repayments would be made from after-tax corporate funds. If Samantha incorporates and doesn’t pay out any salary or dividends, she can take advantage of a tax deferral advantage.

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2024 Greene Dental

Incorporate [Retain income]

Business Income (A) Taxable Income Corporate Tax After-tax Cash Repay Debt

300,000 300,000 39,000 261,000 (95,000) 166,000 0 166,000 3.64

RRSP Balance Additional Repayments Repayment Time Conclusion:

There is a tax deferral benefit through incorporation of $63,348 per year that Samantha can take advantage of ($102,348 tax personally with RRSP deduction less: corporate tax of $39,000). If the business is incorporated, the company has $261,000 available to repay the debt each year relative to $170,652 if she isn’t incorporated (with RRSP deduction). This will allow the debt to be repaid by the corporation in 3.6 years. However, Samantha will not be able to make any RRSP contributions if all of the business income is retained in the corporation. Risks: Better to incorporate to protect her from professional liability issues. Repay loan asap to eliminate personal guarantee. Issue 2: Compensation Options? Qualitative considerations – Compensation options if incorporated Salary vs. Dividends -

Salary creates RRSP room and CPP contributions to support future retirement which meets one of her objectives. A salary of $171,000 would maximize RRSP room of $30,780 (using 2023 RRSP room calculation). A salary of $66,600 would maximize CPP contributions of $3,754 (using 2023 CPP rates).

Salary/dividends reduces the amount available in the corporation to repay corporate debt.

Either salary or dividends allow her to invest in a TFSA/pay down the personal mortgage.

Any salary or dividend payment will result in a loss of the tax deferral benefit through incorporation.

T4/T4 summary for salary & withholdings/payroll costs T5/T5 summary for dividends Perfect integration at 13% combined rate – no tax cost/savings of salary relative to dividends.

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Quantitative – Consider possible salary/dividend options A. Salary to maximize RRSP/salary to maximize CPP Pay sufficient salary to maximize RRSP room vs pay sufficient salary to maximize CPP contributions [or other reasonable options e.g. pay same amount of salary as prior years $120K] The CPP option results in more cash available in the corporation for reinvestment or debt repayments and overall results in more after-tax cash available because she would be taking greater advantage of the tax deferral benefit of incorporation. However, she will lose RRSP contribution room and the ability to maximize her tax-sheltered RRSP investments.

2024 Greene Dental

Incorporation Options Salary to Max RRSP Salary to Max CPP

Corporation Business Income Salary (used 2023 amt) Taxable Income Tax After-Tax Cash Debt Repayment Additional Repayments

300,000 (171,000) 129,000 (16,770) 112,230 (95,000) 17,230

300,000 (66,600) 233,400 (30,342) 203,058 (95,000) 108,058

Hilary Salary/Dividend RRSP Deduction (used 2023 limit) Taxable Income [A]

171,000 (30,780) 140,220

66,600 (11,988) 54,612

Tax Basic Personal Employment Net Tax [B]

44,417 (3,750) (342) 40,325

13,747 (3,750) (342) 9,655

After-tax Cash [A-B]

99,895

44,957

RRSP Balance Additional Repayments

30,780 117,125

11,988 153,015

4.48

3.83

Repayment Time Conclusions:

Due to close to perfect integration there is no tax cost or savings to dividends relative to salary payments. She could consider retaining as much after-tax cash in the corporation as possible to

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maximize corporate debt repayments and reinvest in the business or consider paying salary to maximize RRSP and CPP room under one of the 2 options above. After-tax personal funds could be invested in her TFSA or used to repay the personal mortgage or be reinvested into the corporation to make further debt repayments. Option 1 If Samantha incorporates and pays sufficient salary to maximize her RRSP room, after the $95,000 debt repayment she will have $117,125 after-tax cash available (personal and corporate). There will be $17,230 available for reinvestment or additional debt repayments in the corporation. The remainder $99,895 will be available to her personally to repay personal debt, reinvest in the corporation or personally in a TFSA. She will be able to make the maximum RRSP contribution of $30,780 (Note that we have included the RRSP deduction as the 2024 amount available – i.e., future tax savings from the RRSP deduction into our calculations). Option 2 If Samantha incorporates and pays sufficient salary to maximize her CPP contributions, after the $95,000 debt repayment and CPP contributions, she will have $153,015 after-tax cash available. There will be $108,058 available for reinvestment or additional debt repayments in the corporation. The remainder will be available personally to repay personal debt, reinvest in the corporation or personally in a TFSA. She will be able to make an RRSP contribution of 11,988 in 2024. Risks: Better to repay loan asap to eliminate the personal guarantee. Issue 3: Income splitting/funding Hilary’s car and living expenses from business profits • •

•

Family members can own shares in a professional corporation for dentists as long as the shares are non voting shares. Roger, Mark & Hilary could be issued non-voting shares of the corporation, however, TOSI will limit income splitting through dividends. Dividends would not meet the definition of excluded amounts as the children are currently minors and Roger will not be actively engaged in the business, shares of a professional corporation cannot be excluded shares. Roger would need to make a capital contribution for the shares and dividends would need to be a reasonable return on his investment to be excluded amounts. Roger and the children could be issued a separate class of non-voting common shares. Dividend payments would not be made on the shares as TOSI will apply. Issuing nonvoting common shares will allow future growth to increase the value of the shares and potentially multiply the future use of the capital gains exemption by the spouse, children. Hilary could be issued voting shares once she qualifies as a dentist which would allow for future income splitting opportunities through dividend payments without TOSI concerns if she is actively engaged in the business.

•

Income splitting through salary payments to Hilary and Mark could result in tax savings because of the basic personal credit available to each, tuition tax credits available to Hilary.

•

Salary to family members must be reasonable to be deductible to the business ITA 67

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• •

Business doesn’t need to be incorporated to split business income with family members. Allows Hilary and Mark to start accumulating RRSP contribution room and could set up RRSPs with letter of consent from parents.

•

Loans to Hilary for car/university costs will be subject to 15(2) if incorporated. She will be connected with a shareholder of the corporation. Her vehicle would not be used for employment purposes.

•

Payments to Hilary for a car/living expenses will be taxable as a shareholder benefit to Samantha 15(1)/56(2). No deductions will be available when calculating business income for the dental practice 18(1)(a)(h).

Conclusion: Employ both Hilary and Mark part-time. Document support for reasonableness of salaries paid. T4 slips required. Payroll withholdings (see below). Payments for tuition/car (see possible option below) should not be made from business income but paid with Samantha’s aftertax cash or from Hilary’s after-tax salary. Issue non-voting common shares to Roger, Mark & Hilary on incorporation to multiply future use of the capital gains exemption. Hilary can restructure her shares through a capital reorganization when she becomes a qualified dentist. Risks: Reasonableness of salaries should be well documented. Issue 4: Tax/HST Filing Obligations/Employee withholding obligations a. Proprietorship – T1 due June 15th, April 30th tax payment. Instalment payments will be required quarterly. b. Corporation – Due 6 months after tax year end. Tax is due 3 months after year end for CCPC with income eligible for SBD and perfect compliance, TI prior year below SBD limit, possibly quarterly instalments in second taxation year. c. HST Registration/Returns i. Most dental services are an exempt supply. However, if the dental practice provides cosmetic services or sells products not related to dental medical treatment, these supplies are taxable and ITC’s can be claimed for related expenses proportionately. Also, orthodontics are zero-rated supplies which means HST is not charged but ITC’s can be claimed for related expenses. CRA’s administrative position is that 1/3rd of overhead expenses qualify for ITC’s if orthodontic services are provided. If taxable and zero-rated supplies exceed $30,000 the dental practice is required to register. ii. Proprietor; Annual HST returns required to be filed by June 15th and tax is due April 30th iii. Corporation; Annual HST returns required to be filed 3 months after year end and tax is due the same date. d. Payroll remittances required for EI, CPP, Income Tax

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i. Due the 15 of the month following payment (or quarterly if qualify?) Conclusions: Review of classification of supplies should be performed to consider whether any HST ITCs can be claimed on future expenses. Dental practice should be registered for HST to ensure HST ITCs claimed for asset purchase or 167 election available (see below).

Issue 5: Tax Treatment of Assets Purchased Qualitative discussion – tax treatment of assets purchased • If Samantha purchases the assets personally, she will not be able to take a full deduction for the assets eligible for full expensing eg. Class 13 (leaseholds), Class 8 (Equipment), Class 50 (Computer equipment). Goodwill will be in Class 14.1 and is not eligible. Accelerated CCA will apply. • If Samantha will be able to take a full deduction for the assets eligible for full expensing eg. Class 13 (leaseholds), Class 8 (Equipment), Class 50 (Computer equipment) up to a $1.5M limit. Goodwill will be in Class 14.1 and is not eligible. The $1.5M limit will be prorated if there is a short year. HST considerations • Dr. Vanderstam will need to charge and remit HST on the sale of the inventory, equipment and leaseholds. • Goodwill is not subject to HST. • On the HST return for the period of purchase, the dental clinic will be able to claim a full input tax credit for the HST charged as the assets will be used 90% or more for commercial activities if it registers for HST. • Alternatively, 167 election may be available (See Chapter 21) if Greene Dental registers to eliminate HST on the transaction. Conclusion: If Samantha incorporates, the purchase price of the leaseholds and equipment may be fully deductible for tax purposes. The dental practice should register for HST to either claim ITCs for the properties purchased or file a 167 election. Risks: Ensure that purchase agreement includes a warranty from vendor that they are registered for HST.

Advise/Recommend Issue 1: Samantha should incorporate to take advantage of a significant tax deferral available through incorporation. Incorporation will protect her personal assets from liability (once the personal guarantee is gone). She will be able to deduct the cost of the leaseholds and equipment for tax purposes in the year of purchase (integrated with analysis of Issue 5 below). It will also allow her to repay the bank loan at least 2 years faster. Issue 2: Recommend payment of salary to Samantha to maximize RRSP contribution room. Use $17,230 in the corporation to reinvest in the business (leaseholds, equipment) as needed or increase debt repayments or make vehicle loans to employees/Hilary. $99,895 of after-tax cash she will have personally can be used to reinvest in or loan to the corporation and be used for debt

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repayments until the loan is completely repaid in 4.5 years. After that she could use the amounts to repay the mortgage on her house, or put savings into a TFSA. Issue 3: Minimize tax through income splitting with children through reasonable salary payments. Set up RRSPs for the children now so investment income can accumulate tax free/TFSAs when they are 18. Personal expenses should not be paid for by the corporation as double taxation results. Issue non-voting common shares of corporation to Roger, Hilary & Mark for nominal amounts on incorporation. Issue 4: Register corporation for HST when incorporate. Review activities of dental practice to maximize ITCs on any zero-rated and taxable supplies. Choose October 31, 2024 year end to defer tax/HST payments to January, 2025. Issue 5: File a joint 167 election with Mr. Vander for asset sale as long as eligibility requirements are met. Fully expense leaseholds and equipment (subject to pending legislation).

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Solution 14: Employment Income—Stock Options, Low Interest Loans, Company

Assess the Situation Draw a diagram identifying stakeholders

Ms. Mogul VP Marketing 2,500 CS shares (April, 2023)

Ganz Ltd.

Identify the relationships among the stakeholders, e.g., related, affiliated, associated, connected Ms. Mogul does not control Ganz Ltd. – not related. She will not be a specified employee of the company. Identify the profile of each stakeholder, e.g., tax features, risk profile Ms Mogul – individual, employed for full year Ganz Ltd – CCPC Understand the decision maker and their objectives Decision maker: Controller of Ganz Ltd. Objectives: Determine tax and HST consequences of proposed compensation package to Ganz Ltd. and Ms. Mogul. Identify the relevant past transactions/events or planned future transactions/events and create a timeline. Timeline: January 1, 2023 – Start date for new job January 1, 2023 – Stock options granted for 10,000 shares April 1, 2023 – Exercise stock options for 2,500 shares. Spring 2023 – will move to Toronto from Winnipeg, $250K 2% loan

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Identify the Issues A. Tax treatment salary/commissions B. Tax treatment of stock option exercise for 2,500 shares on April 1, 2023 C. Tax treatment of $50K 0% loan to acquire 2,500 shares a. Does 15(2) apply to include the loan in the Ms. Mogul’s income in 2023 b. Was the loan received by virtue of employment or shareholding? c. Is there an exception applicable? d. If there is no 15(2) inclusion, is there an interest benefit under 80.4? i. Calculate the benefit (Quantitative) e. If there is an interest benefit, can the recipient deduct the benefit? D. Tax treatment of $250K 2% loan to purchase a house a. Does 15(2) apply to include the loan in the Ms. Mogul’s income in 2023 b. Was the loan received by virtue of employment or shareholding? c. Is there an exception applicable? d. If there is no 15(2) inclusion, is there an interest benefit under 80.4? i. Calculate the benefit (Quantitative) e. If there is an interest benefit, can the recipient deduct the benefit? E. Tax and HST treatment of company car F. Tax and HST treatment of monthly $750 travel allowance, reimbursements for airfare/hotel G. Moving expense deduction to Ms. Mogul (note that she is not our client).

Analyze the Issues 1) Tax treatment of salary/commissions

• •

Salary is taxable to Ms. Mogul S. 5 Ganz – salary is deductible 18(1)(a)

2) Tax treatment of stock option exercise

•

Co. is a CCPC so deferral of employment benefit inclusion until year shares are disposed of. As a CCPC, Ganz Ltd. can grant a stock option to an arm's length employee and the employee will qualify under ssec. 7(1.1) for a deferral of the stock option benefit until the taxation year in which the shares are disposed [10,000 x (FMV at exercise - $10)] = $150,000 if FMV remains at $25/share. At that time, the T4 slip for Ms. Mogul should reflect the $150,000 employment benefit. Provided Ms. Mogul does not dispose of the shares (other than as a consequence of her death) for two years after she acquires them under the option arrangement, there will be an offsetting deduction in the year of disposal equal to ½ the employment benefit ($75,000), available under par. 110(1)(d.1). The ACB of Ms. Mogul's shares would be the FMV on the exercise date per share. Any proceeds of disposition in excess of $25 per share would result in a capital gain, possibly eligible for the capital gains deduction if the shares are QSBC shares.

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•

If Ms. Mogul does not hold the shares for two years after she acquires them under the option arrangement, she is not entitled to a deduction in the year of disposal for ½ the stock option benefit available under par. 110(1)(d.1). She also would not be entitled to the deduction under par. 110(1)(d) as the option exercise price was less than the FMV of the shares at the time the option was granted.

• •

Conclusion: Employment benefit to Ms. Mogul when she sells the shares in the future. Potential 50% deduction if shares are held for 2 years. T4 reporting requirements for Ganz Ltd. at that time. 3) Tax treatment of $50K 0% loan to acquire 5,000 shares

a. Does 15(2) apply? • Loan received in contemplation of becoming a shareholder. As a result, 15(2) will apply. b. Was the loan received by virtue of employment or shareholding? • Received by virtue of employment as corporate policy for senior execs. c. Is there an exception applicable? ▪ ▪

▪

15(2.4)(a) loan to an employee but not a specified employee OR a loan to an employee to purchase previously unissued fully paid shares from the corporation is exempt under par. 15(2.4)(c) provided the loan was made in her capacity as an employee [par. 15(2.4)(e)] (this is the case here since it is corporate policy for senior executives to receive such loans) And bona fide arrangements were made for repayment within a reasonable time [par. 15(2.4)(f)]. Five years would likely be reasonable in these circumstances.

d. If there is no 15(2) inclusion, is there an interest benefit under 80.4? ▪

Interest benefit 80.4(1) at prescribed rate. Subsection 80.4(1) deems Ms. Mogul to receive a benefit equal to the amount of the loan multiplied by the prescribed rate of interest, which varies quarterly, minus any interest paid (which is $0 in this case).

e. Calculate the benefit (Quantitative) ▪ i.e. $50K x 3% = $1,500 f. If there is an interest benefit, can the recipient deduct the benefit? ▪

80.5 deemed paid. 20(1)(c) deduction for $1,500. Section 80.5 deems the interest benefit determined under ssec. 80.4(1) to be interest paid in the year. Since the loan was incurred to buy shares of Ganz Ltd., which have the potential of earning dividend income, this will result in an interest expense deduction for Ms. Mogul equal to the taxable benefit under ssec. 80.4(1).

Conclusion: No 15(2) inclusion/80.4(1) benefit offset by 20(1)(c) deduction. T4 reporting requirements for Ganz Ltd. for interest benefit

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4) Tax treatment of $250K 2% loan to purchase a house

a. Does 15(2) apply to include the loan in the recipient’s income in 2023 • Loan received by a shareholder b. Was the loan received by virtue of employment or shareholding? • Received by virtue of employment as corporate policy for senior execs. c. Is there an exception applicable? • 15(2.4)(a) loan to an employee but not a specified employee OR • loan to purchase a house to inhabit. The loan to purchase a house will qualify for exemption under spar. 15(2.4)(b), (e), and (f) following similar reasoning to that given above for the share purchase loan. Note that due to the size of this loan it needs to be considered whether this loan is received by virtue of shareholdings or employment. If received by virtue of shareholdings this exception is not available. • Bona fide repayments in place at the time the loan is made. d. If there is no 15(2) inclusion, is there an interest benefit under 80.4? • Interest benefit 80.4(1) • Interest benefit at lesser of 3% prescribed rate at time loan made and actual prescribed rate each quarter less: interest paid on the loan within 30 days of the end of the year. • Subsection 80.4(4) provides that, in calculating the interest benefit on a home relocation loan, the rate used to calculate the benefit shall not exceed the prescribed rate at the time the loan was made (for purposes of applying this rule, a new loan is deemed to be made every five years on the fifth anniversary date of the original loan). The interest benefit will be calculated using the 3% rate. • The loan must be received by virtue of employment to allow the use of the prescribed rate when the loan was received. Note that due to the size of this loan it needs to be considered whether this loan is received by virtue of shareholdings or employment. If received by virtue of shareholdings the prescribed rate for each quarter would be used to calculate the benefit. e. Calculate the benefit (Quantitative) • Provided the 2% interest on the loan is paid by Ms. Mogul within 30 days of

the end of each year. The taxable benefit calculated under ssec. 80.4(1) for the first year (assuming the loan is received by virtue of employment) would be: ($250,000 x .03) - ($250,000 x .02) = $2,500 x # days outstanding/365 days f. If there is an interest benefit, can the recipient deduct the benefit? ▪ No deduction available Conclusion: No 15(2) benefit, interest benefit, T4 reporting of interest benefit for Ganz

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5) Tax treatment of company car

•

Standby Charge 6(2) 5,000/20,004 x 2/3 x ($900 - $100) x 12 = $1,600

•

Operating Benefit o Par. 6(1)(k) operating costs: lesser of: (i) 0.33 x 5,000 =

$1,650

(ii) election* ½ x $1,650 lesser is: Total employment inclusion

$825

825 $2,425

* this alternative requires that the employer be notified in writing before the end of the taxation year that the employee elects to have the operating benefit calculated in as ½ of the standby charge [par. 6(1)(k)] •

Company can deduct business portion of lease and operating costs in computing business income as allowed by paragraph 18(1)(a). 67.1 lease limit for 2023 is $950/month [Arguably the personal portion is also deductible as the amounts represent reasonable compensation for the role.]

• •

HST is included in the calculation of the benefit. Ganz Ltd. will be able to claim a full ITC for the lease payments and operating costs for the vehicle because it is used more than 50% for commercial purposes. Company can claim an HST ITC for 13/113 x [$800 lease payment +$300 operating costs] = $127x12 = $1,524 because the passenger vehicle is used more than 50% for commercial activities. Company must remit for Operating Benefit of 9% of $800 and 12/112 of $1,600 standby charge = $243 because a full ITC is eligible to be claimed for the lease payments and operating costs for the vehicle.

HST

•

Conclusion: Standby charge and operating benefit of $2,425 taxable to Ms. Mogul and must be reported on her T4 slip. Ganz Ltd. can claim a full HST input tax credit of $1,524 for the HST on the lease payments and operating costs but must remit HST of $243.

6) Tax treatment of monthly $750 travel allowance/Reimbursement

Travel Allowance • •

6(1)(b) employment benefit for travel allowance (unless a reasonable allowance 6(1)(b)(v)-salesperson) As V.P. Marketing, Ms. Mogul would likely be negotiating contracts and, thus, qualify as a “salesperson” under spar. 6(1)(b)(v). As such, a reasonable travelling allowance would not be included in income.

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If the allowance is not reasonable, Ms. Mogul would include the allowance in income and would deduct her travel expenses under par. 8(1)(f) or 8(1)(h)/(h.1). This would be advantageous if the allowance is not high enough to cover the actual expenses.

HST ITC • Company can claim an HST ITC = 13/113 x $750x12 = $1,035 if: ▪ The allowance is reasonable i.e. no taxable benefit. ▪ The allowance relates 90% or more to taxable supplies acquired by the employee and purchased in Canada. ▪ The allowance is deductible for tax purposes ▪ Recapture rule for M&E portion, no ITC if for club dues HST Remittance o Employer is not required to remit HST if allowance is not a taxable benefit or is a taxable benefit under 6(1)(b). Reimbursement • No employment benefit for reimbursements. The reimbursement of business expenses (e.g., airfares and hotels) would not be taxable to Ms. Mogul. HST ITC Company can claim an HST ITC = actual amount of HST in expenses or a proxy of 12/112 x reimbursement • The allowance and reimbursements would be deductible to Ganz Ltd. as long as reasonable as allowed by paragraph 18(1)(a) i.e. the expenses would be incurred for the purpose of earning business income. Conclusion: The travel allowance (if reasonable) and reimbursements will not be taxable to Ms. Mogul. As a result, she will not be able to deduct any of the expenses as employment expenses on her return. Ganz Ltd. can deduct the expenditures. Ganz Ltd. can claim an HST ITC of $1,035 for the travel allowance (adjusted for M&E) and 12/112 x the reimbursements. There would not be an HST remittance for the allowance as it is not a taxable benefit. There are no remittances of HST on reimbursements.

Recommendation: The controller should consider amending the option plan to ensure that the exercise price is not less than the FMV at the time the option is granted. Ms Mogul should be informed of the importance of paying the interest on the housing loan within 30 days of year end. It is important that bona fide repayment terms be in place at the time the loans are made to Ms. Mogal. The controller should ensure that the travel allowance is reasonable and maximize HST ITCs where available.

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Solution 15: Tax on Split Income

Assess the Situation Trustees Mr. Samuel (54)

Samuel Family Trust

600 Class A Common Voting

Beneficiaries; Mrs. Samuel (52) Jonathan (15) Jonas (19) Jane (25)

400 Class B Common Non-voting Holdco

100%

SAL SAL

1. Identify the relationships among the stakeholders e.g. related, affiliated, associated, connected −

Mr. and Mrs. Samuel are related and affiliated by marriage

−

Mr. and Mrs. Samuel are related to their 3 children

−

Holdco and SAL are related, affiliated and associated.

−

Mr. Samuel, Mrs. Samuel and the 3 children are related to Holdco and SAL.

2. Identify the profile of each stakeholder, e.g., tax features, risk profile −

Mr. Samuel is taxed in the highest tax bracket.

−

Mrs. Samuel does not have any income other than dividends from the trust.

−

Jonathan (15) is a minor. No income

−

Jane (25) and Jonas (19) are not minors. Both work for SAL.

−

The trust is a discretionary inter vivos trust taxed at the highest tax rate.

−

SAL is a CCPC and has a December 31st year end.

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3. Understand the decision maker and their objectives Decision maker: Mr. Samuel Objectives: ▪ Pay for Jonathan’s education costs ▪ Income split with family members ▪ Pay year end dividend of $100K to Holdco. and then to Mr. Samuel and the Trust ▪

Distribute $10,000 to each of Mrs. Samuel and Jane

▪

Distribute $20,000 to Jonas for his tuition.

4. Identify the relevant past transaction/events or planned future transactions/events and create a timeline Now – November 2023 December 2023 – Year-end dividends. 5. Identify all of the major tax issues and any non-tax issues Tax treatment of $100K dividend from SAL to Holdco Tax treatment of $60K dividend from Holdco to Mr. Samuel Tax treatment of $40K dividend from Holdco to the family trust Tax treatment of $10K distribution of dividend income from the trust to Mrs. Samuel. Tax treatment of $20K distribution of dividend income from the trust to Jonas Tax treatment of $10K distribution of dividend income from the trust to Jane 6. Identify missing information and assumptions −

None identified

Analyze the Issues Tax treatment of $100K dividend from SAL to Holdco The non-eligible dividend paid from SAL to Holdco is included in income of SAL under Section 9 or paragraph 12(1)(j). An offsetting deduction under 112(1) in Division C is available. Part IV will not apply unless SAL receives a dividend refund because of the payment of the dividend. Tax treatment of $60K dividend from Holdco to Mr. Samuel The dividend paid to Mr. Samuel would not be derived from a related business. As a result, it would be an excluded amount and TOSI would not apply. The non-eligible dividend would be subject to tax at a rate of 42.5% because Mr. Samuel is in the highest tax bracket.

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Tax treatment of $40K dividend from Holdco paid to the family trust (refer to Chapter 19) The dividend would be included in Division B income of the trust under Section 9 or paragraph 12(1)(j). The trust appears to be an inter vivos trust and would be taxed at the highest personal tax rate of 42.5% on dividends and 50% on other investment income if the income were not distributed. Income distributions to the beneficiaries would be deductible in computing Division B income of the trust. Tax treatment of a $10K distribution of dividend income from the trust to Mrs. Samuel. TOSI applies to split income of a specified individual under subsection 120.4(2). Mrs. Samuel is a specified individual because she is an individual who is a resident of Canada at the end of the year per subsection 120.4(1). Income distributed from a trust retains its character. Dividends distributed to Mrs. Samuel would be subject to TOSI as they are taxable dividends from a private corporation received either directly or indirectly through a trust unless the dividends meet the definition of an excluded amount. For a specified individual who has attained the age of 24 before the year, an excluded amount includes income; 1) 2) 3) 4)

not derived from a related business derived directly or indirectly from an excluded business income from excluded shares that is a reasonable return in respect of the individual.

The dividends received from Mrs. Samuel are derived from a related business. The dividends will be derived from the SAL business which is a business carried on by a related person, Mr. Samuel who also owns 10% or more of the fair market value of the shares of the capital stock of the corporation. Mrs. Samuel does not appear to be actively engaged in the business and her dividends would not be derived from an excluded business. 120.4(1) The holding company shares held by the family trust cannot be excluded shares even if the shares provide the trust with 10% of the votes and value of the operating company. Excluded shares must be shares of a corporation owned by a specified individual. As a result, shares held by a family trust cannot be excluded shares. The dividends also would not be considered a reasonable return in regard to work performed, property contributed, risks assumed, amounts paid or payable in respect of the business as Mrs. Samuel is not involved in and has not invested in the business. 120.4(1) Tax treatment of $10K distribution of dividend income from the trust to Jane TOSI applies to split income of a specified individual under subsection 120.4(2). Jane is a specified individual because she is an individual who is a resident of Canada at the end of the year per subsection 120.4(1). Income distributed from a trust retains its character. Dividends distributed to Jane would be subject to TOSI as they are taxable dividends from a private corporation received either directly or indirectly through a trust unless the dividends meet the definition of an excluded amount. Jane has also attained the age of 24 before the year. An excluded amount includes amounts derived directly or indirectly from an excluded business. An excluded business is a business where the individual is actively engaged on a regular, continuous and substantial basis in the tax year or any 5 prior tax years. A person who works in the business at least an average of 20 hours per week during the portion of the year in which the

Solutions to Chapter 13 Assignment Problems

391

business operates is deemed to be actively engaged. Jane may not be considered to be actively engaged in the business as she only works for 20 hours a week for 6 months of the year. The dividends may be considered a reasonable return in regard to Jane’s work performed in support of the business taking into account the salary she already receives. It would be necessary to argue that the dividend and salary together are reasonable return for her work for the company. If such an argument is supportable, TOSI would not apply and she would be taxed on the dividends at her marginal tax rate depending on her income level for the year. 120.4(1) Tax treatment of $20K distribution of income from the trust to Jonas TOSI applies to split income of a specified individual under subsection 120.4(2). Jonas is a specified individual because he is an individual who is a resident of Canada at the end of the year per subsection 120.4(1). Income distributed from a trust retains its character. Dividends distributed to Jonas would be subject to TOSI as they are taxable dividends from a private corporation received either directly or indirectly through a trust unless the dividends meet the definition of an excluded amount. For a specified individual who has attained the age of 17 but not the age of 24 before the year, an excluded amount includes income; 1) 2) 3) 4)

not derived from a related business derived directly or indirectly from an excluded business that is a safe harbor capital return of the individual that is a reasonable return in respect of the individual, having regard only to the contributions of arm’s length capital by the individual

An excluded amount includes amounts derived directly or indirectly from an excluded business. An excluded business is a business where the individual is actively engaged on a regular, continuous and substantial basis in the tax year or any 5 prior tax years. A person who works in the business at least an average of 20 hours per week during the portion of the year in which the business operates is deemed to be actively engaged. Jonas may not be considered to be actively engaged in the business as he has only worked for 20 hours a week during the summer months when not in school. 120.4(1) The dividends also would not be considered a reasonable return in regards to contributions of arm’s length capital and cannot be a safe harbour capital return of the individual because Jonas has not contributed property to SAL. 120.4(1)

Advise/Recommend It is possible to split income with family members through salary payments as long as the salary paid is reasonable. Salary paid to family members should be maximized and documentation prepared to support the deductions. Documentation should also be prepared to support the dividends paid to Jane. It would be necessary to support the argument that she is receiving a reasonable return in respect of the business having regard to the work performed, property contributed, risks assumed considering both her dividends and the amounts she receives in salary. It would be beneficial to maximize the dividend relative to salary mix for her as non-eligible dividends are taxed at a lower tax rate than salary. There is a tax benefit to using a family trust to hold shares. When the shares are disposed of in the future as long as they are QSBC shares the taxable capital gains distributed to the beneficiaries will not be subject to TOSI and will be eligible for any available capital gains exemption. Any excess above the capital gains exemption

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will also not be subject to TOSI. Holding the shares in a family trust multiplies the use of the capital gains exemption.

CHAPTER 14

Rights and Obligations Under the Income Tax Act Solution 1: Filing Deadlines Subsection 150(1): (a) corporations — within six months from the end of the taxation year; (b) deceased persons — the tax return for the year in which the individual died is due on or before the later of six months after the day of death and the day the return would otherwise be due, i.e., by April 30 (or June 15, if the deceased individual or his or her spouse carried on a business in the year of death) following the year of death; (c) trust—within 90 days from the end of the taxation year; (d) individual — on or before April 30 of the next calendar year unless the individual or his or her spouse carried on a business, in which case the deadline is June 15 of the next year.

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Introduction to Federal Income Taxation in Canada

Solution 2: Deadlines for Notice of Reassessment Subsection 152(4): — No limit if fraud or misrepresentation in the 2022 return can be established or on a matter for which the taxpayer has filed a waiver of the limit by May 27, 2026 Individual — Otherwise, the reassessment must be made within three years of May 27, 2023. Public Company — Otherwise, the reassessment must be made within four years of July 31, 2023. Canadian Controlled Private Corporation — Otherwise, the reassessment must be made within three years of May 15, 2023.

Solutions to Chapter 14 Assignment Problems

387

Solution 3: Notice of Objection Rachel should ensure that the required forms are filled out correctly and that they are confirmed by her employer (e.g., T2200 form). She should collect copies of all of her receipts for her car and home office expenses and her mileage log detailing all of her employment related trips. If the form, receipts and any other missing information requested by the auditor are in order, she has the right under section 165 to object to the reassessment made by the CRA by filing a notice of objection within one year of the April 30 filing due date, or within 90 days after the day of mailing of the assessment notice, whichever is later. If Rachel is not satisfied with the reassessment, she can appeal to the courts as outlined under section 169.

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Solution 4: Back Dating The backdating of the document would be considered to be participating in the making of a false statement or omission in a return. As a result, a penalty is imposed equal to the greater of $100 and 50% of the difference in tax liability. [ITA: 163(2)] In addition, a fine of not less than 50% and not more than 200% of the amount of the tax that was evaded, or the fine plus imprisonment for a term not exceeding two years, would be imposed. [ITA: 239(1)] Both Mr. Turner and Ms. Blackford would be subject to the above fines and penalties. Ms. Blackford may also be subject to disciplinary measures by her professional accounting association. Ms. Blackford could be liable for the civil penalty imposed on third parties for a false statement. [ITA: 163.2]

389

Solutions to Chapter 14 Assignment Problems

Solution 5: Personal Instalments Instalment payments are required, since the individual’s net tax owing for the current year and the two previous years was in excess of $3,000 (the instalment threshold) and it appears that there were no withholding taxes on the income [sec. 156.1]. Reg. 5300 determines the instalment base. Instalment payments are required to be made on March 15, June 15, September 15, and December 15 regardless of the option chosen [ssec. 156(1)]. An individual has three methods to choose from to determine the amount of instalments to be paid on the above dates. Option 1 The prior year method: one quarter of the instalment base, which is essentially taxes payable for the immediately preceding year (2022) [spar. 156(1)(a)(ii)]. Option 2 The current year method: one quarter of the estimated tax payable for the current year (2023) [spar. 156(1)(a)(i)]. Option 3 One quarter of the instalment base for the second preceding year (i.e., 2021) for the March and June instalments, and for the September and December instalments, 1/2 of the instalment base for the preceding year (i.e., 2022), less one-half of the instalment base of the second preceding year (i.e., 2021) [par. 156(1)(b)]. The CRA will automatically send instalment reminders setting out the required instalments payments to those individuals who are required to make instalments. The amount of the instalments shown on the instalment reminders is based on Option 3 (the no calculation option on CRAs website. https://www.canada.ca/en/revenue-agency/services/payments-cra/individualpayments/income-tax-instalments/options-calculate.html). If an individual selects the current year method (Option 2), and the actual tax liability is greater than the estimate, the CRA will charge interest on the amount of any deficiency [ssec. 161(4.01)]. In addition, interest will be charged if the instalments under any of the three methods are not made by the due dates [ssec. 161(2)]. The interest charge is calculated from the date each instalment is due until the tax for the year is paid on April 30th of the subsequent year. Interest is calculated using the prescribed rate for the quarter [ssec. 161(2)] and is compounded daily [ssec. 248(11)]. In addition to the interest charge, a penalty equal to 50% of the interest payable will be charged if the instalment payments are late or less than the required amount. The penalty does not apply to the greater of the first $1,000 of interest or 25% of the interest charged under section 161 as if no instalment payments had been made in the year. In essence, a penalty is not charged if the instalment interest charges are less than $1,000 [sec. 163.1]. Based on the information provided, Mr. Logan’s instalments payments under each of the options available are as follows: Option 1 Option 2 Option 3 March 15, 2023 ...................................................... $1,910 $1,380 $2,187.50 June 15, 2023 ......................................................... September 15, 2023 ............................................... December 15, 2023 ................................................

(1)

(2)

(3)

1,910 1,910 1,910

1,380 1,380 1,380

2,187.50 1,632.50 1,632.50

Based on the above calculations, Option 2 results in a lower instalment requirement than the other methods. However, as indicated above, if the 2023 actual tax liability is higher, interest will be charged on the deficiency.

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—NOTES TO SOLUTION (1) 1/4 of $7,640 (instalment base for 2022) = $1,910 (2) 1/4 of $5,520 (estimated 2023 tax payable) = $1,380 (3) First two instalments: 1/4 of $8,750 (instalment base for 2021) = $2,187.50 Last two instalments: 1/2  [$7,640 – (1/2  $8,750)] = $1,632.50

Solutions to Chapter 14 Assignment Problems

391

Solution 6: Corporate Instalments The alternatives available to Ruffle Limited are as follows: (1) 1/12 of the estimated tax liability for the current year (2023) [spar. 157(1)(a)(i)]: 1/  $1,045,000 = $87,083 12 1 (2) /12 of the instalment base which is defined in Regulation 5301 and which is essentially the tax payable for the immediately preceding taxation year (i.e., 2022) [spar. 157(1)(a)(ii)]: 1/  $1,069,036 = $89,086 12 1 (3) /12 of the instalment base for the second preceding taxation year (i.e., 2021) for the first two months, then 1/10 of the instalment base for the immediately preceding taxation year (i.e., 2022) net of the amount paid in instalments for the first two months [spar. 157(1)(a)(iii)]: (a) two instalments of $87,835 (1/12  $1,054,024); (b) ten instalments of $89,337 (1/10  [$1,069,036 – (2  $87,235)]). In Ruffle’s situation, Alternative 1 results in the least amount to be paid each month during the year. However, if the total of the instalment payments is less than the actual tax payable and the amount of tax that would have been paid under Alternatives 2 and 3, Ruffle Limited will be subject to interest charges.

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Solution 7: Notice of Reassessment Part (A) Since this corporation is not a CCPC, the normal assessment period expires four years after the receipt of the notice of assessment for that year, or September 30, 2022. Reassessments issued after that time are not valid unless there has been fraud or misrepresentation or where a waiver has been filed by the taxpayer within the normal reassessment period. Even if such events have occurred, the CRA is generally not allowed to use its collection powers for at least 90 days after the reassessment (or July 28, 2023) [sec. 225.1], and this period is extended if a Notice of Objection is filed. You indicate that it will be important to investigate on whether a waiver has been previously filed for the 2017 taxation year end to understand the reason for the reassessment being issued beyond the normal assessment period. It is too late to file a Notice of Objection for the reassessment. Part (B) Tax Owing for 2022 Estimated tax for 2022 Installments made: January – February (2  $550,000) – option 3 below $1,100,000 March – October (8 months  $810,000) –option 3 below 6,480,000 November — December 1,450,000 Estimated tax owing

$12,760,000

(9,030,000) $ 3,730,000

Minimum installments: Least of: 1. 1/12  $12,760,000 (2022 estimate) 2. 1/12  $9,200,000 (2021 actual) 3. 1/12  $6,600,000 (2020 actual) for January and February, i.e., $550K 1/10  ($9,200,000 - $1,100,000) for March to December, i.e., 810K Penalties Since the tax return appears to be unfiled at its due date of June 30, 2023 there will be a late filing penalty under section 162 of 5% of the unpaid taxes plus 1% per month for each complete month to a maximum of 12 months. To date the penalty will be 5%  $3,730,000 + 1%  2 months  $3,730,000 = $261,100. The amount of unpaid tax excludes interest charges. There is the possibility of an additional penalty under 163.1 on late or deficient instalments. This penalty is 50% of the interest charged on late or underpaid instalments less the greater of $1,000 or 25% of the interest calculated as if no instalments had been made. Part (C) Interest Charges There will be interest charged on the $3,730,000 unpaid balance owing on February 28, 2023 at the prescribed rate + 4 points, in this case 8% There will also be interest charged on the late-filing penalty of $261,100 from June 30, 2023 until paid.

Solutions to Chapter 14 Assignment Problems

There will be interest charged on the instalment payments that were not made. Minimum instalments of $9,200,000 were due but only $9,030,000 were paid. Interest on the $170,000 deficiency will be payable at the prescribed rate plus 4 points or 8% and is considered due February 28, 2023. Interest on the late November instalment of $810K will be calculated from December 1st to December 31st when the payment was made. Interest on the deficient December instalment of $170K will be calculated from January 1st to February 28th. Any applicable penalty under 163.1 for late or deficient installments is also considered to be due on February 28, 2023 [par. 161(11)(b)] and interest will apply to the balance owing at the prescribed rate plus 4% until paid. Interest is compounded daily. The tax, late filing penalty and late instalment penalty (if any) should be paid as soon as possible to avoid further interest charges. Interest is not deductible in computing business income per 18(1)(t) and will result in an adjustment on Schedule 1 for the year the interest is expensed for financial reporting purposes (2023)

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Solution 8: Preparer Penalties If Bill knew that the neighbour was likely not reporting all of his income but prepared the tax return, anyway, then he participated in making a false statement and, as such, could be liable to a penalty under subsection 163.2(4). If assessed, the penalty would be, at least, $1,000 and could be as high as $100,000 plus Bill’s fee for preparing the tax return. The penalty would be limited to 50% of the additional tax owing by the neighbour [ssec. 163.2(5)]. If Bill did not know that the neighbour was not reporting all of his income, but would be reasonably expected to knowit is necessary to determine if Bill’s action resulted in culpable conduct. The definition of culpable conduct requires that the accountant must have acted in a manner tantamount to intentional conduct, or the accountant must have shown indifference as to whether the Act was complied with, or the accountant must have shown a wilful, reckless or a wanton disregard of the law [ssec. 163.2(1)]. A person is not considered to have acted in circumstances amounting to culpable conduct in respect of the false statement solely because he relied, in good faith, on information provided by the taxpayer [ssec. 163.2(6)]. Subsection 163.2(6) provides an exception to culpable conduct when the information used by the tax return preparer is not on its fact, clearly false, or obviously unreasonable to a prudent person or does not raise obvious questions in the mind of the preparer. Culpable conduct refers to conduct (an act or a failure to act) that is tantamount to intentional conduct, shows an indifference as to whether the ITA is complied with, or shows a wilful, a reckless or a wanton disregard of the law. The following facts are relevant for this purpose: the quantum of the income differential; Bill’s knowledge of his neighbour’s affairs; and the terms of the accounting engagement. Normally, if an amount seemed to be questionable, it would be common for the accountant to question the taxpayer, as Bill did in this case. However, having received a response that was questionable, Bill should have questioned the neighbour further or refused to prepare the tax return. Bill may be subject to the penalties for assisting in the understatement of tax. The filing was highly suspect and even though Bill asked one question, the response did not address the concern. The CRA’s position is that an adviser or a tax return preparer who has knowledge of the personal circumstances of a client is expected to recognize obvious inconsistencies in the information provided by the client [IC 01-1]. In this case, Bill turned a “blind eye” to the false filing by not asking questions and obtaining plausible answers to the question of how the neighbour could afford a house in his neighbourhood, despite having such a small income. Use of the following flowchart present in the chapter may be helpful in analyzing this situation and reaching this conclusion.

395

Solutions to Chapter 14 Assignment Problems Yes

Did Bill know? No

Would Bill be reasonably expected to know? Yes

Yes

Did Bill rely in good faith on information provided by another person?

Yes No NO PENALTY

Did Bill exhibit culpable conduct?

PENALTY Preparer’s Penalty $1,000 < penalty < $100,000 + fee charged

Limited to 50% of additional tax owed

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Solution 9: Withholding Tax on Compensation It is necessary to determine whether the lecturer is an employee of the Canadian university. If this is the case, withholding tax on employment income would be required [sec. 153] and section 2 would require her to pay Canadian tax on the employment income. In this case, it does not appear that she is an employee, since she has been hired to provide a service rather than to work at an employer’s discretion. However, withholding on “fees, commissions or other amounts for services” is required [par. 153(1)(g)] and a 15% withholding tax on payments to non-residents for services rendered in Canada is prescribed [Reg. 105(1)]. It may be possible to obtain a waiver of the withholding requirement (IC75-6R2) As well, the Canada-US Tax Convention should be consulted.

Solutions to Chapter 14 Assignment Problems

397

Solution 10: Comprehensive (1) Withholding tax of 25% of the royalty payments is required under ITA 212(1)(d). The rate is reduce to 10% thereof per the Canada US Tax Convention Article XII(2). Therefore, $5,000 should have been withheld and remitted for the $50,000 royalties paid in 2022. An NR4 slip and an NR4 Summary should be prepared and provided to CRA by March 31, 2023 to report the royalty payments. [IC 77-16R4, par. 55] The withheld tax was owing on the 15th of the month following the royalty payment eg. May 15th for the April 30th payment. The failed withholding should be paid as soon as possible to stop the interest accruing on the late withholding payments. Interest applies from the date of the required remittance. As well, a penalty of 10% of the failed withholding remittance plus interest will apply. The $20,000 royalty payable at December 31, 2022 is due on January 31, 2023. The $2,000 of tax withholdings must be remitted to CRA by the 15th of February [IC 77-16R4, par. 54]. The net royalty payment to the designer should be $18,000. (2) Since average payroll remittances were less than $15,000 per month, the company is allowed to remit payroll deductions on the 15th of the month following the payment of the bonus [sec. 153, Reg. 108(1.11)], that is, July 15, 2023 if the bonus is paid in June. The bonus must be paid on or before June 29, 2023 [ssec. 78(4)]. (3) There are no required withholdings for dividend payments to Canadian resident individuals. T5 slips will need to be prepared and provided to each shareholder by February 28, 2024. As well, a T5 summary and copies of the slips will need to be remitted to CRA on the same date. [ITR 201] (4) Since the president’s wife is self-employed, his deadline for filing returns is June 15 following the taxation year rather than April 30 [par. 150(1)(d)]. Since the president late-filed his 2020 and 2021 returns and had a balance due on those returns he is subject to late-filing penalties [ssec. 162(1)]. Since he has a late-filing penalty for his 2020 return and he received a demand to file his 2021 return, his 2021 return is subject to double penalties (ssec. 162(2)). Note that because penalties are assessed based on the “person’s tax payable . . . for the year that was unpaid when the return was required to be filed”, the refund for 2019 cannot be offset by the balances owing for 2020 and 2021 in determining the amount of the penalty.

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The penalties are as follows:

2019

Balance Due Refund ($10,500)

2020

$9,200

2021

$4,350

Date Return Due June 15, 2020 June 15, 2021

Number Full Months Late N/A 18 months

Penalty N/A — refund $ 1,564

June 15, 2022

6 months

957

Total penalty

$9,200 @ 17% (5% plus 1%  12 months*) $4,350 @ 22% (10% plus 2%  6 months**)

$ 2,521

* maximum number of months per ssec. 162(1) ** double penalty per ssec. 162(2) (5) Section 233.3 requires the president to report ownership of the shares of the U.S. shares at its cost to him ($120,000, i.e., the fair market value at the relative’s death) on a foreign reporting form (Form T1135) for 2022, which is due on the deadline for filing his 2022 return (June 15, 2023, per par. 150(1)(d)). This is an information reporting requirement. No tax is payable on the receipt of the shares. The president is a “reporting entity” [ssec. 233.3(1)] who must report the cost, if it exceeds $100,000, of a “specified foreign property,” i.e., the stock [par. (c) of the definition in ssec. 233.3(1)], since the stock is of a non-resident corporation. The location of the stock certificates is not relevant. Simplifed reporting is available where the specified foreign property has a total cost of more than $100,000 and less than $250,000 throughout the year.

CHAPTER 15

Purchase and Sale of a Business – Share Transactions

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404

Solution 1: QSBC Shares Note to Instructors: The capital dividend account is covered in Chapter 16 so some explanation of the concept will be required and/or students could be told to ignore this request.

Assess the Situation 1. Draw a diagram identifying all stakeholders, e.g., corporate org charts

Karen Cdn resident/CGE available 100%

FMV $1.7M ACB/PUC $1,000 Related, affiliated Distribution business

Cyber Corp CCPC Others 75%

25%

Cyber Sub CCPC

connected

Distribution business 100% ABAs

Dec 31 year end 2. Identify the relationships among the stakeholders, e.g., related, affiliated, associated, connected − Karen controls Cyber Corp so she is related and affiliated with Cyber Corp − Cyber Corp has a 25% interest in Cyber Sub so they are connected (more than 10% of votes/value)

Solutions to Chapter 15 Assignment Problems

405

3. Identify the profile of each stakeholder, e.g., tax features, risk profile − Karen 1. Individual 2. A Canadian resident throughout the year 3. Capital gains exemption available. − Cyber Corp : 1. CCPC 2. Owns shares of Cyber Sub - 25% investment 3. Goodwill of $200,000 4. FMV $1,700,000 5. PUC/ACB $1,000 6. Value of assets stable over past 3 years 7. Marketable securities not part of active business − Cyber Sub 1. CCPC 2. 25% interest worth $100,000 3. All of its assets are used in an active business 4. Understand the decision maker and their objectives Karen is the decision maker, whose objective is to determine the impact of the potential sale of the shares of Cyber Corp. − Determine if she can use her CGE and maximize her after-tax cash on the sale. − Is there any action she can take to be able to access her CGE? − Partner has asked you to consider impact of the payment of a $300,000 capital dividend before the share sale. 5. Identify the relevant past transaction/events or planned future transactions/events and create a timeline − 2006 Incorporation − Past 3 years – Asset fair market values are stable Future − Possible sale of Cyber Corp shares − Possible capital dividend of $300K before sale

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Cyber Sub purchased 2 years ago

2005 Incorporation

Past 3 years Asset values stable Cyber Corp

Offer 1.7M Now Future share sale

Identify the Issues 1. Identify all of the major tax issues and any non-tax issues −

Is Karen eligible to use her CGE?

−

Are the shares of Cyber Corp QSBC shares? − Is Cyber Corp a small business corporation? − Is the holding period test met? − Does Cyber Corp meet the basic asset test?

−

If not, are there steps that can be taken to have the Cyber Corp shares qualify as QSBC shares? Discuss purification options

−

Consider impact of a $300,000 capital dividend payment before the share sale. Eligibility?

2. Identify missing information or assumptions made −

None identified

Analyze the Major Issues 1. Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act Does Karen qualify to claim the CGE? −

Karen is an individual who is resident in Canada presumably throughout the year

Conclusion; Yes, she qualifies. See assumptions below. Need to review prior year’s tax returns for relevant tax balances that could impact the capital gains deduction. Are the shares of Cyber Corp QSBC shares? −

There are three tests that must be met: (1) SBC test (2) Holding period test (3) Basic asset test

Solutions to Chapter 15 Assignment Problems

407

(1) SBC Test At the time of sale, Cyber Corp must be a small business corporation (SBC). Cyber Corp is a CCPC since all of the shares are owned by Karen who is a resident of Canada. Cyber Sub is connected to Cyber Corp, because Cyber Corp owns 25% of Cyber Sub. Cyber Sub is a small business corporation because all of its assets are used in a Canadian active business.

Is Cyber Corp a small business corporation? An SBC is defined as a CCPC having all or substantially all (i.e., at least 90%) of the FMV of its assets either used principally in an active business carried on primarily in Canada, or shares or debt of a connected SBC, or a combination of the two [s. 248(1)]. As shown in the quantitative analysis below, Cyber Corp does not meet the 90% test since the marketable securities are not active business assets. The fair market value of Cyber Corp’s active business assets and the shares in Cyber Sub (a connected SBC) make up 72.7% of the total fair market value of its assets (see quantitative analysis below). Conclusion: Cyber Corp. does not meet the SBC test. It is not a SBC as it does not meet the 90% test. (2) Holding Period Test Throughout the 24 months preceding the sale, the shares of Cyber Corp cannot be owned by anyone other than Karen or a person related to Karen. Karen has owned the shares of K Ltd. since 2006. Thus, this test is met. (3) Basic Asset Test In order to meet this test, Cyber Corp needs to have more than 50% of the FMV of its assets used in an active business carried on primarily in Canada for the 24 months preceding the sale. Cyber Corp does have more than 50% of its assets used in an active business. It is not necessary to consider the modification to the basic asset test and consider the shares of Cyber Sub in this determination because Cyber Corp meets the 50% test with its own active business assets. Conclusion: The basic asset test is met. 2. Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format Do the shares of Cyber Corp meet the 90% and 50% tests? Small Business Corporation Test

Introduction to Federal Income Taxation in Canada

408

Cyber Corp Cash Marketable Securities Accounts receivable Inventory Prepaid expenses Investment in Cyber Sub Fixed assets Goodwill

FMV 4,500 800,000 780,000 920,000 1,000 80,000 150,000 200,000 2,935,500

Active Business Assets Shares of Connected SBC Less than 90% threshold

70.0% 2.7% 72.7%

Small Business Corporation Test

Cyber Corp Cash Marketable Securities Accounts receivable Inventory Prepaid expenses Investment in Cyber Sub Fixed assets Goodwill

Active Business Assets Shares of Connected SBC

% 0.2% 27.3% 26.6% 31.3% 0.0% 2.7% 5.1% 6.8% 100%

FMV 4,500 800,000 780,000 920,000 1,000

% 27.3%

80,000

2.7%

150,000 200,000 2,935,500

100% 70.0% 2.7% 72.7%

Solutions to Chapter 15 Assignment Problems

409

The non-active business assets make up 27.3% of the total FMV of the assets of the company. Shares of connected small business corporations (Cyber) make up 2.7% of the total FMV of the assets of the company and can be included with active business assets when considering whether the company is a small business corporation at the time of sale. As a result, only 72.7% of the total FMV of the assets of the company is active business assets and shares of a connected small business corporation - below the 90% threshold. The active business asset test is met of the relative fair market values for the past 24 months before sale are similar to the above. Identify risks including missing information, assumptions and uncertain research positions −

The active business assets of Cyber Corp are well below the 90% level so the variability of the fair market values is not an issue

Assumptions: −

Karen does not have a cumulative net investment loss

−

Karen has not claimed an ABIL in the past

−

Karen has not claimed a CGE in the past

4. Reach a conclusion on each issue −

Cyber Corp meets both the holding period test and the basic asset test, but fails the SBC test. Therefore, the shares of Cyber Corp are not QSBC shares and thus Karen cannot claim the capital gains deduction.

5. Evaluate the strengths/weaknesses/risks of your conclusions −

None identified

If the shares of Cyber Corp are not QSBC shares then determine if there are steps that could be taken to have them qualify 1. Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act The following alternative could be considered as a way to have Cyber Corp. become an SBC immediately before the sale of the shares. To be an SBC, Cyber Corp must have 90% of its assets made up of assets used in an active business and/or shares or debt of a connected SBC. Cyber Sub does meet the test to be an SBC since it uses all of its assets in a Canadian active business. A minimum of $562,722 of the marketable securities could be sold on the open market and the cash used to reduce the liabilities. Note that the sale of the marketable securities would result in a capital gain which would be subject to full corporate tax net of Part I refundable tax if non-eligible dividends are paid prior to the sale of shares. We have assumed that the $1.7M share price reflects an adjustment for the tax on the potential future sale of the marketable securities.

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The company has $600,000 of accounts payable and accrued liabilities and a loan payable of $400,000 that could be paid down with the after-tax proceeds from the sale of the marketable securities. The tax savings available to Karen through the use of the capital gains exemption assuming she is in the highest tax bracket is $242,798.

Consider the impact of a $300,000 capital dividend payment before the share sale. If a capital dividend is paid out to Karen before the shares are sold, it can be received by her tax free. The purchaser will expect a reduction in the share price as the value of the corporation will be reduced by the funds that are removed from the company. Marketable securities will need to be sold to pay the capital dividend. As the capital gain on the disposition of the Cyber Corp shares will be lower, Karen’s taxable capital gain and tax from the sale of the shares will be reduced. Her after-tax cash from the share sale will be $75,000 higher as calculated below. Note that a sale of marketable securities will result in capital gains (need the ACB) which will increase the capital dividend account and NERDTOH. The value of the shares on sale would need to be adjusted for the capital dividend payout and also the tax on the sale of the marketable securities (net of NERTOH).

2. Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format How much in marketable securities need to be sold (at a minimum) to purify Cyber Corp? Total assets less: non-active assets (marketable securities)/90% Less: active business assets and Cyber Sub shares Maximum value of marketable securities

$2,372,778 2,135,500 $237,278

Current marketable securities Maximum marketable securities

800,000 -237,278

Sell marketable securities

$562,722

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Result of Purification Karen's Personal Tax Return Proceeds of Disposition on Sale ACB Capital Gain Taxable Capital Gain Capital Gains Deduction Net Taxable Capital Gain Tax (50% assumed) After - Tax Cash ($1.7M - 181,953)

1,700,000 (1,000) 1,699,000 849,500 (485,595) 363,905 181,953 1,518,048

Tax Savings from Purification ($485,595x50%)

(242,798)

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Result of Payment of Capital Dividend of $300,000 Before Share Sale Karen's Personal Tax Return Capital Dividend Proceeds of Disposition on Sale ACB Capital Gain Taxable Capital Gain (50%) Capital Gains Deduction Net Taxable Capital Gain Tax (50% assumed) After - Tax Cash ($1.7M - $106,953 Tax) Increase in After - Tax Cash from CDA Payout

300,000 1,400,000 (1,000) 1,399,000 699,500 (485,595) 213,905 106,953 1,593,048 75,000 [ 1,593,048 - 1,518,048 ]

3. Identify risks including missing information, assumptions and uncertain research positions Be careful not to become too precise when doing this calculation. Remember, the fair market value of the assets, especially goodwill, is subject to challenge. If your fair market values are too high, then you will not have sold enough securities to meet the 90% test. The optimal alternative would be to have Cyber Corp sell all of the marketable securities and use the cash to pay the tax liability on the sale plus pay down the liabilities and loans payable and also possibly a capital dividend if the company has capital dividend account available. This way 100% of the assets are used in an active business and the risk of a CRA challenge of the fair market value of the assets is eliminated. 4. Reach a conclusion based on your analysis of each major issue It would be possible to purify Cyber Corp through the sale of marketable securities followed by a payment of the corporation’s liabilities and possibly a capital dividend to Karen. 5.

Evaluate the strengths/weaknesses/risks of your conclusions If all the marketable securities are sold and the proceeds used to pay liabilities then there should be little risk.

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Advise/Recommend Advise the decision maker, integrating your conclusions on each of the issues with their objectives, giving priority to the most important issues Advise Cyber Corp to sell all of the marketable securities and pay liabilities to have all the assets used in an active business. Review the company’s capital dividend account balance and consider a capital dividend payout before the sale of the shares. Then, at the time of sale, Cyber Corp will meet the small business corporation, holding period test and the modified asset test. Karen will be able to use her capital gains exemption to minimize tax on the sale of the shares.

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Solution 2: QSBC Shares Rogo Dan 100%

Julie Inc

100%

Opco Inc

100%

RE Inc.

Part (A) The first step is to analyze the fair market value of the assets of each of the companies. The analysis would be as follows: Julie Inc. assets: Shares of Opco Inc. at FMV Shares of RE Inc. at FMV Portfolio investments at FMV

850,000 800,000 75,000 1,725,000

49.3% 46.4% 4.3%

Opco Inc. assets and liabilities: Active business assets at FMV Term deposits Total assets Liabilities

900,000 50,000 950,000 (100,000)

94.7% 5.3%

RE Inc. assets and liabilities: Land and building at FMV Portfolio investments at FMV Total assets Mortgage

800,000 200,000 1,000,000 (200,000)

80.0% 20.0%

In order for the shares of Julie to qualify as QSBC shares, the following tests must be met: (1) SBC Test At the determination time, Julie must be a small business corporation, which means that all or substantially all (generally 90%) of the fair market value of its assets must be used in an active business carried on primarily in Canada by the corporation or a related corporation, or invested in shares or debt of a connected SBC. In this case, Julie has 4.3% of the fair market value of its assets held in portfolio investments which are not used in an active business. While Julie has 95.7% of its assets invested in Opco and RE, it still needs to be determined whether these two subsidiaries are

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415

connected SBCs. Since both are owned 100% by Julie, they are both connected corporations to Julie. In this case, Opco is an SBC, since 94.7% of its assets are used principally in an active business carried on primarily in Canada by the corporation or a related corporation. RE, on the other hand, is not an SBC, but the real estate is used “principally” in the active business of Opco, a related corporation. As a result, RE meets the 50% test. Then, since only 49.3% of the assets of Julie are invested in connected SBCs, Julie is not an SBC. (2) Holding Period Test To meet this test, Rogo or a related party must have owned the shares of Julie throughout the 24 months preceding their disposition. This test is met by the facts given in the question. (3) Basic Asset Test In order to meet this test, Julie needs to have more than 50% of its assets used in an active business carried on primarily in Canada for the previous 24 months. In this particular case, Julie does not have any of its assets used directly in an active business, but it does have shares of connected corporations. Therefore, the modified asset test must be used. (4) Modified Asset Test If Julie meets the 90% test with a combination of its own active business assets (it has none) and shares or debt of connected corporations that meet the 50% test, the modified asset test is met. This test requires, in this particular case, both of the connected corporations meet the 50% test throughout the 24 months preceding the determination time and that Julie meets the 90% test throughout the 24 months preceding the determination time. If RE is reviewed, it can be seen that the real estate is used principally in an active business carried on by RE or by a related company, Opco. Therefore, its main or principal use is in the active business of Opco. However, the land and building only represents 80% of RE’s assets. Thus, RE only meets the 50% test. On reviewing Opco, it can be seen that more than 50% of its assets are used principally in an active business carried on primarily in Canada, i.e., 94.7% of its assets are used in this way. Finally, on reviewing Julie, it can be determined that since both Opco and RE meet the 50% test, Julie must meet the 90% test with the shares of both RE and Opco considered. Julie has 95.7% of its assets invested in the shares of Opco. As a result, Julie will meet the modified basic asset test with the shares of Opco considered. If the facts were somewhat different, such that Julie did not meet the 90% test, but Julie did not need to include the shares of either Opco or RE to meet the more than 50% asset test, then the following interpretation would apply. According to a private CRA technical interpretation, only the assets of the corporation whose shares help Julie meet the 50% test must meet the 90% test. According to this interpretation, the assets of both corporations must meet the 90% test only if the shares of both corporations are needed to help Julie meet the 50% test. In the case at hand, this is not necessary, because the assets of Julie meet the 90% test i.e. the 90/50 test is met. Conclusion: Julie meets both the holding period test and the modified basic asset test, but fails the SBC test. Therefore, the shares of Julie are not QSBC shares at this time.

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Part (B) In order for Julie to become an SBC it can look at a number of different options. It can dispose of the shares of RE. Another option is to cause RE to decrease the proportion of portfolio investments to less than 10%. By disposing of the shares of RE, Julie will possibly create a significant tax liability on any capital gain realized. The net proceeds would first be used to pay any tax liability on the sale and then could be used to pay off any liabilities in Opco. After that, the excess funds will have to be paid as a dividend with the resulting tax liability to Rogo. If this option is chosen, then the shares of RE should be sold to someone who would continue to rent the property to Opco. If RE were to dispose of $111,200 of its portfolio investments, then it would have 90% of its assets ($800,000 out of $888,800) used in the active business of a related corporation but only if the $111,200 of cash proceeds is used to pay off part of the mortgage to reduce it to $88,800. In this way, a non-qualified asset is eliminated by reducing a liability. To minimize risk of reassessment, all of the non-active assets should be removed from all three companies if possible. The company’s capital dividend account balances should be determined to consider tax free options to removing funds from the corporations for payout to Rogo.

Purification Total assets less: non-active assets (portfolio investments)/90% Less: active business assets Maximum value of non-active assets

$888,889 800,000 $88,889

Current non-active assets Maximum portfolio investments Sell portfolio investments (rounded to $111,200)

200,000 -88,889 $111,111

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Solution 3: Capital Gains Deduction Section 110.6 (A) Unused lifetime deduction in 2023: Lifetime cumulative deduction limit Less: Prior years’ deductions: Capital gains deduction claimed in 2018 Capital gains deduction available for 2023

485,595 12,000 473,595

(B) Cumulative gains limit for 2023: Cumulative Annual gains limit (A) net taxable capital gains ($12,000 + $82,000) Minus: Cumulative Annual gains limit (C) net capital losses & allowable business investment losses Cumulative net capital losses deducted Cumulative ABILs realized (Note 2) Minus: Cumulative capital gains deductions Minus: Cumulative net investment loss: (C) Annual gains limit for 2023: Net taxable capital gains for 2023 (Note 1) Minus: Net capital losses deducted in 2023 ABILs realized in 2023 Annual gains limit for 2023

94,000 12,000 1,000 12,000 29,800

(13,000) (41,800) 39,200 82,000

12,000 -

Least of (A)(B)(C )

12,000 70,000 39,200

—NOTES TO SOLUTION

Note 1 Net Taxable Capital Gain for 2023 Lesser of: a) & b) Taxable capital gain ($185,000 x 1/2) Less: Allowable capital loss ($21,000 x 1/2) Net Taxable capital gain Net taxable capital gains for the year on QSBC shares

a) b)

92,500 (10,500) 82,000 92,500

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Note 2 Allowable business investment loss (ABIL): BIL before 39(9) reduction 2020 Disallowed portion — Lesser of: (a) BIL (b) Adjustment factor X cumulative CG deductions of previous years Minus: Cumulative disallowed BIL of prior years

26,000 (a)

26,000 24,000 24,000

(b) Lesser of (a) and (b) BIL after adjustment ABIL (1/2 x 2,000) claimed in 2020

(24,000) 2,000 1,000

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419

Solution 4: Corporate Attribution Assess the Situation 1. Draw a diagram identifying all stakeholders, e.g., corporate org charts Original Bob Smith Cdn resident

Today Bob

Betty Cdn resident

100% affiliated related

ACB $100

affiliated/related

50 c/s ACB/PUC $50 $600k Pref

50 c/s affiliated ACB/PUC $50 related

ACB ?

CCPC

Smith Inc FMV $600k

Holdco related connected associated

Investment $150,000 Smith Inc. 800,000 $950,000

100%

Smith Inc

CCPC/SBC FMV $800k

Identify the relationships among the stakeholders, e.g., related, affiliated, associated, connected −

Bob and Betty are related and affiliated to each other

−

Bob and Betty are each related and affiliated to both corporations

−

Holdco and Smith Inc. are related, connected and associated

3. Identify the profile of each stakeholder, e.g., tax features, risk profile −

Bob Smith o

−

Betty Smith o

−

Canadian resident – married to Betty Canadian resident – married to Bob

Holdco o

CCPC

Shares of Smith Inc. - $800,000

Cash - $150,000

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420 −

Smith Inc. o

CCPC

Small business corporation

FMV of $800,000

carries on an active business in Canada

4. Understand the decision maker and their objectives −

Bob and Betty are the decision makers.

−

They have emailed you to identify any tax concerns regarding the July 1, 2023 property sale by Smith Inc. and $150K dividend from Smith Inc. to Holdco.

−

They don’t have a decision to make until you determine if there is a tax issue that needs to be resolved.

−

They are not aware of corporate attribution.

5. Identify the relevant past transaction/events or planned future transactions/events and create a timeline − Twenty years ago Bob incorporated Smith Inc. − Thirteen years ago Holdco was incorporated and Mr. Smith transferred his common shares of Smith Inc. to Holdco. − July 1, 2023 Smith Inc sold some active business assets and a dividend of $150,000 was paid to Holdco. Smith Inc. is still a SBC following the dividend. − December 2023, a dividend of $6,000 was paid on the preference shares owned by Bob

Identify the Issues 1. Identify all the major tax issues and any non-tax issues −

Identify whether corporate attribution applies

−

If corporate attribution does apply − What are the tax consequences?

−

Can anything be done to mitigate the tax consequences?

−

Are dividends received by Bob and Betty from Holdco subject to Tax On Split Income (TOSI)?

2. Identify missing information or assumptions made −

None identified

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Analyze the Major Issues 1. Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act Do the corporate attribution rules apply [74.4]? 1. An individual, Bob, transferred property, shares of Smith Inc., to a corporation, Holdco Inc., in which a designated person [74.4(1), 74.5(5)], Betty, was a specified shareholder (she owned 50% of the common shares). 2. One of the main purposes of the transfer may reasonably be considered to reduce the Bob’s income and benefit Betty, the designated person. 3. While Holdco Inc. would have been a small business corporation at the time of the transfer, since its only asset was shares of the small business corporation, Smith Inc., once Smith Inc. sold the property and paid the dividend to Holdco Inc., the balance sheet of Holdco Inc. would have investments of $150,000 and shares of Smith Inc. worth $800,000. Then, only 84.2% of the fair market value of the assets of Holdco is invested in the small business corporation while 15.8% is invested in non-active assets. As a result, as of the date of the dividend, July 1, Holdco is no longer a small business corporation, since it fails the 90% test. Conclusion – Corporate attribution applies. The benefit must be calculated starting July 1, 2023.

2. Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format As Holdco Inc. is not a small business corporation, then Bob will be deemed to have received interest [74.4(2)] in 2023 of the following amount: Outstanding amount (the value of the preference shares) .................................

$600,000

Prescribed rate...................................................................................................

Proportion of the year that Holdco was not an SBC .........................................

184/365

Deemed interest ($600,000  4%  184/365) ...................................................

12,099

Less: 1.15  dividends paid to Bob (1.15  $6,000) .........................................

6,900

Net imputed benefit to Bob ...............................................................................

$ 5,199

Bob will pay tax of $2,600 (50% x $5,199) on this benefit. In a full calendar year, the tax cost will be doubled. Determine steps to mitigate the tax consequences of corporate attribution It may be possible to argue that the corporate attribution rules do not apply on the basis that one of the main purposes of the transfer 13 years ago was not to reduce the income of Bob and benefit Betty. This would be a difficult argument to support, since why else would he have transferred the shares of Smith Inc. to a holding company in which his wife owns 50% of the common shares?

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Alternatively, Holdco needs to be purified and its SBC status maintained to avoid the interest benefit. To be safe the $150,000 should be used to: 1. Pay a dividend to the common shareholders. However, dividends paid to Betty will be subject to TOSI (see below). 2. Redeem some of the preference shares held by Bob. The deemed dividend on redemption will not be subject to TOSI (see below). This option also reduces the outstanding amount for purposes of calculating the interest benefit under corporate attribution. 3. Loan to Smith Inc. to pay off debt There will be tax on the non-eligible dividends of $150,000 at the top rate of 42.5% or $63,750. There will still be a deemed interest benefit from July 1 up to the day the mitigating transaction takes place. So, the sooner the dividend is paid the lower the tax cost. If the sale of the property in Smith Inc. resulted in a capital gain then there will be both a capital dividend account and non-eligible RDTOH. To deal with the CDA, either: 1. A capital dividend can be paid from Smith Inc. through Holdco to the common shareholders Bob and Betty. 2. A capital dividend can be paid from Smith Inc. to Holdco. Holdco can then redeem enough preference shares to create a deemed dividend equal to the CDA in Holdco. To deal with the non-eligible RDTOH, a non-eligible dividend can be paid from Smith Inc. to generate a full dividend refund in Smith Inc. This will create a non-eligible RDTOH balance in Holdco equal to the dividend refund received in Smith Inc. Holdco can then either: 1. Pay a non-eligible dividend to Bob and Betty to generate a dividend refund. 2. Preference shares can be redeemed with the deemed (non-eligible) dividend causing a refund of the non-eligible RDTOH balance. Conclusion: Holdco needs to be purified to eliminate the corporate attribution issue. Options include; dividends on the common shares (potentially capital dividends and/or resulting in dividend refunds), preferred share redemptions. Are dividends received by Bob and Betty from Holdco subject to TOSI? The dividends received by Bob from the Holdco would not be subject to TOSI. Related Business Excluded Amount – N/A Dividends on both his common and preferred shares are likely to be considered to be derived from a related business. The business of Smith Inc. is not carried on by a related person (a source individual). Betty does not carry on the business of Smith Inc. However, Betty does own shares of Holdco that would be considered property that derives is fair market value from shares of the capital stock of Smith Inc. The business of Smith Inc. is considered a related business of a Bob (a specified individual) if the value of the shares Betty (a

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source individual) holds in Holdco are derived from 10% or more of the fair market value of all of the issued and outstanding shares of Smith Inc. Excluded Business Excluded Amount - Met Dividends on both Bob’s common and preferred shares are likely to be considered to be derived from an excluded business. The business in Smith Inc. is an excluded business of Bob (a specified individual) because he is actively engaged on a regular, continuous and substantial basis in the activities of the business in the year dividends are received or any five prior taxation years. Dividends received by Betty from Holdco would be subject to TOSI unless paid from investment income earned on the $150,000 invested by Holdco. •

Dividends on her common shares of Holdco that are paid from dividends received by Holdco from Smith Inc. would be derived from a related business i.e. a business carried on by a related person (a source individual), in which Bob is actively engaged on a regular basis (assumed).

•

Dividends received by Betty that are derived from the Smith Inc. business would not meet the “excluded business” exception as she is not actively engaged on a regular, continuous and substantial basis in the Smith Inc. business.

•

Dividends received by Betty would not be dividends on “excluded shares” because although the fair market value of the common shares owned by Betty were 10% or more of the fair market value of Holdco, 90% or more of the income of Holdco is likely derived from the Smith Inc. related business.

•

The only possible exception that could apply for Betty would be the “reasonable return” exception. Any dividends she receives would need to be reasonable in regard to the work she performs, the property she has contributed or other relevant factors. It is unlikely that dividends she would receive would be considered a reasonable return on her $50 investment in Holdco.

Conclusion: Dividends received by Bob on preferred and common shares of Holdco will be “excluded amounts” not subject to TOSI. Dividends received by Betty on common shares of Holdco will likely be subject to TOSI and taxed at the highest rate of tax. Dividends received by Betty will reduce the interest benefit to Bob under corporate attribution because dividends received by a designated person subject to TOSI are deducted when calculating the interest benefit. 3. Identify risks including missing information, assumptions and uncertain research positions −

How close to 90% can you be and still be a SBC?

4. Reach a conclusion based on your analysis of each major issue. −

Corporate attribution does apply

−

Bob will have to report an imputed interest benefit of $5,199 and pay tax at 50%

−

TOSI needs to be considered for dividends paid to Betty.

5. Evaluate the strengths/weaknesses/risks of your conclusions.

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Conclude and Advise Advise the decision maker, integrating your conclusions on each of the issues with their objectives, giving priority to the most important issues −

Holdco should use the $150,000 to redeem some of the preference shares held by Bob. This will eliminate the current benefit by ensuring Holdco is a SBC and reduce the outstanding amount potentially subject to corporate attribution in the future. It will also generate a dividend refund if Holdco has one. If a capital dividend account balance is available, some of the deemed dividend on redemption could be received tax-free. TOSI will not apply to the deemed dividend (Bob is in the highest tax bracket anyways).

−

As excess funds become available, they should be used to redeem more preference shares.

−

To eliminate the corporate attribution issue, all of the preference shares should be redeemed for $600,000 resulting in a $0 outstanding amount.

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Solution 5: Acquisition of Control Assess the Situation 1. Draw a diagram identifying all stakeholders, e.g., corporate org chart.

Purchaser Inc. Target Inc.

CCPC st

December 31 year end

December 31st year end

CCPC

2. Identify the relationships among the stakeholders, e.g., related, affiliated,

associated, connected. Purchaser Inc. is not related to Target Inc.

3. Identify the profile of each stakeholder, e.g., tax features, risk profile Target Inc. – CCPC, December 31 year end, non-capital and net capital losses since 2019, paper product manufacturer Purchaser Inc. – CCPC, December 31 year end, wholesaler of office supplies and equipment

3. Fully understand the decision maker and their objectives. Client: Purchaser Inc. Objectives: 1. Purchase shares of Target Inc. 2. Determine amount of losses available after the purchase. 3. Use losses of Target Inc. after purchase

4. Identify the relevant past transaction/events transactions/events and create a timeline.

planned

September 1, 2023 - Date of proposed purchase

Identify the Issues Identify all of the major tax issues and any non-tax issues. 1. Tax implications of acquisition of control of Target Inc. and filing requirements 2. Availability of losses following the acquisition of control.

future

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a. Determination of losses available (quantitative)

Analysis of Issues 1. Tax implications of acquisition of control of Target Inc. and filing requirements The deemed year-end, by virtue of s. 249(4) as a result of the acquisition of control, for Target of August 31, 2023. Unrealized losses of $20,000 and $15,000 on the accounts receivable and inventory respectively must be realized in the deemed year end. The loss on the accounts receivable is recognized as a bad debt expense under subsection 111(5.3). Inventory is valued at lesser of cost and market under subsection 10(1). Business income for the August 31, 2023 year end after realization

of these amounts will be $85,000 ($50,000+$20,000+$15,000) The following losses are restricted because of the acquisition of control on September 1, 2023: •

2019 net capital loss of $50,000 and 2022 net capital loss of $100,000 expire on September 1, 2023 as a result of the acquisition of control, unless an election is made under par. 111(4)(e) to realize an accrued taxable capital gain of $150,000 to offset the net capital losses.

Par. 111(4)(e) designation to use up net capital losses In order to use the $150,000 of net capital losses that would otherwise expire on the acquisition of control, a minimum total gain of $300,000 must be elected under par. 111(4)(e). The only asset that could be elected on would be the internally generated goodwill. The CRA has confirmed that it is possible to make a designation under 111(4)(e) for internally generated goodwill in a technical Interpretation 2017-0709141C6. It would be possible to designate the goodwill to have been deemed disposed of at $100,000. Target would be deemed to have reacquired the goodwill at $100,000 which would be reported as a Class 14.1 addition. Note that accelerated CCA does not apply to the CCA calculation according to Regulation 1104(4)(b)(ii)(B). As well, the half year rule does not apply to the CCA calculation according to Regulations 1100 (2.2)(e) & Regulation 1100(2.21). This designation will allow for use of $50,000 of net capital losses. The remaining $100,000 of net capital losses will expire at September 1, 2023. The designation will result in the 7% CCA rate applying to the UCC balance of $50,000 post AOC (original cost of $0 + $50,000 TCG realized). $3,500 of CCA prorated for the short year ending December 31, 2023 will be available in the first taxation year following the acquisition of control. As well, should the business be sold in the future, the adjusted cost base of the goodwill on sale will be $100,000. Par. 111(4)(e) designation to use up non-capital losses

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The manufacturing equipment has unrealized recapture of $300,000. As a result, the election could be made to trigger the $300,000 of recapture, which is business income, and to increase the UCC of the equipment to $300,000. The ACB and CC of the equipment will continue to be $1,000,000 for purposes of future dispositions. The designation under 111(4)(e) deems the proceeds of disposition to be the lesser of (A) fair market value of $300,000 and (B) greater of the adjusted cost base of $1,000,000 and the designated amount (chosen to be $300,000). The recapture of $300,000 will be calculated as the undepreciated capital cost of $0 less the lesser of cost of $1,000,000 and proceeds $300,000. Non-capital loss — 2023 Par. 111(8)(b) - Proof Business loss Recapture resulting from election Business income

$(85,000) 300,000 $215,000

The 2019 non-capital loss will be used against the resulting $215,000 of income. The designation should be made if it is likely that the use of non-capital losses will be restricted following the acquisition of control. It is also advantageous if the equipment will be sold in the near future from the perspective of higher CCA deductions.

2. Availability of losses following the acquisition of control. •

The non-capital losses available under par. 111(1)(a) for carryover on December 31, 2023 are: Non-Capital Losses 2019 non-capital loss 2020 non-capital loss 2021 non-capital loss 2022 non-capital loss

$300,000 250,000 200,000 150,000

Utilized

Balance

$215,000

$85,000 250,000 200,000 150,000 $685,000

Conditions of deductibility: Condition 1 a. the loss business must be carried on for a profit or reasonable expectation of profit; and b. loss business must be carried on throughout each year that a non-capital loss carryforward is to be deducted. Condition 2 Sources of income from which non-CL's from a loss business may be deducted: a. income from the loss business, or b. income from a business where substantially all of the income is derived from the sale of similar properties or the rendering of similar services. Comments on above rules

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a. Is Target being operated with a reasonable expectation of profit? – The company has goodwill. How was the goodwill value determined and does the value reflect expected future profitability of the company? – Losses are declining o is there any other evidence available from the purchaser that it will continue the manufacturing business and attempt to turn Target around?

b. The losses are only available in Target − It would be necessary to consider whether there can be a transfer of another source of income into Target − It may be possible to offset o Target 's losses against that source of income, as long as that source is from the sale of similar products or services; − If Purchaser transferred some of its business to Target or Target was amalgamated with the Purchaser o the income of the office supplies and equipment business would only be considered similar if it were considered vertically integrated with Target 's paper product manufacturing business (IT-206R)).

Advise/Recommend While it appears that some non-capital loss carried forwards can be used prior to the acquisition of control through the election, the question of whether the losses should be utilized remains; o o o

o o

The losses will not expire for 16 to 20 years, depending on when they arose. They can be offset with business income as soon as the Target Ltd. business generates the income. Electing the recapture on the equipment will result in an increase in the UCC that can only be recovered at the rate of CCA for Class 53 (if the property was purchased after 2015), but that is quite rapid. In this case, the election may make sense, since there are still plenty of losses to utilize by carry-over. A designation to realize the gain on the internally generated goodwill will utilize some of the expiring net capital losses and allow for CCA deductions on the Class 14.1 asset. The value of the goodwill should be verified and documented.

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Solution 6: Acquisition of Control (A) Maximum Election Because of the acquisition of control by Holdco Ltd., Lofty Ltd. is deemed to have a taxation year-end on March 9, 2023. This taxation year will be only 69 days long, having commenced on January 1, 2023. The exception does not apply, since the date of the acquisition of control is more than seven days after the last year end. Lofty Ltd. will be required to make certain adjustments as of March 9, 2023. The adjustments will increase the company’s business losses of $3,000 to $48,000, as follows: Business losses ................................................................................. $ 3,000 Excess of UCC ($70,000) over fair market value ($40,000) of assets in Class 8 ...................................................................... 30,000 Doubtful accounts receivable deemed to be actual bad debts ............. 15,000 Losses from non-capital sources (all from business) ...................... $48,000 Division B income for the deemed taxation year ended March 9, 2023 would be computed as follows with a maximum election: Par. 3(a): Income from non-capital sources (Business income – recapture Class 14.1 $6,300 Par. 3(b): Net taxable capital gains: Election under par. 111(4)(e) on land (1/2 x $56,000) $28,000 Election under par. 111(4)(e) on customer list (1/2 x $3,000) $1,500 Allowable capital losses .................................................. $0 $29,500 Par. 3(c): Par. 3(a) + par. 3(b) ………………………………………………... $35,800 Par. 3(d): Losses from non-capital sources (above) .................. ....................... (48,000) Division B income (can’t be negative).................................................................... $0 Division C deduction for net capital losses ........................................................................................................................ ($20,000) Taxable Income…………………………………………………………………… $0

Since the net capital losses of $20,000 will expire on March 10, 2023, the corporation should claim the net capital losses of $20,000. Although the taxable income will be unaffected, the noncapital losses can be increased by this amount. The non-capital loss for the deemed year ending March 9 , 2023, would be: Losses from business sources ($48,000) .................................................. $48,000 Add: net capital losses deducted....... 20,000 $68,000 Less: par. 3(c) income determined above .................................................(35,800) Non-capital loss for deemed year............................................................. $32,200 The adjusted cost base of the land will be increased by the amount of the gain elected to $256,000 (i.e., $200,000 + $56,000) on March 10, 2023. The adjusted cost base of the customer list will be increased to $63,000. The capital cost and UCC balance for the customer list will be $61,500 ($60,000 capital cost plus $1,500 taxable capital gain). CCA following the acquisition will be calculated at 7% of that amount prorated for the short year end. The undepreciated capital cost in Lofty’s Class 8 will be reduced from $70,000 to $40,000 as at March 10, 2023. Lofty Ltd. will be deemed to have deducted the $30,000 as capital cost allowance

Introduction to Federal Income Taxation in Canada 430 for taxation years ending before March 10, 2023; thereby, making Lofty Ltd. liable for recapture on that amount if the assets are subsequently sold for more than $40,000.

Similarly, the corporation will be deemed to have made a claim for bad debts totalling $15,000. Accordingly, Lofty Ltd.’s accounts receivable will be $225,000 as at March 10, 2023, the start of its next taxation year. Lofty Ltd. will be allowed the deduction of the 2022 $600,000 non-capital losses in any year up to 2041 including the short deemed taxation year (if the corporation reverts to a December 31 year end) after which they will expire. Similarly, the $32,200 non-capital losses of the March 9, 2023 taxation year will be eligible for carryforward 20 years to December 31, 2042 if the company reverts to a December 31 year end. However, in order to be deducted, 2 conditions must be met; Condition 1: The manufacturing business must be carried on by Lofty Ltd. and for profit or with a reasonable expectation of profit throughout each taxation year the loss can be used. It appears that this condition will be met, since Holdco Ltd. will provide capital and management to turn Lofty’s business around. Condition 2: The non-capital losses may be deducted in a carryforward year from the income of the widget manufacturing business and income from a business selling similar products in that year. (B) Partial Election to Offset Expiring Losses Lofty Ltd. would still have business losses of $3,000 plus the deemed business loss on the Class 8 assets of $30,000 and the loss on the accounts receivable of $15,000, which gives a total of $48,000 of losses from business sources. In addition, Lofty Ltd. has a property loss of $10,000. The minimum designated proceeds or deemed proceeds on the land would be as follows: Deemed proceeds = 2 x ($20,000 net capital losses plus $10,000 property losses) plus ACB of the land of $200,000 = $260,000 Now, the Division B and taxable income for the deemed taxation year ended March 9, 2023 would be:

Par. 3(a) Income from non-capital sources ........................................................ $0 Par. 3(b) Net taxable capital gains: Election under par. 111(4)(e) — ($260,000 − $200,000) x 1/2 ............................................... .. $30,000 Less allowable capital losses .................................................. $0 $30,000 Par. 3(c) ................................................................................................................ $30,000 Par. 3(d) Losses from non-capital sources: Business losses ....................................................................... $48,000 Property losses ........................................................................ 10,000 (58,000)

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Division B income ................................................................................................ $0 Division C deductions: Net capital losses .......................................................................................... $20,000 Taxable income .................................................................................................. $0 Note how just enough paragraph 3(c) income was created (i.e., $30,000) to offset the property loss of $10,000 plus the net capital loss of $20,000, both of which are about to expire. The non-capital loss balance for the deemed year ended March 9, 2023 would be: Par. 3(d) losses.............................................................................. $58,000 Add: net capital losses deducted......................................................... 20,000 $78,000 Less: par. 3(c) income .......................................................................(30,000) Total non-capital loss for the year ended March 9, 2023 ........................ $48,000 The non-capital loss of $48,000 for the year ended March 9, 2023 would be added to the 2022 non-capital loss balance to give a total of $648,000 to be deducted in the future. If Lofty Ltd. reverts to a December 31 year end, these could be deducted in any year that the loss business is carried on and with a reasonable expectation of profit against income of the business that generated the loss or against business income from the sale of similar products up to: 2022 non-capital loss....................................................... 2041 March 2023 non-capital loss.......................................... 2042 The adjusted cost base of the land will now be increased to $260,000. [Note that it would have been possible to designate the customer list to be disposed of at $63,000 and the land at $257,000 as an alternate partial election. The impact of this option would have been $6,300 of recapture on the Class 14.1 property would reduce the loss carryforward balance to $641,700. The ACB of the land would be lower at $257,000 after the acquisition. The adjusted cost base of the customer list would be increased to $63,000. The capital cost and UCC balance for the customer list will be $61,500 ($60,000 capital cost plus $1,500 taxable capital gain). CCA following the acquisition will be calculated at 7% of $61,500 prorated for the short year end.]

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Solution 7: Acquisition of Control The data given in the problem statement can be summarized as follows: carryforward losses

non-capital losses

2022—repair business

$40,000

—rental property

$2,000

current deemed year-end losses

from non-capital sources

rental property

net capital losses $5,000

2,000 allowable capital losses $10,000

business

$60,000

property

$4,900

recapture—building

10,000

4,900 $21,900

business income potential elections

expiration after deemed year-end $5,000

taxable capital gain $3,000

TCG—land —building

$30,000 40,000 $70,000

Expected Results from Summary of Data (a) No Election Note that if no election is made, there is no income to offset the current business loss of $60,000 or the non-capital loss carryforward of $40,000. Therefore, the non-capital loss available to carry forward from October 31, 2023 is $100,000 (i.e., $60,000 + $40,000). Note that the $2,000 of non-capital loss carryforward from a property loss and the net capital losses of $5,000 expire. As well the $10,000 allowable capital loss and property loss of $4,900 will expire. (b) Maximum Election If the maximum election is made, the $3,000 of recapture is offset by the business loss, leaving $57,000 (i.e., $60,000 – $3,000) of net business loss. The $70,000 of taxable capital gain is partially offset by the $10,000 allowable capital loss, $5,000 net capital loss and $4,900 property loss. This leaves $50,100 to be offset by the $57,000 business loss. The $2,000 property loss from 2022 will expire as there is insufficient Division B income to use up the loss. There will be $6,900 of unused business loss to be added to the non-capital loss carryforward. There is no remaining taxable capital gain to offset some of the $40,000 non-capital loss carryforward. As a result, the non-capital loss available for carry forward from October 31, 2023 is $46,900 ($40,000 from 2022+6,900 from October 31, 2023). (c) Partial Election If only a partial election is made, it should be enough to offset only $19,900 of the $21,900 of expiring losses. The other $2,000 of expiring loss is the property loss carryforward which can only be utilized if enough Division B income is elected. As was the case with the maximum election, this loss will expire because Division B income will be $0. If a partial election of only $19,900 of

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taxable capital gain is made, the current business loss of $60,000 is not used and, hence, is available to carry forward, along with the $40,000 of business non-capital losses, from December 31, 2022 for a total of $100,000. In either of (b) or (c) there is not sufficient unrealized taxable capital gains to be able to create sufficient Division B income to use up the $2,000 expiring property loss.

Part A (Ignoring all possible elections) Deemed Year End An acquisition of control occurred when Chris acquired more than 50% of the voting shares of Transtek Inc. from an unrelated person, Tom. The taxation year of Transtek is deemed to end immediately before the acquisition of control, October 31, 2023 [ssec. 249(4)]. Tax returns are required to be filed for this short year (i.e., 10 months) and amounts, such as CCA (if claimed), will have to be prorated. Accrued Losses It is assumed that any accrued losses in inventory and accounts receivable have been recognized in calculating the business loss of $60,000. There are no accrued losses on the depreciable property. Therefore, there is no adjustment required [ssec. 111(5.1)]. There is a $20,000 accrued capital loss on the rental property land that must be recognized. The ACB of the land is reduced from $90,000 to $70,000 [par. 111(4)(c)]. The $20,000 reduction is deemed to be a capital loss [par. 111(4)(d)]. Quantitative – No Election The income (loss) for the taxation year ended October 31, 2023 is computed below. Par. 3(a) Business income Property income Par. 3(b) Net capital gains: Taxable capital gains Allowable capital loss: rental property ($20,000 x 1/2) Par. 3(c ) Par. 3(d) business loss Property Loss Division B income

(10,000) (60,000) (4,900)

(64,900) -

The net capital losses (($10,000  1/2) + $10,000 = $15,000) expire immediately following the October 31, 2023 year-end [par. 111(4)(a)]. The non-capital loss balance at November 1, 2023 is computed as follows:

Introduction to Federal Income Taxation in Canada

434 Balance, Jan 1, 2023 Loss for taxation year ended Oct 31, 2023 from business from property Less Par. 3(c ) amount determined above Balance, Oct. 31, 2022 Less: unutilized losses to expire: non-capital property losses current property loss Balance, Nov 1, 2023

42,000 60,000 4,900 64,900 -

2,000 4,900

64,900 106,900

(6,900) 100,000

Loss availability after the loss restriction event; Only the portion of the non-capital loss that may reasonably be regarded as a loss from carrying on a business ($40,000 + $60,000 = $100,000) is deductible after October 31, 2023. Thus, the rental losses ($2,000 + $4,900 = $6,900) expire immediately following the October 31, 2023 year-end [par. 111(5)(a)]. The $100,000 non-capital loss will be deductible only if the following conditions are met; Condition 1: The transmission repair business is carried on and for profit or with a reasonable expectation of profit throughout the taxation year in which the losses are to be claimed [spar. 111(5)(a)(i)]. The condition appears to be met for the June 30, 2024 and the June 30, 2025 taxation years. The transmission repair business was carried on throughout each of the years. It was carried on for profit for the taxation year ended June 30, 2025. Due to Chris’s work ethic and contacts in the industry, it is reasonable to assume that it was carried on with a reasonable expectation of profit for the taxation year ended June 30, 2024, despite the loss that was actually realized. Condition 2: The $100,000 non-capital loss is deductible only to the extent of income from the transmission repair business and income from a business selling similar products or providing similar services [spar. 111(5)(a)(ii)]. Thus, $54,000 of the non-capital loss incurred prior to November 1, 2023 is deductible for the June 30, 2025 taxation year. None of it is deductible for the June 30, 2024 taxation year due to the loss in that year. The remainder ($100,000 – $54,000 = $46,000) can be carried forward to 2026 subject to these same restrictions. These restrictions do not apply to the non-capital loss ($25,000 – $6,000 = $19,000) incurred in the taxation year ended June 30, 2024. Thus, $11,000 of the 2024 non-capital loss is deductible in 2025, in addition to the $54,000 mentioned above. Part B (i) (Maximum election) Paragraph 111(4)(e) allows Transtek to elect to be deemed to have disposed of the repair shop land for proceeds of $140,000 (maximum) and the repair shop building for proceeds of $730,000 (maximum). If Transtek makes this election, the ACB of the land on November 1, 2023 will be $140,000 and the ACB of the building will be $730,000. The new undepreciated capital cost for the building will be limited by paragraph 13(7)(f) to $650,000 + 1/2 ($730,000 – 650,000) = $690,000. The income for the taxation year ended October 31, 2023 will be as follows:

Solutions to Chapter 15 Assignment Problems

Par. 3(a): Par. 3(b)

435

Business income Property income Net capital gains: Repair shop land ($140,000 - $80,000) x 1/2 Repair shop building ($230,000 - $150,000) x 1/2

30,000 40,000 70,000 10,000

Allowable capital loss on land ($20,000 x 1/2) Par. 3(c ) Par. 3(d)

Business loss Less: recapture - building ($147,000 - $150,000)

(60,000) 3,000 (57,000) (4,900)

Property loss Division B income Division C deductions: Par. 111(1)(a) Net capital loss from 2020 Par. 111(1)(b) Non-capital loss: Business Property Taxable income

Non-capital loss balance, Nov 1, 2023: Balance, Jan 1, 2023 Added in taxation year ended Oct. 31, 2023 ($60K - $5K - $4.9K - $57K) Unutilized in taxation year ended Oct. 31 2023 - expired Remaining

60,000 60,000

(61,900) -

(5,000) -

Business

Property

(5,000) -

40,000

2,000

Total 42,000

6,900 46,900

(2,000) -

6,900 (2,000) 46,900

The $46,900 remaining may reasonably be regarded as a loss from carrying on business and thus is deductible in a taxation year after October 31, 2023, subject to the restrictions discussed in Part A. By making the maximum elections possible, the non-capital loss balance of Transtek at November 1, 2023 has been significantly reduced.

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Part B (ii) (Minimum election to utilize expiring losses) The following losses will expire October 31, 2023, if not utilized:

The 2022 net capital loss The Oct 31, 2023 allowable capital loss The rental loss portion of the 2022 non-capital loss The Oct 31, 2023 rental loss

5,000 10,000 2,000 4,900 21,900

As was seen above with the maximum election, it is impossible to utilize the rental loss portion of the 2022 non-capital loss of $2,000 without triggering sufficient income under paragraph 3(c) to utilize the entire October 31, 2023 business loss. Therefore, it is only possible to use up $19,900 of the expiring losses. To utilize these losses in the taxation year ending October 31, 2023, a capital gain of 2  $19,900 = $39,800 is needed. To avoid recapture, the election should be made on the land, not the building. Thus, Transtek will elect under paragraph 111(4)(e) to be deemed to have disposed of the repair shop land for proceeds of $119,800, i.e., (2  $19,900) + 80,000. The ACB of the land at November 1, 2023 will be $119,800. The income for the taxation year ended October 31, 2023 will be as follows:

Par. 3(a) Par. 3(b)

Par. 3(c ) Par. 3(d)

Business income Property income Net capital gains: Taxable capital gain: Repair shop land ($119,800 - $80,000) x 1/2 Allowable capital loss on land ($20,000 x 1/2)

Business loss Property loss Division B income Division C deductions: Par. 111(1)(a) Net capital loss from 2022 Taxable income

19,900 (10,000) (60,000) (4,900)

9,900 9,900 (64,900) (5,000) -

The net capital loss claimed has no effect on taxable income, but it will increase the non-capital loss balance. The non-capital loss balance at November 1, 2023 is computed as follows:

Solutions to Chapter 15 Assignment Problems Balance, Jan 1, 2023 Loss for taxation year ended Oct 31, 2023 from business from property Add: Net capital loss deducted Less: Par. 3(c ) amount determined above Balance, Oct 31, 2023 Less: the unutilized non-capital property loss Balance, Nov 1, 2023

437 42,000 60,000 4,900 64,900 5,000 69,900 (9,900)

60,000 * 102,000 (2,000) 100,000

* the current year loss is $60,000

Only the portion of the non-capital loss that may reasonably be regarded as a loss from carrying on a business ($40,000 + $60,000 = $100,000) is deductible after October 31, 2023. It is subject to the restrictions discussed in Part A. Summary: The results of the above comparison of the three alternatives are further summarized as follows: Options Taxable income Net capital loss deducted Non-capital loss balance, Nov 1, 2023 Net capital losses expired ($5,000+$10,000) Property losses expired (Note 1) ACB of repair shop land ACB of repair shop building UCC of repair shop building (Note 2)

No Election (A) 100,000 15,000 6,900 80,000 650,000 647,000

Maximum Election Partial Election (B)(I) (B)(ii) 5,000 5,000 46,900 100,000 2,000 2,000 140,000 119,800 730,000 650,000 690,000 647,000

Note 1 Property loss from 2022 expires in maximum and partial election options because of insufficient Division B income to utilize the losses. Note 2 $650,000 + 1/2 x ($730,000 - $650,000) for Maximum election option Option B (ii) is best if the $100K non-capital loss can be offset by income generated in the next 20 years, preferably sooner. The resultant lower ACB of the land and building under this option is only relevant on a disposition. The lower UCC on the building only represents an opportunity loss of CCA at a 4% Class 1 or 6% Class 1 NRB declining balance rate. If it is unlikely that the losses will be available following the acquisition of control because of loss restrictions, Option B (i) will provide the best result and will capture all but $2,000 of the expiring losses in the tax cost balances of capital assets. [ Note: Another potential alternative involves electing deemed proceeds of disposition of $189,800 (i.e., (2  $19,900) + $650,000) on the repair shop building. Income under paragraph 3(b) would be the

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same as for Part B (ii). However, the business loss under paragraph 3(d) would be only $57,000 (i.e., $60,000 – $3,000 recapture), since recapture would be triggered. This would reduce the non-capital loss balance at November 1, 2023 by $3,000 to $97,000. However, the UCC of the repair shop building could be increased to $769,900 (i.e., $750,000 cost + $19,900 of taxable capital gain). The increased CCA base would begin to shelter income from tax, in this case, in the year ended June 30, 2025, when the corporation earns a profit. If, for example, the corporation uses a discount rate of 10% and faces a tax rate of 13%, the present value of the tax shield on the incremental UCC base of $22,900 (i.e., $769,900 – $647,000) at the 4% CCA rate is:

$22,900 x .04 = $851 x .13 .04 + .10 The value of the extra $3,000 in the non-capital loss balance in the same year and at the same assumed tax rate of 13% is $390 (i.e., 13% of $3,000).]

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Solution 8: Acquisition of Control/Loss Restriction Events Assess the Situation John 100% Related/affiliated CCPC Pro Ltd. retailer Prior owner

unrelated 20%

80% Related/affiliated Style Ltd.

CCPC Retailer/warehouse operation Non CL $400K + $5,500 Net CL $9,500 Dec 31 year end

Relationships: John/Pro Ltd – related/affiliated through control John/Style Ltd – related/affiliated through control (post AOC) John and previous owner of Style Ltd – not related Pro Ltd/Style Ltd – related, affiliated, associated through control, connected (control, & >10% votes & value) Tax Profile: Pro Ltd – CCPC, retailer of fashion shoes, warehousing operation, income in excess of $1M for 2022 Style Ltd – CCPC, retailer of athletic shoes, December year end, Non CLs for 2021, 2022, Net CL $9,500 2022

Timeline: Early 2000s – Pro Ltd. started operations 2021 – Style Ltd. commenced operations 2021/2022 – Style Ltd. non capital losses/net capital loss 2022 - $1M+ profit for Pro Ltd. 3Jan 1, 2023 to March 31, 2023 - $5,500 loss Style Ltd. April 1, 2023 – Pro ltd. acquired Style Ltd. AOC Date September 1, 2023 – Pro Ltd. transferred warehouse division to Style Ltd.

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2024 January 1, 2024 to February 28, 2024 – profit from retailing business Style Ltd $7K March 2024 – now Future Discontinue retail business in Style Ltd. , projected profit for warehousing $950K Client: John Forstill Objectives: 1) Ensure all filing obligations met/pay tax. 2) Maximize use of the Style Ltd. retail business losses effectively. 3) Discontinue the Style Ltd. retail business.

Issue Identification Issue 1: Tax implications re: April 1, 2023 acquisition of common shares of Style Ltd. a. Year end/filing requirements b. Realization of losses in short year end. c. Election to realize gains/income in short year end. Issue 2: Loss utilization following loss restriction event. a. Net capital losses b. Non capital losses

Issue Analysis Issue 1: Tax implications re: April 1, 2023 acquisition of common shares of Style Ltd. Year End/filing requirements. Loss Restriction Event As a result of Pro Ltd.’s acquiring of control of Style Ltd., Style Ltd. is subject to a loss restriction event (ssec. 251.2(2)). Deemed Year-End Style Ltd. is deemed to have a year-end immediately before the acquisition of control by Pro Ltd. on March 31, 2023 (ssec. 249(4)). The tax return was due September 30, 2023. A new year end can be chosen within 365 days and the December 31 year end can be retained. This tax return is due June 30, 2024 and the tax is due March 31, 2024 Realization of losses in short year end a. The unrealized terminal loss on the store fixtures/equipment 111(5.1) and the unrealized

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441

loss on the inventory 10(1) are required to be realized in the short year-end. This ensures that the losses are captured in any non-capital loss balance at the acquisition date and are subject to the loss restrictions (see below). b. Net Capital Losses The $6,000 accrued capital loss on the marketable securities will be deemed to be an allowable capital loss of $3,000 for the period ended March 31, 2023 (par. 111(4)(d)). The adjusted cost base of the securities will be reduced to their fair market value of $3,000 (par. 111(4)(c)). Unless taxable capital gains are generated in the taxation year ending March 31, 2023, the allowable capital loss of $3,000 will become a net capital loss and expire on the acquisition of control. The 2022 net capital loss of $9,500 will also expire. Election to realize gains/income in short year end. Maximum Election Style Ltd. may elect to realize a capital gain on the land of up to $200,000 and/or on the building of up to $15,000 and up to $25,000 on the goodwill. There will be $5,000 of recapture on the disposition of the building. If a maximum election on the land and building is filed, this will result in utilization of $99.000 of the non-capital loss balance and reduce the amount available to be carried forward. The net capital loss balance of $9,500 will be used and therefore will not expire. The designation will also increase the ACB/CC/UCC balance of land, goodwill & building which will benefit the company when the properties are sold and through higher CCA deductions on the building and goodwill. Partial Election Options Style Ltd. could elect to generate a capital gain on either the land or the goodwill of $25,000. This will generate a taxable capital gain of $12,500, which will be sufficient to offset the allowable capital loss deemed to have been realized on the acquisition of control as well as the $9,500 net capital loss carryforward balance. If land is chosen, this would cause the adjusted cost base of the land to be increased by $25,000 to $525,000 (par. 111(4)(e)). This option results in a higher noncapital loss balance carryforward to the post acquisition of control years ($413,500). Another option would involve electing on the land at $510,000 or goodwill at $25,000 and the building at $705,000 to realize the $12,500 of taxable capital gain needed to use expiring losses. This would result in recapture of $5,000 on the building and a higher UCC balance and future CCA deductions on the building. The non-capital loss carryforward balance would be $408,500. The UCC balance would be $697,500 instead of $685,000] Conclusion: An election of sufficient capital gains to realize the allowable capital loss and expiring net capital loss should be made in the short year end return. Consider a maximum election if the non-capital loss utilization will be restricted following the acquisition of control. The September 30, 2023 tax return is late and should be filed as soon as possible. There will not be a tax liability resulting in interest/penalties.

Introduction to Federal Income Taxation in Canada

442 Quantitative Analysis: Short Year End Tax Calculation Partial Election Division B income - March 31, 2023 3(a) 3(b)

Income 3(b) TCG - 111(4)(e ) land or goodwill ACL - 111(4)(d) securities

3(c ) 3(d)

Loss to March 31 Store fixtures and equipment (111(5.1)) ($26,000 - $23,000) Inventory (10(1)) ($45,000 - $40,000) Division B Income (technically cannot be negative) Division C Deduction: Net capital loss Taxable Income

12,500 (3,000) 9,500 (5,500) (3,000) (5,000) (13,500) (9,500) -

Non-Capital Losses Non-capital losses available for carry forward by Style Ltd. at March 31, 2023 are as follows: Non-capital loss 2021 Non-capital loss 2022 Non-capital loss March 2023

$175,000 225,000 13,500 $413,500

The UCC balance for the store fixtures and equipment is reduced to $23,000 (ssec. 111(5.1)).

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Maximum Election

March 31, 2022 Taxation Year End Net TCG Elect Land 111(4)(e) Elect Building Elect Goodwill ACL - Securities

100,000 7,500 12,500 (3,000) 117,000

Business loss Jan to March Recapture Inventory loss Store fixtures 111(5.1) Total

(5,500) 5,000 (5,000) (3,000) (8,500)

Division B Income

108,500

Division C Deductions Net capital loss Non capital loss Taxable Income

(9,500) (99,000) 0

($700,000-$500,000)x1/2 ($705,000-$690,000)x1/2 ($25,000-$0)x1/2 ($3,000-$9,000)x1/2

Non Capital Loss Carryforwards 31-Dec-22 400,000 Used in 2023 (99,000) 01-Apr-23 301,000

Tax Attributes Post AOC ACB Land 700,000 ACB Building 705,000 CC/UCC Building 697,500 ACB/CC Store Fixtures 30,000 UCC Store Fixtures 23,000

($690,000+$7,500) 13(7)(f) 111(5.1) 111(5.1)

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Issue 2: Loss utilization following loss restriction event. Net capital losses - $3k and $9,500 net capital loss expire Non capital losses Condition 1 -

Business created losses (retailer of ladies athletic shoes) must be carried on for profit or a reasonable expectation of profit throughout the year o carried on until 2024 sometime o There is a loss of $20K in 2023 and small profit of $7K for first 2 months of 2024 o Can it be argued that the business is carried on with a REOP? o Pro Ltd has expertise, funding etc. – possibly o 2024 – Plans to discontinue (business is not carried on throughout the year)

Only to extent of income from that business or business with income derived from sale of similar properties. – o no income in 2023 from the retailing athletic shoe business, o $7,000 in 2024 but business not carried on throughout the year (both conditions must be met.

Condition 2

Conclusion: Non capital losses cannot be used following AOC. Even if Style Ltd. is amalgamated with Pro Ltd. losses cannot be used because the business is to be discontinued. Best to use maximum election to use losses in short year end.

Advise/Recommend • • •

File the 111(4)(e) election to realize the maximum capital gains on the land/building/goodwill. Continue to operate Style Ltd. with a REOP until remaining $301,000 of losses are used. Consider amalgamating Style Ltd. with Pro Ltd which earns income from the sale of similar products to use losses faster.

Solutions to Chapter 15 Assignment Problems

445

Evaluation of election Trade-Offs

3(a) 3(b)

3(c ) 3(d)

Division B Income Less:

Income TCG

-land -building -goodwill -securities

ACL 3(a) + 3(b) Recapture Loss to March 31 Store F & E Inventory Net capital losses Non-capital loss

Taxable Income

$ $

No Election $ -

-$ 3,000 -$ $ -$ -$ -$ $ $ $ $

Elect Land At $525,000 $ $ 12,500 $ -

3,000 -$ -

3,000

$ $

5,500 3,000 5,000 -

-$ -$ -$ $ -$ $ $

$ $413,500 $500,000 $690,000 $685,000 $ -

$ $ $ $ $ $

Maximum Election $ $100,000 $ 7,500 $ 12,500 9,500 -$ 3,000 $117,000 9,500 $117,000 $ 5,000 5,500 -$ 5,500 3,000 -$ 3,000 5,000 -$ 5,000 $108,500 9,500 -$ 9,500 -$ 99,000 $ -

Balances Net capital losses Non-capital losses ACB - land ACB building UCC - building ACB - goodwill UCC - goodwill Class 14.1

413,500 525,000 690,000 685,000 -

$ $301,000 $700,000 $705,000 $697,500 $ 25,000 $ 12,500

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446

Solution 9 A) Assess the Situation Stakeholders

Pre-AOC Janece Davenport

Alfonso 100% ACB $1.5M, FMV $8.2M

Holdco

18% 82%

DSL

100%

Solutions to Chapter 15 Assignment Problems

447

Post - AOC Janece Davenport

Alfonso 100%

ACB/FMV $8.2M 100%

Holdco

DI 18%

82%

DSL

Relationships

a. Janece and DI • Pre-AOC - Related, affiliated through control • Post-AOC - Unrelated b. Alfonso/DSL and Janece • Unrelated, arm’s length c. DI and DSL • Pre-AOC • Connected – DI owns more than 10% of the votes and value of DSL • Not associated • Not related, not affiliated • Post AOC – connected (>10% votes, value), associated, related, affiliated – control by Alfonso d. Alfonso and Holdco • Related, affiliated through control e. Holdco and DSL • Related, affiliated, associated through control, connected f. Alfonso and DSL • Related, affiliated through control g. Alfonso and DI • Pre-AOC - unrelated • Post AOC Related, affiliated through control

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448 Tax Profile

a. Janece – Individual, top tax bracket, has not used CGE, Cdn resident b. DI – CCPC (not controlled by non resident ) a. Non capital loss, Net capital loss, NERDTOH, Capital dividend account b. Cabinetry manufacturing, installation business c. Sept 30 year end c. Alfonso – Individual, Cdn resident d. Holding Co – CCPC (not controlled by non resident etc. etc.) e. DSL – CCPC (not controlled by non resident etc. etc. ), 100% assets used in an active business (SBC), Interior architectural design business Client/Objectives Client: Janece Objectives: Sell DI to Alfonso for $8.2M Retire & pursue other interests Utilize her CGE Maximize retirement funds Determine after-tax cash from share sale Minimize tax on share sale Potential Future Client: Alfonso Objectives: Amalgamate DSL and DI in 2024 Use DI’s losses in future Other Objectives: Minimize risk of CRA reassessment related to share sale Partner would like to advise Alfonso in the future Tax planning re: 2023 tax filings and future loss utilization

Timeline/Key Transactions

2008

2014

Husband Death of Husband (Joe) purchased shares Acquired CS of DI

2020

2021

Stable asset mix

2022

March 2023

Sale of Marketable Securities

30-Sep-23 01-Nov-23 01-Jan-24

DI Tax Year End $250K Loss $100 ACL

Now

Future 2024

Proposed DI/DSL Share Sale Amalgamation $120K Profit DI

Solutions to Chapter 15 Assignment Problems

449

B) Identify the Issues 1) Tax treatment of share sale to Janece a. Can Janece use her CGE for the share sale (Qualitative discussion)? i. Availability of CGE ii. Shares QSBC shares? 1. SBC test a. Quantify non-ABA % 2. Holding period test 3. Basic asset test b. Purification options (Qualitative discussion) i. Quantify amount of marketable securities to be sold c. Maximizing retirement funds (Qualitative discussion) i. Quantify after-tax cash from sale and potential options 2) Tax implications to DI of Acquisition of Control by Alfonso’s Holding Company a. Discussion of Impact of AOC on 2023 tax filings for DI (Qualitative discussion) i. Quantify estimate of losses to be realized in short year end ii. Quantify estimate of LCFs b. Loss utilization following AOC (Qualitative discussion of conditions) c. Designation options for 2023 filing for DI (Qualitative discussion of potential options) i. Quantify potential election options

Analyze the Issues Issue 1: Share sale Can Janece use her CGE for the share sale? Availability of CGE • • •

Individual Canadian resident throughout the year Unused deduction $971,190 (needs to be adjusted for 2024 amount).

Information needs: CNIL balance, ABILs in current, prior years?, net capital losses in 2024? 2024 CGE amount. Shares QSBC shares? •

must be QSBC shares at time of sale

SBC test •

Definition of SBC in 248(1) o At determination time

Introduction to Federal Income Taxation in Canada

450 o o

CCPC All or substantially all (90%) of the FMV of the assets attributable to assets used principally in an active business carried on primarily in Canada or shares/debt of connected SBC DSL is a connected SBC because it is a CCPC with 100% of the FMV of its assets used principally in an active business carried on primarily in Canada (assumed)

The term deposits are considered to be non-active business assets (build up of surplus cash). They do not appear to be needed in the active business of DI

DI is not a SBC because the 90% test isn’t met (see calculation below).

Holding period test •

Janece has held the shares for more than 24 months.

Basic Asset Test •

> 50% of assets attributable to assets used principally in an active business carried on primarily in Canada by the corporation for prior 24 mths

•

DI meets the Basic Asset Test, since its own active business assets constitute more than 50% of the FMV of its gross assets (see calculation below).

•

Therefore not necessary to consider the Modified Asset Test.

Quantitative analysis: SBC Test Less than 90% [i.e., 85% (100% - 15%) of the FMV of DI’s gross assets, including unrecorded assets (goodwill), consist of a combo of assets used in an active business carried on primarily in Canada and shares of a connected small business corporation.

% Goodwill Cash

FMV 900,000 36,000

Accounts receivable (net of $15,000 allowance)

127,000

Inventory Term deposits/marketable securities Shares in Design Solutions Ltd. (DSL) Land Building, fixtures and equipment (net of amortization)

15% 2%

2,000,000 1,800,000 Non ABA 187,000 Connected SBC 2,150,000 4,920,000 12,120,000

Solutions to Chapter 15 Assignment Problems

451

Purification • It is possible to purify the company to meet the definition of a SBC prior to sale. • Need to sell term deposits • Need to use the cash to pay off A/P and long term debt of the corporation (or other valid alternative)

Quantitative analysis: Purification 900,000 36,000

10%

127,000 2,000,000 1,146,667 187,000 2,150,000 4,920,000 11,466,667

Conclusions: The shares of DI do not meet the definition of QSBC shares because of the SBC test. Holding period and BATs are met. Purification should be considered before the shares are sold. The minimum amount of term deposits that would need to be sold to purify DI would be $653,333 ($1,800,000 - $1,146,667) ignoring tax on the disposition of the term deposits. The company has $180,000 of accounts payable that could be paid off and $3,250,000 of long term debt. [Note that students do not need to calculate the exact amount of term deposits to cash-in. Any reasonable method to purify eg. cashing in 100% of the term deposits and paying down liabilities is acceptable/competent. Other options could include using the cash to purchase active business assets. This works but is less practical as business assets are likely not needed/desirable to the purchaser. Using the cash to pay out the capital dividend account is tax effective or paying a dividend of $130,435 to receive a refund of $50,000 of NERDTOH results in a tax cost of $5,543 ($55,435 - $50,000). Using the cash to pay taxable dividends in excess of that needed to refund NERDTOH results in a tax cost of 42.5% of the dividends distributed so will be less tax effective.]

Information needs/assumptions: The repayment terms of the long term debt should be reviewed to determine if pre-payments are possible. We should also consider the tax treatment of the term deposits/marketable securities and will need to verify the tax cost information in regards to the investments disposed of. We have assumed that there would not be any capital gains realized on the disposition of the marketable securities. F/Ss for prior 24 months should be reviewed to verify the basic asset test.

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452

Maximizing retirement funds - Options • • • •

• •

Janece has a capital gain on the disposition of the shares Eligible for CGE if company is purified After-tax cash on sale is $6,767,798 without any payouts prior to the share sale as calculated below Option 1 - Capital dividend account of $400K could be received tax free from the corporation to minimize Janece’s tax liability on the sale of the shares (also helps with purification of the company). After-tax cash on the sale would be $6,867,798 as calculated below. Will need to use cash from sale of term deposits to pay out $400K capital dividend. Option 2 - In addition to the capital dividend payment, pay out the $130,435 noneligible dividend noted above to obtain a $50,000 dividend refund in the corporation. This would result in an additional $80,435 reduction ($130,435 - $50,000) in the value of the shares which reduces the taxable capital gain. The reduction in the tax on the taxable capital gain on the share sale is offset partially by the tax on the dividend calculated using a marginal rate of 42.5%. After-tax cash on the sale would be $6,882,471 calculated below.

Alternative Minimum Tax The March 28, 2023 Federal Budget proposes to amend the Alternative Minimum Tax legislation for high income individuals. The calculation is a parallel calculation to the normal personal tax calculation and will apply a 20.5% (federal) minimum tax to a base calculation. For capital gains eligible for the lifetime capital gains exemption, 30% of capital gains are included in the AMT base (unchanged). The AMT exemption amount is increased to $173,000. The AMT calculation should be prepared for Janece for 2024 to determine whether the tax has any impact. If AMT applies, it can be carried forward 7 years and used to reduce her personal tax liability in future years.

Quantitative analysis:

Dividend Capital Dividend Proceeds of Disposition ACB Capital Gain Taxable Capital Gain Capital Gains Deduction Tax After-tax Cash

Option 1 No CDA Payout

Option 2 CDA Payout

8,200,000 1,500,000 6,700,000 3,350,000 485,595 2,864,405 1,432,203 6,767,798

400,000 7,800,000 1,500,000 6,300,000 3,150,000 485,595 2,664,405 1,332,203 6,867,798

Option 3 CDA Payout Dividend

1 -

130,435 400,000 7,719,565 1,500,000 6,219,565 3,109,783 485,595 2,624,188 1,367,529 6,882,471

3 4

Solutions to Chapter 15 Assignment Problems

453

1 $8,200,000-$400,000 CDA 2 $8,200,000-$400,000 CDA - $130,435 Dividend + $50,000 Dividend refund 3 $2,624,188 x 50% + $130,435 4 $130,435 + $400,000 + $7,719,565 - $1,367,529

Conclusion: Janece can maximize her after-tax cash on the share sale if she has the company pay out a $400K capital dividend from the disposition of term deposits/marketable securities prior to the share sale. A capital dividend election will be required. Her after-tax cash from the sale will be $6,867,798 using the 2023 CGE threshold. Information needs: Selling costs for the sale of shares reduces the proceeds of disposition. Need CGE level for 2024. Need to verify CDA balance before paying out a capital dividend to minimize risk of penalty.

Issue 2: Acquisition of Control/Loss Restriction Event 1) Impact of AOC on 2023 tax filings for DI • • • •

De jure control of DI is acquired by the Holdco/Alfonso Deemed taxation year end on December 31, 2023 Short year end return is due June 30, 2024 Any tax payment due Feb or March 2024.

2) Unrealized losses must be realized o A/R loss = $7K bad debt expense ($134K - $127K) o Shares of DSL = $43K capital loss ($230K - $187K) o Class 10 = $20K CCA deduction ($80K-$60K) 3) Loss utilization following AOC o

o o

DI will have a net capital loss balance of $121,500 that will expire on AOC. This includes the $100,000 net CL related to the March 2023 sale of marketable securities and the $21,500 ACL on the deemed disposition of the shares of DSL in the short year end. DI will have a non capital loss balance of $347,000 that will be subject to restriction following the AOC (see calculation and discussion below). This includes the $350,000 of non capital losses as of September 30, 2023 net of $3,000 of business profit ($120,000/12 months x 3 months estimate) for the short year end. The non capital loss can only be used if Condition 1: the DI manufacturing and installation business continues after the shares are acquired and with a reasonable expectation of profit throughout any

Introduction to Federal Income Taxation in Canada

454 o o

year losses will be used AND Condition 2: Only against income from that business OR income from a business that sells similar products and services. It is a question of fact whether the interior architectural design business is considered to be selling similar services (vertically integrated businesses may be considered similar). The DI business is projected to have $120,000 of profits for the year ended September 30, 2024 so likely can use up some non capital losses in 2024 year end.

Quantitative Analysis: Short year end return – No designation (estimate)

December 31, 2023 Losses Profit estimate $120K/12 x 3 Bad debt A/R Class 10 CCA Income for tax purposes

30,000 7,000 20,000 3,000

[Prorated CCA on Class 1, 8 and 53 also could be deducted in this estimate. Above calculation assumes accounting depreciation in the $30,000 of profit is equal to the CCA deduction.] Conclusion: Short year end return will result in non capital loss carryforward of $347K and net capital loss balance of $121,500 if a designation is not made in the short year end return. The net capital loss balance will expire. It appears that DI’s business is expected to continue and with a reasonable expectation of profit based on the controller’s profitability forecasts. The non-capital losses can be used against those profits. Further work is necessary to determine whether the losses can be used against business income from DSL’s business after an amalgamation of the 2 companies. Information needs/assumptions; Losses to be realized in short year end are just estimates. Need actual FMVs on December 31, 2023. Also need actual income for 3 months. We have estimated based on projections. More research is required to support the use of the non capital losses against DSL’s business income after the acquisition of control/amalgamation. A position should be researched and supported with documentation. Projected profits of the DSL business for 2024 and the DI business would help determine how quickly the losses could be utilized. 4) Designation options for December 31, 2023 filing for DI o It is possible to designate a capital property to be deemed disposed of in the short year end o It would be possible to designate the land o It would be possible to designate the building but any designation will result in $1.5M of recapture and a significant tax liability in short year end. Not a good option. o It would be possible to designate the goodwill. Results in higher CCA in future

Solutions to Chapter 15 Assignment Problems

o o o

o o

455

It would be possible to designate Class 8 and Class 53 which will result in recapture of $10,000 and $180,000 respectively. Partial Designation Land or goodwill could be designated to be disposed of to realize sufficient TCG to use up the allowable capital loss realized in the short year end on marketable securities and the expiring $100K net CL (partial designation) This will result in the tax cost of the land being bumped up to the designated amount of $1,643,000 ($1,400,000 + $121,500x2) which will be the ACB for future dispositions of the land. The net CLs will be fully utilized. The non CL balance available for future use (subject to the restrictions described above) will be $347,000 [Students may have discussed goodwill instead of land to increase future CCA deductions] Max Designation Land could be designated to be disposed of to realize the full TCG on the property to use up the allowable capital loss realized in the short year end on marketable securities, the expiring $100K net CL as well as some of the non capital loss balance (max designation on the land) This will result in the tax cost of the land being bumped up to the designated amount of $2,150,000 (FMV) which will be the ACB for future dispositions of the land. The net CLs will be fully utilized The non CL balance available for future use (subject to restrictions) will be $93,500 If the land is held long term, the benefit of the higher tax cost will not be realized until disposition in the future i.e. little benefit to the maximum designation. Also possible to designate the Class 8 and 53 assets and realize recapture to use up remaining non capital losses. Also possible to designate the goodwill and create TCG to use up remaining non capital losses. [Note could have recommended goodwill instead of land above]. A maximum designation on all properties will result in tax on the short year end tax return.

Quantitative Analysis: Short year end return – Possible Designations on Land

Introduction to Federal Income Taxation in Canada

456

Possible Designations Land TCG ACL Shares of DSL Income for tax purposes Division B Income Use expiring Net CL Use Non CL subject to restriction Taxable Income

Option (Partial) Partial

375,000 121,500 21,500 - 21,500 3,000 3,000 356,500 103,000 100,000 - 100,000 256,500 - 3,000 -

Option (Partial) Partial Remaining Non CL 93,500 347,000 Option (partial) designation Non CL is calculated as September 30, 2023 balance of $350,000 less the $256,500 used on the short year end return. Conclusion: A designation for the land results in full utilization of the allowable capital loss on the shares of DSL and the net capital loss carryforward balances. This prevents the expiration of the loss and captures it in the adjusted cost base of the land. A maximum designation for the land results in partial utilization of the non capital loss balance and captures the used loss in the adjusted cost base of the land. If the availability of the losses will be restricted after the acquisition of control this option should be considered. A designation for the building should not be made. Information needs: Need F/Ss prepared for short year end and actual net income for tax purposes calculated on Schedule 1. We have used $120K/12x3 mths as an estimate of profits. Discuss options with Alfonso to determine if any assets will be sold in near future.

Summary of Recommendations: • • • • • •

DI should be purified before the share sale through a disposition of term deposits and payment of liabilities. Recommend selling 100% of term deposits to minimize risk of CRA reassessment/disallowance of CGE. Have DI pay out a capital dividend of $400K (election required) prior to the share sale. Consider having DI pay out a taxable non-eligible dividend of $130,435 to result in a dividend refund of NERDTOH of $50,000 prior to share sale. In the short year end tax return for DI, a partial election on the land (or goodwill) should be filed to prevent the expiration of net capital losses. Tax research in regard to the future utilization of losses by DI should be performed before Alfonso incurs the costs of amalgamating the corporations. It will be necessary to support a position that DSL will be earning income from the sale of services that are similar to the business of DI (or vertically integrated business).

Solutions to Chapter 15 Assignment Problems

• • • •

457

It will also be necessary to continue the business of DI with a reasonable expectation of profit to allow the use of the non-capital losses after the AOC. The partial election is recommended as loss availability after the acquisition appears likely based on the information provided. The maximum election on the land (or other properties) is recommended if profitability expectations are uncertain, if the DI business will be discontinued or for properties that will be sold in the near future (this should be discussed with Alfonso). The building should not be designated in the short year end return as a significant tax liability will result.

[Note: Competent students should demonstrate consistency between the loss utilization analysis and recommendations in regard to partial election options.]

CHAPTER 16

Corporate Distributions, Asset Sales and Winding-Up, and Sales Solution 1: Capital Dividend Account Effect on Income Investments: ACL 1/2  ($22,000 – ($60,000 + $500)) ................................................ $(19,250) Land: TCG 1/2 ´ ($1,000,000 – ($400,000 + $50,000)) 275,000 Building: TCG 1/2 ´ ($1,250,000 – ($700,000 + $60,000)) Building: recapture ($450,000 – $700,000) 245,000 250,000 Equipment: recapture (($8,000 – $400) – $0) .......................................................

7,600

Class 14.1: goodwill and customer lists: Proceeds ..................................................................................... $ 95,000 Less: Cost .......................................................................................... 40,000 Capital gain ................................................................................ $ 55,000 Taxable capital gain....................................................................

$27,500

UCC balance ..................................................................................... $34,000 Lower of cost and proceeds (LOCP) ................................................. (40,000) (6,000) Recapture ...................................................................................

$6,000

Capital Dividend Account Balance: January 1, 2023 ..................................................................................... Nil Investments: 1/2  ($22,000 – ($60,000 + $500)) untaxed portion ............................... $(19,250) Land: 1/2 ´ ($1,000,000 – ($400,000 + $50,000)) untaxed portion Building: 1/2 ´ ($1,250,000 – ($700,000 + $60,000)) untaxed portion 275,000 245,000 Goodwill and customer lists: ½ (95,000 - $40,000) (untaxed portion) 27,500 Balance: December 31, 2023 ....................................................................................... $528,250

443

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Introduction to Federal Income Taxation in Canada

The above can be summarized in tabular form as follows: Capital Dividend Account

AII $(19,250)

Untaxed fraction of net cap. gains $(19,250)

275,000 245,000

Income effect Asset Investments ................. Land ......... Building.... Equipment. Class 14.1 .

ABI

$250,000 7,600 6,000 $ 263,600

27,500

$528,250

Capital dividend received

Untaxed life ins. proceed s

Capital dividend paid

Solutions to Chapter 16 Assignment Problems

445

Solution 10: Capital Dividend Account

Assess the Situation 1. Draw a diagram identifying all stakeholders, e.g., corporate org charts

Bob Son

PUC/ACB $10,000 100% Stein Ltd.

CCPC incorporated in 2007

2. Identify the relationships among the stakeholders, e.g., related, affiliated, associated, connected − Bob is related to and affiliated with Stein Ltd. − Son related to Bob/Stein Ltd. − Son connected to Bob for 15(2) 3. Identify the profile of each stakeholder, e.g., tax features, risk profile − Bob is an individual − Bob lives in Vancouver and is a Canadian resident − Stein Ltd is a CCPC; $0 GRIP, $30,000 of non-eligible RDTOH 4. Fully understand the decision maker and their objectives − Bob wants to remove $200,000 (after-tax) from his corporation in a tax effective manner. − Invest in a TFSA − Help son purchase his first home. − Receive salary of $90,000 in 2024 5. Identify the relevant past transaction/events or planned future transactions/events and create a timeline − Historical − Incorporation of Stein Ltd 2007 − Transactions from 2009 to 2023. These events have already taken place Future – Future sale of investments with a $140,000 capital loss. Distribution of $200,000 (after-tax) from Stein Ltd. Investment in a TFSA, gift to son. − 2024 salary of $90,000

446

Introduction to Federal Income Taxation in Canada

Identify the Issues 1. Identify all of the major tax issues and any non-tax issues − Issue 1: Identify the options available and tax treatment of fund withdrawal •

PUC distribution

•

Capital dividend

•

Taxable dividends

•

Additional salary

•

Salary/dividend mix

•

Shareholder loans

Qualitative: Discuss above options and result on after-tax funds available to Bob. Quantitative: Calculation of the CDA balance for all the transactions Issue 2: Savings Options TFSA FHSA 2. Identify missing information or assumptions made − None

Analyze the Issues 1. Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act

Solutions to Chapter 16 Assignment Problems

447

Issue 1: Identify the options available to withdraw funds PUC Distribution •

$10,000 of paid up capital can be removed tax free through a PUC distribution

•

The PUC distribution will reduce the PUC and the ACB of Bob’s shares by $10,000

•

A distribution without an equivalent reduction in PUC will result in a taxable dividend.

Capital Dividend [s. 89(1)] −

The CDA is a element of integration for private corporations. [s. 83(2)]

−

It allows tax-free receipts received by the corporation to be passed tax free to the shareholders

−

Represents the tax free portion of transactions arising from: o

Capital gains

Life insurance proceeds net of cost basis

Capital dividends received

−

You can pay it out the CDA as a tax-free dividend to shareholders [s. 83(2)]

−

The CDA needs to be calculated immediately before the dividend and an election needs to be filed.

−

CDA available is $99,750 per calculation below.

Taxable Dividends •

Non-eligible dividends can be paid and Stein Ltd. can obtain a dividend refund of the $30,000 non-eligible RDTOH balance.

•

A dividend of $78,261 is needed to be paid to receive a full refund of the NERDTOH balance ($30,000/38 1/3%) of $30,000.

•

Marginal tax rates on the non eligible dividends of 22.4%, 32.2%,37.9%,42.5%.

•

Dividends are not deductible.

Col will need to pay a total NE dividend of $140,000 to provide Bob with $200,000 Additional Salary • • • •

Deductible to the corporation, taxable to Bob at marginal tax rates. Provides Bob with full RRSP contribution room for the next year. Co. will not get a dividend refund. Tax saved in the corporation through the deduction of the salary.

448 • • • • •

Introduction to Federal Income Taxation in Canada

Salary of $160,000 on top of $90,000 will provide Bob with $200,000. Salary/Dividend Mix Provides almost max RRSP contribution room. Salary of $70,000 and non eligible dividend of $78,261 will provide Bob with $200,000 Tax saved in the corporation through deduction of the salary Co. will get a dividend refund.

Shareholder Loan •

Bob could remove funds through a shareholder loan

•

The loan would need to be repaid by December 31, 2025 to avoid an income inclusion for the loan on his 2024 personal tax return. He would report an interest benefit for the period the loan was outstanding if the repayment is made.

•

If the loan was made directly to the son, the same tax treatment applies as the son is connected to Bob who is a shareholder. The loan would be included in the son’s income on his 2024 personal tax return unless repaid by December 31, 2025. The housing exception to 15(2) would only apply if the loan was received by virtue of the son’s employment and bona fide repayment terms were made at the time of the loan.

Conclusion: Stein Ltd is a CCPC therefore it qualifies to have a CDA. The capital dividend account balances is $99,750 as calculated below. Bob also has access to $10,000 of paid up capital that can be distributed tax free. Salary/dividend mix provides Bob with RRSP contribution room and a dividend refund to the corporation. 2024 2025

Issue 2: Savings Options •

TFSA o

•

As Bob has never contributed to a TFSA he will have $88,000 of available room at the end of 2023 and an additional $6,500 of room for 2024.

FHSA Starting in 2023 a Canadian resident who is at least 18 years of age can set up a FHSA for a first time home purchase. Contributions are tax deductible and there will be an annual contribution limit of $8,000. Withdrawals to purchase a first home will be nontaxable. If the funds aren’t used to purchase a home they can be transferred to an RRSP without impacting RRSP contribution room or withdrawn and subject to tax. Bob could give $8,000 to his son in 2024 to be contributed to an FHSA. This would allow the son to take a deduction for the $8,000 against his income in 2024. There won’t be any tax consequences when the funds are withdrawn for the purchase of the house. The son will also be eligible for a new home buyer’s tax credit of $750.

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449

2. Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format

450

Introduction to Federal Income Taxation in Canada

Capital Dividend Account

Date Transaction 2009 Bond Disposition

Untaxed CG/CL

Capital Dividend

Life Insurance

Capital Dividend

Available CDA

5,000

2010 Capital Dividend

5,000

2011 Share Disposition

(2,000)

2014 Equipment Disposition

3,000

2015 Life Insurance Proceeds

80,000

2016 Sale Vacant Land

2018 Share Disposition

10,000

2020 Capital Dividend Paid

(50,000)

2023 Customer List Sale

30,000

2023 Share Disposition

18,750 64,750

5,000

80,000

(50,000)

99,750

The following amounts are not included in the capital dividend account: (1) Recapture is not included in the capital dividend account. (2) Since the 2016 gain on the vacant land was reassessed as income, it is not included in the capital dividend account.

Distribution Options Option 1 – all non-eligible dividends Option 2 – all salary Option 3 – dividend/salary mix. NE dividend sufficient to refund NERDTOH

451

Solutions to Chapter 16 Assignment Problems NERDTOH

30,000 No Sal/Div Option 1

Salary Additional Salary NEDividend Gross up Division B/TI

90,000

140,000 21,000 251,000

Tax DTC

25,248

Option 2 90,000 160,000

250,000

30,000 Option 3 90,000 70,000 78,261 11,739 250,000

95,304 (21,000)

94,229

94,229 (11,739)

Add'l Tax

49,056

68,981

57,242

After-tax addl

90,944

91,019

Cash Outlflow Corp Corp savings

140,000 (30,000)

160,000 (20,800)

148,261 (39,100)

After - tax cost Corp

110,000

139,200

109,161

Option 1 Option 2 PUC CDA After-tax Add'l Total

10,000 99,750 109,750

10,000 99,750 90,944 200,694

Best Overall

10,000 99,750 91,019 200,769

Option 3 10,000 99,750 91,019 200,769

Provides RRSP 28,800

(div ref or deduction)

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Introduction to Federal Income Taxation in Canada

(3) Sale of customer list Proceeds Cost

$100,000 (40,000)

Capital gain

$60,000

Taxable capital gain Capital dividend account

$30,000 $30,000

[Note: The recapture on the sale of the customer list would have been included in business income. UCC Lower of cost and proceeds Recapture

$33,000 (40,000) (7,000)

3. Identify risks including missing information, assumptions and uncertain research position There is a risk of a reassessment that would change a capital gain to an income gain. Given the assets disposed of this is unlikely. The 2024 loss reduces the capital dividend account to $35,000. 4. Reach a conclusion on each issue −

Reach a conclusion based on your analysis of each major issue. ▪

Stein Ltd does qualify to have a CDA balance since it is a private corporation.

▪

The balance in the CDA available to pay out as a capital dividend is $99,750 at the end of 2023.

▪

After the 2024 disposition of investments, the CDA available to pay out as a capital dividend will be reduced to $35,000. Note that the negative balance in the untaxed CG/CL column will not impact the ability of the company to pay out the life insurance proceeds and capital dividend received by the corporation as capital dividends.

▪

A salary/dividend mix is most tax effective to distribute funds to Bob.

5. Evaluate the strengths/weaknesses/risks of your conclusions −

None noted

Solutions to Chapter 16 Assignment Problems

453

Advise/Recommend Advise the decision maker, integrating your conclusions on each of the issues with their objectives, giving priority to the most important issues −

Stein Ltd. should make a $10,000 PUC distribution to be received tax free by Bob

−

Stein Ltd should pay, and elect on, a capital dividend before the 2024 disposition of investments to prevent any negative adjustment from reducing the balance in the CDA that can be paid out. This will allow the company to pay out a $99,750 tax free dividend to Bob. If he waits until after the disposition of the investments, a dividend of only $35,000 can be paid out tax free to Bob.

−

Stein Ltd. should pay out a non-eligible dividend of $78,261 to provide the corporation with a $30,000 dividend refund.

−

Stein Ltd. should pay the remainder needed in salary to provide RRSP contribution room or additional non-eligible dividends. This will provide $28,800 in contribution room.

−

Bob could consider paying out a shareholder loan instead of the salary/dividend mix option and then have the company pay a dividend to repay the loan before December 31, 2025. This could provide tax savings through the use of lower marginal tax rates/brackets in 2025 rather than have all of the distributions taxed in 2024.

−

Bob should contribute the maximum of $88,000 plus an additional $6,500 to his TFSA in 2024. The remaining funds could be gifted to his son for the house purchase. His son could contribute $8,000 to an FHSA and get a corresponding deduction against income. He could put the remainder in his own TFSA until the house is purchased.

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Introduction to Federal Income Taxation in Canada

Solution 2: Deemed Dividends Explanation of paid-up capital and how it is calculated −

Calculated at the corporate level, not at the shareholder level

−

Averaged over all shares issued

−

No identification with the shareholder who contributed the share capital

−

Not impacted by transactions among shareholders

Calculation of tax consequences

(a)

1350 P/S

Capital $110,500 cash Inc. 28,000 assets $138,500 PUC $148,500 PUC Corporation Gave PUC (1,350 sh x $110)

$148,500

Corporation Received Cash

$110,500

Assets Total assets

28,000 $138,500

Deemed dividend

$10,000

ACB

$138,500 10,000 $148,500

455

Solutions to Chapter 16 Assignment Problems

The transaction results in an immediate deemed dividend of $10,000 since the PUC of the preferred shares increased by $148,500, but the increase in the FMV of the assets was only $138,500 [ssec. 84(1)]. The dividend would be a non-eligible dividend unless designated from GRIP. Also, the ACB of the shares increases by $10,000 to $148,500 [para 53(1)(b)].

(b)

Shareholder ACB $16,000

PUC reduction: $4,000 or $8,000

Plastics Ltd. FMV $35,000 PUC $5,500 PUC

ACB

$4,000 Opening balance

5,500 $

16,000

(4,000) 1,500 $

(4,000) 12,000

5,500 $

16,000

(8,000) (2,500) $

(5,500) 10,500

PUC reduction No deemed dividend $8,000 Opening balance PUC reduction Deemed dividend

2,500

(i) The payment of $4,000 will not result in an immediate deemed dividend, as the payment is less than the PUC of the shares ($5,500) [ssec. 84(4)]. This payment would be considered to be a return of the original capital injected by the shareholders. This payment will, however, reduce the adjusted cost base to $12,000 ($16,000 – $4,000) [spar. 53(2)(a)(ii)]. This reduction would result in a higher capital gain upon ultimate disposition of the shares because $4,000 of the cost in the shares has been recovered taxfree by this payment. (ii) The payment of $8,000 will result in an immediate deemed dividend of $2,500 because the payment of $8,000 is in excess of the PUC of $5,500. The ACB of the shares will be reduced by the non-taxed portion of the payment of $5,500 ($8,000 – $2,500).

456

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Introduction to Federal Income Taxation in Canada

Shareholders 15% stock dividend – PUC 3,375

4,500 c/s Festivals Ltd. PUC $22,500

Opening balance Stock dividend of 15% Ending balance

PUC

ACB

DD 82(1)

4,500 675 5,175

22,500 3,375 25,875

3,375

The payment of the stock dividend of $3,375 increased the PUC by $3,375 but it does not result in a deemed dividend, because paragraph 84(1)(a) excludes a stock dividend from deemed dividend treatment under section 84. However, subsection 82(1) and the definition of an “amount” [ssec. 248(1)] require that a dividend equal to the increase in PUC be included in income. In addition, the ACB increases by $3,375.

(d)

Shareholder 100%

Cash Common shares

$15,400

Common shares repurchased one year later Baker Corp Ltd.

Assets

$38,400

457

Solutions to Chapter 16 Assignment Problems

Issuance Assets Cash Net assets contributed PUC/ACB Common shares

38,400 (15,400) 23,000 23,000

Redemption Repurchase price PUC Deemed dividend

$30,000 (23,000) 7,000

Proceeds of disposition Deemed dividend Adjusted Proceeds of Disposition ACB

$30,000 (7,000) 23,000 23,000 0

(i) The contribution of the assets will not result in a deemed dividend as long as the increase in the PUC of the shares of $23,000 does not exceed the increase in net assets of $23,000 ($38,400 – $15,400). (ii) The shareholder of Baker Corp. Ltd. will receive a $7,000 deemed dividend, the repurchase value exceeds PUC [ssec. 84(3)]. Since the ACB of the shares is $23,000 (i.e., $38,400 − $15,400), there will also be no capital gain or loss on the redemption (i.e., proceeds ($23,000) – ssec. 84(3) dividend (nil) – ACB ($23,000)).

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Introduction to Federal Income Taxation in Canada

Solution 3: Redeem vs. Sell Shares Assess the Situation 1. Draw a diagram identifying all stakeholders, e.g., corporate org charts

Ms. Chiu

FMV ACB PUC

1,000 Cl A

1,000 Cl B

1,000 Cl C

1,000 Cl D

$50,000 20,000 20,000

$50,000 40,000 20,000

$50,000 20,000 40,000

$50,000 80,000 100,000

Co A

Co B

Co C

Co D

2. Identify the relationships among the stakeholders e.g., related, affiliated, associated, connected − Ms. Chiu is not related to any other shareholders 3. Identify the profile of each stakeholder e.g., tax features, risk profile − Ms. Chiu is an individual presumably resident in Canada (since the companies are CCPCs) − She is in the top tax bracket − The shares are not QSBC shares − None of the companies have a GRIP balance − The 4 companies are associated corporations (Ms. Chiu controls all of the corporations) 4. Fully understand the decision maker and their objectives − Identify the tax consequences of the redemption or sale of each set of shares 5. Identify the relevant past transaction/events or planned future transactions/events and create a timeline − Future: She is considering the redemption or sale of her shares in the future

Solutions to Chapter 16 Assignment Problems

459

Identify the Issues 1.

Identify all of the major tax issues and any non-tax issues Discuss the tax treatment of a share redemption − Quantitative: Calculate the deemed dividend then capital gain or loss on the redemption of the shares Discuss the tax treatment of a share sale − Quantitative: Calculate the capital gain or loss on the sale of the shares 2. Identify missing information or assumptions made −

None identified

Analyze the Major Issues 1. Identify and complete an appropriate qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act Tax consequences of a redemption of CCPC shares −

S. 84(3) applies to any corporate redemption and results in the calculation of a deemed dividend. A non-eligible dividend is grossed up at 15% and a dividend tax credit equal to the gross up is available in computing tax. In the top marginal tax bracket, an effective tax rate of 42.5% will apply to the dividend.

−

Since the redemption is also a disposition there is also a potential capital gain/capital loss on redemption. To avoid double taxation the redemption dividend is deducted from the proceeds to arrive at adjusted proceeds for purposes of determining the capital gain or loss on disposition.

Tax consequences of a sale of CCPC shares −

The disposition of shares will result in a capital gain or loss. Only half of the gain is subject to tax at the taxpayer’s graduated tax rate. In the top marginal tax bracket, an effective tax rate of 25% will apply to the gain which is lower than the tax rate applicable to dividends. If the shares are QSBC shares, the capital gains deduction could be used to shelter the taxable capital gain from tax.

2. Identify and complete the supporting quantitative analysis using an appropriate analysis format

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Introduction to Federal Income Taxation in Canada

Redemption proceeds Less: PUC Deemed dividend Tax @ 42.5%

Corp A Redemption 50,000 (20,000) 30,000 12,750

Corp B Redemption 50,000 (20,000) 30,000 12,750

Corp C Redemption 50,000 (40,000) 10,000 4,250

Corp D Redemption 50,000 (100,000) -

Redemption proceeds Deemed dividend Proceeds of disposition Less: ACB Capital gain (loss) Tax @ 25% After- tax Cash

50,000 (30,000) 20,000 (20,000) 37,250

50,000 (30,000) 20,000 (40,000) (20,000) (5,000) 42,250

50,000 (10,000) 40,000 (20,000) 20,000 5,000 40,750

50,000 50,000 (80,000) (30,000) (7,500) 57,500

Proceeds of disposition ACB Capital gain (loss) Tax @ 25%

Corp A Sale 50,000 (20,000) 30,000 7,500

Corp B Sale 50,000 (40,000) 10,000 2,500

Corp C Sale 50,000 (20,000) 30,000 7,500

Corp D Sale 50,000 (80,000) (30,000) (7,500)

After- Tax Cash

42,500

47,500

42,500

57,500

Note that in all cases, the economic gain is equal to the capital gain. Corp A:

The redemption results in a higher tax since dividends are taxed at a higher rate than capital gains

Corp B:

The redemption results in significantly more tax since the PUC is lower than the ACB. And, if the capital loss cannot be used the tax differential will be even more

Corp C:

The redemption results in a higher tax since some of the gain is taxed as a dividend, which is taxed at a higher rate than capital gains Both are taxed the same since there isn’t any dividend to be taxed at a different rate. PUC of $50,000 is lost.

Corp D:

Tax is saved due to an allowable capital loss only where Ms. Chui has taxable capital gains available to use the loss. The stop loss rules will not apply as long as Ms. Chui is redeeming all of the shares owned in the corporation.

Solutions to Chapter 16 Assignment Problems

461

Conclusions: Corp A – After -tax cash through redemption is less than from sale because marginal tax rate on DD is 42.5% relative to 25% on capital gains. Corp B - After -tax cash through redemption is less than from sale because marginal tax rate on DD is 42.5% relative to 25% on capital gains and most of appreciation is treated as a DD. Also capital loss can only be used against capital gains. PUC of $20K is lower than ACB of $40K likely due to shares being purchased later. Corp C – After-tax cash through redemption is less than from sale because marginal tax rate on DD is 42.5% relative to 25% on capital gains. PUC of $40K is higher than ACB of $20K. Could be due to another shareholder investing in the class of shares and PUC is averaged over all shares. Or shares purchased later. Corp D – Same after-tax cash. In both cases capital loss can only be used against a capital gain. PUC of $100K is higher than ACB of $80K. Could be due to another shareholder investing in the class of shares and PUC is averaged over all shares. Or shares purchased later. Note that if shares are redeemed PUC of $50K is lost. Advice/Recommendation: Sell shares if possible to take advantage of lower marginal tax rate. Also a redemption requires the company to buy back shares and it must have cash to do so.

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Introduction to Federal Income Taxation in Canada

Solution 11: Withdrawing funds from investment corporation Assess the Situation 1. Draw a diagram identifying all stakeholders, e.g., corporate org chart

Mark

Hilary

50 c/s

ACB $50,000

ACB $50,000 HII

PUC $100,000 2. Identify the relationships among the stakeholders, e.g., related, affiliated, associated, connected −

Mark and Hilary are related to and affiliated with each other

−

Mark and Hilary are each related to and affiliated with HII

3. Identify the profile of each stakeholder, e.g., tax features, risk profile i. Mark and Hilary 1. Individuals resident in Canada 2. Bought their 50 shares from HII for $50,000 each so ACB is $50,000 each 3. Both plan to retire in five years ii. HII 1. CCPC since it is a private corporation controlled by two Canadian residents 2. PUC is $100,000 3. Non-eligible RDTOH of $25,000 4. Eligible RDTOH of $23,000 5. CDA of $30,000 6. GRIP of $60,000 7. Net capital loss of $10,000 4. Fully understand the decision maker and their objectives i. Both Hilary and Mark want to minimize any risk of reassessment. ii. Mark and Hilary would like your advice on the following: 1. How much money they can take out of the corporation without paying any corporate or personal tax?

463

Solutions to Chapter 16 Assignment Problems

2. Does it make sense for them to take more money out of the corporation as salary or dividend? 3. Any advice on the $40,000 Hilary borrowed from HII given she will repay it in October?

5. Identify the relevant past transaction/events or planned future transactions/events and create a timeline. −

The only transaction that has taken place is the loan from HII to Hilary.

2022

2023

Aug 31

Dec 31

2024

Aug 31

Dec 31

July 1

Oct (today)

Loan received

Plan to repay loan

Aug 31

Identify the Issues 1. Identify all of the major tax issues and any non-tax issues. −

−

Possible ways of getting money out tax free: o

PUC reduction - $100,000

CDA - $30,000

Possible ways of getting money out with tax o

Dividend to obtain a dividend refund

Salary ▪

o −

What is reasonable?

Is salary or dividend better?

Shareholder loan o

Does she have to take the loan principal into income?

Is there a deemed interest benefit?

2. Identify missing information or assumptions made −

Assume there are less than five full-time employees in HII

−

Investment income in this corporation in excess of $50,000 would impact of the small business deduction limit of any associated corporations. Adjusted aggregate investment income includes dividends from non-connected corporations.

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Introduction to Federal Income Taxation in Canada

Analyze the Issues Issue 1 Possible ways of getting money out tax free: PUC Reduction and CDA 1. Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act PUC reduction - $100,000 −

Paid up capital [s. 89(1)] is averaged over the 100 common shares of the company and is therefore, $1,000 per common share.

−

Paid up capital can be distributed tax free to shareholders through a paid up capital reduction resolution.

−

As long as the funds or property distributed from the corporation do not exceed PUC a deemed dividend will not result.

−

The PUC reduction will also reduce the ACB of the shares held by Mark and Hilary

CDA - $30,000 −

It is possible to elect [s. 83(2)] to treat a dividend as having been distributed from a private corporation’s capital dividend account.

−

Such a dividend is received tax free by the shareholder.

−

HII’s capital dividend balance of $30,000 is a cumulative balance.

−

This balance relates to the untaxed portion of capital gains in excess of the amount by which capital losses exceed allowable capital losses.

−

The calculation of the CDA balance requires that any capital losses be reflected in this account even if the allowable capital loss is not yet deducted for tax purposes, i.e., net capital loss has impacted the CDA calculation in the year the loss was incurred.

2. Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format −

A PUC reduction of $99,998 will reduce PUC to $2 and reduce the ACB of the shares to Mark and Hilary from $50,000 to $1 each

−

We should review the components of the capital dividend account to confirm that the $10,000 net capital loss has already been reflected in the $30,000 CDA balance and will not impact the potential $180K addition to the capital dividend account upon the sale of investments in the future.

3. Identify risks including missing information, assumptions and uncertain research positions −

If we pay out a capital dividend that is higher than the balance in the capital dividend account there are penalties.

−

Make sure the balance is correct.

Solutions to Chapter 16 Assignment Problems

465

4. Reach a conclusion on each issue −

It is possible to distribute $50,000 of PUC to each shareholder without either a deemed dividend or capital gain/loss −

−

To maintain some PUC, the reduction should be $49,999 each or $99,998 in total

Subject to a confirmation of the balance in the CDA, a tax-free capital dividend of $15,000 dividend can be declared to each shareholder with the appropriate election.

5. Evaluate the strengths/weaknesses/risks of your conclusions −

None identified

Issue 2 Possible ways of getting money out with tax a. Pay Dividends to Generate a Dividend Refund 2. Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act −

Hilmar Investments Inc. is earning aggregate investment income [interest, dividends and taxable capital gains].

−

Interest and taxable capital gains (net of taxes) can be distributed as non-eligible dividends to shareholders.

−

Dividends received from Canadian public companies are “eligible dividends” and go into HII’s GRIP balance

−

The current GRIP balance is $60,000

−

Dividends can be designated to be paid from HII’s GRIP balance as eligible dividends. The gross up for GRIP dividends in 2023 is calculated at 38% with a dividend tax credit equal to the gross up.

−

All other dividends paid from HII are non-eligible dividends. The gross up for these dividends in 2023 is calculated at 15% with a dividend tax credit equal to the gross up.

−

The company can choose whether a dividend paid is an eligible (up to available GRIP) or is a non-eligible dividend

−

Dividends paid by the corporation will result in a refund of RDTOH equal to the lesser of: 1. 38⅓ % of taxable dividends paid in the year and 2. The corporation’s relevant RDTOH balance at the end of the year.

Part IV tax on eligible portfolio dividends are included in eligible RDTOH. A refund of eligible RDTOH (using the above calculation) can be received on the payment of eligible or non-eligible dividends (once the non-eligible RDTOH pool is fully refunded). Refundable Part I tax is included in the non-eligible RDTOH pool. Non-eligible RDTOH can only be refunded through the payment of non-eligible dividends. Non-eligible dividends must be used to provide a refund from the non-eligible RDTOH pool before any refund of the eligible RDTOH account can be accessed. As a result, the company in the above situation will be able to pay an eligible dividend of $60,000 to obtain a $23K refund of eligible RDTOH and a noneligible dividend of $65,217 to obtain a $25K refund of non-eligible RDTOH.

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Introduction to Federal Income Taxation in Canada

3. Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format −

A dividend of $65,217 ($25,000/38⅓%) would need to be paid to result in a refund of $25,000 of non-eligible RDTOH.

−

The personal tax on an eligible (GRIP) dividend of $60,000 (equal to GRIP) at the highest tax bracket personal tax rate would be 31% [50% x 1.38 – .38] or $18,600. There is a dividend refund of $23,000 of eligible RDTOH resulting from this dividend payment. o

−

Therefore, pay an eligible dividend to generate net cash of $4,400

The personal tax on a non-eligible dividend of $65,217 at the highest tax bracket personal tax rate would be 42.5% [50% x 1.15 – .15] or $27,717 of personal tax. There is a dividend refund of $25,000 resulting from this dividend payment. There is a tax cost of $2,717. o

Since the personal tax at 42.5% is greater than the dividend refund at 38.33% an option is to leave this non-eligible dividend in the corporation

Wait until retirement in five years when the personal tax rates on non-eligible dividends are lower, e.g., non-eligible dividends in a year in which they each earn $130,000 would be taxed at a rate of 32.2%.

4. Identify risks including missing information, assumptions and uncertain research positions −

None identified

5. Reach a conclusion on each issue −

Dividends are not deductible to the corporation but can be paid to generate a $48,000 dividend refund.

−

Dividends eligible for a dividend refund are a tax efficient way to get cash out of the company, especially if they are eligible dividends.

−

Eligible dividends of $60,000 should be paid first to generate a dividend refund of $23,000 with personal tax of $18,600.

−

Non-eligible dividends of $65,217 can then be paid to generate the dividend refund of $25,000 with personal tax of $27,717. Mark and Hilary must decide whether they want to pay this dividend now or when they retire and their personal tax rate is lower.

6. Evaluate the strengths/weaknesses/risks of your conclusions −

No weaknesses identified

Solutions to Chapter 16 Assignment Problems

467

Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act b. Pay Salary 1. −

Salaries are deductible to the corporation and taxable to the individual. If the individual is in the highest tax bracket, only 50% of the salary will be available after tax.

−

An amount that is reasonable in the circumstances is deductible for tax purposes under section 67. CRA’s administrative position is that they will not challenge the reasonableness of salaries or bonuses to shareholder-managers if profits are usually distributed by way of bonus or the company’s policy is to pay bonuses to compensate for special knowledge or skills. As this company is not active in nature, it is not clear that CRA’s administrative position would apply to salaries paid from investment income. It may be necessary to support the reasonableness of the deduction by documenting the activities performed by the shareholders for the salaries received.

−

While the payment of a salary provides RRSP room, Hilary and Mark are already receiving employment income from their technology sector jobs that provide them with maximum RRSP room.

−

If they leave the money in the corporation they will be able to pay it out as a dividend when they retire and their income is in a lower tax bracket.

2. Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format −

A $10,000 salary will provide $5,000 after-tax for either of Hilary or Mark as they are in the highest tax bracket. The corporation will save $2,000 of tax because of the deduction for the salary paid [$10,000 x 50.67% or $5,067 less lost non-eligible RDTOH of $3,067 ($10,000 x 30.67%)].

− A $10,000 non-eligible dividend will provide $5,750 [$10,000 – [$10,000 x 1.15 x 50% – $10,000 x.15]] after-tax for Hilary or Mark as they are in the highest tax bracket. Dividends are not deductible and therefore no Part 1 tax savings to the corporation result. −

If sufficient dividends have already been paid to refund the RDTOH then there is no dividend refund related to the dividend payment.

3. Identify risks including missing information, assumptions and uncertain research positions −

Salary expenses can be challenged by the CRA as being unreasonable

4. Reach a conclusion on each issue −

Do not pay salary due to the risk of challenge from the CRA

−

Do not pay dividends at this time unless they are eligible dividends and there is a balance in eligible RDTOH

−

In the future pay capital dividends as the investments are sold and capital gains are realized

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Introduction to Federal Income Taxation in Canada

−

Pay non-eligible dividends to Mark and Hilary when they retire and are in a lower tax bracket

5. Evaluate the strengths/weaknesses/risks of your conclusions −

No weaknesses identified

Issue 3 Shareholder loan 1. Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act −

−

The July 1, 2022 $40,000 loan to Hilary is a shareholder loan subject to subsection 15(2) and would be required to be included in her 2022 income since the exceptions are not met. o

The loan was not repaid by August 31, 2023, i.e., one year from the end of the taxation year end in which the loan was made.

The loan could not be argued to have been received by virtue of employment. Other employees of the company (confirm this) do not receive loans of a similar nature and it is clearly a loan that she is receiving as a shareholder of the corporation.

The loan is for a vehicle but not a vehicle to be used in the performance of employment duties.

Where there is an income inclusion of the principal there is no interest benefit.

2. Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format −

None needed

3. Identify risks including missing information, assumptions and uncertain research positions −

None identified

4. Reach a conclusion on each issue

−

The $40,000 shareholder loan to Hilary is taxable and her 2022 tax return should be amended to include it in her Division B income in 2022 and remove any interest benefit included on the 2022 return.

−

The repayment of $40,000 in October of 2023 (after the August 31, 2023 year end) will be deductible in Hilary’s 2023 personal tax return.

−

There is no interest benefit to Hilary in relation to the loan.

Evaluate the strengths/weaknesses/risks of your conclusions −

No weaknesses identified

Solutions to Chapter 16 Assignment Problems

469

Advise/Recommend Advise the decision maker, integrating your conclusions on each of the issues with their objectives, giving priority to the most important issues Tax Free −

Funds removed from the corporation should be distributed as tax free paid-up capital distributions. $99,998 should be removed in this manner.

−

Also, $30,000 of capital dividends should be paid out.

−

The components of the capital dividend account should be reviewed to confirm the balance in this account.

−

An election should be filed to treat the dividend as a tax-free capital dividend to the shareholders.

−

In the future pay capital dividends as the investments are sold and capital gains are realized.

Taxable −

Salaries should not be paid due to the risk of challenge from the CRA.

−

Do not pay dividends at this time unless they are eligible dividends and there is a balance in the eligible RDTOH.

−

Pay non-eligible dividends to Mark and Hilary when they retire and are in a lower tax bracket.

−

If further funds are to be removed from Hilmar, eligible dividends out of GRIP of $60,000 should be paid out first to receive a dividend refund of $23,000 with personal tax of $18,600.

−

If they decide they want to, an additional non-eligible dividend of $65,217 can then be paid to generate the dividend refund of non-eligible RDTOH of $25,000 with personal tax of $27,717.

−

Dividend payments could be deferred until they retire and are in a lower tax bracket.

−

In the future, as the GRIP balance builds up, pay an eligible dividend to Mark and Hilary.

Shareholder Loan −

Hilary’s 2022 personal tax return should be amended to include the $40,000 shareholder loan in income and remove any interest benefit. When she files her 2023 return, the $40,000 repayment can be deducted when computing her income.

−

A letter should be written to the CRA requesting the amendment and the related 2022 tax payment should be made as soon as possible to stop interest accruing on the balance owing.

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Introduction to Federal Income Taxation in Canada

Solution 4: Wind-Up of a Corporation Assess the Situation 1. Draw a diagram identifying all stakeholders and their relationships, e.g., corporate org charts

Mr. Prasad

related affiliated

Cdn resident Top tax rate

100% ACB/PUC 18K

J. Tilkenhurst Ltd

Purchaser unrelated

CCPC

2. Identify the relationships among the stakeholders, e.g., related, affiliated, associated, connected − Mr. Prasad owns 100% of the company so they are related and affiliated − Purchaser is not related 3. Identify the profile of each stakeholder, e.g., tax features, risk profile − Mr. Prasad −

An individual resident in Canada (since JTL is a CCPC)

−

Planning to sell the assets of JTL in January 2024 and wind up the company

−

He is in the top tax bracket in 2023 and 2024

−

In 2025 and later years he expects his income to be approximately $120,000

− J. Tilkenhurst Ltd. −

CCPC (given) – controlled by a Canadian resident

−

PUC of shares is $18K, NERDTOH $6K, CDA $12K, no GRIP

− Purchaser −

A corporation

Solutions to Chapter 16 Assignment Problems

471

4. Understand the decision maker and their objectives − Mr. Prasad wants to retire − He wants the company to sell its assets and wind up JTL − Wants to determine how much capital he has to invest if he winds up JTL − He wants to know whether he should wind up JTL or keep it 5. Identify the relevant past transaction/events or planned future transactions/events and create a timeline − Mr. Prasad purchased the shares 10 years ago − He wants the company to sell its assets and wind up in January 2024

−Planning transaction Identify the Issues 1. Identify all of the major tax issues and any non-tax issues Issue 1 Tax treatment of an asset sale Quantitative: After-tax cash in JTL after selling the assets? Issue 2 Tax treatment of a wind up of JTL Quantitative: After-tax cash with Mr. Prasad on winding up the company? Issue 3 Pro and cons of retaining the corporation Should he wind up JTL or keep it? 2. Identify missing information or assumptions made −

Assume that JTL and the purchaser are neither related nor affiliated

Analyze the Issues 1. Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act -

Issue 1 Tax treatment of asset sale −

The sale of assets will result in: o

Disposition of the properties sold for tax purposes.

Taxable income in JTL; Business income, TCGS/ACLs, Recapture/terminal loss

Possible additions to the CDA and non-eligible RDTOH

Liabilities, including income tax to be paid

After-tax cash in the corporation available for distribution to Mr. Prasad

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Introduction to Federal Income Taxation in Canada

Issue 2 Tax treatment of a wind up of JTL −

If JTL is to be “wound up” so s. 84(2) applies o

While s. 88(2) does apply, the assets have already been sold so there are no assets remaining to be deemed to be disposed of; the only asset is cash. 88(2) applies to a Canadian corporation where all or substantially of the property owned is distributed to the shareholders on wind up.

Consequences of wind up – The shares will disappear along with the company. As a result, the wind up is treated like a redemption since the funds are coming from the company to Mr. Prasad. Therefore, calculate ▪

Deemed dividend [84(2)]

▪

Capital gain or loss [84(9)]

Issue 3 Pros and cons of retaining JTL −

−

If JTL is NOT wound up o

The PUC and CDA can still be paid out tax free

The dividend refund is not received but future dividends can be paid to generate a dividend refund.

More flexibility; Dividends can be paid out over time at lower tax rates.

Investment income earned in a corporation is taxed at the highest tax rate and there is a tax cost to earning investment income in a corporation.

Avoids immediate tax on the deemed dividend on wind up under 84(2)

More difficult to access funds held in a corporation.

If JTL is wound up o

Mr Prasad no longer has ongoing filing and administrative costs associated with having a corporation.

Funds from the corporation can be invested personally and taxed at lower marginal tax rates or could be invested in an RRSP or TFSA where investment income is not taxed.

Significant deemed dividend on wind up will be taxed at highest marginal tax rate of 42.5%.

2. Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format Sale of Assets Calculate the tax cost of selling all the assets of the company and the after-tax corporate cash available for distribution if the JTL is wound up.

Solutions to Chapter 16 Assignment Problems

473

Proceeds

Non-Eligible CDA RDTOH 12,000 6,000

Opening balance Cash Accounts receivable Inventory Land Building Equipment Marketable securities Class 14.1 Assets Liabilities Income taxes Dividend Refund

ABI

AII

15,000 52,000 5,000 (4,000) (4,000) 127,000 17,000 950,000 282,500 282,500 1,197,000 343,000 315,500 315,500 60,000 (50,000) 26,000 130,000 21,853 43,774 43,774 (645,000) 336,853 637,774 13% 50.67% (366,930) 43,791 323,139 1,545,070 201,584 1,746,654 649,774

1 2 3 4 5 6 7

195,584 201,584 / 38.33% 525,871

Wind up the Company

Calculate the components of the distribution Deemed Dividend Funds available for distribution Less: paid-up capital Deemed dividend on winding up Less: capital dividend elected Deemed taxable dividend (sufficient to clear RDTOH) T axable capital gain to shareholder: Proceeds on winding-up Less: Deemed dividend Proceeds of disposition Cost Capital gain Taxable capital gain C alculate the tax cost and after-tax cash to Mr. Prasad personally Cash distribution Tax on non-eligible dividend 1,078,880 42.5% After-tax cash * (1 + .15) x 50% - .15 = 42.5%

1,746,654 (18,000) 1,728,654 (649,774) 1,078,880 1,746,654 (1,728,654) 18,000 (18,000) 1,746,654 (458,524) 1,288,130

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Introduction to Federal Income Taxation in Canada

Compare the after-tax cash available to invest if JTL is wound up (Option A) to the after-tax cash available if the company is retained (Options B & C). If the company is retained, the PUC and CDA can be distributed tax free to provide some personal funds for Mr. Prasad to invest (Option B). If the company is retained, it would also be possible to pay a non-eligible dividend of $525,871 to receive a refund of the company’s non-eligible RDTOH balance of $201,584 at a low tax cost of $21,911.

Corporation After- tax Cash PUC Distribution Capital Dividend Taxable Dividend Paid Dividend Refund Available to Invest

Option A Asset Sale Wind Up

Option B Asset Sale No Wind Up

Option C Asset Sale No Wind Up

JTL

JTL 1,545,070 (18,000) (649,774) 877,296

JTL 1,545,070 (18,000) (649,774) (525,871) 201,584 553,009

Mr P

18,000 649,774 -

Individual Cash Received on Wind up PUC Distribution Rec'd Capital Dividend Rec'd Taxable Dividend Rec'd Tax on Dividend Available to Invest

Mr P 1,746,654

(458,524) 1,288,130

667,774

18,000 649,774 525,871 (223,495) 970,150

Total Available to Invest

1,288,130

1,545,070

1,523,159

3. Identify any risks including missing information, assumptions, and uncertain research positions −

None identified

4. Reach a conclusion on each issue a. If Mr. Prasad sells the assets for the amounts specified and subsequently winds up the company he will have personal after-tax cash of $1,288,130 to invest personally. b. If he does not wind up the company, JTL will have $1,545,070 (before the dividend refund) available to invest in the company, pay out as taxable dividends, or pay out as capital dividends ($649,774) or to make a paid up capital distribution ($18,000).

475

Solutions to Chapter 16 Assignment Problems

c. If he does not wind up the company −

He will be able to withdraw the PUC ($18,000) and CDA ($649,774) tax free.

−

Between the corporation and Mr. Prasad they will have a total of $1,545,070 available to invest.

−

He will also be able to access the $201,584 of non-eligible RDTOH on the payment of a dividend of $525,871. Since his personal tax rate on this non eligible dividend of 42.5% is greater than the dividend refund rate of 38 ⅓% he should wait until he is in a lower personal tax bracket before paying this dividend

−

He will be able to defer the personal tax of $458,524 on the winding-up dividend.

5. Evaluate the strengths/weaknesses/risks of your conclusions −

No weaknesses identified

Advise/Recommend Advise the decision maker, integrating your conclusions on each of the issues with their objectives, giving priority to the most important issues −

Do not wind up

−

Pay out the PUC and CDA and invest in a TFSA or RRSP

−

Pay a dividend to generate the dividend refund when he is in a lower tax bracket

—NOTES TO SOLUTION (1) Accounts receivable: Inclusion of last year’s reserve (active business income) ...................................... Proceeds of disposition* ...................................................................................... Cost .....................................................................................................................

$ 5,000 52,000 (60,000)

Capital loss ..........................................................................................................

(8,000) (4,000)

Allowable capital loss ( /2  $8,000)..................................................................... Capital dividend account (1/2  $8,000) ................................................................ 1

$ (4,000)

* The disposition does not qualify for the section 22 election, since the accounts receivable were sold to a factoring company and, hence, the disposition does not meet the “all or substantially all” and “carrying on the business” tests.

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Introduction to Federal Income Taxation in Canada

(2) Inventory: Proceeds ....................................................................................................................... $127,000 Cost .............................................................................................................................. (110,000) $ 17,000 (3) Land: Proceeds of disposition ................................................................................................ $950,000 Cost .............................................................................................................................. (385,000) Capital gain .................................................................................................................. $565,000 Taxable capital gain ..................................................................................................... $282,500 Capital dividend account (1/2  $565,000) ................................................................... $282,500 (4) Building: UCC ............................................................................................................................. $223,000 LCP .............................................................................................................................. (566,000) Recapture ..................................................................................................................... $343,000 Proceeds of disposition...............................................................................................

$ 1,197,000

Less: capital cost ........................................................................................................ Capital gain................................................................................................................

(566,000) $631,000 $315,500

Taxable capital gain (1/2  $631,000).................................................................... Capital dividend account (1/2  $631,000).............................................................

$315,500

(5) Equipment: UCC .................................................................................................................... LCP ..................................................................................................................... Terminal loss .......................................................................................................

$110,000 60,000 $(50,000)

(6)Marketable securities: Proceeds ....................................................................................................................... $ 26,000 Adjusted cost base ....................................................................................................... (26,000) Increase in value .........................................................................................................

Taxable capital gain ....................................................................................................

Capital dividend account .............................................................................................

477

Solutions to Chapter 16 Assignment Problems

(7) Sale of intangibles Proceeds

$130,000

Cost

42,453

Capital gain Taxable capital gain

$87,547 $43,774

Capital dividend account

$43,774

UCC opening balance LCP Negative balance

$20,600 (42,453) (21,853)

(8) Tax @ 13% on active business income (13% of $336,853)................................... Tax @ 502/3% on investment income (502/3% of $637,774) ..................................

$ 43,791 323,139

Total tax ..............................................................................................................

$ 366,930

(9) Refundable Part I Tax(302/3% of $637,774)..........................................................

$195,584

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Introduction to Federal Income Taxation in Canada

Solution 5: Sale of Assets With Wind-Up (A)

Proceeds Opening balance Cash Accounts receivable Inventory Land Building Equipment Goodwill Marketable securities Liabilities Income taxes After-tax Proceeds Dividend Refund

25,000 75,000 155,000 450,000 950,000 100,000 475,000 320,000 (540,000) (413,183) 1,596,817 244,183 1,841,000

ABI

AII

(12,500) (67,500) 275,000 (120,000)

75,000 13% 9,750

CDA 40,000

Non-Eligible RDTOH -

1 2

170,000 300,000

237,500 88,750 796,250 50.67% 403,433

237,500 88,750

3 4 5

836,250

244,183 244,183 / 38.33% 637,000

(B) Funds available for distribution Less: paid-up capital Deemed dividend on winding up Less: capital dividend elected Deemed taxable dividend (sufficient to clear RDTOH)

1,841,000 (100,000) 1,741,000 (836,250) 904,750

1,841,000 (1,741,000) 100,000 (100,000) -

(D) In order to deduct a reserve for doubtful debt or write off a bad debt, an amount in respect of the debt must have been included previously in income. This is not the case, if accounts receivable have been purchased from someone else. Where a person has sold all or substantially all of the property used in a business to a purchaser who will continue the business, section 22 provides for a joint election by the vendor and purchaser which results in permitting the purchaser to take the reserve or write-off with respect to the accounts receivable. Under section 22, the purchaser must include in income the difference between the face amount and amounts paid. This inclusion will allow the purchaser to deduct a reasonable reserve for doubtful debts on the accounts receivable purchased and to deduct any bad debts as they occur.

Solutions to Chapter 16 Assignment Problems

479

The vendor, regardless of whether section 22 is used, must add to income the reserve for doubtful accounts deducted in computing Division B income for the preceding taxation year. Under section 22, the vendor would have a business loss with respect to the disposition of the accounts receivable. If section 22 is not used, any loss on the disposition of the accounts receivable would be considered a capital loss, and any loss realized by the purchaser on the collection of accounts receivable will be a capital loss with no reserve or write-off permitted to the purchaser.

—NOTES TO SOLUTION (1) The reserve for doubtful accounts of $15,000 must be added to income regardless of whether a section 22 election is used. If a section 22 election is used, the excess of face amount over proceeds of $27,500 would be a business loss such that the net effect on income would be a $12,500 business loss. (2) Income/loss from business is the difference between the fair market value and the cost of inventory. In this case such a loss results due to: Fair market value (proceeds) ....................................................................... $155,000 Cost of inventory ........................................................................................ 222,500 $(67,500) (3) Land Taxable capital gain: Proceeds ............................................................................................... $450,000 Adjusted cost base ................................................................................ 110,000 Gain ..................................................................................................... $340,000 Taxable capital gain (1/2 of gain) ........................................................... $170,000 Capital dividend account (1/2 of gain) .......................................................... $170,000 (4) Building Taxable capital gain: Proceeds ............................................................................................... $950,000 Capital cost (adjusted cost base) ........................................................... 350,000 Gain ..................................................................................................... $600,000 Taxable capital gain (1/2 of gain) ........................................................... $300,000 Capital dividend account (1/2 of gain) .......................................................... $300,000 Active business income UCC $ 75,000 LCP...................................................................................................... $350,000 Negative balance is recapture ............................................................... $(275,000)

(5) Equipment UCC LCP............................................................................................................

$ 220,000 $100,000

Positive balance - terminal loss ..........................................................................$120,000

ITA 12(1)(d)

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Introduction to Federal Income Taxation in Canada

(6) Marketable securities Taxable capital gain: Proceeds ............................................................................................... Adjusted cost base................................................................................ Gain ..................................................................................................... Taxable capital gain (1/2 of gain) ........................................................... Capital dividend account (1/2 of gain) .......................................................... (7) (a) Unrecorded goodwill (given) Class 14.1 Proceeds ............................................................................................... Cost...................................................................................................... Capital gain .......................................................................................... Taxable capital gain.............................................................................. (b) Capital dividend account ...................................................................... (8) Income taxes Investment income: 502/3%  $796,250................................................................................ Business income: 13%  $75,000 ..................................................................................... Tax payable ................................................................................................ (9) Refundable Part 1 Tax 302/3%  $796,250......................................................................................

$320,000 142,500 $177,500 $ 88,750 $ 88,750

$ $ $

475,000 475,000 237,500

$237,500

$403,433

9,750 $413,183 $244,183

481

Solutions to Chapter 16 Assignment Problems

Solution 6: Sale of Assets With Wind-Up Assess the Situation 1. Draw a diagram identifying all stakeholders, e.g., corporate org charts

Mr. Chow 100% ACB $20,000

Purchaser

Chow Enterprises PUC $20,000 GRIP – 0 Non-Eligible RDTOH 5K CDA 8K

2. Identify the relationships among the stakeholders, e.g., related, affiliated, associated, connected − Since Mr. Chow controls Chow Enterprises, he is related and affiliated to CEL and they do not deal at arm’s length − Purchaser – no information on purchaser (assumed unrelated) 3. Identify the profile of each stakeholder, e.g., tax features, risk profile − Mr. Chow 1.An individual 2.A Canadian resident − Chow Enterprises 1.A CCPC 2. Carries on an active business in Canada therefore eligible for the small business

deduction 3. Has a non-eligible RDTOH balance of $5,000

4.Has a capital dividend account balance of $8,000 − Purchaser 1.Corporation 2.They will continue the business

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Introduction to Federal Income Taxation in Canada

4. Fully understand the decision maker and their objectives − Mr. Chow is the key decision maker − His goal is to sell the business of Chow Enterprises − His decision is: − If he sells the assets and keeps the corporation, how much would he have available in the corporation to invest? − If he sells the assets should he wind up the company? − How much would he need to sell the shares for to be as well off as selling the assets? − Wondering about HST implications of the asset sale (optional). 5. Identify the relevant past transaction/events or planned future transactions/events and create a timeline Incorporated 2015 Goodwill acquired 2018 Future sale of assets/potential wind up OR share sale.

Incorporated

Current: Company selling assets

Future decision: Does he keep the company or wind it up?

Or, should he sell the shares of Chow?

This is a planning transaction

Identify the Issues 1. Identify all of the major tax issues and any non-tax issues a. Tax treatment of an asset sale i. Quantitative: after-tax cash available to invest b. Tax treatment of wind up of CEL after the asset sale i. Quantitative: after-tax cash available to invest after wind up c. Pros and cons of retaining CEL after the asset sale d. Tax treatment of a share sale. i. Quantitative: Determine the price he would need to receive for the shares to be as well off as if he sold the assets e. HST consequences of asset sale (optional) 2.

Identify missing information or assumptions made −

That the purchaser and Chow Enterprises are neither related not affiliated

Solutions to Chapter 16 Assignment Problems

483

Analyze the Major Issues 1. Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act Issue 1 Tax treatment of asset sale Explain tax treatment of disposition of assets of the business − − − −

− −

−

Sale of assets results in disposition of properties for tax purposes Business income, TCGs/ACLs, Recapture/Terminal Losses Additions to CDA, NERDTOH Section 22 election is available for A/R as all or substantially all of properties being sold to a purchaser who will carry on that business. Loss is business loss to the vendor. Purchaser will include the loss in income and can claim bad debts/reserves in the future. Liabilities pd, including tax to be paid. Assumed the company was eligible for the SBD rate on first $500K of business income, 27% of excess. Need to look at business income reported on corporate return for year of sale. Conclusion: Sale of assets is a taxable disposition and company will have $2,694,473 available in after-tax cash to invest or pay out as dividends/PUC distribution as calculated below. A $1,218,000 capital dividend can be paid as well as a $20,000 PUC distribution.

Issue 2 Tax treatment of a Windup of CEL −

−

If CEL is to be “wound up” so s. 84(2) applies o

While s. 88(2) does apply, the assets have already been sold so there are no assets remaining to be deemed to be disposed of; the only asset is cash. 88(2) applies to a Canadian corporation where all or substantially all of the properties of the corporation are distributed to the shareholders on a wind up.

Consequences of wind-up – The shares will disappear along with the company. As a result, the wind-up is treated like a redemption since the funds are coming from the company to Mr. Chow. Therefore, calculate ▪

Deemed dividend [84(2)]

▪

Capital gain or loss [84(9)]

Conclusion: The company can be wound up following the share sale. Mr. C will receive the CDA of $1,218,000 tax free as well as his $20,000 of PUC. He will pay tax on a $1,832,540 dividend (calculated below) which will result in a dividend refund of NERDTOH of $376,067 in the corporation. After tax he will have $2,320,359 of cash available to him (calculated below) to invest personally.

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Introduction to Federal Income Taxation in Canada

Issue 3 Pros and cons of retaining CEL after the asset sale. −

If CEL is NOT to be wound up: o

The PUC and CDA can still be paid out tax free

The dividend refund is not received but future dividends can be paid to generate a dividend refund at a small tax cost

Defers the significant tax on the deemed dividend on wind up under 84(2). The tax can be deferred until a future year when Mr. Chow is in a lower tax bracket. Can pay dividends over time when lower marginal tax rate. Flexibility

What does Mr. Chow plan to do with the after-tax funds from the asset sale? Investment income in a corporation is taxed at the highest rate and there is a tax cost associated with earning investment income in a corporation.

If he plans to purchase another business, it would be tax effective to keep CEL and earn the business income in the corporation.

o o

But more difficult to access funds in a corporation. We don’t know what Mr. Chow plans to do with the after-tax cash from the asset sale – need info.

— If CEL is wound up: o

No ongoing filing and administration costs associated with retaining a corporation.

After-tax funds can be invested personally in a tax effective manner; TFSAs, RRSPs etc.

Significant tax liability at highest marginal tax rate on the wind up dividend.

Conclusion: Retaining the corporation will defer personal tax of $750,181 on the taxable dividend on wind up. The company will not receive the dividend refund of $376,067 unless non-eligible dividends of at least $981,129 are paid at a tax cost of $416,980 (overall tax cost of $40,913). A capital dividend of $1,218,000 and a PUC distribution of $20,000 can still be received by Mr. C tax free. Overall, he will have $2,694,473 (or $2,653.560 with dividend payment) available to invest if he retains the corporation ($1,456,473 in the corporation and $1,238,000 personally). Overall, the tax deferral of $374,114 increases the amount available to invest.

Solutions to Chapter 16 Assignment Problems

485

Issue 4 Tax treatment of a share sale: -

Capital gain on the disposition on the sale.

Mr. Chow could use his capital gains exemption of the shares are QSBCS at the time of sale if he has any remaining capital gains exemption. You need to find out how much capital gains exemption he has available.

−

Determine if the shares of Chow Enterprises are QSBC shares

−

If not, can the company meet the QSBC conditions by December 31st?

−

Determine the selling price for the shares needed to give Mr. Chow the same after-tax cash as if the company sold the assets and wound up

Eligibility? Mr. Chow is an individual who is a Canadian resident throughout the year. We should check to see if he has used any CGD in the past, has a CNIL balance or prior year ABILs. Are the shares of Chow Enterprises QSBC shares? Three tests: 1. SBC test – CEL does meet this test since the company does not have any non-active business assets. [100% assuming cash is needed in operations]2. Holding period test – Sidney has held the shares for more than two years (since 2014). 1. 3. Basic asset test – throughout the previous 24 months CEL has had more than 50% of its assets used in an active business carried on in Canada. [need to check F/Ss for prior 24 months] -

To calculate the share price equivalent, we need to start with the after-tax personal cash assuming a wind-up.If Mr. Chow is not able to use his capital gains exemption he will need to ask for a higher share price.

Equivalent Share Price

To calculate the share price equivalent we need to start with the after-tax personal cash assuming a wind-up which is $2,320,359 (calculated below).

Conclusion: If the CGE is available to Mr. Chow, he could accept a share price of $2,736,415 and be in the same position as the asset sale.

If the CGE is not available his minimum price for the shares to be in same position as the asset sale would be $3,087,145. Must charge a higher price to be in the same position.

If he would have the company pay out the CDA of $8K tax free before the share sale, he could lower his price to $2,752,749 (with CGE), $3,076,479 (without CGE) and be in the same position as an asset sale.

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Introduction to Federal Income Taxation in Canada

Issue 5 HST consequences of asset sale (optional); HST exempt – A/R, Goodwill, HST applicable – land, building, equipment Section 167 election – Eligible - Business established or carried on by the supplier (Chow Enterprises) - Recipient (purchaser corporation) acquires ownership or use of all or substantially all of the property needed for the recipient to carry on the business (ignoring exempt assets) Recipient (purchaser corporation) needs to be a registrant (CEL should confirm or obtain a warranty) - Joint GST 44 election filed by the recipient by the due date of the HST return for the period of the supply. Conclusion: If Joint GST 44 election form is filed, Chow Enterprises does not need to charge and remit HST on the sale.

2. Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format Sell the assets and keep the company – After tax cash of $2,742,913

Proceeds Opening balance Cash Accounts receivable Land Building Equipment Goodwill Liabilities Income taxes Dividend Refund

10,000 18,000 1,500,000 3,200,000 3,000 120,000 (1,385,000)

ABI

AII

CDA 8,000

Eligible RDTOH 5,000

(7,000)

850,000 (9,000) 12,000 846,000 13%/27% (771,527) 158,420 2,694,473 376,067 3,070,540

475,000 700,000

35,000 1,210,000 50.67% 613,107

35,000

2 3 4

1,218,000

371,067

376,067 38.33% 981,129

Sell the assets and wind up - Same analysis as “sell the assets and keep the company” but now pay out any funds at the corporate level as a dividend to Mr. Chow

487

Solutions to Chapter 16 Assignment Problems

Calculate the components of the distribution Deemed Dividend Funds available for distribution Less: paid-up capital Deemed dividend on winding up Less: capital dividend elected Deemed taxable dividend (sufficient to clear non-eligible RDTOH) Taxable capital gain to shareholder: Proceeds on winding-up Less: Deemed dividend Proceeds of disposition Cost Capital gain Taxable capital gain Calculate the tax cost and after-tax cash to Mr. Chow personally Cash distribution Eligible Dividend 31% Tax on non-eligible dividend @ * 42.5% After-tax cash * (1 + .15) x 50% - .15 = 42.5%

3,070,540 (20,000) 3,050,540 (1,218,000) 1,832,540

3,070,540 (3,050,540) 20,000 (20,000) -

249,120 1,583,420 1,832,540

Sell the assets and don’t wind up Compare the after-tax cash available to invest if CEL is wound up (Option A) to the after-tax cash available if the company is retained (Options B & C). If the company is retained, the PUC and CDA can be distributed tax free to provide some personal funds for Mr. Chow to invest (Option B). If the company is retained, it would also be possible to pay a non-eligible dividend of $981,129 to receive a refund of the company’s non-eligible RDTOH balance of $376,067 at a tax cost of $40,913. A capital dividend of $1,218,000 and a PUC distribution of $20K can still be received by Mr. C tax free. Overall he will have $2,694,473 Option B (or $2,653,560 Option C) available to invest if he retains the corporation.

3,070,540 (77,227) (672,953) 2,320,359

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Introduction to Federal Income Taxation in Canada

Corporation After- tax Cash PUC Distribution Capital Dividend Taxable Dividend Paid Dividend Refund Available to Invest

Option A Asset Sale Wind Up

Option B Asset Sale No Wind Up

Option C Asset Sale No Wind Up

CEL

CEL 2,694,473 (20,000) (1,218,000) 1,456,473

CEL 2,694,473 (20,000) (1,218,000) (981,129) 376,067 851,411

Mr C

20,000 1,218,000 -

Individual Cash Received on Wind up PUC Distribution Rec'd Capital Dividend Rec'd Taxable Dividend Rec'd Tax on Dividend Available to Invest

Mr C 3,070,540

(750,181) 2,320,359

1,238,000

20,000 1,218,000 981,129 (416,980) 1,802,149

Total Available to Invest

2,320,359

2,694,473

2,653,560

If the company is retained, paying out the PUC and CDA will leave cash of $1,238,000 in Mr. Chow’s hands and $1,456,473 in the company for a total of $2,694,473 to invest. The shareholder can defer the tax on the deemed taxable dividend that arose on the winding-up.

If he sells the assets, should he keep the after-tax cash in the company or wind up the company? Unless Mr. Chow needs the funds from the sale of the business personally, he should not wind up the company since he will be paying personal tax of $750,181 earlier than he needs to on the windup dividend.

Determine the selling price for the shares needed to give Mr. Chow the same after-tax cash as if the company sold the assets and wound up. From the sale of assets and the resulting distribution Sidney would realize after-tax cash of $2,320,359.

489

Solutions to Chapter 16 Assignment Problems

If Sidney has the full capital gains exemption available to him, he would need to sell the shares for $2,763,415 to be in the same after-tax position as if he sold the assets and wound up the company. The equivalent share price would be calculated using the following formula; P – 50%[1/2(P-20,000) – 485,595] = $2,763,415 If he does not have capital gains exemption available to him, he would need to sell the shares for $3,087,145 to be in the same after-tax position as if he sold the assets and wound up the company. If Mr. Chow is not able to use his capital gains exemption he will need to ask for a higher share price. The equivalent share price would be calculated using the following formula; P – 50%[1/2(P-20,000)] = $2,320,359

CGE Available

CGE Not Available

After- tax Cash on Sale of Assets and Wind Up

2,320,359

Capital Dividend - Tax Free Proceeds on sale of CEL shares ACB Capital Gain

2,763,415 (20,000) 2,743,415

3,087,145 (20,000) 3,067,145

Taxable capital gain Capital gains deduction Tax at 50% After-tax cash from share sale

1,371,708 (485,595) (443,056) 2,320,359

1,533,573 0 (766,786) 2,320,359

He could have CEL pay out a capital dividend of $8,000 before the sale. This would reduce the equivalent share price to $2,752,749 if he has his capital gains exemption available;

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Introduction to Federal Income Taxation in Canada

The equivalent share price would be calculated using the following formula if he does not have his capital gains exemption available; 8,000 + P – 50%[1/2(P-20,000) – 485,595)] The equivalent share price would be calculated using the following formula if he does not have his capital gains exemption available; 8,000 + P – 50%[1/2(P-20,000)] = $2,320,359

CGE Available

CGE Not Available

Capital Div Pd $8K

After- tax Cash on Sale of Assets and Wind Up

2,320,359

Capital Dividend - Tax Free Proceeds on sale of CEL shares ACB Capital Gain

8,000 2,752,749 (20,000) 2,732,749

8,000 3,076,479 (20,000) 3,056,479

Taxable capital gain Capital gains deduction Tax at 50% After-tax cash from share sale

1,366,374 (485,595) (440,390) 2,320,359

1,528,239 (764,120) 2,320,359

3. Identify risks including missing information, assumptions and uncertain research positions Check on the amount of capital gains exemption available to Mr. Chow. Check to ensure that the basic asset test is met. i.e., the company did not own non active business assets that made up more than 50% of the fair market value of all of the assets in the corporation in the 24 months prior to the sale date.

2. Evaluate the strengths/weaknesses/risks of your conclusions None identified

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Solutions to Chapter 16 Assignment Problems

Conclude and Advise Advise your client, integrating your conclusions on each of the issues with the client’s objectives, giving priority to the most important issues Do not wind up the corporation. Pay out the PUC and CDA and invest the maximum possible in his TFSA or RRSP. Time dividends to minimize tax through use of graduated tax rates. Mr. Chow should pay out an $8K capital dividend prior to a share sale. If Mr. Chow has his CGD available, he should sell shares if the offer price is greater than $2,763,415 He should ensure the shares are QSBC shares at the time of the sale. If Mr. Chow does not have his CGD available, he should sell shares if the offer price is greater than $3,087,145. File a 167 election GST Form 44 for the asset sale if assets are sold. Mr. Chow should ensure there is a warranty in the sale agreement.

NOTES TO SOLUTION (1) Inclusion of last year’s reserve (active business income)

5,000

Proceeds of disposition ...............................................................

18,000

Cost............................................................................................ Business loss ..............................................................................

(30,000) $ (12,000)*

* The disposition does qualify for section 22 election, since the accounts receivable were sold to a purchaser and the disposition does meet the “all or substantially all” and “carrying on the business” tests. (2) Taxable capital gain (½  ($1500K – $550K)) (investment income) .................... $ 475,000 Capital dividend account (½  ($1500K – $550K)) .............................................. $ 475,000 (3) UCC....................................................................................................................... $ 950,000 LCP........................................................................................................................ (1,800,000 Recapture ($95K – $170K) (active business income) ..................

$(850,000)

Capital gain: Proceeds of disposition ............................................................... $3,200,000 Cost ............................................................................................. (1,800,000 Capital gain ................................................................................. $1,400,000 Taxable capital gain (½  $150,000) (investment income)...........

$ 700,000

Capital dividend account (½  $150,000)....................................

$ 700,000

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Introduction to Federal Income Taxation in Canada

(4) UCC

$ 12,000

LCP............................................................................................................... Terminal loss (active business income offset).................................................

3,000 $

9,000

(5) Sale of Goodwill (class 14.1) Proceeds

$120,000

Cost Capital gain Taxable capital gain

(50,000) $70,000 $35,000

Capital dividend account

$35,000

UCC opening balance

$38,000

LCP Recapture

(50,000) (12,000)

(6) Tax @ 13% on active business income (13% of $500,000).............................

$65,000

Tax @ 27% on active business income (27% of $346,000)

$93,420

Total Tax

$158,420

Tax @ 50⅔% on investment income (50⅔% of $1,210,000) ..........................

613,107

Total tax ........................................................................................................ Refundable Part I (30⅔% of $1,210,000) .......................................................

$ 771,527 $ 371,067

(7) Assumes a minimum $981,129 (i.e., $376,067/38.33%) is to be distributed as a taxable dividend to produce a refund to clear the non-eligible RDTOH.

493

Solutions to Chapter 16 Assignment Problems

Solution 7: Assets vs. Shares

(A)

Proceeds Opening balance Cash Marketable Securities Inventory Land Building Goodwill Liabilities Income taxes Dividend Refund

23,000 54,000 50,000 210,000 440,000 85,000 (45,400) (71,429) 745,171 25,607 770,777

ABI

AII

CDA 48,000

Non-Eligible RDTOH -

(2,000)

28,000 15,000 42,500 83,500 50.67% 42,309

28,000 15,000 42,500

9,000 215,000 224,000 13.0% 29,120

Calculate the components of the distribution Deemed Dividend (B) Funds available for distribution Less: paid-up capital Deemed dividend on winding up Less: capital dividend elected Deemed taxable dividend (sufficient to clear non-eligible RDTOH) Taxable capital gain to shareholder: Proceeds on winding-up Less: Deemed dividend Proceeds of disposition Cost Capital gain Taxable capital gain Calculate the tax cost and after-tax cash to Ms. Debbie personally (C) Cash distribution Tax on non-eligible dividend @ * 42.5% 519,277 After-tax cash * (1 + .15) x 50% - .15 = 42.5%

3 4

25,607 131,500

25,607 6 38.33% 66,806

770,777 (120,000) 650,777 (131,500) 519,277 770,777 (650,777) 120,000 (120,000) 770,777 (220,693) 550,084

(D) Minimum share price acceptable to Ms. Debbie: The calculation of net retention can be represented algebraically as: P – .50 [½ (P – $120,000)], where P = proceeds of disposition To equate the above expression with the net cash retained of $550,084 derived in Part (C), above, from the sale of assets and the wind-up of the corporation, the following equation with P as the unknown results:

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Introduction to Federal Income Taxation in Canada

P – .50 [½ (P – $120,000)]= $550,084 Solving for P, P= $693,446 Therefore, Ms. Debbie should require an offer of $693,446 for the shares, given the indicated fair market value of the net assets. (E) Impact of Capital Dividend payment prior to sale If the capital dividend account is paid to Ms. Debbie, before the sale of the shares, the $48,000 would be received tax free, instead of as proceeds for the shares. Although the value of the shares would fall, tax on $48,000 of capital gain would be saved. In that case, the minimum share price would be determined from the following: $48,000 + P – .50 [½ (P – $120,000)]= $550,084 Solving for P,P= $629,446

(F) Maximum share price acceptable to Let’s-Make-A-Deal: On the purchase of marketable securities, which are part of the working capital requirements of the business, the ACB is established at fair market value of $54,000. If shares of Shining Ltd. are purchased, the resultant acquisition of control will require a realization of the accrued capital loss [par. 111(4)(c)] at the deemed taxation year-end with a new ACB established at $54,000, the fair market value. Therefore, there is no difference in the tax consequences between a purchase of assets and a purchase of shares on the marketable securities. On the purchase of inventory, the cost is established at fair market value of $50,000. If shares are purchased, the purchaser steps into the vendor’s tax position for the inventory which has a cost of $41,000. A gain of $9,000 will be realized on the ultimate disposition of the inventory by the purchaser corporation. Therefore, on the purchase of the shares there is an inherent tax liability of $1,170 (i.e., $9,000  .13) on the sale of inventory within the year. This inherent tax liability should lower the value (i.e., increase the cost) of the shares by $1,170 from the purchaser’s perspective. On the purchase of the land, the ACB is established at fair market value of $210,000. If the shares are purchased, the purchaser assumes the inherent tax liability for the $56,000 of capital gain accrued on the land (assuming a 111(4)(e) designation isn’t made). However, this tax is only incurred on the sale of the land by the purchaser. In this case, since the purchaser does not anticipate a sale in the foreseeable future, the present value of this future tax can be assumed to be negligible. On the purchase of the building, the UCC and the ACB are established at fair market value of $440,000. If shares are purchased, the purchaser assumes the tax liability for the recapture of $215,000 and the capital gain of $30,000 (assuming a 111(4)(e) designation isn’t made) if they are ultimately realized on the disposition of the building. Again, since the purchaser does not anticipate a sale of the building in the foreseeable future, the present value of this future tax can be assumed to be negligible.

Solutions to Chapter 16 Assignment Problems

495

However, on the purchase of the building, the purchaser can benefit from an increase in CCA, relative to a purchase of shares, which will shield future income from tax. The present value of the tax shield for the purchase of a building in Class 1(4%) in this case is given by:

= [(440,000x.04x.13)/(.04+.05)] x [(1+1.5x.05)/(1+.05)] = $26,028 If shares are purchased, the corporation continues to deduct CCA in Class 1 on a UCC base of $195,000, providing a tax shield with a present value given by:

(195,000x.04x.13) / (.04+.05) = $11,267 The incremental tax saved from CCA on the purchase of assets in present value terms is $14,761 (i.e., $26,028 – $11,267). On the purchase of goodwill at a fair market value of $85,000, the purchaser can add $85,000 to Class 14.1 and it can amortize that amount at 5% on a declining balance basis. The present value of the write-off is given by:

[(85,000x.05x.13)/(.05+.05)] x [(1+1.5x.05)/(1+.05)] = $5,657

To summarize these effects, the following is a calculation of the cost of a purchase of assets net of the cost reduction discussed above: Cost of assets at FMV ($839,000 + $23,000*) .................................................... Tax savings: PV of future CCA:

$ 862,000

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Building.............................................................................. Goodwill.............................................................................

$ 26,028 5,657

(31,685)

After-tax cost of assets .......................................................................................

$ 830,315

Next, we need to determine what the purchaser would pay for the shares to have an after-tax cost of $830,315. This calculation would be as follows: Price of shares ................................................................................. Liabilities assumed..........................................................................

Tax savings: PV of future CCA: Building.............................................................................. Tax costs: PV of tax on accrued gains: Inventory ............................................................................ After-tax cost of assets ....................................................................

$795,012 45,400

(11,267)

1,170 $ 830,315

This net cost of $795,012 is the maximum amount that the purchaser should be willing to pay for the shares of Shining Ltd. The results of the analysis of Parts (E) and (F) can be summarized, in terms of pre-tax costs and equivalent values, as follows: Purchaser’s after-tax cost: Asset purchase .............................. Share purchase..............................

Pre-tax $862,000 $795,012

After-tax $830,315 $830,315

Pre-tax $862,000 $693,446

After-tax $550,084 $550,084

Vendor’s after-tax proceeds: Asset sale...................................... Share sale ..................................... This table can be further summarized as follows: Assets The maximum the purchaser will pay.................................... $ 862,000 The minimum the vendor will accept .................................... 862,000

Shares $ 795,012 693,446

In this case, given that the value of the assets is established to be $862,000, a transaction in shares can be negotiated to the benefit of both vendor and purchaser. To be better off on the sale of shares, Ms. Debbie, the vendor, must receive more than $693,446. To be better off on the purchase of the shares, the purchaser must pay less than $795,012. In this case, therefore, there is a negotiation range for a transaction in shares between $693,446 and $795,012. If the $48,000 balance in the capital dividend account is paid to Ms. Debbie as a tax-free dividend, then she requires a minimum of only $629,446 for the shares, to be indifferent between a sale of shares and a sale of assets (see Part D above). In this case, the range for negotiation of a share price changes from a low of $629,446 to a high of $747,012 (i.e., $795,012 – $48,000),

Solutions to Chapter 16 Assignment Problems

497

since the value of the shares to the purchaser will decrease by the $48,000 distributed as a capital dividend).

* While the purchaser would not buy cash, if the corporation requires the $23,000 for working capital, the purchaser will have to invest that amount in the business being acquired.

—NOTES TO SOLUTION (1) Proceeds of disposition................................................................................. ACB ............................................................................................................ Capital loss .................................................................................................. Allowable capital loss .................................................................................. Capital dividend account ..............................................................................

$ 54,000 (58,000) $ (4,000) $ (2,000) $ (2,000)

(2) Proceeds of disposition................................................................................. ACB ............................................................................................................ Capital gain.................................................................................................. Taxable capital gain (½  $56,000)............................................................... Capital dividend account ..............................................................................

$ 210,000 (154,000) $ 56,000 $ 28,000 $ 28,000

(3) Proceeds of disposition................................................................................. Capital cost .................................................................................................. Capital gain.................................................................................................. Taxable capital gain ..................................................................................... Capital dividend account .............................................................................. Recapture ($195,000 – $410,000).................................................................

$ 440,000 (410,000) $ 30,000 $ 15,000 $ 15,000 $ 215,000

(4) Taxable capital gain = 50% x (proceeds – cost) = 50% x ($85,000 – $0).......

$ 42,500 $ 42,500

Capital dividend account .............................................................................. The $500,000 business limit for the small business deduction must be prorated for the number of days in the taxation year. Since the winding-up may take some time to complete, this solution assumes that the corporation maintains its eligibility for the small business deduction in the year in which the sale of assets occurs [IT-73R6 pa. 9]. (5)

Tax @ 13% of $224,000 ............................................................................. Tax @ 502/3% (i.e., 40% + 102/3%) of $83,500 ............................................. Total Part I tax .............................................................................................

(6) Refundable portion of Part I tax for non-eligible RDTOH (302/3% of $83,500).............................................................................................................

$ 29,120 42,309 $ 71,429 $ 25,607

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Solution 8: Purchase of Assets vs. Shares Assess the Situation 1.

Draw a diagram identifying all stakeholders and their relationships, e.g., corporate org charts Samuel Molton share sale OR

Glenda (Cdn resident)

PCL

asset sale

1. Identify the relationships among the stakeholders, e.g., related, affiliated, associated, connected Glenda and Sam are not related, arm’s length parties. Glenda and PCL are not related, arm’s length parties. 2. Identify the profile of each stakeholder, e.g., tax features, risk profile Glenda; individual, employee earning $13K for first quarter. PCL is a CCPC with an active catering business. The company has $84,000 in non-capital losses. 3. Fully understand the decision maker and their objectives Glenda (our client) would like to acquire the catering business in PCL either through a share purchase or a purchase of assets. Finance the purchase using a bank loan Finance post acquisition losses with personal investments. 4. Identify the relevant past transaction/events or planned future transactions/events and create a timeline. Past: PCL has non-capital losses Future: Purchase of the catering business either through a share purchase or an asset purchase Start a new profitable baked goods business (to hotels and restaurants).

Solutions to Chapter 16 Assignment Problems

499

Identify the Issues 1. Identify all of the major tax issues and any non-tax issues.

Issue 1: Should Glenda purchase the shares or assets of the corporation? Issue 2: If she were to purchase the assets, should she incorporate a new company (presently or in the future)? Analyze the Issues 1. Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act

Issue 1: Should Glenda purchase the shares or assets of the corporation? Issue 2: If she were to purchase the assets, should she incorporate a new company (presently or in the future)? Share Purchase If Glenda purchases the shares of the corporation, the non-capital loss carryforwards will continue to be available to the corporation (against future profits from the catering business) as the loss business is continuing to operate. Also, the losses may be available for use against the new bakery business if a position could be supported that the income from the bakery business is from the sale of similar products or services. As she is forecasting profitability for both the catering business and the bakery business, there is a low risk that the carryforward losses could expire before they are used within the 20 year carryforward period. If Glenda acquires shares, any losses will be trapped in the legal corporate entity and will not be available for use against Glenda’s employment income. If Glenda acquires the shares, she could write off her share purchase price as an ABIL (against any type of income), should the business fail and the company become insolvent or she sells the shares of the company to an arm’s length person at a loss. Although a corporation provides “limited liability” in the event of a business failure, banks advancing loans often require that shareholders sign personal guarantees. Considering Glenda’s lack of business experience, she will most likely have to sign such a guarantee in order to obtain her 6% small business loan. The corporate form of organization does not provide Glenda with limited liability in regard to the bank loan with a personal guarantee. It will limit her liability from lawsuits of customers or potential customers of the business in the corporation. If the shares are acquired, Glenda will not have protection from undisclosed liabilities or potential future tax reassessments.

If shares are acquired, the corporation could borrow the required funds from the bank to finance the purchase. The interest would be deductible to the corporation and the after-tax funds from the business operations could be used to repay the loan principal. The low corporate tax rate for income eligible for the small business deduction would allow Glenda to repay the loan faster.

Introduction to Federal Income Taxation in Canada 500 The low corporate tax rate applicable to income eligible for the small business deduction provides a tax deferral benefit to incorporation that would allow Glenda to reinvest a greater amount in the business and start up the new bakery business.

The profits of the business will be less accessible for Glenda’s personal use as to remove funds from the corporation they will need to be paid to her in salary or dividends or be received through a shareholder loan potentially subject to 15(2). Asset Purchase (1)

If assets are purchased personally, Glenda will include the business income from the proprietorship in her personal tax return. She will benefit from the tax shield on the purchase price on the depreciable assets purchased from higher CCA deductions available on the assets relative to the CCA deductions available by a corporation if shares of the company are acquired. Immediate expensing would be available for depreciable properties other than property included in CCA classes 1 to 6, 14.1, 17, 49 and 51. All of the equipment purchased would therefore be eligible up to a maximum of $1.5M. Immediate expensing cannot be used to create a loss for a sole proprietor.

(2)

If Glenda acquires assets and operates the business as a proprietorship, the accumulated noncapital loss carryover is not available. However, as she has not paid anything for the “value” of those losses, she has not really lost anything in this respect.

(3)

If Glenda acquires assets and operates as a proprietorship, if the operating losses continue (or other losses such as terminal losses arise) they would be deductible from her other sources of income and shelter her personal tax on employment and investment income.

(4)

The interest on the bank loan to acquire the assets will be deductible in computing the business income to be reported in Glenda’s personal tax return.

(5)

If the business is operated as a proprietorship, the profits will be easily accessible for personal use.

2. Identify missing information or assumptions made Need information on the bond investments and tax treatment of disposition. The fair market value and tax cost amounts of the assets including goodwill should be provided to determine the potential tax shield benefits to an asset purchase.

Advise/Recommend Advise the decision maker, integrating your conclusions on each of the issues with their objectives, giving priority to the most important issues No information is provided about the purchase price of either the assets or the shares. If shares are being acquired, the purchase price is (presumably) less as liabilities are also being assumed. The two different prices must be considered in any decision. A conservative approach would be to acquire assets to allow for the use of losses against Glenda’s personal sources of income and take advantage of the immediate expensing of bakery equipment purchased. If the business ultimately proves profitable, Glenda could incorporate at that time to take advantage of the tax deferral benefit to incorporation. If Glenda decides to acquire shares of the corporation, she should retain an accounting firm to perform a due diligence review to identify potential risks and hidden liabilities.

501

Solutions to Chapter 16 Assignment Problems

Solution 9: Refundable Dividend Tax on Hand; Capital Dividend Account Part A Capital Dividend Account Paragraph (a) of the definition of "capital dividend account" in ssec. 89(1) Land P of D ACB Capital Gain

$175,000 (115,000) 60,000

Addition to capital dividend account ½ × 60,000

$ 30,000

Equipment (No capital loss on depreciable property) Securities P of D ACB Capital loss

22,500 (31,500) (9,000)

Deduction from capital dividend account ½ × (9,000) Sale of licence P of D ACB Capital Gain

(4,500) 310,000 (10,000) $300,000

Addition to capital dividend account ½ x $300,000 Vacant Land P of D ACB Capital loss

$150,000 590,000 (785,000) (195,000)

Deduction from capital dividend account ½ × 195,000

(97,500)

Total paragraph (a) (balance cannot be negative)

$ 78,000

Paragraph (b) of the definition of "capital dividend account" in ssec. 89(1) Subsection 83(2) dividends received

50,000

Less: Capital dividends paid

(50,000)

Balance in Capital dividend account as at February 28, 2024

$78,000

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Introduction to Federal Income Taxation in Canada

Recommendation: XYZ Limited should pay a capital dividend prior to January 31, 2024, before the capital loss realized on the sale of the land reduces the available balance in the company's capital dividend account. By paying the capital dividend on or before January 30, 2024, XYZ Limited could pay out a capital dividend in the amount of $175,500 ($30,000 - $4,500 + $150,000)

Part B Taxable dividends (eligible) subject to Part IV tax

$ 10,000

Part IV tax @ 38⅓%

$ 3,833

Refundable Part I Tax Least of: (a) 30⅔% × AII - NBFTC - 8% × FII = 30⅔% × $15,500 - $0 – $0

4,753

(b) 30⅔% × (TI - SBD amt - 100/38 2/3 × NBFTC - 4 × BFTC) = 30⅔% × ($515,500 * - $500,000 - $0 - $0)

4,753

$ 50,993

Least = $4,753 * taxable income = $500,000 active business income + $15,500 of taxable interest income

Eligible RDTOH Opening balance Part IV tax (eligible RDTOH)

$ 0 3,833 $ 3,833

The eligible dividend needed to reduce eligible RDTOH to $0 is $3,833/38 1/3% = $10,000. The company will have GRIP of $10,000 related to the eligible dividends received from nonconnected companies. It is possible to designate an eligible dividend to be paid from this GRIP balance.

Non-eligible RDTOH Opening balance Refundable Part I

$ (non-eligible RDTOH)

$4,753 $ 4,753

The taxable dividend needed to reduce non-eligible RDTOH to $0 is $4,753 / 38 ⅓% = $ 12,399.

Solutions to Chapter 16 Assignment Problems

503

Alternatively, a $22,399 non-eligible dividend can be paid to obtain a refund of both the non-eligible and eligible RDTOH balances. The non-eligible RDTOH balance must be fully exhausted before any eligible RDTOH can be refunded. The marginal tax rate on an eligible dividend for a shareholder in the highest tax bracket is 31% vs. 42.5% for a noneligible dividend making eligible dividends more attractive to the individual shareholder.

CHAPTER 17

Tax Deferred Transactions: Section 85 Rollover on a Transfer to a Corporation, Section 86, Estate Freeze Transactions, Amalgamations and Wind Ups Solution 1: Section 85 Elected Amounts A. Qualify for transfer under section 85 Subsection 85. (1) Transfer of property to corporation by shareholders — Where a taxpayer has, in a taxation year, disposed of any of the taxpayer's property that was eligible property to a taxable Canadian corporation for consideration that includes shares of the capital stock of the corporation, if the taxpayer and the corporation have jointly elected in prescribed form and in accordance with subsection (6), the following rules apply: − − − − −

Taxpayer Disposed of eligible property To a taxable Canadian corporation For consideration that includes shares Joint election

Refer to subsection 85(1.1) for the definition of “eligible property” Land – if it is capital property and not inventory Marketable securities – if either capital property or inventory Building – if capital property and not inventory Equipment – if capital property or inventory Furniture and fixtures – if capital property or inventory Licence – if capital property or inventory B/C/D: Minimum possible elected amounts, maximum boot, and effects on income

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474

Consideration "Boot" - Non-share Asset

Note Tax Value

Elected

New Debt

160,000

15,000

55,000

10,000

495,000 470,000 50,000 40,000

470,000

25,000

40,000

10,000

7,000 60,000

40,000

577,000

78,000

FMV

Amt

Land

Marketable securities

$160,000 $175,000 160,000 55,000 65,000 55,000

Building*

470,000

Equipment

40,000

Furniture and fixtures

7,000

10,000

Licence**

60,000

100,000

7,000 60,000

577,000

655,000

577,000

Assumed Debt

Income

3,000 -

Solutions to Chapter 17 Assignment Problems

475

E. Modification of “Boot”

Consideration

Asset

Note

Land Equipment

7 8

Tax Value

FMV

Minimum Elec

160,000

7. By increasing boot to $170,000, which is greater than the tax value, the elected amount is increased by $10,000 to $170,000. This will result in proceeds of $170,000 for the land and a resulting capital gain of $10,000. 8. By increasing boot to $45,000, which is greater than the tax value, the elected amount is increased by $5,000 to $45,000. This will result in proceeds of $45,000 for the equipment and resulting recapture of $5,000. —NOTES TO SOLUTION Part A (1) (a) Minimum elected amount: Greater of: (i) FMV of boot ................................................................................................................ $ 160,000 (ii) Lesser of: (A) FMV of property ......................................................................... $175,000 $ 160,000 (B) ACB ............................................................................................ $160,000 (b) Income: Proceeds..................................................................................................................... ............ $ 160,000 Cost .............................................................................................................................................. (160,000) Capital gain/loss........................................................................................................................... $0 (2) (a) Minimum elected amount: Greater of: (i) FMV of boot .......................................................................................................... $ 55,000 (ii) Lesser of: (A) FMV of property ......................................................................... $ 65,000 $55,000 (B) ACB ............................................................................................ $ 55,000 (b) Proceeds..................................................................................................................... ............ $ 55,000 Cost......................................................................................................................... ............... 55,000 Gain ....................................................................................................................................... $ $0 (3) (a) Minimum elected amount: Greater of: (i) FMV of boot ................................................................................................................ $470,000 (ii) Least of: (A) FMV of property ......................................................................... $495,000 (B) UCC of class .......................................................................... $470,000 470,000 (C) Cost of property .......................................................................... $485,000 (b) Taxable capital gain: Proceeds..................................................................................................................... .... $ 470,000 Cost ...................................................................................................................................... (485,000) Gain/Loss ............................................................................................................................ $0

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Terminal loss/Recapture: UCC ............................................................................................................................. .. Less: lesser of: (i) Capital cost .................................................................................. $485,000

$470,000

470,000 (ii) Proceeds ....................................................................................... $470,000 $0 (4) (a) Minimum elected amount: Greater of: (i) FMV of boot .......................................................................................................... (ii) Least of: (A) FMV of property .......................................................................... $ 50,000 (B) UCC of property..................................................................... $ 40,000 (C) Cost of property ........................................................................... $ 65,000 (b) Taxable capital gain: Proceeds..................................................................................................................... .... Cost......................................................................................................................... ....... Recapture: UCC ............................................................................................................................. .. Less: lesser of: (i) Capital cost .................................................................................. $ 65,000

$ 40,000

$ 40,000 (65,000) $0 $ 40,000

40,000 (ii) Proceeds ....................................................................................... $ 40,000 Recapture .......................................................................................................................

(5) (a) Minimum elected amount: Greater of: (i) FMV of boot .......................................................................................................... $ 7,000 (ii) Least of: (A) FMV of property .......................................................................... $ 10,000 (B) UCC of class .......................................................................... $ 7,000 $ 7,000 (C) Cost of property ........................................................................... $ 15,000 (b) Taxable capital gain: Proceeds..................................................................................................................... .... $ 7,000 Cost ....................................................................................................................................... (15,000) Gain/Loss ............................................................................................................................. $0 Recapture/Terminal loss: UCC ............................................................................................................................. .. $ 7,000 Less: lesser of: (i) Capital cost .................................................................................. $ 15,000 7,000 (ii) Proceeds ................................................................................. $ 7,000 Recapture $0 (6) (a) Minimum elected amount: Greater of: (i) FMV of boot .......................................................................................................... (ii) Least of: (A) FMV of property .......................................................................... $ 100,000 (B) UCC – Class 14.1.................................................................. $ 60,000 (C) Cost of property ..................................................................... $ 82,500

$ 60,000

Solutions to Chapter 17 Assignment Problems

477

(b) Taxable capital gain: Proceeds..................................................................................................................... .... $ 60,000 Cost ....................................................................................................................................... (82,500) Gain/Loss ............................................................................................................................. $0 Recapture/Terminal loss: UCC ............................................................................................................................. .. $ 60,000 Less: lesser of: (i) Capital cost .................................................................................. $ 82,500 60,000 (ii) Proceeds ....................................................................................... $ 60,000 Recapture $0

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Solution 2: Transfer of Assets to a Corporation Assess the Situation 1.

Draw a diagram identifying all stakeholders and their relationships, e.g., corporate org charts

Assess the Situation Before Peter Henry Cdn Resident related 100% affiliated

CCPC

Resurface

related affiliated

After Peter Henry Cdn Resident 100%

CCPC

Resurface connected associated

100%

CCPC Paintshop Inc..

Identify the relationships among the stakeholders, e.g., related, affiliated, associated, connected − Peter owns Resurface therefore he is related to and affiliated with the company − Resurface will own shares in Paintshop and the companies will be associated, connected and related.

Identify the profile of each stakeholder, e.g., tax features, risk profile −

−

Pete Henry o

Canadian resident individual

Owns Resurface

Resurface Inc. o

CCPC

Carrying on an active business

Paintshop Inc. o

CCPC

Starts off as a shell company

To receive the business assets of Resurface

Understand the decision maker and their objectives

Decision Maker: Peter Henry Objectives: Protect his real estate in Resurface from potential lawsuits. Transfer business assets and liabilities to a new subsidiary without any tax liability. Leave land/building and mortgage in Resurface. Accumulate assets in Resurface away from the business.

Solutions to Chapter 17 Assignment Problems

479

Identify the relevant past transaction/events or planned future transactions/events and create a timeline

10 yrs ago

Future

Operations started

Incorporate sub. Transfer assets/liabilities

Identify the Issues Identify all of the major tax issues and any non-tax issues 1) Eligibility for Section 85 election 2) Determine which assets can be transferred using section 85 3) Determine which assets to be transferred without section 85 4) Determine which assets should not be transferred. 5) Determine elected amounts 6) Determine boot/share consideration and tax attributes

6. Identify missing information or assumptions made 1.

None identified

Analyze the Major Issues 1.

Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act Assess whether eligible to file a s. 85 election. −

Paintshop is a taxable Canadian corporation

−

Joint election between Resurface and Paintshop

−

Property must be eligible property

−

•

Cash is not an eligible asset

•

Furniture is eligible and has an accrued gain

•

Goodwill is eligible and has an accrued gain

Share consideration received

Identify assets that should not be transferred at all Non-active business assets or assets that he wants to protect from creditors −

Land and building can be kept in Resurface to protect them from the creditors of Paintshop

−

The mortgage should also be kept Resurface

Assets that should be transferred but not using section 85 −

The following assets cannot or should not be transferred using section 85:

−

Cash

−

Inventory does not have a gain so s. 85 is not useful

Introduction to Federal Income Taxation in Canada

480 2.

Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format Consideration Asset Cash (not eligible) Inventory (no gain)

Tax Value $

FMV

Assumed Debt

New Debt

Income

220,000

220,000 $

220,000

395,000

330,000

65,000

615,000

550,000

65,000

The accounts payable and the bank loan can be assumed by Paintshop as consideration for the transfer along with $65,000 of new debt.

Assets that should be transferred using section 85 The following assets should be transferred using section 85:

There should be no adverse tax consequences on this transfer, since the FMV of the consideration received (i.e., debt and shares) was exactly equal to the fair market value of the transferred assets. In addition, the non-share consideration did not exceed the tax values of the transferred assets. ACB of shares received as consideration: Elected transfer price ............................................................................................................

$ 60,001

Deduct: non-share consideration ..........................................................................................

60,000

Adjusted cost base of shares .................................................................................................

PUC of shares received as consideration Legal stated capital before reduction ....................................................................................

$ 820,000

Subsection 85(2.1) reduction in PUC: (a)

increase in LSC ..........................................................................................

(b) elected amount ...................................................................... less: boot ..................................................................................

$820,000 (A)

$ 60,001 60,000

excess, if any ..............................................................................................

1 (B)

PUC reduction (A – B) .............................................................................................................. 819,999 Tax PUC after reduction ...........................................................................................................

The tax PUC after reduction reflects the fact that the tax-paid cost of the assets transferred has been recovered through the debt assumed. The tax basis of all assets was $60,000 which, along with the $1 for

Solutions to Chapter 17 Assignment Problems

481

goodwill, was the amount Resurface elected for the transfer price. The amount of non-share consideration was $60,000 leaving the $1 for the ACB and PUC of the shares.

The balance sheet (at FMV) of Paintshop after the transfer will look like this:

FMV

Cost

Cash

$220,000

Inventory

395,000

Furniture & fixtures

80,000

120,000

Goodwill (Class 14.1)

800,000

ACB 1/CC .5

Accounts payable

(250,000)

Bank loan

(300,000)

Due to Resurface

(125,000)

(820,000)

UCC

$60,000 .5

HST Implications of Transfer of Property to Paintshop Inc. (Optional) HST exempt – Cash, Goodwill (S.85) HST applicable – Furniture & fixtures (S.85), Inventory Section 156 election – Eligible Election to treat certain taxable supplies between closely held Canadian-resident corporations as having been made for no consideration Resurface and Paintshop are related since Resurface controls Paintshop; therefore, Resurface and Paintshop form a qualifying group eligible to make the election Once the election is made, the election will continue to be in effect until jointly revoked If Resurface and Paintshop make the election prior to the transfer of business assets, all HST applicable assets will be deemed to have been made for no consideration and HST does not need to be collected or remitted by Resurface. Further, if the election is made, no HST will need to be charged on the HST for the lease of the real estate to Paintshop Note that the Section 156 election does not apply to a sale of real property Section 167 election – Eligible Business established or carried on by the supplier (Resurface) Recipient (Paintshop) acquires ownership or use of all or substantially all of the property needed for the recipient to carry on the business (ignoring exempt assets) Recipient i.e. Paintshop Inc. needs to be a registered Joint GST 44 election filed by the recipient by the due date of the HST return for the period of the supply. Lease of Land/Building Resurface must charge HST on the lease of the real estate to Paintshop Inc. unless it is a small supplier i.e. $30K or less in gross revenues for the year or a Section 156 election has been made Resurface can claim ITCs for expenses related to the property leased Paintshop Inc. pays HST and can claim an ITC for space used in the business.

Identify risks including missing information, assumptions and uncertain research positions Are the fair market values supported by valuations from qualified valuators?

Reach a conclusion based on your analysis of each major issue. −

Peter is able to transfer the assets from Resurface to Paintshop without any additional tax liability.

Introduction to Federal Income Taxation in Canada

482 −

Peter can receive debt of $125,000 for assets transferred without section 85 ($65,000) and those transferred using section 85 ($60,000).

−

He can receive shares with an ACB and PUC of $1 since he took the maximum non-share consideration, except on the goodwill where he did not take the $1 elected amount as boot. These shares have a fair market value of $820,000.

−

The land and building remain in Resurface and can be rented to Paintshop 1.

A fair market rent will need to be established for Resurface to charge Paintshop

−

Rental income will be ABI since the two are associated and the rent is deducted against ABI in Paintshop

−

The rental income will offset the interest expense on the mortgage, the property taxes and insurance

Evaluate the strengths/weaknesses/risks of your conclusions No weaknesses identified

Advise/Recommend Advise your client, integrating your conclusions on each of the issues with the client’s objectives, giving priority to the most important issues −

The cash and inventory should be transferred to Paintshop but ss. 85(1) is not needed since there is no gain to defer. −

−

The consideration received should include the assumption of accounts payable of $250,000, the assumption of the bank loan of $300,000 and new debt of $65,000.

The furniture and goodwill should be transferred using ss. 85(1) with an election at the tax value of these assets to defer the gain. −

The consideration received should include new debt of $60,000 and preference shares of $820,000. The preference shares represent the deferred gain on the furniture and goodwill with the ACB and PUC of these shares being $1.

Solutions to Chapter 17 Assignment Problems

483

Solution 3: Transfer of Assets to a Corporation, Sale or Redeem Shares Assess the Situation 1.

Draw a diagram identifying all stakeholders e.g., corporate org charts

Ms. Hart

Cdn resident

Mr. Hart Cdn resident

45 yrs old

PSs Proprietorship

Assets & liabilities

100% CS Hart Ltd.

CCPC

Technology Accessories Business 2.

Identify the relationships among the stakeholders e.g., related, affiliated, associated, connected − Ms. Hart and her husband are related and affiliated − Ms. Hart – related/affiliated with Hart Ltd (spouse controls) − Mr. Hart – related/affiliated with Hart Ltd.

Identify the profile of each stakeholder e.g., tax features, risk profile a.

Ms. Hart − An individual resident in Canada, 45 years old − Carrying on an an active business through a proprietorship

Mr. Hart − An individual resident in Canada − He doesn’t seem to have any connection to the business but will own the common shares of Hart Ltd.

Hart Ltd − A CCPC − It will be carrying on an active business after Mrs. Hart transfers the proprietorship assets

Introduction to Federal Income Taxation in Canada

484 4.

Understand the decision maker and their objectives

Decision-maker: Ms. Hart Objectives:

Ms. Hart wants to incorporate her business and have her husband receive the benefit of all of its future growth in value

She wants advice on how to do this with the minimum amount of tax

She wants you to come up with a tax-efficient plan

She wants to know the tax consequences if she sells or redeems the shares she receives as consideration

She wants Hart Ltd. to assume the $360K of liabilities of the business

Identify the relevant past transaction/events or planned future transactions/events and create a timeline −

On Nov 10th , 2023 Ms. Hart will transfer all of her business assets and liabilities to Hart Ltd.

Identify the Issues 1.

Identify all of the major tax issues and any non-tax issues

1) Tax consequences and possible tax deferral for transfer of the business to Hart Ltd. Qualitative a.

Discuss eligibility to elect under Section 85

−

Confirm that ss. 85(1) can be used to defer the gain on the sale of the assets to the corporation

b. c. d.

Discuss the assets that can be transferred with an election under ss. 85(1) Discuss the assets that should be kept by Ms. Hart Discuss the assets that should be transferred but where ss. 85(1) cannot be used

Discuss consideration to be received & characteristics of the preferred shares that give them value

Discuss issues with husband as the common shareholder i. Gifting/benefit conferred

Quantitative g.

Complete the chart to determine (Quantitative) −

Tax liability for assets transferred without S. 85

−

Elected amount for each asset transferred with S. 85

−

Determine consideration received (Boot/shares)

Determine tax attributes i.e. ACB/PUC of shares received

Tax consequences if the share consideration is sold or redeemed a.

Discuss share sale vs redemption (Qualitative)

Calculate tax on sale/redemption (Quantitative)

GST/HST consequences of transfer of properties (Qualitative)

Identify missing information or assumptions made None identified

Solutions to Chapter 17 Assignment Problems

485

Analyze the Major Issues 1.

Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act Issue 1: Eligiblity to elect under Section 85 Does ss. 85(1) apply? −

Taxpayer (individual or corporation) transferring property to a taxable Canadian corporation

−

Hart Ltd is a taxable Canadian corporation

−

Joint election between Mrs. Hart and Hart Ltd.

−

Property must be eligible property o

Land held as inventory is not eligible property

Prepaid expenses are not eligible property

Conclusion: Ms. Hart is eligible to use Section 85 to defer the tax on the transfer of the retail business to Hart Ltd. Issue 2: Identify the assets that should not be transferred at all but kept by Ms. Hart Shares in public company If Ms. Hart intends to sell the shares, it might be more advantageous to keep them out of the company and realize the loss personally rather than in the corporation. It is unlikely that she would need the shares to carry on the business. The shares would not be earning Canadian active business income. It may therefore make sense to keep the shares out of the corporation to ensure that Hart Ltd. qualifies as a small business corporation [ss. 248(1)] and a qualified small business corporation [s. 110.6]. Since Mr. Hart is a shareholder of Hart Ltd., s. 74.4(1) may apply if Hart Ltd. is not a small business corporation. (If the shares are to be transferred, section 85 is not necessary because there is no gain. The shares should be sold for $6,000 of debt consideration.) Land inventory −

Not eligible for section 85 since not eligible property

−

Do not transfer in since not needed for the business—better to postpone the realization of the $120,000 business income

−

(If the land inventory is to be transferred, the consideration should be debt of $520,000 equal to the fair market value of the land.)

Conclusion: The public company shares and land inventory should not be transferred to Hart Ltd. Issue 3: Identify the assets that should be transferred but where s. 85(1) cannot be used A/R – loss property (without S. 22 capital loss denied – superficial loss), Section 22 election possible (person selling all or substantially all of property used in carrying on the business to purchaser proposing to carry on the business), take back new debt or assumed liabilities $10K. Prepaids – Take back new debt or assumed liabilities $600 Conclusion: A Section 22 election should be filed for the transfer of the A/R. New or assumed debt should be taken back as consideration for A/R & Prepaids. She can deduct a net business loss of $3K on her personal return for the year of transfer.

Introduction to Federal Income Taxation in Canada

486

Issue 4: Identify the assets that can be transferred with an election under ss. 85(1) Inventory, Land, Building, Goodwill (must elect an amount $1) FMV=FMV Conclusion: All other assets of the business can fall under the Section 85 election and an elected amount chosen to defer the gains/recapture on the properties. Ms. Hart must elect at $1 on the goodwill and will need to report a TCG of 50cents on her personal return. Issue 5/6: Determine consideration received, i.e., Boot/Shares Determine tax attributes, i.e., ACB/PUC of shares received Maximize boot – assumed liabilities, new debt up to the elected amount Must take back shares for rest of FMV Identify characteristics of the preferred shares that give them value Pref shares should be: • • •

voting if Ms. Hart wants to retain control of the business, redeemable/retractable to allow her to have co. redeem shares for FMV, dividend rate to provide source of income,

Issue 7: Identify issues with husband as the common shareholder a.

Gifting/benefit conferred

Important to take back total consideration that is equal in FMV to property transferred and that fixed value preferred shares received or benefit to Mr. Hart will result through increase in value of his common shares (double taxation) Conclusion: Debt and assumed debt up to the elected amounts for the properties transferred and fixed value preferred shares should be received by Ms. Hart and will have a PUC/ACB of $1. Her future objectives should be discussed with her to determine desirable non-tax attributes for the shares.

Issue 8: Tax consequences if the share consideration is sold or redeemed Tax Treatment of Sale – Capital gain, Capital gains exemption if shares are QSBC shares when sold Tax Treatment of Redemption – Deemed dividend, Capital gain/loss ($0 as PUC/ACB equal) TOSI applies the highest marginal rate of tax to split income. Split income includes taxable dividends from a private corporation (including deemed dividends) unless the income meets the definition of an excluded amount. An excluded amount includes income from a property to the extent that the amount is (where the individual has attained the age of 17) is not derived directly or indirectly from a related business in respect of the individual. A related business is defined to include a business carried on by a source individual in respect of the specified individual or a business if the source individual owns not less than 10% of the fair market value of the shares of the corporation. A source individual is a Canadian resident who is related to the specified individual. As the dividend on the share redemption or taxable capital gain realized by Ms. Hart would not be considered to be derived directly or indirectly from a related business carried on by Mr. Hart it would be an excluded amount. The dividend/taxable capital gain in this case is derived from the

Solutions to Chapter 17 Assignment Problems

487

technology accessory business that was carried on by Ms Hart. The dividend/taxable capital gain would not be subject to TOSI. 2.

Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format Assets transferred without ss. 85(1) Asset

Tax Value

A/R

14,000

Prepaids

600

Consideration Assumed New Debt Debt

FMV 10,000 $

14,600

600

Income (3,000) Reserve $1k Business Loss $4K S.22

10,000 $

10,600

600

10,600

(3,000)

Since there is no deferral the only consideration that should be taken back is either assumed liabilities or new debt for a total of $10,600.

Assets transferred under ss. 85(1)

Asset

Tax Value

FMV

Elected Amt

Inventory Building Land Goodwill

Consideration "Boot" - Non-share Assumed New Debt Debt

38,000 670,000 340,000 nil

59,000 1,150,000 660,000 180,000

38,000 670,000 340,000 1

38,000 322,000

1,048,000

2,049,000

1,048,001

360,000

348,000 340,000

688,000

0.5

1,001,000

0.5

ACB Share Consideration Elected amount Allocated to:

1,048,001 360,000 688,000

Assumed debt New debt

ACB of pref shares

1,048,000 1

PUC Share Consideration LSC before reduction S85(2.1) PUC reduction (A) Increase in LSC of all shares (B) Elected amount Less: Boot PUC reduction PUC after reduction FMV in = FMV out Boot not > elected amount Elected amount not < tax value

1,001,000 1,001,000 1,048,001 1,048,000

Income/TCG

21,000 480,000 320,000 180,000

1 1,000,999 1

Introduction to Federal Income Taxation in Canada

488 Tax cost to corporation of assets transferred:

Tax cost

Reason

Accounts receivable..................................

14,000

Actual cost $14,000, before any reserve claimed by purchaser corporation at its year end [s. 22]

Inventory...................................................

38,000

Elected amount [par. 85(1)(a)]

Prepaid ......................................................

600

Building ....................................................

670,000

UCC is deemed to be $670,000 [par. 85(5)(b)]; Capital cost is deemed to be $690,000 [par. 85(5)(a)]

Land ..........................................................

340,000

elected amount [par. 85(1)(a)]

Goodwill (ACB) .......................................

FMV transfer price

UCC/Capital Cost = .5 (TCG on transfer)

GST/HST Implications of Transfer of Property to Hart Ltd. (Optional) GST/HST exempt – Shares public companies (not transferred), A/R, Goodwill (S.85) GST/HST applicable – land (S.85), building (S.85), prepaids, inventory (S.85), Section 167 election – Eligible Business established or carried on by the supplier (Ms. Hart) Recipient (Hart Ltd.) acquires ownership or use of all or substantially all of the property needed for the recipient to carry on the business (ignoring exempt assets) Recipient (Unrelated purchaser) needs to be a registrant (Hart Ltd. should be registered) Joint GST 44 election filed by the recipient by the due date of the GST/HST return for the period of the supply.

Identify risks including missing information, assumptions and uncertain research positions Corporate attribution [s. 74.4] −

Individual (Ms. H) transferring property (business assets) to a Canadian corporation (Hart Ltd.)

−

One of the main purposes of the transfer is to reduce Ms. H’s income and benefit a designated person (Mr. H who is a spouse).

−

Interest benefit applies for a period where Mr. Hart is a specified shareholder of the corporation (he owns 100% of the common shares) and Hart Ltd is not a SBC.

−

As long as Hart Ltd remains a small business corporation there will not be a deemed interest benefit to Ms. Hart.

Benefit conferred [par. 85(1)(e.2)] −

As long as Ms. Hart receives full fair market value for the assets she transfers to Hart Ltd she will not have conferred a benefit on Mr. Hart.

Tax consequences if share consideration sold or redeemed

If she sells the shares she will have a capital gain of $1,000,999 •

tax @ 25% = $250,250

If she redeems the shares she will have a deemed dividend of $1,000,999 and no capital gain or loss •

tax @ 42.5% = $425,425.

Solutions to Chapter 17 Assignment Problems

Share Sale

489

Share Redemption

Redemption Proceeds PUC Deemed Dividend

1,001,000

Redemption Proceeds Deemed Dividend Proceeds of Disposition Adjusted Cost Base Capital Gain (Loss) Taxable Capital Gain (ACL) Tax After-tax Cash

1,001,000 1,000,999 1 1 -

Tax rate

1,001,000 1 1,000,999 500,500 250,250 750,750 50%

425,425 575,575 42.50%

Reach a conclusion based on your analysis of each major issue. −

1 1,000,999

See above

Evaluate the strengths/weaknesses/risks of your conclusions −

No weaknesses identified

Advise/Recommend Advise the decision maker, integrating your conclusions on each of the issues with their objectives, giving priority to the most important issues • •

• • • • • • •

The public company shares and land inventory should not be transferred to Hart Ltd. A Section 22 election should be filed for the transfer of the A/R. New or assumed debt should be taken back as consideration for A/R & Prepaids. Ms. Hart can deduct a net business loss of $3K on her personal return for the year of transfer. All other assets of the business Inventory, Land, Building, Goodwill can fall under the Section 85 election and an elected amount chosen to defer the gains/recapture on the properties. Ms. Hart must elect at $1 on the goodwill and will need to report a TCG of 50cents on her personal return. Debt and assumed debt up to the elected amounts for the properties transferred and fixed value preferred shares should be received by Ms. Hart and will have a PUC/ACB of $1. Her future objectives should be discussed with her to determine desirable non-tax attributes for the shares. She should ensure that preferred shares are voting if she wants to retain control, redeemable/retractable and a dividend rate if she wants dividend income in the future. Consideration received must be equal in FMV to property transferred to avoid a benefit conferred on the husband. Hart Ltd. should register for HST (unless the proprietorship is a small supplier). A GST Form 44 form (section 167 election) should be filed by Hart Ltd. by the filing due date of its HST return i.e. 3 months after its first tax year end if it is annual filer.

Introduction to Federal Income Taxation in Canada

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Solution 4: Accounting for Related Party Transactions ASPE Part A

Issue: Is the transfer of the business to Hart Ltd a related party transaction? According the ASPE 3840.04,

•

A related party includes an individual who directly or indirectly controls the reporting enterprise and members of the immediate family of the individual who controls the enterprise. Conclusion: Mr. and Ms. Hart are related parties to Hart Ltd.

Per ASPE 3840.08, 3840.09,

•

• •

A related party transaction is measured at the carrying amount unless the transaction has commercial substance and is in the normal course of operations per ASPE 3840.18 and 3840.19. A transaction has commercial substance when the entity’s future cash flows are expected to change significantly as a result of the transaction. The future cash flows are expected to change significantly when the entity-specific value of the asset received differs from the entity-specific value of the asset given up and the difference is significant in relation to the exchange amount. A RPT that has commercial substance and is not in the normal course of operations is measured at the exchange amount when the change in ownership interests of the item transferred is substantive and the exchange amount is supported by independent evidence. This would generally require an independent appraisal of the assets transferred to verify the fair market values provided. Transactions not in the normal course of operations include the sale/purchase of capital assets and the issue or redemption of an enterprise’s capital. A change in ownership interest of an item transferred is presumed to be substantive when a transaction results in unrelated parties having acquired at least 20% of the total equity ownership interests.

Conclusion:

•

This transaction is not in the normal course of operations and likely doesn’t have commercial substance as Ms. Hart is receiving fair market value consideration in the form of preferred shares for the transfer of the property. Mr. Hart (a related party) owns 100% of the common shares. Ms. Hart will own preferred shares that may provide her with voting control. Not a substantive change in ownership interests of the business as no unrelated party has acquired a minimum 20% interest. The transaction should be reported at the carrying amount.

Solutions to Chapter 17 Assignment Problems

491

Measurement:

•

When a RPT is measured at the carrying amount, any difference between the carrying amounts of items exchanged, together with any tax amounts related to the items transferred, shall be included as a charge or credit to equity ASPE 3480.09

Issue: How should the preferred share consideration be reported in the financial statements? ASPE 3856 provides guidance on accounting for financial assets/liabilities issued in a related party transaction. Retractable or mandatorily redeemable shares (ROMRS) issued in a tax planning arrangement are treated as a financial liability unless they meet the following conditions; 1) The shareholder receiving the shares retains control of the enterprise 2) No consideration is received by the enterprise issuing the ROMRS or only shares of the enterprise issuing the retractable or mandatorily redeemable shares are exchanged. and 3) No written arrangement exists that gives the holder of the shares the right to require the enterprise to redeem the shares on a fixed or determinable date or within a fixed or determinable period. Conclusion: The preferred shares received by Ms. Hart could be voting and provide her with control. The facts do not indicate the intent in respect to voting rights. A note receivable is received by Ms. Hart. This is not a share for share exchange. It was determined that the preferred shares should be retractable/redeemable shares and as a result Ms. Hart will have the right to require the company to redeem the shares. It is not possible for all three requirements to be met. As a result, the shares must be treated as a financial liability per ASPE 3856.23. If the preferred shares are retractable or redeemable on demand they should be classified as a current liability on the balance sheet. It will also be necessary to describe the asset transfer transaction in the notes to the financial statements. Measurement: ROMRS must be measured at the redemption amount per ASPE 3856.09A. Entry to record asset purchase/preferred share issuance at carrying value. Dr. Prepaids $600 DR A/R $14,000 CR Allowable for Doubtful Accounts $4,000 CR Note Payable $10,600 Note that as a Section 22 election is filed for the transfer, the purchaser will include income of $4,000 on the Schedule 1 on the tax return. It would be possible to deduct an offsetting doubtful account reserve of $4,000 also on Schedule 1 under 20(1)(l).

Introduction to Federal Income Taxation in Canada

492

DR Inventory $38,000 DR Land (CV) $340,000 DR Building (CV) $690,000 DR Future Tax Asset $38,272 DR Retained Earnings $1,257,128 CR Financial liability (Redeemable/retractable PSs) CR Accumulated Depreciation CR Note Payable $688,000 CR Liabilities

$1,001,000 $314,400

$360,000

The future tax liability is calculated using the expected future tax rate of 13% on the difference between the tax value of $670,000 and the NBV of the building of $375,600 which results in a temporary deductible difference of $294,400. Balance Sheet (Beginning) Hart Ltd Current Assets Cash Prepaids Inventory Future Tax Asset A/R Less: Allowance for Doubtful Accounts

Property, plant, equipment Land Building Less: Accumulated Depreciation Total Assets

100 600 38,000 38,272 14,000 (4,000)

10,000 86,972

340,000 690,000 (314,400)

375,600 802,572

Current Liabilities Preferred Shares Note Payable Liabilities Total Liabilities

1,001,000 698,600 360,000 2,059,600

Retained Earnings Equity Total Shareholder's Equity

(1,257,128) 100 (1,257,028)

Total Liabilities/Shareholder's Equity

802,572

Part B Entry to record the dividend on the preferred shares; DR Interest expense $10,000 CR Cash/Dividend payable $10,000 According to ASPE 3856.15, an enterprise shall report dividends relating to a financial instrument that is classified as a financial liability in net income as expense for income. Note that when the tax return is prepared for the year, this expense will need to be added back on the Schedule 1. The dividend would be treated as a non-eligible dividend paid to Ms. Hart.

Solutions to Chapter 17 Assignment Problems

Part C Entry to record future redemption of the preferred shares. DR Financial liability (Redeemable/retractable PSs) $1,001,000 CR Cash $1,001,000

493

Introduction to Federal Income Taxation in Canada

494

Solution 5: Transfer of Assets to a Corporation Assess the Situation 1.

Draw a diagram identifying all stakeholders and their relationships, e.g., corporate org charts.

Joe Cdn resident - 55

C3 C4

100 shares each at $1/share

100% ACB/PUC $100 TSE

TEL

Retail bus $3K net CLs

Joe 100% TEL

Land/building/mtg Note receivable

C1 Assets/liabs Transferred

PSs voting/retractable

CSs (300)

TSE

Identify the relationships among the stakeholders e.g., related, affiliated, associated, connected − Joe controls TEL so he is related to and affiliated with it − Joe is related to each of his children − TEL and TSE are related − After the transfer, TEL and TSE will be associated.

Identify the profile of each stakeholder e.g., tax features, risk profile −

Joe Tse – Canadian resident individual

−

Children – Canadian resident individuals, all adults

Solutions to Chapter 17 Assignment Problems

−

Three are active in the business and will own shares of TSE

−

One is not active in the business and does not own shares in TSE

Understand the decision maker and their objectives −

Decision-maker: Joe Tse

−

Objectives:

−

His goal is to transfer the business assets from TEL to TSE and have his three children as the common shareholders.

−

Wants to share growth of the business assets with the 3 children.

−

Wants to earn retirement income from the TEL even if the business in TSE doesn’t prosper.

−

He wants to keep the land and building in TEL to earn rental income.

−

Maximize boot consideration.

−

He wants control of TSE through voting, retractable preferred shares.

−

Wants to use up a $3,000 net CL in TEL.

−

Wants advice on: o

which assets to transfer or not

what consideration to receive

tax values of assets in TSE

Identify the relevant past transaction/events or planned future transactions/events and create a timeline −

November 30th, 2023 is the date for the sale of assets to the corporation.

Identify the Issues 1.

Identify all of the major tax issues and any non-tax issues − −

− − − − − 2.

495

Eligibility to elect using Section 85 Transfer of assets − Which asset should not be transferred at all? − Which assets should be transferred but not under s. 85? − Which assets should be elected under s. 85? − Tax values of assets to the corporation Elect to create TCG to use up net capital loss Income in retirement Control TOSI on dividends to Joe from TEL TOSI on dividends to 3 children from TSE

Identify missing information or assumptions made

−

None identified

Introduction to Federal Income Taxation in Canada

496 Analyze the Major Issues 1.

Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act Issue 1 Assess whether s. 85 applies to each of the assets −

TSE is a taxable Canadian corporation

−

Joint election between TEL and TSE −

Property must be eligible property

−

Consideration includes shares

−

Eligible Property o Cash is not eligible property o A/R is an eligible property o Inventories are eligible property and have an accrued gain o Equipment is eligible property and has an accrued gain o Goodwill is eligible property and has an accrued gain o Shares of Supplyco Ltd. are eligible property and have an accrued gain

Issue 2 Identify which assets should not be transferred to TSE at all Shares of Supplyco Ltd. should not be transferred to the corporation if they would jeopardize the qualification of the shares of the new corporation as QSBCs. At this time, the FMV of the Supplyco Ltd. shares is less than 10% of the FMV of all of the assets of the new corporation, but this could change in the future. There is no advantage to having the corporation owning these shares. Land and building should be kept in TEL to provide creditor protection and retirement income for Joe. He can lease them to TSE. The mortgage will be kept in TEL with the land and building. S. 22 cannot be used on the transfer of the accounts receivable to TSE since not “all or substantially all” of the business assets are being transferred to TSE (the land and building are not being transferred). As a result, the accounts receivable should be collected in TEL. Then, if cash is needed in TSE the cash from the receivables collected in TEL can be loaned to TSE. The reserve of $10,000 must be included in income but any receivables not collected will be a business loss. Issue 3 Identify which assets should be transferred but not under s. 85 Cash should be transferred if it is needed to finance the business. It can be loaned to the company. Issue 4 Identify which assets should be transferred under s. 85 Inventories, equipment and goodwill Issue 5 Elect to create TCG to use up net capital loss The $3,000 net CL in TEL can be used on the transfer of the assets by electing on the Class 14.1 goodwill to create a capital gain of $6,000. Issue 6 Future Income Sources The rental income in TEL will be deemed to be ABI in TEL since it is deducted from the ABI of an associated corporation (TEL controls TSE). This income will be available to Joe in his retirement. As TSE makes money they can pay a X% dividend (X% x $197,000 ) on the preference shares. Alternatively, TSE can redeem the preference shares held by TEL.

Issue 7 Control The preference shares in TSE can be voting with more votes than the common shares. Through his control of TEL Joe will effectively control TSE as well.

Solutions to Chapter 17 Assignment Problems

497

Issue 8 TOSI Dividends to Joe from TEL TOSI applies the highest marginal rate of tax to split income. Split income includes taxable dividends from a private corporation (including deemed dividends) unless the income meets the definition of an excluded amount. Dividends received by Joe from TEL would be derived directly or indirectly from a related business carried on by the 3 children (source individuals). For an individual who has attained the age of 24, income from excluded shares is an excluded amount and is not included in split income. The common shares owned by Joe in TEL will not be excluded shares because although the shares provide Joe with 10% of the votes and value of the corporation andthe company is not a professional corporation or a corporation that earns 90% or more of its income from the provision of services, it is likely that all or substantially all (90%) or more of the income of the corporation will be derived directly or indirectly from a related business through the rents and management fees charged to TSE. However, dividends on Joe’s common shares in TEL could be an excluded amount under the excluded business exception. It could be argued that the dividends are derived directly or indirectly from an excluded business if coming from rents or dividends paid from TSE to TEL. The business in TSE is an excluded business for Joe because he was actively engaged on a regular, continuous and substantial basis in the activities of the business in any 5 prior taxation years. Dividends to 3 children from TSE TOSI will not apply to dividends on the common shares held by any of the children who are actively engaged on a regular continuous and substantial basis in the activities of the TSE business in the taxation year. In such case, the dividends will be an excluded amount because they will be derived from an excluded business of each individual. An individual is deemed to be actively engaged if he/she works at least 20 hours a week during the portion of the year the business operates. In this case, all three of his children are actively involved in the business therefore, the dividends received would likely be excluded and not be subject to TOSI (assuming they work at least 20 hours a week). The shares will also meet the definition of excluded shares because TSE is not a professional corporation, doesn’t earn 90% or more of its income from the provision of services, the shares provide each shareholder with 10% or more of votes and value in the corporation and the company does not have all or substantially all (90%) or more of its income derived from a related business. 2.

Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format Determine the consideration and tax consequences of the assets transferred without s. 85 The following assets cannot or should not be transferred using section 85:

Consideration Asset Cash

Note

Tax Value

Introduction to Federal Income Taxation in Canada

498

Determine the consideration and tax consequences of the assets transferred under s. 85 The following assets should be transferred using section 85:

The tax cost of the assets to TSE; -

Inventory Cost $90,000

Equipment UCC $57,000, CC/ACB $110,000

Goodwill UCC/CC $3,000, ACB $6,000

ACB of shares received: Elected amount

153,000

Allocated to: Assumed debt

55,000

New debt

98,000

ACB of pref shares

153,000 -

PUC of shares received: LSC before reduction

197,000

S85(2.1) PUC reduction (A) Increase in LSC of all shares

197,000

(B) Elected amount

153,000

Less: Boot

(153,000)

PUC reduction PUC after reduction

197,000 -

Solutions to Chapter 17 Assignment Problems

499

Consideration Received The new debt/notes can be demand notes with or without interest. The value is established by the note being a demand note. The preference shares should be redeemable and retractable. The retraction feature establishes the fair market value. There should be a dividend rate of up to x% of the retraction value. This provides a flexible income stream from TSE to TEL. 3.

Identify risks including missing information, assumptions and uncertain research positions Is there a benefit conferred (gifting) under par. 85(1)(e.2)? Since Joe controls TEL, he is related to the company. Since Joe is the father of the three children he is related to them. TEL is related to the three children. As long as the FMV in is equal to FMV consideration received there should not be any gifting. Is there corporate attribution under s. 74.4? Since the transaction does not start with an individual, the corporate attribution rules do not apply. FMV issues. There is a risk of problems in the estate when the shares of TEL are left to the four children. The inactive child will have voting retractable shares at that point.

Reach a conclusion based on your analysis of each major issue a.

Joe has frozen the current value of the business and his children will benefit from any future appreciation in the value through their ownership of the common shares

Joe controls TSE through his control of TEL

Joe can received dividends from TEL supported by the rental income and dividends from TSE

Evaluate the strengths/weaknesses/risks of your conclusions None identified

Advise/Recommend Advise your client, integrating your conclusions on each of the issues with the client’s objectives, giving priority to the most important issues −

Joe can transfer assets from TEL to TSE to freeze the value of his business and have the children benefit from any future growth in value.

−

Joe can earn retirement income in TEL through the rent charged from TEL to TSE and from dividends received by TEL from TSE.

−

Joe can maintain control of TSE through the voting features of the preference shares.

−

The net capital loss of $3,000 can be used against the taxable capital gain created on the sale of the goodwill.

−

All of Joe’s objectives are met.

Introduction to Federal Income Taxation in Canada

500

Solution 6: Transfer of Assets to a Corporation (A) The shares in Public Co. should not be transferred to the corporation since the capital loss would be denied under paragraph 40(2)(g) and the section 54 definition of “superficial loss”. Also, the Public Co. shares could impact the QSBC status of the shares of the corporation if transferred. Similarly, the land (Parcel II) should not be transferred to the corporation. Since this land would be land inventory, it cannot be transferred on a tax-free basis using section 85 [ss. 85(1.1)]. Any other form of transfer must be at fair market value since Mr. Schminkie and the corporation do not deal at arm’s length, and will result in triggering a business income inclusion. Recommend that this parcel of land be held personally.

(B) Items which cannot or should not be transferred under section 85: Consideration Asset

Note

Tax Value

FMV

Assumed New Debt

Debt Cash

20,000

A/R

96,000

85,000 $

85,000

Inventory

86,000

Equipment

35,000

5,000

237,000

196,000

Income

(5,000) Net of $6,000 reserve

(5,000)

A/R Section 22 election: Proprietorship Reserve .................................. $ 6,000 Income ........................... Consideration......................... 85,000 Business loss on transfer 11,000 Accounts receivable .......

$ 6,000

96,000

Corporation Accounts receivable ............... $ 96,000 Consideration ................... Income ............................. — can take a reserve. — can write off bad debts.

$ 85,000 11,000

A terminal loss of $30,000 is not allowed to Mr. Schminkie on the equipment by virtue of subsection 13(21.2). The corporation will have a UCC of $5,000, and Mr. Schminkie will retain a UCC in that class of $30,000 and can deduct CCA on his personal return. When the equipment is disposed of by the corporation, the balance remaining in the UCC class can be deducted as a terminal loss on his personal return.

Solutions to Chapter 17 Assignment Problems

501

Consideration "Boot" - Non-share Asset

Note

Tax Value

FMV

Elected

Assumed Debt 46,000

New Debt

Class A

Land: Parcel I

200,000

339,000

Amt 200,000

154,000

139,000

Building

150,000

750,000

150,000

61,000

Auto

11,000

12,000

11,000

60,000

361,000

1,161,000

361,001

Goodwill

46,000

315,000

Class B

Income

539,000 1,000

200,000

60,000

0.5

600,000

0.5

(D) Cost of consideration taken on section 85 transfer: ACB of shares received: Elected amount Allocated to: Assumed debt New A

S85(2.1) PUC reduction (A) Increase in LSC of all shares (B) Elected amount Less: Boot PUC reduction

800,000 361,001 (361,000)

(1) 799,999 Class A $ 200,000(C)

Increase in LSC for each class ..................................................... Reduction in each class [(A – B)  C/A]

Class B $600,000(C)

$200,000

Class A shares, $799,999 .......................................... (199,999) 

$800,000 $600,000 Class B shares, $799,999  .................... $800,000 Tax PUC after reduction for each class ........................................

(600,000) $

The $1 total PUC after the reduction reflects the fact that all of the tax-paid cost in the assets transferred (i.e., $361,000) has been recovered through assumed liabilities and new debt received. (E) Proceeds of redemption ......................................................... Less: PUC (total) ................................................................... Deemed dividend [ssec. 84(3)] .............................................. Proceeds of disposition .......................................................... Less: deemed dividend [ssec. 84(3)]...................................... Adjusted proceeds of disposition ........................................... Adjusted cost base (total)....................................................... Capital gain (loss)(3)...............................................................

$ 800,000 1 $ 799,999 $ 800,000 799,999 $ 1 1 $0

502

Introduction to Federal Income Taxation in Canada

Since Mr. Schminkie and his wife are affiliated with the corporation, had there been a capital loss, the capital loss would have been denied and added to the cost base of the common shares held by Mr. Schminkie by virtue of subsection 40(3.6). TOSI applies the highest marginal rate of tax to split income. Split income includes taxable dividends from a private corporation (including deemed dividends) unless the income meets the definition of an excluded amount. An excluded amount includes income from a property to the extent that the amount is (where the individual has attained the age of 17) not derived directly or indirectly from a related business in respect of the individual. A related business is defined to include a business carried on by a source individual in respect of the specified individual or a business if the source individual owns not less than 10% of the fair market value of the shares of the corporation. A source individual is a Canadian resident who is related to the specified individual (Mr Schminkie). The deemed dividend on Mr. Schminkie’s preferred shares (and future dividends on his common shares) could be considered to be derived from a related business if Mrs Schminkie is involved in the business and/or owns at least 10% of the fair market value of the shares at the time. However, the deemed dividend would be an excluded amount because it would be derived from an excluded business of Mr. Schminkie. Future dividends paid to Mrs Schminkie would be considered to be derived directly or indirectly from a related business carried on by Mr. Schminkie. For an individual who has attained the age of 24, income from excluded shares is an excluded amount and is not included in split income. The common shares owned by Mrs Schminkie in the new corporation will be excluded shares as long as the shares provide 10% of the votes and value of the corporation and the other conditions found in the definition of excluded shares will be met; the company is not a professional corporation, it will not earn 90% or more of its income from the provision of services, 90% or more of its income will not be derived from a related business. The income of the corporation will be from a manufacturing business. The dividends may also be considered to be derived from an excluded business depending on Mrs. Schminkie’s involvement in the business. As a result, TOSI is not likely to apply.

Solutions to Chapter 17 Assignment Problems

503

Solution 7: Transfer of Shares to a Corporation – 84.1 Assess the Situation 1.

Draw a diagram identifying all stakeholders and their relationships, e.g. corporate org charts.

Before

Mrs. Andrews

Cdn resident full CGE of $971,190 available

100% 100% ACB $200,000 QSBC shares

100 common ACB $100 Holdings

Plummer Ent.

CCPC

FMV $100 PUC $100

SBC FMV $4,000,000 PUC $1,000 After

Mrs. Andrews 100 common – ACB $100 Note $200,000 Pref $3,800,000 6% Holdings 100% Plummer Ent.

Identify the relationships among the stakeholders e.g., related, affiliated, associated, connected − Mrs. Andrews is related to and affiliated with Plummer and Holdings − Plummer and Holdings are related and associated − Plummer and Holdings are connected corporations after the transfer.

Introduction to Federal Income Taxation in Canada

504 3.

Identify the profile of each stakeholder e.g., tax features, risk profile o

Mrs. Andrews ▪

A Canadian resident

▪

Has not used any of her CGE

▪

Owns 100% of both Plummer and Holdings

▪

She has the full CGE of $971,190 available

Plummer ▪

Values identified above

▪

CCPC

▪

SBC/QSBC shares

Holdings ▪

Shell company

▪

CCPC

Understand the decision maker and their objectives o

Decision-maker: Mrs. Andrews

Objectives: ▪

transfer her shares of Plummer to Holdings

▪

use up her capital gains exemption

▪

set up a holding company to accumulate capital away from the risks of the business ▪

Use section 85 for the transfer.

▪

Possibly take back more debt consideration i.e. $400,000.

Identify the relevant past transaction/events or planned future transactions/events and create a timeline −

She plans to transfer her shares of Plummer to Holdings on December 3rd

−

Consideration will be a $200,000 note and 6% preference shares retractable for $3,800,000

Identify the Issues 1.

Identify all of the major tax issues and any non-tax issues 1.

Determine if it is possible to elect under section 85

Determine if it is possible for her to use her CGE on the transfer of the Plummer shares

Does s. 84.1 apply? Tax implications/attributes of shares received?

Decide if the consideration she proposed is appropriate

Identify missing information or assumptions made None identified

Solutions to Chapter 17 Assignment Problems

505

Analyze the Major Issues 1.

Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act Issue 1 Assess whether s. 85 applies - Yes •

It appears that the shares of Plummer are capital property and therefore eligible property to Mrs. Andrews.

•

A s. 85 election can be filed for the transfer.

•

Share consideration will be received on the transfer.

•

Joint election is required.

Issue 2 Ability to use CGE - Yes •

She has not used any of her exemption

•

The shares are QSBC shares

Issue 3 Assess whether s. 84.1 applies Tax implications/attributes of shares received? •

This transaction will be subject to the provisions in section 84.1.

•

An individual, resident in Canada (i.e., Mrs. Andrews), must dispose of shares of a corporation resident in Canada (i.e., Plummer) to another corporation (Holdings) with which the individual (i.e., Mrs. Andrews) does not deal at arm’s length.

•

As Mrs. Andrews owns 100% of the shares of Holdings, Mrs. Andrews and Holdings do not deal at arm’s length, since they are related [spar. 251(2)(a)(i)].

•

After the transaction Plummer and Holdings must be connected, within the meaning assigned by subsection 186(4).

•

Plummer and Holdings are connected as VTHL controls Plummer.

Therefore, all the conditions for section 84.1 to apply are met. Issue 4 Impact if debt consideration is increased to $400K and share consideration is $3.6M If boot exceeds the modified ACB of the shares transferred a deemed dividend will result. The impact will be as follows (per quantitative analysis below): 1)

Deemed dividend of $200K ($400Kboot - $200Kmodified ACB).

The proceeds of disposition will be reduced by the deemed dividend to 971,190 ($1,171,190 proceeds – 200K deemed dividend). As a result, the capital gain on the disposition of the shares will be 771,190 and $200K of capital gains exemption will remain unused.

The ACB and PUC of the share consideration will be $771,190, and $0 respectively.

Introduction to Federal Income Taxation in Canada

506 2.

Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format Use the section 85 chart to analyze sale and election including ACB/PUC of preference shares received as consideration

Asset Plummer Shares

Tax Value 200,000

FMV 4,000,000

Elected Amt

Consideration "Boot" - Non-share Assumed New Debt Debt

1,171,190

200,000

Income/CG

3,800,000

Mrs. Andrews should elect to transfer the Plummer shares to Holdings for $1,171,190. This represents the $200,000 cost base plus the $971,190 capital gain that she wishes to crystallize to utilize her capital gains deduction for qualified small business corporation shares.

Capital Gain Pof D Deemed Dividend Revised PofD ACB Capital Gain Capital Gain Exemption Net Gain

1,171,190 1,171,190 (200,000) 971,190 (971,190)

Unused Exemption

ACB Share Consideration Elected amount Allocated to: Assumed debt New debt ACB of pref shares

1,171,190 200,000

200,000 971,190

If an arm’s length purchaser can be found for the preference shares, Mrs. Andrews will be able to reduce the potential capital gain on such a sale by $971,190 because this amount is built into the ACB.

Calculate any deemed dividend or PUC reduction under s. 84.1 PUC Reduction Paragraph 84.1(1)(a) will apply to reduce the tax PUC of the shares Mrs. Andrews takes back from Holdings.

971,190

Solutions to Chapter 17 Assignment Problems

PUC Share Consideration 84.1(1)(a) PUC Reduction LSC before reduction Increase in LSC Less: Greater of: PUC of shares transferred Modified ACB of shares transferred Less: Boot PUC reduction (A - B) PUC after reduction

507

3,800,000 3,800,000 A 1,000 200,000

200,000 200,000

B 3,800,000 -

The $0 PUC after reduction reflects the fact that all of the “hard cost” of the Plummer shares has been recovered by the $200,000 note taken back as consideration on the transfer. Deemed Dividend No deemed dividend will arise [par. 84.1(1)(b)], since the non-share consideration did not exceed the greater of the PUC ($1,000) or modified ACB ($200,000) as shown below. Deemed Dividend Sum of: Increase in LSC of new shares FMV of boot

3,800,000 200,000 4,000,000

Less the sum of: Greater of: PUC of shares transferred Modified ACB of shares transferred PUC reduction (above) Deemed Dividend

1,000 200,000

200,000 3,800,000

Calculate any deemed interest benefit under corporate attribution N/A Calculate any minimum tax Not enough information at this point Impact if debt consideration is increased to $400K and share consideration is $3.6M Consideration "Boot" - Non-share Asset Plummer Shares

Tax Value 200,000

FMV

Elected A

4,000,000 -

Introduction to Federal Income Taxation in Canada

508 ACB Share Consideration Elected amount Allocated to:

1,171,190 Assumed debt New debt

400,000

ACB of pref shares

400,000 771,190

PUC Share Consideration 84.1(1)(a) PUC Reduction LSC before reduction Less:

3,600,000 Increase in LSC Greater of: PUC of shares transf Modified ACB of sha Less: Boot

3,600,000 1,000 200,000

200,000 400,000

PUC reduction (A - B) PUC after reduction

3,600,000 -

Deemed Dividend Sum of: Increase in LSC of new shares FMV of boot

3,600,000 400,000 4,000,000

Less the sum of: Greater of: PUC of shares transferred Modified ACB of shares transferred PUC reduction (above) Deemed Dividend

1,000 200,000

200,000 3,600,000

3,800,000 200,000

Identify risks including missing information, assumptions and uncertain research positions Assess whether corporate attribution (s. 74.4) applies While an individual, Mrs. Andrews, is transferring property to a corporation she is not trying to benefit a designated person. This provision will not apply since there are no other shareholders in Holdings after the transfer. Assess whether gifting applies [par. 85(1)(e.2)] Since she is the only shareholder of Holdings she is not conferring a benefit on a related person. Assess whether minimum tax [s. 127.5] applies Given the significant size of the capital gain, minimum tax may apply. It will depend on what other income Mrs. Andrews has in the year. Any minimum tax payable will be recoverable over the following 7 years.

Reach a conclusion based on your analysis of each major issue. −

Mrs. Andrews can transfer her shares of Plummer to Holdings and use up her full CGE. She will be able to receive $200,000 of new debt and preference shares worth $3,800,000.

Evaluate the strengths/weaknesses/risks of your conclusions −

No weaknesses identified

Advise/Recommend Advise the decision maker, integrating your conclusions on each of the issues with their objectives, giving priority to the most important issues −

There are no adverse tax consequences unless minimum tax applies

−

Recommend the transfer and elect using s. 85 to use the CGE

Solutions to Chapter 17 Assignment Problems −

Ensure boot is limited to the $200,000 note

509

Introduction to Federal Income Taxation in Canada

510

Solution 8: Capital Reorganization – Section 86 Assess the Situation 1. Draw a diagram identifying all stakeholders e.g., corporate org charts Matt

100% ACB $300,000

Beam Inc. PUC $300,000 FMV $900,000

Matt is to exchange his common shares of Beam Inc. in exchange for one of two packages of consideration Matt Son 30 yrs

Matt Son 30 yrs

Cash $10,000 CS

Bond $80,000

Cash $500,000 CS

Class A $810,000

Class A $400,000

Beam Inc.

2. Identify the relationships among the stakeholders e.g., related, affiliated, associated, connected − Matt and son are related − Matt controls Beam Inc. so they are related and affiliated before the reorganization because he controls − Son is related to Beam Inc. because he is related to Matt who controls the company − Son affiliated and related to Beam Inc. after reorganization if he controls with common shares. Matt is related to the corporation − Matt affiliated and related to Beam Inc. after reorganization if Class A shares are voting and provide control. Son is related to the corporation 3. Identify the profile of each stakeholder e.g., tax features, risk profile − Matt is an individual resident in Canada − Son is an individual resident in Canada − Beam Inc. is a CCPC

Solutions to Chapter 17 Assignment Problems

511

4. Understand the client/decision maker and their objectives − Matt has to decide between two different consideration packages he could receive from Beam Inc. in exchange for his common shares 5. Identify the relevant past transaction/events or planned future transactions/events and create a timeline − No definite timeline but it says they are in the “course of capital reorganization”

Identify the Issues 1. Identify all of the major tax issues and any non-tax issues 1. Are the conditions of s. 86 met for the proposed transaction to qualify? 2. What impact does the consideration have on the tax-free rollover under s. 86? 3. Does Tax on Split Income have application?

Identify missing information or assumptions made None identified

Analyze the Major Issues 1. Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act 1.

Are the conditions of s. 86 met for the proposed transaction to qualify? −

Reorganization of capital is taking place

−

A taxpayer, Matt, is disposing of all of his common shares of Beam and shares are capital property

−

The consideration received includes shares (preferred shares)

−

Conclusion: S. 86 does apply

What impact does the consideration have on the tax-free rollover under s. 86?

• S. 86 results in an automatic tax free rollover as long as boot does not exceed the PUC of the old shares If boot exceeds the PUC of the old shares a deemed dividend results. [ITA 84(3) dividend on redemption (ITA 84(5))]

Conclusions: Package A does not result in income, the unrealized gain on the shares is deferred until the Class A shares are disposed of in the future. Package B results in a deemed dividend and tax must be paid immediately on the dividend. If the company does not have GRIP or a CDA, the dividend will be a non-eligible dividend taxed at marginal rates. 1.

Does Tax on Split Income have application?

TOSI applies the highest marginal rate of tax to split income. Split income includes dividends (including deemed dividends) from the shares of a private corporation unless the amount meets the definition of an excluded amount. Deemed dividend with Package B is a dividend from a private corporation and meets the definition of split income.

Introduction to Federal Income Taxation in Canada

512 a.

Excluded amount? i. Not derived from a related business carried on by a source individual (the son) or a business of a corporation if at any time in the year a source individual (the son) owns shares of the capital stock of the corporation worth not less than 10% of the FMV of all of the shares of the capital stock of the corporation. This looks to be a related business (if the business is considered to be carried on by the son?). Not met. ii. Excluded business? Specified individual (Matt) is actively engaged on a regular, continuous basis in the activities of the business in the year of the dividend or any 5 prior taxation years. Met. iii. Excluded shares? Specified individual (Matt) owned shares of corporation; It is not a corporation earning 90% service income. It is not a professional corporation. He owned 10% or more of the votes and FMV immediately before the time. 90% of more of income not derived from related business. Met. iv. Reasonable return. A question of fact. Future dividends on common shares received by Son (age 30) i.

ii.

iii.

iv.

Not derived from a related business carried on by a source individual (Matt) at any time in the year or a business of a corporation where at any time in the year a source individual (Matt) owns not less than 10% FMV of the shares. This is a related business. Not met. Excluded business? Specified individual (Son) is actively engaged on a regular, continuous basis in the activities of the business in the year of the dividend or any 5 prior taxation years. He works full time for the Beam Inc. Met. Excluded shares? Specified individual (Son) owned shares of corporation; It is not a corporation earning 90% service income. It is not a professional corporation? The son does not own 10% or more of votes/FMV of the shares of the company but may at some point in the future. 90% of more of income not derived from related business. Not met until sometime in the future? Reasonable return.

Conclusion: TOSI doesn’t apply to the deemed dividend on Matt’s disposition of his old common shares (excluded business or excluded shares). TOSI doesn’t apply to future dividends on common shares held by son (excluded business).

2. Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format Analyze the results of the two consideration packages under s. 86.

Package (a) There is no deemed dividend [ss. 84(1)] because the non-share consideration is less than the PUC of the old shares. The PUC reduction [par. 86(2.1)(a)] of $600,000 provides a total reduced PUC of $210,000 which is equal to the PUC of the old shares of $300,000 less the non-share consideration. A tax deferral results [ss. 84(3)] because the redemption amount paid, consisting of boot of $90,000 and total reduced PUC of shares issued, $210,000, does not exceed the PUC of the old shares of $300,000. Issuance of New Shares

Solutions to Chapter 17 Assignment Problems

513

(1) PUC of new shares: LSC increase for all new shares...................................................................... Less: PUC of old shares ........................................................... Less: boot ($10K + $80K) .................................................

$ 810,000

$ 300,000 90,000

210,000

PUC reduction ................................................................................................

$ 600,000

Reduced PUC of all shares ($810K – $600K) ................................................

$ 210,000

(2) Cost of all new shares: ACB of old shares .....................................................................

$ 300,000

Less: Cost of boot......................................................................

90,000

$ 210,000

Cost of non-share consideration (= FMV) ...........................................................

90,000

Redemption of Old Shares (1) Proceeds of redemption of old shares: Reduced PUC of new shares ..........................................................................

$ 210,000

FMV of non-share consideration (boot) ............................................................. Redemption proceeds .....................................................................................

90,000 $ 300,000

Deemed dividend [ss. 84(3)]: Redemption proceeds .....................................................................................

$ 300,000

PUC of old shares ................................................................................................(300,000) Deemed dividend [ss. 84(3)] ...............................................................................

(2) Proceeds of disposition of old shares: Cost of all new shares.....................................................................................

$ 210,000

Boot .................................................................................................................... Total

...............................................................................................................

90,000

$ 300,000

Less: ss. 84(3) deemed dividend ......................................................................... Adjusted Proceeds of disposition of old shares ..............................................

Nil $ 300,000

CG or CL on disposition of old shares: Adjusted Proceeds ..........................................................................................

$ 300,000

ACB .....................................................................................................................300,000 CG/CL ................................................................................................................

Nil

Net economic effects: Deemed dividend on reorganization ...............................................................

CG (CL) on disposition of old shares .............................................................

Accrued CG on new shares: FMV ...................................................................................

$ 810,000

ACB....................................................................................

(210,000)

$ 600,000

Introduction to Federal Income Taxation in Canada

514

The accrued gain on the new shares reflects the same accrued gain on the old shares before the reorganization. All of the gain is deferred until the new shares are redeemed or disposed of in the future.

The PUC of the new preferred shares will be equal to the reduced PUC calculated above. These PUC values reflect the remaining tax-paid cost which has not been returned to the shareholder in the form of nonshare consideration (i.e., cash of $10,000 and a bond of $80,000).

Package (b) In this case, there will be no deemed dividend [ss. 84(1)]. The PUC of the corporation has not increased. Prior to the reorganization, the PUC of the corporation was $300,000 and after the reorganization PUC is nil. A deemed dividend does arise, however, under subsection 84(3). This is because the non-share consideration consisting of boot of $500,000, exceeds the PUC of the old shares of $300,000.

Issuance of New Shares (1) Reduced PUC: LSC increase for all shares .................................................................................... Less: PUC of old shares ............................................................... Less: boot ............................................................................

$ 400,000

$ 300,000 500,000

PUC reduction .......................................................................................................

$ 400,000

Total reduced PUC ($400K – $400K) ......................................................................

(2) Cost of new shares received: ACB of old shares .................................................................................................

$ 300,000

Less: Boot..............................................................................................................

500,000

Cost of new shares.................................................................................................

Cost of boot (= FMV) .................................................................................................

$ 500,000

Redemption of Old Shares (1) Redemption proceeds of old shares: Reduced PUC of new shares .................................................................................

Boot .......................................................................................................................

$ 500,000

Redemption proceeds ............................................................................................

$ 500,000

Deemed dividend [ss. 84(3)]: Redemption proceeds ............................................................................................

$ 500,000

Less: PUC of old shares ........................................................................................

300,000

Deemed dividend [ss. 84(3)].............................................................................

$ 200,000

(2) Proceeds of disposition of old shares:

Solutions to Chapter 17 Assignment Problems

515

Boot .......................................................................................................................

$ 500,000

Cost of new shares .................................................................................................... Total ......................................................................................................................

$0 $ 500,000

Less: Ss. 84(3) deemed dividend [par. (j) of def. “proceeds of disposition” in s. 54] .................................................................................................................. (200,000) Adjusted Proceeds of disposition of old shares .....................................................

$ 300,000

Capital gain (loss) on disposition of old shares: Adjusted proceeds of disposition...........................................................................

$ 300,000

ACB of old shares ..................................................................................................... (300,000) Capital gain (loss) ..........................................................................................................

The PUC will be nil [ss. 86(2.1)], since all of the PUC of the old shares of $300,000 has been recovered through the cash consideration of $500,000.

Net economic effect: Deemed dividend [ss. 84(3)] ..........................................................................

$ 200,000

Capital gain (loss) on old shares.....................................................................

Accrued capital gain on new shares: FMV ................................................................................... ACB ......................................................................................

$ 400,000 $0

400,000

Net economic effect .......................................................................................

$ 600,000

The net economic effect is equal to the capital gain inherent in the old shares ($900,000 – $300,000). With package B, $200,000 of the gain is recognized immediately as a deemed dividend.

Introduction to Federal Income Taxation in Canada

516 Summary comparison of the two options Package Cash

(a)

(b)

10,000 $

500,000 $

Optimal 300,000

Bond

80,000

Class A pref

810,000

400,000

300,000

PUC of new shares

210,000

ACB of new shares

210,000

ACB of debt

90,000

500,000

300,000

Deemed dividend

Capital gain (loss) Accrued CG on new shares $

200,000 $

600,000

400,000

600,000

600,000 $

600,000

Old Shares PUC $

300,000

ACB

300,000

FMV

900,000

Accrued gain

600,000

Package (a) results in no income since the non-share consideration is less than the PUC of the old shares. However, the consideration package could be improved by taking non-share consideration equal to the PUC of the old shares ($300,000) and the balance in Class A shares ($600,000). Package (b) results in an immediate deemed dividend since the non-shares consideration exceeded the PUC of the old shares. This consideration package could be improved by reducing the non-share consideration to the PUC of the old shares ($300,000). 2.

Identify risks including missing information, assumptions, and uncertain research positions None identified

Reach a conclusion on each issue −

Package (a) does not result in any income at the time of exchange

−

Package (b) results in a dividend of $200,000 since the non-share consideration exceeds the PUC of the old common shares

Evaluate the strengths/weaknesses/risks of your conclusions None identified

Advise/Recommend Advise your client, integrating your conclusions on each of the issues with the client’s objectives, giving priority to the most important issues −

Matt should propose improved package (a) with non-share consideration equal to the PUC of the old shares ($300,000) and the balance in Class A shares ($600,000).

Solutions to Chapter 17 Assignment Problems

517

Solution 9: Amalgamation vs. Wind-up Assess the Situation 1. Draw a diagram identifying all stakeholders, e.g. corporate org charts. Norm Bass (Cdn resident) Related Affiliated

100%

Normpar Ltd.

CCPC - profitable

Dec 31st y/e

Connected Associated

100% Affiliated ACB

Dividends paid

$4,000,000

Jonsub Ltd.

$500,000

CCPC

PUC $1,000 Dec 31st y/e Non-capital losses of $50,000 Net capital losses of $24,000

Identify the relationships among the stakeholders e.g., related, affiliated, associated, connected − Norm, Normpar and Jonsub are related and affiliated − Normpar and Jonsub are connected and associated

Identify the profile of each stakeholder e.g., tax features, risk profile − Norm Bass 1.

Canadian resident individual

− Normpar Ltd 1.

a CCPC

December 31st year end

paid $4,000,000 for Jonsub

received dividends of $500,000 from Jonsub

it is profitable

− Jonsub Ltd 1.

a CCPC

Introduction to Federal Income Taxation in Canada

518

December 31 year end

PUC of $1,000

Net and non-capital losses

Understand the decision maker and their objectives − Norm would like to merge the two companies on June 30, 2023 to allow Normpar access to the net and non-capital losses in Jonsub − What happens to the $4.0 million ACB in the shares of Jonsub? − When can Normpar access the losses of Jonsub?

Identify the relevant past transaction/events or planned future transactions/events and create a timeline 2018

2020

Normpar purchases Jonsub

Jonsub pays dividend

ACB $4,000,000

of $500,000

June 30, 2023 Proposed amalgamation or wind up

Jonsub FMVs Land $1,900,000 Building $400,000 Goodwill $300,000

Identify the Issues 1.

Identify all of the major tax issues and any non-tax issues 1.

Is it better to amalgamate or wind-up?

Jonsub has net and non-capital losses − Timing of access to non and net capital losses

3. 2.

Is there an opportunity to bump the cost of non-depreciable capital property in Jonsub to recover some of the ACB in the shares of Jonsub?

Identify missing information or assumptions made 1.

None identified

Analyze the Major Issues 1.

Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act Windup Will ss. 88(1) apply? Can they wind-up tax free? −

Both are taxable Canadian corporations

−

100% owned sub

−

Ss. 88(1) does apply

Par. 88(1)(d)? Is the bump available? −

Yes, the bump is available. Refer to calculation

When can Normpar access the losses of Jonsub?

Solutions to Chapter 17 Assignment Problems

519

−

Jonsub’s non-capital losses and net capital losses are available to Normpar, but not until the first taxation year of the parent commencing after the wind-up (i.e., the taxation year commencing January 1, 2024 and ending December 31, 2024)

−

The year end of the parent remains the same

Amalgamation Will s. 87 apply? Can they amalgamate tax free? −

Both are taxable Canadian corporations

−

All the property of the predecessors becomes property of the new corporation

−

All the liabilities of the predecessors become liabilities of the new corporation

−

All the shareholders who owned shares of the predecessor corporations (except predecessor corporations) received shares of the new corporation

−

S. 87 applies

ss. 87 (11) Is the bump available? −

Wholly owned subsidiary – Yes, the bump is available

When can Normpar access the losses of Jonsub? −

subsection 87(2.1) provides that for the purposes of determining non-capital and net capital losses of Normpar it shall be deemed to be a continuation of Jonsub

−

Normpar and Jonsub are deemed to have a taxation year-end on June 30, 2023

−

this will count as one of the years available for the carryforward of non-capital losses

the non-capital losses will be available to Normpar in its December 31, 2023 taxation year end (i.e., the first taxation year of the amalgamated company) and subsequent taxation years until expiry under the 20-year limitation

all of the net capital losses will also be deductible on the same basis

The short taxation years for Normar and Jonsub on amalgamation will advance the period for loss carryovers, investment tax credit carryovers, unpaid amounts, capital cost allowance, etc. o

any provision that depends on a taxation year will be affected in an amalgamation

Conclusion – Amalgamation vs. Windup −

Therefore, on the basis of the deductibility of losses, both provisions allow for the same deductions, although the amalgamation will allow faster absorption of losses if the new corporation sets an early fiscal year-end for its first year.

Other factors

−

A winding-up under subsection 88(1) is generally more expensive to implement administratively than an amalgamation under section 87.

−

We are not concerned about when the losses will expire since, with a 20-year carry over for non-capital losses, that is too far in the future.

Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format What are the tax values of the assets of Jonsub after it is wound up or amalgamated into Normpar?

Introduction to Federal Income Taxation in Canada

520

Jonsub Ltd. is deemed to have disposed of its assets for proceeds equal to the cost amount of the assets immediately before the amalgamation or the winding-up and Normpar Ltd. is deemed to have acquired the property at a cost equal to the deemed proceeds of the subsidiary. Cash......................................................................................................................... ..............

80,000

Accounts receivable ($800,000 plus $30,000 reserve = Face amount) ................................

830,000

Inventory at lower of cost or market .....................................................................................

920,000

Land at cost ...........................................................................................................................

1,200,000

Building at UCC ...................................................................................................................

300,000

Equipment at UCC ................................................................................................................

200,000

Goodwill ............................................................................................................................. ..

$0 $ 3,530,000

Can they “Bump” the ACB of non-depreciable capital property?

Normpar Ltd's ACB of Jonsub Ltd's shares Less the cost amount of the subsidiary net assets Cash Accounts receivable ($800,000 plus the $30,000 reserve) Inventory at the lower of cost or market Land at cost Building at the UCC Equipment at the UCC Goodwill Reserve Accounts payable and accrued liabilities Loans payable

4,000,000 80,000 830,000 920,000 1,200,000 300,000 200,000 (30,000) (709,000) (700,000) 2,091,000 500,000

Add: dividends paid by Subco to Parentco ACB not recovered from assets/Maximum bump available Limit of bump on non-depreciable capital property: Fair market value of land at time Normpar Ltd. acquired control ACB of land Limit of the bump on land ACB lost New ACB of the land

1,900,000 1,200,000 700,000

2,591,000 1,409,000

(700,000) 709,000

1,900,000

Because the building and the goodwill are not non-depreciable capital properties, the bump cannot be allocated to these two assets. Whether the two companies are amalgamated or Jonsub Ltd. is wound up into Normpar Ltd., the results should be the same, since the “bump” is also available on vertical amalgamations. Deemed disposition of shares by Normpar Ltd. Proceeds equal to greater of: (a) lesser of: (i) PUC of shares of Jonsub Ltd.

1,000

Solutions to Chapter 17 Assignment Problems

(ii) cost amount of net assets

521 $2,091,000 4,000,000

(b) ACB of shares held by Normpar Ltd.

$4,000,000

ACB

(4,000,000)

Capital gain (loss) Note from this formula that a gain will be rare, since PUC of the Jonsub Ltd. shares would have to be greater than their ACB to Normpar Ltd. A loss is impossible from this formula, because proceeds cannot be less than ACB. 3.

Identify risks including missing information, assumptions and uncertain research positions −

None identified

Reach a conclusion based on your analysis of each major issue. −

Either winding up or amalgamating is effective for both the utilization of losses and the bump

−

The amalgamation will allow for faster access to the loss of Jonsub in Normpar

Evaluate the strengths/weaknesses/risks of your conclusion −

None identified

Advise/Recommend 1.

Advise your client, integrating your conclusions on each of the issues with the client’s objectives, giving priority to the most important issues −

From a tax perspective they should amalgamate in this case due to the earlier access to the losses of Jonsub and the lower transaction costs.

522

Introduction to Federal Income Taxation in Canada

Solution 10: Estate Planning - Sections 85, 86, 84.1 Assess the Situation 1.

Draw a diagram identifying all stakeholders e.g., corporate org charts.

Current

Alison 55 Cdn resident 100% CGE available No CNIL/Never claimed an ABIL 100% CSs QSBC shares FMV$2.7M ACB 400K PUC $100K

Related/affiliated

3 children Sandra -32 Bank Tom – 30 CPA Helen – 28 employee

KML

CCPC

Active business - SBC Expected to increase in value

Solutions to Chapter 17 Assignment Problems

523

Proposed Alison 2,700 Cl A Voting 6% div rate Redeemable/retractable FMV $2.7M

Sandra 100 CS

Tom 100 CS

Helen 100CS

ACB/PUC $100 each

Holdco

KML

Identify the relationships among the stakeholders, e.g., related, affiliated, associated, connected − Alison controls KML so they are related and affiliated

Identify the profile of each stakeholder, e.g., tax features, risk profile − Alison −

Individual resident in Canada

−

Has not used any of her CGE of $971,190

−

Would like to retire in 3 to 5 years and travel

−

Will be financially dependent on KML for her retirement

−

Does not have a cumulative net investment loss

−

Has never claimed an ABIL

− KML −

CCPC

−

Common shares of KML: a.

meet the QSBC share tests

FMV of $2,700,000

PUC of $100,000

− Children −

Adults, presumably resident in Canada

Introduction to Federal Income Taxation in Canada

524

−

Sandra and Tom have careers outside of KML

−

Helen is building her career inside KML and showing good leadership

Understand the decision maker and their objectives −

Alison is the key decision maker

−

Alison’s objectives A. Freeze the value of her common shares of KML B.

Her children benefit from the current value of KML

Helen is to benefit from any future growth in value of KML

D. She can get her retirement income from KML E.

She can use her capital gains exemption

Alison maintains voting control while she has a significant investment in KML

G. Future sibling conflict minimized H. She does not want her children involved in her financial affairs while she is alive I.

Tax efficient

Identify the relevant past transaction/events or planned future transactions/events and create a timeline − The freeze would be at a future date that is unspecified − Proposed Holdco Freeze −

Children incorporate Holdco using their own money

−

Each child to own 100 common shares paid for with their own money

−

Alison sells her common shares of KML to Holdco in exchange for redeemable and retractable preference shares of KML

Identify the Issues 1.

Identify all of the major tax issues and any non-tax issues Perform a Technical Assessment of the Proposed Plan 1.

Confirm that s.85 can be used

Confirm that the capital gains exemption can be claimed on the sale [s.110.6(2.1)]

Confirm that the elected amount is optimal

Confirm that s.84.1 does not result in any tax payable

Confirm that the consideration received for the sale of her shares to KHL is optimal

Confirm the calculations of the ACB and PUC of the shares she received

Consider TOSI implications

Determine whether Alison’s objectives are met under the proposed plan 2.

Identify missing information or assumptions made 1.

none

Solutions to Chapter 17 Assignment Problems

525

Analyze the Major Issues 1.

Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act Technical Assessment 1. Confirm that s. 85 can be used −

A taxpayer (Alison) has disposed of eligible property (KML common) to a taxable Canadian corporation (Holdco)

−

Consideration includes shares.

−

Joint election to be filed.

−

The conditions are met

2. Confirm that the capital gains exemption can be claimed on the sale [s. 110.6(2.1)] −

Alison is an individual

−

The KML shares meet the three tests for QSBC shares

−

Alison has not used any of her CGE

−

Alison does not have a CNIL balance and she has not claimed an ABIL in the past (given)

−

Alison can claim the capital gains exemption

3. Confirm that the elected amount is optimal −

The elected amount reflects the CGE value i.e., $400,000 + $971,190 = $1,371,190

4. Confirm that s. 84.1 does not result in any tax payable −

New paragraph 84.1(2)(e) will apply to deem Holdco and KML to be arm’s length if; ▪

The shares are qualified small business corporation shares

▪

As long as the purchaser corporation (Holdco) is controlled by one or more children who are 18 years or older and

▪

The purchaser corporation does not dispose of the subject shares within 60 months of purchase

In this case, Alison retains control of Holdco with her Class A shares. As a result, the transfer is a non arm’s length transfer and s. 84.1 applies.

The March 28, 2023 Federal Budget amends par. 84.1(1)(e) and allows the exception to 84.1 to apply if the disposition of the shares meets the conditions of either ss 84.1(2.31) (an Immediate intergenerational business transfer) or ss 84.1 (2.32) (A Gradual intergenerational business transfer). Both exceptions require the taxpayer Alison to dispose of QSBC shares of the subject corporation to a purchaser corporation that is controlled by one or more children of the taxpayer and each of whom is 18 years or older. This condition is met as Holdco will be controlled by the 3 adult children at the time of the share disposition. However, after the disposition the taxpayer cannot legally control (de jure) the subject corporation or the purchaser corporation. The amendments apply to dispositions of shares that occur on or after January 1, 2024. As Alison will control both corporations through her Class A voting shares following the disposition it would not be possible for her to meet either exception under the amended provisions.

Introduction to Federal Income Taxation in Canada

526 −

The maximum non-share consideration she can receive is $400,000. She did not receive any nonshare consideration so s. 84.1 will not result in a deemed dividend. The non-share consideration does not exceed the greater of modified ACB ($400,000) and PUC ($100,000)

−

S. 84.1 will reduce the PUC to $400,000 on the preference shares she receives

5. Confirm that the consideration received for the sale of her shares to KHL is optimal −

Alison could have received $400,000 of non-share consideration on the sale of her KML common shares to Holdco

−

It is preferable to have non-share consideration instead of PUC since the note is easier for her to access

6. Confirm the calculations of the ACB and PUC of the shares she received −

Given the proposed consideration, the calculations of the ACB and PUC are accurate

7. Consider TOSI Implications TOSI applies the highest marginal rate of tax to split income. Split income includes taxable dividends from shares of a private corporation unless the amount meets the definition of an excluded amount. An excluded amount includes an amount that is not derived from a related business. A related business is defined to include a business carried on by a source individual in respect of the specified individual. A source individual is a Canadian resident who is related to the specified individual. Sandra, Tom and Alison would be considered to receive future dividends from the Holdco that would be derived from a related business carried on by Helen. Dividends received by Helen and Alison would be excluded amounts because they would be considered to be derived from an excluded business. Helen is actively engaged in the KML business. Alison was actively engaged in the KML business in any 5 prior taxation years. However, TOSI would apply to future dividends received by Sandra and Tom. The shares are not excluded shares in the year of a dividend payment because all or substantially all of the income of the Holdco will be derived from a related business. The dividends would not be considered a reasonable return on Sandra and Tom’s $100 investment in the Holdco. As a result, TOSI will apply to any future dividends paid to Sandra and Tom

Are the objectives met?

Confirm whether her objectives are met A. Freeze the value of her common shares of KML a. B.

This objective is met

Her children benefit from the current value of KML a.

Her children benefit from the value of KML through the preference shares that Alison owns

As long as Alison’s will leaves the Class A shares to the three children

While this objective is met it causes other problems identified in F and G below

Helen is to benefit from any future growth in value of KML a.

All three children benefit from any increase in value of KML, not just Helen

This objective is not met

Solutions to Chapter 17 Assignment Problems

527

D. She can get her retirement income from KML

Yes, she can

She can withdraw the PUC of $400,000 in her preference shares in Holdco. This will reduce both the PUC and the ACB of her shares

But in order to get a dividend from Holdco she will need to pay the full 6% dividend which would amount to $162,000. This may be more than she wants but she is forced to take all or nothing

This objective is met but it could be more efficient

She can use her capital gains exemption a.

Yes, she can

This objective is met

Alison maintains voting control while she has a significant investment in KML a.

Given she has 2,700 Class A shares compared to 300 common shares, she retains control

G. Future sibling conflict minimized a.

When Alison is gone, assuming the Class A voting shares are left equally among the three children, Sandra and Tom will hold voting control and Helen can be outvoted

This is likely to cause future conflict over access to or use of cash in KML

This objective is not met

H. Alison does not want her children involved in her financial affairs while she is alive

While Alison is alive she will be receiving her retirement income from Holdco

Since all three children are the common shareholders of Holdco they are entitled to financial statements which will show them how much money Alison is taking as a PUC reduction, dividends or redemption

This objective is not met

Tax efficient a.

No negative tax consequences identified

She did not take the maximum boot on the transfer of KML shares to Holdco

The only open question is whether minimum tax will apply. This depends on her other income in the year the capital gain is realized

Reach a conclusion on each issue. −

S. 85(1) can be used.

−

Alison’s shares of KML qualify as QSBC shares.

−

S. 84.1 applies but does not result in a deemed dividend. 84.1(2)(e) does not apply because the children do not control Holdco (purchaser corporation). Under the amended exception provisions to S. 84.1, 84.1(2)(e) will not apply because Alison will control both the subject and purchaser corporations following the share disposition through her Class A shares.

−

The elected amount is correct at $1,371,190.

Introduction to Federal Income Taxation in Canada

528

−

The non-share consideration should be $400,000 and the preferred shares should be $2,300,000.

−

Alison does freeze the value of her shares in KML.

−

She wanted Helen to benefit from the growth in value of KML but all three children benefit. This does not meet her objective.

−

She can receive dividend income from KML but it could be more flexible if the dividend rate was “up to” 6%.

−

Alison can use her CGE.

−

Alison does maintain control.

−

Given the proposed share ownership it is likely that there will be conflict among the children after Alison dies.

−

Given that her children own shares in Holdco they will be involved in her financial affairs. This does not meet her objectives.

Evaluate the strengths/weaknesses/risks of your conclusions −

None identified

Advise/Recommend Advise your client, integrating your conclusions on each of the issues with the client’s objectives, giving priority to the most important issues −

Refer to problem 11

Solutions to Chapter 17 Assignment Problems

529

Solution 11: Estate Planning - Extension of Problem 10 Is the following a better way for her to accomplish her objectives? Proposed

Alison

Original

Alison

Note $400,000 Common $2,300,000

ACB $400,000

Holdco

C lass A $2,600,000

Helen

Common

Note $100,000

KML

PUC $100,000 FMV $2,700,000

KML

Assess the Situation See Problem 10

Analyze the Major Issues Are Alison’s objectives met? A. She wants to freeze the current value of her common shares of KML B.

She wants all of her children to benefit from the value of KML today

She wants future growth to accrue to Helen

D. She wants to be able to receive retirement income from KML E.

She wants to use her capital gains exemption

She wants Helen to have operating control in the long term but she wants control while she has a significant investment in KML

G. She wants to minimize possible future sibling conflict H. She does not want her children involved in her financial affairs while she is alive I.

She wants the plan to be tax efficient

Assess whether this structure can achieve her objectives A. Freeze the value of her common shares of KML − The Class A shares are freeze shares and will not increase in value − This objective is met

Her children benefit from the value of KML − Yes. In the estate her children can share equally in the value that accrued up to the time of the freeze. This is reflected in the note and common shares of Holdco owned by Alison

Introduction to Federal Income Taxation in Canada

530

− Need to provide a way for these shares to be redeemed so the estate will not have conflict with Helen in KML

−

Life insurance

−

Redeem over time

− This objective is met

Helen is to benefit from the future growth in KML − Through her common shares of KML Helen will benefit from all future growth in value − This objective is met

D. She can get her retirement income from KML − Yes, Alison controls Holdco − She can get her retirement income −

Tax free intercorporate dividends can be paid from KML to Holdco

−

6% x $2,600,000 = $156,000 a.

Then paid out to Alison tax free as a repayment of the note

Then paid out to Alison as a dividend on the common shares

− KML can pay the $100,000 note to Holdco and it can then pay this to Alison as a reduction of the $400,000 note or as a dividend − KML can redeem the Class A shares owned by Holdco over time −

This will result in a deemed dividend that is received by Holdco tax free a.

Proceeds of $2,600,000

ACB of $1,271,190 (EA of $1,371,190 – note $100,000)

PUC of $0

Redemption proceeds from the Class A shares can accumulate in Holdco for Alison’s retirement capital

Redemptions will result in capital losses that will be subject to a stop loss rule and added to the ACB of the remaining shares (KML is affiliated with Holdco)

− This objective is met E.

She can use her capital gains exemption − She can use her CGE on the transfer of the KML shares to Holdco − This objective is met

Helen has operating control and Alison maintains voting control while she has a significant investment in KML Helen has operating control − Helen has operating control as long as the Board of Directors support her − The Board is elected by the voting shareholders − Yes, Helen owns the only voting shares of KML and has legal control

Solutions to Chapter 17 Assignment Problems

531

Alison has defacto control while she has a significant investment through her Class A non-voting shares − Helen has legal control over Holdco through her common shares − Holdco has de facto control over KML through the 2,600 Class A shares −

De facto control is achieved through the retraction feature of the Class A shares owned by Holdco

−

The plan would be to redeem the Class A shares over time

− This objective is met

G. Future sibling conflict minimized − On Alison’s death all three children share equally in the value of Holdco. If the Class A shares of KML have been redeemed then the only thing in Holdco will be cash or investments − KML needs to develop a plan to redeem the Class A shares before or on Alison’s death − This objective is met H. Alison does not want her children involved in her financial affairs while she is alive − Alison is the only shareholder of Holdco so her financial affairs will be confidential − This objective is met I.

Tax efficient − Yes − No current tax − Minimum tax still unknown in the year the CGE is claimed − Capital gains exemption used

Propose the technical steps needed to move from the current ownership structure to this one 1.

Alison would transfer her common shares of KML to a holding company A. She would transfer her common shares of KML to Holdco in exchange for a note for $400,000 and common shares of Holdco worth $2,300,000 − She would elect under s. 85 at $1,371,190 to use up her capital gains exemption ($400,000 ACB + CGE of $971,190) − The common shares of Holdco received would have an ACB of $971,190 (EA – Boot) and a PUC of $0 [s. 84.1] Note that if Helen were to control the Holdco, s. 84.1 would not apply because the company would be deemed arm’s length to Alison and par. 84.1(2)(e) would apply. This would allow boot of up to $1,371,190 to be removed from the companies instead of only $400,000 without a deemed dividend arising and without impacting Alison’s ability to use her capital gains exemption. The March 28, 2023 Federal Budget amends par. 84.1(1)(e) and allows the exception to 84.1 to apply if the disposition of the shares meets the conditions of either ss 84.1(2.31) (an Immediate intergenerational business transfer) or ss 84.1 (2.32) (A Gradual intergenerational business transfer). Both exceptions require the taxpayer Alison to dispose of QSBC shares of the subject corporation to a purchaser corporation that is controlled by one or more children of the taxpayer and each of whom is 18 years or older. This condition will not be met as Holdco will be controlled Alison at the time of the share disposition. The amendments apply to dispositions of shares that occur on or after January 1, 2024. It would be necessary to change the proposed structure to

Introduction to Federal Income Taxation in Canada

532

ensure the conditions of one of the two exceptions in the amended legislation if the share disposition is happening in 2024 or later. − The common shares of KML, owned by Holdco, would have an ACB equal to the elected amount of $1,371,190

KML would then have a reorganization of capital (s. 86) −

It is after May 6, 1974

−

KML is reorganizing its capital (replacing common shares with new preference shares)

−

A taxpayer (Holdco) has disposed of capital property (KML common shares) that is all of its common shares of KML that it owns and it receives consideration from KML that includes other shares

−

The conditions are met

A. KML would file articles of amendment to create Class A shares with the following characteristics: − Non-voting − Redeemable and retractable at $1,000 each − Non-cumulative dividend of up to 6% annually

Using s. 86 all of the common shares of KML owned by Holdco will be exchanged for 2,600 Class A preference shares [s. 86(1) conditions met] and a note for $100,000 − The Class A shares will have a PUC equal to the PUC of the common shares less the boot ($100,000-$100,000 = 0) − The Class A shares will have an ACB equal to the ACB of the exchanged common shares of $1,371,190 (elected amount under s. 85) less boot of $100,000 or $1,271,190

Solutions to Chapter 17 Assignment Problems

533

Section 86 Reorganization Issuance of New Shares PUC Shares LSC before reduction S86(2.1) (a) PUC reduction (A) Increase in LSC of all shares (B) PUC old Less: Boot PUC reduction PUC after reduction

2,600,000 2,600,000 100,000 100,000

2,600,000 -

ACB Shares ACB Old Shares Less: Boot ACB New Shares

1,371,190 100,000 1,271,190

Redemption of Old Shares

PUC New Shares Boot Redemption Proceeds PUC Old Shares Deemed Dividend

0 100,000 100,000 100,000 -

ACB New Shares Boot Proceeds of Disposition ACB Old Shares Capital Gain/Loss

1,271,190 100,000 1,371,190 1,371,190 -

Helen would subscribe for 100 common shares of KML for $100. Since all of the fair market value of KML is reflected in the Class A shares the common shares can be purchased from the company for a nominal amount

Alison and Helen would establish a plan to redeem, or fund the redemption of, the Class A shares over time to ensure that, on Alison’s death, KML is not called on to redeem the shares without a plan

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Introduction to Federal Income Taxation in Canada

Conclusion This plan achieves Alison’s objectives A. Since she is the one generating the increase in value, Helen owns the common shares of KML. This eliminates the control issues among the siblings after Alison dies. B. Holdco can then redeem the $2,600,000 of Class A shares of KML over time and have this capital in KHL as Alison’s retirement and estate capital. C. KML can pay a dividend of up to $156,000 ($2,600,000 x 6%) each year to Holdco. This can be accumulated in Holdco or can be paid to Alison. She does not have to take the full amount. D. Helen has operational and legal control of KML. E. Alison has de facto control through her control of Holdco and its ownership of the retractable Class A shares. F. Her children are not involved in her financial affairs while she is alive. G. No estate distribution issues. As noted above, the above reorganization will not take advantage of paragraph 84.1(2)(e) which has application to intergenerational transfers of QSBC shares and family farm corporations. The paragraph will not apply to deem the transfer of the shares to the Holdco to be an arm’s length transfer because Helen will not control the Holdco (the purchaser corporation). As the legislation currently reads, if Helen were to be issued common shares on the incorporation of Holdco (the purchaser corporation) before the time when the common shares of KML were transferred to Holdco, Alison would be deemed to be arm’s length with Holdco and s. 84.1 would not apply. It would be necessary to ensure that Holdco does not dispose of the KML shares within 60 months of purchase. Because s. 84.1 would not apply, Alison could receive a note up to the elected amount on the transfer of $1,371,190 and non-voting Class A preferred shares with a redemption value of $1,228,810, PUC and ACB of $0. Helen would still have operational control of KML through her common shares in Holdco. It is not clear under the current legislation whether the Class A shares received by Alison on the transfer to Holdco could be voting shares as it is not clear whether Helen is required to retain control of the purchaser corporation. Because the shares of KML cannot be disposed of within 60 months, the capital reorganization of KML should not proceed. Also, it would not be possible to have the KML common shares repurchased within 60 months of the transaction. Dividends could be paid to Holdco and then distributed to Alison or retained in Holdco. Helen would be able to review the financial statements of Holdco and would have some knowledge of Alison’s financial affairs while living. Estate distribution issues would be minimal. All 3 children could receive the Class A shares of Holdco on Alison’s death under the terms of her will and therefore, share in the current FMV of the KML shares. Although, some of Alison’s objectives will not be met, this strategy allows Alison to remove an additional $971,190 of funds tax free at the time of the estate freeze without a deemed dividend or reduction in the capital gains exemption resulting.

If the disposition occurs in 2024 or later it will be necessary for the disposition to meet the conditions of either an Immediate intergenerational business transfer or a Gradual intergenerational business transfer to allow Alison to take back non-share consideration of $1,371,190 as noted above. • • • •

Helen will need to control Holdco when the shares of KML are disposed of to the company. After the disposition, Alison cannot own 50% or more of any equity other than non-voting preferred shares in either Holdco or KML. By the end of 36 months of the disposition, Alison can own only non-voting preferred shares in Holdco or KML A joint election must be filed in the year of the disposition of the shares.

To be an immediate intergenerational business transfer the following will also be required; • •

After the disposition, Alison cannot have either defacto or legal control of either of Holdco or KML. Helen must have control of Holdco and KML and be actively engaged on a regular, continuous and substantial

Solutions to Chapter 17 Assignment Problems

•

535

basis in a relevant business of KML for the 36 months after the disposition. [It would be possible for the 3 children to control Holdco and Helen to control KML] Helen must be transferred management of each relevant business of KML and Alison must cease management activities within 36 months of the disposition.

To be a gradual intergenerational business transfer the following will also be required; • • •

•

After the disposition, Alison cannot have legal control of either Holdco or KML. Within 10 years of disposition, Alison’s debt and equity interest in both Holdco and KML must be 30% or less of the fair market value of interests in the company immediately before the disposition eg. 30% of $2.6M or $780,000. Helen must have control of Holdco and KML and be actively engaged on a regular, continuous and substantial basis in a relevant business of KML for 60 months after the disposition. [It would be possible for the 3 children to control Holdco and Helen to control KML] Helen must be transferred management of each relevant business of KML and Alison must cease management activities within 60 months of the disposition (or a greater period that is reasonable in the circumstances).

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Introduction to Federal Income Taxation in Canada

Solution 12: Sale of Shares By Corporation Both Plan A and Plan B would result in an application of subsection 55(2) by the CRA, converting what would have been a tax-free intercorporate dividend or a deemed dividend into capital gains. Under Plan B, only part of the dividend would be a deemed dividend under subsection 84(3) on the redemption of the Corporate Raider Inc. shares. Subsection 55(2) applies in both of these scenarios because: (a) Holden Limited received a dividend that was deductible under section 112; (b) One of the purposes of the dividend in Plan A and one of the results of the dividend in Plan B was to effect a significant reduction in the capital gain that would have been realized on a disposition of the shares of Profits Galore; (c) The dividend exceeds the amount of safe income in Profits Galore Ltd.; and (d) In the case of Plan B, the deemed dividend under subsection 84(3) is part of a series of transactions where there is a disposition of property to an unrelated person.

The results of these two proposed transactions would be: Plan A Of the $1,900,000 dividend received by Holden Limited from Profits Galore Ltd., $900,000 can be attributed to post-1971 earnings. The portion of the dividend in excess of safe income is automatically deemed to be a separate dividend of $900,000. Therefore, only $1,000,000 is deemed a capital gain of Holden Limited for the purpose of paragraph 55(2)(b). These results are equivalent to Holden Limited receiving a dividend from Profits Galore of $900,000 (equal to the sheltered post-1971 earnings) and then selling the shares to Corporate Raider Inc. for their then fair market value of $1,500,000, giving rise to a capital gain of $1,000,000 (i.e., $1,500,000 – $500,000). Plan B Under this alternative, the Profits Galore shares are to be transferred to Corporate Raider using section 85 electing a transfer price of $500,000 equal to the adjusted cost base of the transferred shares. Therefore, the adjusted cost base of the shares accepted as consideration (i.e., the special shares of Corporate Raider) will also be $500,000. When Holden Limited retracts the shares it holds in Corporate Raider Inc. there will be a deemed dividend [ss. 84(3)] calculated as: etra

Redemption/retraction price ......................................................................................................... $2,400,000 Less: Paid-up capital .................................................................................................................. 500,000 Deemed dividend [ssec. 84(3)] ..................................................................................................... $1,900,000 Less: Amount deemed not to be a dividend par. 55(2)(a) Remaining deemed dividend under ss. 84(3) .......................................................................

1,000,000 $ 900,000

Capital gain on the disposition of the shares: Proceeds of disposition (redemption price)................................................................................... $2,400,000 Less: Remaining ss. 84(3) deemed dividend as determined above(2) ................................. 900,000 Deemed proceeds of disposition par. 55(2)(b)................................................................... $1,500,000 Less: Adjusted cost 500,000 Capital gain ……........................................................................................ $1,000,000

—NOTES TO SOLUTION (1) The definition of proceeds of disposition in section 54 would exclude the subsection 84(3) deemed dividend on the redemption of shares.

CHAPTER 19

Partnerships, Trusts and Death of a Taxpayer Solution 1: Partnership Income, ACB

Assess the Situation: 1.

Draw a diagram identifying all stakeholders, e.g., corporate org charts

Mr. Clancy 25%

3 Partners 75%

Ludlum, Clancy Follet & Associates

Identify the relationships among the stakeholders, e.g., related, affiliated, associated, connected

Not related to other partners 3.

Identify the profile of each stakeholder, e.g., tax features, risk profile

Mr. Clancy – 31 years old, Cdn resident, no other source of income, not married, no children LCF&A – appears to be a general partnership but may be a limited liability partnership since it is a law firm – we should confirm. 4.

Understand the client/decision maker and their objectives

Client: Mr. Clancy Prepare his 2023 tax return and determine his 2023 tax liability. Identify personal deductions and credits available to minimize tax. Determine if he is required to contribute to CPP. Understand the tax treatment of a sale of his partnership interest and what to report on the 2024 return if the interest is sold. 5.

Identify the relevant past transaction/events or planned future transactions/events and create a timeline

Future – potential future sale of partnership interest Identify the Issues: •

What is the tax treatment of partnership income in the partnership and to the partners? 563

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Introduction to Federal Income Taxation in Canada

• • • •

What are the potential deductions/credits for a partner? What is Mr. Clancy’s tax payable for 2023? Is Mr. Clancy required to make CPP contributions? What is the tax treatment of a future potential sale of his partnership interest?

Analyze the Issues: (1)

Tax treatment of partnership income in partnership/to partners?

• • • • •

Partnership is not subject to tax. Division B income calculated for partnership and allocated to the partners. 25% is allocated to Mr. Clancy. Income retains character when allocated to Mr. Clancy, i.e., GU/DTC. Calculate Division B income for partnership and allocation to Mr. Clancy (quantitative).

Conclude:

The partnership is not subject to tax – the income will be allocated out to the partners who will report their proportion of the income on their own respective tax returns. Mr. Clancy’s allocation for 2023 is $124,873 of business income, $4,500 of eligible dividends, and $6,250 of charitable donations. (2) Potential personal deductions/credits for a partner.

• •

Donations allocated and personal credits on Mr. Clancy’s personal return. Other personal deductions available: o Business use of vehicle expenses. Need to collect this information from the client. o Home office if either it was the principal place of business or the space is used exclusively to earn income and used on a regular and ongoing basis to meet clients/customers. o Need to collect this information from the client. Conclude:

Mr. Clancy will be entitled to claim the charitable donation tax credit for the partnership’s donations allocated to him. Other deductions may be available and we should inquire to see if Mr. Clancy uses his vehicle to earn his partnership income or if he has a home office. (3) Requirements to make CPP contributions.

Mr. Clancy is not an employee of the partnership so there is no deductions at source. He would report his self-employment income and pay the employer and employee portion of CPP contributions. Mr. Clancy would need to contribute a total of $7,508 ($3,754 + $3,754) (the employee and employer portions of CPP) which would be added to his taxes payable.

He can claim a deduction for the employer portion of CPP of $3,754 plus the enhanced contribution to CPP of $631 and claim the non-refundable credit for the employee portion of the base CPP of $3,123 when he files his personal tax return resulting in a credit of $781 ($3,123x25%). Since he is not an employee he will neither pay nor receive benefits from EI.

565

Solutions to Chapter 19 Assignment Problems Conclude:

Mr. Clancy is required to make CPP contributions and this will impact his tax payable for 2023. Quantitative: Calculate Mr. Clancy’s Division B income, Taxable income, Taxes payable. (See below) (4) Tax treatment of future potential sale of a partnership interest.

• • • • •

There will be a disposition of capital property which will result in a capital gain or loss, for $300,000 less the adjusted cost base in 2024. Cumulative balance of ACB needs to be tracked. Adjusted for contributions/withdrawals. Adjusted for items subject to tax by partner or items that are not taxable. Calculate Mr. Clancy’s ACB of his partnership interest (quantitative) (see below).

Conclude:

The ACB of Mr. Clancy’s partnership interest at January 1, 2024 is $81,415 (see below). If Mr. Clancy wants to sell his partnership interest in the future, there will be a capital gain or capital loss on disposition. The ACB of his partnership interest should be tracked to appropriately calculate the capital gain/loss on the disposition of his partnership interest. Identify missing information or assumptions made

•

home office/vehicle expenses

Quantitative analysis using an appropriate analysis format

Mr. Clancy will owe $32,378 of personal tax in 2023 for the income allocated from the partnership. This will leave him with $65,122 of after-tax cash based on his 2023 drawings.

(A) Calculate Partnership Income (similar to Schedule 1) Net income per financial statements .................................................................................. Add:

(1)

Client entertainment (50%)

..............................................................................

$489,953 2,538

Donations to charities..........................................................

25,000

Income to be allocated (Division B Income Partnership)...................

$517,491

Mr. Clancy’s share (1/4) ......................................................................

$ 129,373

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Introduction to Federal Income Taxation in Canada

Nature of the income: Mr. Clancy (1/4) Dividends $18,000 x 25%...........................................................

$ 4,500

Business income $499,491 x 25% ..............................................

124,873

Allocation to partner ($517,491 x 25%) ...................................................

$129,373

Share of other items: Donations(2)$25,000 x 25%

6,250

All of these items affect the ACB of his partnership interest. Mr. C. (B) Clancy’s Division B income, Taxable income, Personal tax Dividends.................................................................................... Business income .........................................................................

4,500 124,873

$ 129,373 Gross-up in respect of Clancy’s share of dividend (.38. $4,500).......................

1,710

Division B and taxable income ..........................................................................................

$ 131,083

Add:

567

Solutions to Chapter 19 Assignment Problems

Ignored CPP for purposes of the calculation. (C) Clancy’s ACB of Partnership Interest

Adjusted Cost Base January 1, 2023 Additions; Share of 2023 Income Deductions; Drawings Share of Charitable Donations ACB January 1, 2024

55,792 129,373 (97,500) (6,250) 81,415

After-tax Personal Cash Mr. Clancy's draw from the partnership Personal tax payable After-tax personal cash

97,500 (32,378) 65,122

Capital Gain on Sale Proceeds of Disposition ACB Capital Gain Taxable Capital Gain

300,000 (81,415) 218,585 109,293

—NOTES TO SOLUTION (1) The deduction in respect of business meals and entertainment is restricted by section 67.1 to 50% of the lesser of (i) the amount actually paid; and (ii) the amount that would be reasonable in the circumstances. /4  $25,000

$ 6,250

(b) 75%  $131,083 =

$98,312

(2) Lesser of (a)

(25%  $200) + 46%  ($6,250 – $200)

$2,833

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Introduction to Federal Income Taxation in Canada

Advise/Recommend: • Mr. Clancy will owe $32,378 of taxes for 2023, ignoring the consequences of CPP. • Mr. Clancy will also need to remit CPP of $7,508 on his partnership income. • This tax could be reduced if he has other deductions for vehicle usage or home office expenses – we should inquire to see if these apply. • If Mr. Clancy intends to sell his partnership interest in 2024 for $300,000, there will be a capital gain on the disposition of $218,585 and taxable capital gain of $109,293 to be included in his Division B income on his personal tax return. • We should keep track of the ACB of his partnership interest by calculating this annually.

569

Solutions to Chapter 19 Assignment Problems

Solution 2: Incorporation of partnership interest Assess the Situation: 1.

Draw a diagram identifying all stakeholders and their relationships, e.g., corporate org charts

Current Structure Unincorporated

Proposed Structure Incorporated

Mr. C.

Mr. C 100%

25%

Related, affiliated Clancy Inc.

LCFA

Drawings $97,500 Less: Personal tax $32,378 After- tax cash $65,122 2.

25% LCFA

Identify the relationships among the stakeholders, e.g., related, affiliated, associated, connected − Mr. Clancy owns 25% of the partnership − Partnerships are not part of the related party rules [ssec. 251(2)] − He is not a majority interest partner so he is not affiliated [sec. 251.1]

CCPC

Identify the profile of each stakeholder, e.g., tax features, risk profile −

−

Mr. Clancy o

age 31

owns 25% of the partnership

no income other than from partnership ▪

$124,873 of business income

▪

$4,500 of eligible dividends

▪

$6,250 of donations available to be claimed

Single, no children

No information on other partners

Draws $97,500 from the partnership

Pays personal tax of $32,378

Partnership o

Earns active business income of $489,953 and eligible dividends of $18,000

December 31st year end

Four partners share income equally

570 4.

Introduction to Federal Income Taxation in Canada

Understand the client/decision maker and their objectives −

Mr. Clancy is the decision maker

−

He wants to determine: o

How the partnership income would be taxed if his partnership interest was owned by a corporation that he personally owned.

Whether he should incorporate his partnership income i.e., have a corporation he owns earn, and pay tax on, the partnership income.

Continue to receive $97,500 of salary to pay his personal expenses.

Identify the relevant past transaction/events or planned future transactions/events and create a timeline −

No past events

−

Planning to incorporate a company to hold his partnership interest and earn the income from the partnership

−

Partnership F/S for December 31, 2023

−

Incorporation to take place in the future

Identify the Issues: 1. −

− −

Identify all of the major tax issues and any non-tax issues

Tax treatment of income of the partnership if partnership interest is held in a corporation. (Qualitative) o Business income o Eligible dividends o Donations Tax treatment of salary paid by the corporation to Mr. Clancy. (Qualitative) Benefits/disadvantages of incorporation of the partnership interest (Qualitative) o Tax deferral benefit? (Quantitative – compare after-tax cash available unincorporated to after-tax cash available if incorporated after $97,500 salary payment) o Tax cost/savings of incorporation? o Non-tax considerations? Identify missing information or assumptions made −

None identified

Analyze the Issues: The purpose of this question is to let the students see how partnership income flows through to a corporation and is taxed. 1.

Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act.

Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format.

How will the partnership income be taxed in his corporation? −

Identify the types of income earned in the partnership.

Solutions to Chapter 19 Assignment Problems

571

Qualitative analysis −

Partnership income will be allocated to and taxed in the corporation.

−

ABI of $124,873 will be allocated to the corporation.

−

Dividends from public companies of $4,500 will be allocated to the corporation. $6,250 of donations will be allocated to the corporation and available for a Division C deduction.

Explain how these types of income would be taxed in a corporation −

ABI: o

−

Would be taxed at a combined federal/provincial rate of 13% (38-10-19+4)

In this case all of Mr. Clancy’s share of business income from the partnership would be eligible for the small business deduction. Conceptually, the small business deduction is calculated as 19% of the least of: a) the total of active business income of the corporation itself plus specified partnership income. b) taxable income of the corporation less the usual adjustments. c) the corporation’s business limit of $500,000.

Specified partnership income in this case is equal to the lesser of; − a) The corporation’s share of active business income of the partnership. − b) The partner’s proportion of the business limit i.e., Partner income/Total partnership income x $500,000. −

There is no general rate reduction since all of the allocated taxable income is eligible for the small business deduction.

−

The provincial tax is all at the low rate. −

Dividends from public companies: o

Would be subject to Part IV tax (38.33%).

This amount would also be added to ERDTOH to be refunded at the rate of 38.33% of dividends paid.

Should he incorporate his partnership interest? −

Qualitative analysis − Using what you already know: 1.

Can he get a tax deferral using a corporation? − Yes, by leaving money in the corporation. − His effective tax rate is 24.7% ($32,378/$131,083) vs 13% in the corporation.

− Can he afford to leave money in the corporation? 1.

Currently he has $65,122 in after-tax personal cash from his drawings.

Therefore, he can afford to leave some money in the corporation.

Will there be a savings or cost if he pays everything out? − No, integration should leave him even.

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Introduction to Federal Income Taxation in Canada

−

Non-tax Considerations − Costs to incorporate/annual filings. − Payroll costs/withholdings/T4 reporting. − Reduced RRSP contribution room with a $97,500 salary instead of $124,873 of business income.

Salary vs Dividend Mix a.

−

Dividends i.

No payroll costs.

ii.

No RRSP room.

iii.

Non-eligible dividends marginal tax rate of 22.4%1. No tax savings result.

iv.

Eligible dividends marginal tax rate of 6.8%2 and result in a dividend refund of 38.33% of dividend paid out. Therefore, tax savings result.

Quantitative analysis using an appropriate analysis format − Comparison of earning income in partnership vs. incorporating and paying salary of $97,500. − Currently he has $65,122 to live on ($97,500 draw less tax of $32,378) with the business in a partnership and Mr. Clancy owning the partnership interest personally. −

1 2

1.15x32.5%-.15 1.38x32.5%-.38

Calculate the after-tax cash if incorporates and pays his drawings ($97,500) out as a salary. He will have after-tax cash of $69,435 available and the corporation will provide a tax deferral benefit of $4,313.

Solutions to Chapter 19 Assignment Problems

573

The partnership only paid $97,500 of drawings to the corporation so that is all that is available for salary. If he had the corporation pay a dividend of $4,500 it would generate a dividend refund of eligible RDTOH of $1,725 (at 38.33%) and be taxed as an eligible dividend to Mr. Clancy at 6.8% in his tax bracket (1.38 x 32.5% - 0.38). The benefit of incorporation comes from leaving the money in the corporation to take advantage of the low corporate rates (SBD) and the tax deferral.

Corporate Tax on Partnership Income If all the income is kept in the corporation the maximum tax deferral benefit to incorporation available to Mr. Clancy is $15,232 as follows:

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Introduction to Federal Income Taxation in Canada

No Salary Corporate Tax Division B Income ABI Salary Dividend Division B Income Division C Deductions Dividend Donations Taxable Income

124,873 0 4,500 129,373 (4,500) (6,250) 118,623

Part 1 Tax (13%) Part IV Tax (Eligible RDTOH) Total Tax

15,421 1,725 17,146

Partnership Option (Tax Paid)

32,378

Tax Deferral through Incorporation

15,232

Advise/Recommend: 1.

Advise the decision maker, integrating your conclusions on each of the issues with their objectives, giving priority to the most important issues −

He should incorporate and leave as much in the corporation as possible. He could take out less than $97,500 to provide him with the $65,122 he had available to him with an unincorporated interest in a partnership because of the tax deferral advantage of incorporation.

−

However, he should pay an eligible dividend of $4,500 to generate a dividend refund (38.33%) of eligible RDTOH in the corporation and pay very little personal tax (6.8%). Therefore it would be better to pay a salary of $93,000 and a dividend of $4,500 if he would like to receive a total of $97,500.

−

Paying salary from the corporation would allow him to make RRSP and CPP contributions.

Advice on how to incorporate (not asked for) −

Sell his partnership interest to a new corporation in exchange for shares and/or debt

−

Elect under s. 85(1)

Solution 3: Partnership Income, ACB, Disposition (A) Compute Bob’s income for tax purposes for 2023 as a result of his participation in the partnership Net income per financial statements

$652,500

Less: Capital gain on land

$135,000

Capital dividends

14,400

Add: Charitable donations

$247,500

149,400 $503,100

Taxable capital gain on land (1/2 × $135,000)

67,500

315,000

Income to be allocated

$818,100

Bob’s share (1/3 × $818,100)

$272,700

575

Solutions to Chapter 19 Assignment Problems

(B)

Bob’s taxable income for 2023: Division B income Less: Net capital loss carryover (limited to the taxable capital gain of 22,500) Taxable income

$274,500 22,500 $252,000

*Net capital loss carryforward is $127,500 ($150,000-$22,500). (C) Bob’s capital gain on the disposition of the partnership interest to be reported on his 2024 personal tax return.

Proceeds of disposition for partnership interest Adjusted cost base Capital gain

$240,000 -104,850 $135,150

Adjusted cost base of Bob’s partnership interest: Capital contribution Add: Share of income — 2020 (1/3 × $121,500) — 2023 Share of previous full capital gain — 2022 (1/3 × $19,800) Share of untaxed capital gain — 2023 (1/3 × ($135,000 − $67,500)) Share of capital dividend — 2023 (1/3 × $14,400)

$30,000 $40,500 272,700 6,600 22,500 4,800

347,100 $377,100

Less: Share of loss — 2022 ( /3 × $67,500) 1

Share of donations — 2021 (1/3 × $1,350) — 2023 (1/3 × $247,500) Drawings — 2021 — 2022 — 2023 ACB, January 1, 2024

$22,500 450 82,500 28,800 18,000 120,000

272,250 $104,850

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Introduction to Federal Income Taxation in Canada

Solution 4: Partnership Income, ACB, Disposition 1)

Partnership income for the year ended December 31, 2023:

Partnership’s net income for financial accounting purposes Add: Charitable donations Allocation to the partners: Samara: 20% Isabelle: 40% Joy: 20% Eden: 20% 2)

$65,000 2,000 67,000 $13,400 26,800 13,400 13,400

Adjusted cost base of Isabelle’s partnership interest:

Adjusted cost base of Samara’s partnership interest:

Capital contribution Add: Share of income, to 2022 ($750,000 x 20%) Share of income, 2023 Share of capital gain ($10,000 x 20%) Deduct: Share of losses ($80,000 x 20%) Drawings ($250,000 + $5,000) Share of donations ($17,000 x 20%) Negative ACB of partnership interest Capital gain on disposition of partnership interest in 2024: Proceeds of disposition Add: Negative ACB Capital gain Taxable capital gain (1/2)

$50,000 150,000 13,400 2,000 $215,400 $16,000 255,000 3,400

274,400 -$59,000

$125,000 59,000 $195,000 $97,500

Solutions to Chapter 19 Assignment Problems

Samara’s 2023 taxable income: Partnership income Interest income Total income RRSP (18% of $15,000) Taxable income Samara’s tax liability: Combined Federal and Provincial Tax (25 Less: Non-refundable tax credits Basic Personal Credit Charitable do Tota —NOTES TO SOLUTION (1) Charitable donation: Share of charitable donation (40% x $2,000) = $800; tax credit = (25% x $200) + (46% x ($800 – $200)) (2) Charitable donation: Share of charitable donation (20% x $2,000) = $400; tax credit = (25% x $200) + (46% x ($400 – $200))

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Introduction to Federal Income Taxation in Canada

Solution 5: Trusts Part A (a)

Settlor: Mrs. A

Trustees: Daughters B&C Beneficiaries: Grandchildren

Painting ACB $500 FMV $1,000 Inter vivos trust a.

The trust is an inter vivos trust because it arose during the lifetime of Mrs. A.

The federal rate of tax payable by the trust is 33% [sec. 122]. Calendar year end.

Since this is not a spousal trust, the painting gifted to the trust is deemed to be disposed of by Mrs. A at its fair market value at the time of the gift of $7,000. She will then report the capital gain of $6,000 (this is listed personal property and personal use property so its cost is the greater of actual cost and $1,000). The trust will have a cost equal to her proceeds of $7,000.

If the painting is transferred from the trust to the grandchildren, then the trust will be deemed to have disposed of it at its cost of $7,000. The grandchildren will receive it with a cost of $7,000.

Part A (b)

Settlor: Mrs. A

Trustees: Daughters B&C Beneficiaries: Grandchildren

Shares ABC Co ACB $10K FMV $35K Testamentary Trust a.

Because the trust is created as a consequence of the death of Mrs. A, it is a testamentary trust.

The rate of tax payable by the trust will be 33% because the trust is not a graduated rate estate. A testamentary trust created by a will is not an estate and cannot be a graduated rate estate.

The trust will have a calendar year end.

Since this is not a spousal trust the shares gifted to the trust are deemed to be disposed of by Mrs. A on her final return at its fair market value at the time of death of $35,000. She will then report the $25,000 capital gain in her final return. The trust will have a cost equal to her proceeds of $35,000. It should be determined whether the shares are QSBC shares to determine whether her capital gains exemption could be used on the terminal return.

If the shares are transferred from the trust to the grandchildren then the trust will be deemed to have disposed of them at their cost of $35,000. The grandchildren will receive them with a cost of $35,000.

f. If dividends are paid on the ABC shares and distributed to the grandchildren, TOSI should be considered if the shares are private company shares. Dividends on private company shares are split income unless they meet the definition of an excluded amount. If the shares have been received on the death of a parent or on the death of any person if the individual receiving the dividend was enrolled as a full-time student during the year in a post-secondary institution, the dividends would be considered an excluded amount. Otherwise, TOSI will apply particularly where the grandchildren are minors. g.If the ABC shares are public company shares, the dividends will be eligible dividends and retain their character when distributed to the grandchildren. The trust will deduct the dividends distributed when computing income of the trust.

Solutions to Chapter 19 Assignment Problems

579

Part B

Settlor: Mr. B Trust

Trustees: Executors? Beneficiaries: Spouse while living Children on death spouse

Shares XYZ Inc. ACB $1K FMV $100K (A) The trust created under Mr. B’s will is a testamentary spouse trust for purposes of subsection 70(6): a.

Mrs. B is a resident of Canada;

Mrs. B is entitled to receive all of the income of the trust before her death; and

no person, except Mrs. B, may receive or obtain the use of any of the income or the capital of the trust.

Because the trust is a spouse trust, Mr. B will be deemed to have disposed of the shares of ABC Inc. on his death for proceeds of disposition equal to the adjusted cost base of those shares to him (that is, $1,000). (B) Any dividends earned by the trust will be eligible for the gross-up and tax credit if they are kept in the trust. If the dividends are paid out to Mrs. B then she will receive them and be eligible for the gross-up and tax credit. The trust will get a deduction for dividends paid out to Mrs. B. The trust is not a graduated rate estate so it will have a tax rate of 33%. (C) If the shares are distributed to Mrs. B then they will be disposed of by the trust at its cost of $1,000 and Mrs. B will receive them at a cost of $1,000. (D) If the shares are still in the trust when Mrs. B dies then they will be deemed to be disposed of at FMV at the time of her death. Then, when they are distributed to the children, they will receive them at a cost equal to the FMV at the time of her death. The taxation year-end of the trust is deemed to end on Mrs. B’s date of death. The income for the deemed year end is taxed in the trust unless there is a joint election between Mrs. B’s graduated rate estate and the trust to have the income taxed in Mrs. B’s terminal return. Where an election is made, the income deemed taxable in the terminal return is deductible in computing the income of trust. (E) Because the trustees have the power to encroach on capital for the benefit of the B’s children, it is no longer a spouse trust. As such, Mr. B will be deemed to have disposed of the shares of ABC Inc. for proceeds equal to fair market value. Accordingly, on his death, Mr. B would be deemed to realize a gain of $99,000 (i.e., $100,000 – $1,000).

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Introduction to Federal Income Taxation in Canada

Part C

Settlor: Ms. C Died June 1, 2023 Estate

Trustees: Long-time partner Ms. J Beneficiaries: Children (adults)

Publico shares RRSPs, House/cottage Art, Partnership interest

(A) At the time of Ms. C’s death, she will have a deemed disposition of all of her properties at fair market value. Her terminal tax return will include any taxable capital gains and allowable capital losses related to her investments, the fair market value of her RRSPs, taxable capital gains on personal use property and taxable capital gain on her partnership interest. She would able to claim the principal residence exemption on the house or cottage whichever is most beneficial in terms of minimizing tax. She may be able to include stub period income from the partnership on a separate return.

(B) The estate is a testamentary trust for tax purposes. The executor can designate the estate as a graduated rate estate on the first year’s tax return filed for the estate. A graduated rate estate can benefit from graduated tax rates on any income earned in the estate for the first 36 months after the individual’s death. Only one graduated rate estate is allowed per deceased individual. The estate can choose a non-calendar year end. In this case, the year end could be chosen to be May 31, 2023. After 36 months, if the estate is still in existence (i.e., the properties have not been distributed to the beneficiaries), the estate will no longer be treated as a graduated rate estate and will adopt a calendar year end. The first calendar year end for the trust in this case will be December 31, 2025 and the tax rate applicable to income earned in the trust will be the high personal tax rate. Alternatively, it would be possible to choose a December 31, 2023 calendar year end. This could be beneficial to take advantage of graduated tax rates as the estate would have 4 (rather than 3) taxation year ends in the 36 month period. [Year ends; December 31, 2023, 2024, 2025, May 31, 2026.

(C) The estate will exist until all tax liabilities are paid and a clearance certificate is received. At the time, the properties of the estate are distributed, they will be disposed of by the trust at tax cost to the beneficiaries Ms. C’s daughters, resulting in no tax implications on the disposition to the beneficiaries. The tax cost of the properties in the trust will be the fair market value of those properties at the time of Ms. C’s death.

581

Solutions to Chapter 19 Assignment Problems

Solution 6: Establish a Trust, Income Allocation, Personal Tax Assess the Situation: 1.

Draw a diagram identifying all stakeholders and their relationships, e.g., corporate org charts

Mr. Bilodeau

Trustees Jan 1/2022

Mr. & Mrs. B + friend

$250,000 cash 1,500 shares

5% bond purchased - $12,500 of interest Beneficiary:

1,500 shares of Retailers - $40,000 dividend

Daughter Jane Retailers

- 17 years old in 2022 - 18 years old in 2023

Identify the relationships among the stakeholders e.g., related, affiliated, associated, connected −

Mr. Bilodeau, Mrs. Bilodeau and his daughter are related, non-arm’s length

−

Mr. Bilodeau is related to two of the three trustees (Mrs. Bilodeau and himself)

Identify the profile of each stakeholder, e.g., tax features, risk profile −

All individuals are presumed to be Canadian residents

−

Mr. B is in the top tax bracket

−

Jane – no other sources of income

−

Trust – Inter vivos trust, calendar year end, highest tax rate applies, Cdn resident

−

Retailers – CCPC, no GRIP, controlled by Jane as beneficiary

Understand the client/decision maker and their objectives −

Mr. Bilodeau needs to know the tax consequences of giving the cash and shares to the trust

−

The trustees need to know what income is allocated to Jane and what is taxed in the trust each year

−

The trustees need to know the tax payable in the trust

−

Mr. B. and Jane need to know if there is any attribution

−

Jane needs to know her tax liability

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Introduction to Federal Income Taxation in Canada

2. Identify the relevant past transaction/events or planned future transactions/events and create a timeline 2022 − Mr. Bilodeau gave $250,000 and 1,500 shares of Successful Retailers Limited to the trustees to hold in trust for his daughter Jane − Jane turned 17 years old − The trustees purchased a 5% bond that earned $12,500 of interest − Non-eligible dividends of $40,000 were received

2023 − Jane turned 18 years old − The bond will earn $12,500 of interest − Non-eligible dividends of $40,000 were received − The trust accumulates 60% of the income before pays the rest out

− The trust accumulates 60% of the income and pays the rest out

Identify the Issues: 1.

Identify all of the major tax issues and any non-tax issues 1.

Tax treatment of Mr. Bilodeau’s gift to the trust on January 1, 2022

Tax treatment of income retained in trust. − Determine income of the trust in 2022 and 2023 − Determine the allocation of income by the trust in 2022 and 2023 (Quant) − Determine the tax payable by the trust in 2022 and 2023 (Quant)

Tax treatment of distributions to Jane. − Attribution applies to interest/dividends distributed to Jane?’ − TOSI applies to dividends distributed to Jane? − Determine the tax payable by Jane in 2022 and 2023 (Quant)

Identify missing information or assumptions made

1. None identified Analyze the Issues: 1.

Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act 1. Tax treatment of Mr. Bilodeau’s gift to the trust on January 1, 2022

Mr. Bilodeau made a gift to the trust on January 1, 2022 Since the trust is not a spousal trust the property is deemed to be disposed of at FMV – calculate CG/CL Mr. Bilodeau would realize a disposition [par. 69(1)(b)] on the transfer of the shares into the trust TCG: (($500 – $17)  1,500)  ½ = $362,250 CGE: No indication that the shares are QSBC shares Tax: 50% x $362,250 = $181,125 The trust will acquire the shares also at fair market value [par. 69(1)(c)] Conclude: The settlement of the inter vivos trust for Mr. B’s daughter will result in a taxable capital gain and tax of $181,125 on his personal tax return for 2022.

Solutions to Chapter 19 Assignment Problems

583

Tax treatment of income retained in trust.

Trust treated as individual

Dividends – GU/DTC 15% -

Deduction for income distributed − Determine income of the trust in 2022 and 2023 (Quant) − Determine the allocation of income by the trust in 2022 and 2023 (Quant) − Determine the tax payable by the trust in 2022 and 2023 (Quant)

Conclude: The inter vivos trust must file a T3 for 2022 and 2023. 60% of the interest and dividends will be taxed in the trust at the highest marginal tax rates. A DTC will be available for the dividends. 3. Tax treatment of distributions to Jane. -

Taxable to Jane – retains character (i.e., dividends non-eligible)

Determine whether attribution applies Where an individual has lent or transferred property to a trust and a designated person benefits then attribution applies [s. 74.3] A designated person [ssec. 74.5(5)] includes a child under 18 years Attribution of property income results for 2022 (the year Jane turns 17) Regular attribution does not apply if “TOSI” applies [ssec. 74.5(13)] Determine whether TOSI applies TOSI income applies to split income other than an excluded amount. Split income includes taxable dividends received by a specified individual in respect of shares of the capital stock of a private corporation. The dividends in this case would be derived from a related business carried on by Mrs. and. Mr. Bilodeau. For 2023, the only possibility of the dividend being an excluded amount would be if it were derived from an excluded business. Jane would have to be actively engaged on a regular, continuous and substantial basis for that to be the case. −

Split income – dividends from private co.

−

Excluded amount a.

17 in the year (2022) i. only on death of parent or another person. NO

Attained age of 17 before the year (2023) i. derived from a business that is not a related business – NO ii. excluded business – NO (confirm) iii. safe harbor return/reasonable return – NO (unlikely)

Conclude:: The interest earned in the trust and distributed to Jane will be deductible to the trust and subject to the attribution rules. As a result, the interest will need to be reported on Mr. B’s personal tax return in 2022. In 2023, the interest will be reported on Jane’s personal return. The attribution rules do not apply to dividends subject to TOSI. TOSI applies to dividends received by Jane in 2022 and 2023 (not an excluded amount).

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Introduction to Federal Income Taxation in Canada

2. Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format The calculation of income earned by the trust in 2022 and 2023 The allocation of income between the trust and Jane in 2022 and 2023 Tax payable by the trust in 2022 and 2023 Tax payable by Jane in 2022 and 2023

585

Solutions to Chapter 19 Assignment Problems

2022 (Jane is 17) Trust

Mr. B

(Inter Vivos)

(Attribution)

Dividends (Non-eligible) Interest

40,000 12,500 52,500 (21,000) 31,500 3,600 35,100

Paid/Payable to Beneficiary Dividend Gross-up 15% Taxable Income Tax 2 Tax rate Tax 3 Personal credit Dividend Tax Credit Total Tax

Jane 40% 16,000

5,000 16

50% 17,550 (3,600) 13,950

2023 (Jane is 18) Trust

Dividends Interest Paid/Payable Gross-up 15% Taxable Income Tax Tax rate 4 Tax 5 TO 3

Notes: 1.

In 2022 the interest on the bond will be attributed to Mr. Bilodeau since Jane has not yet turned 18 and he has transferred property by means of a trust for her benefit. In 2023, Jane turns 18 and attribution ceases.

In 2022 Jane will pay tax on the dividend at 50% since “TOSI” applies. The inter vivos trust will have a flat tax rate of 50%.

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Introduction to Federal Income Taxation in Canada

In 2022 Jane is eligible for the personal credit but the trust is not. However, her only income is subject to “TOSI” so she doesn’t have any other income and resulting tax to use her personal credit against. Therefore, in 2022, she can’t claim her basic personal credit. In 2023, Jane will be able to use sufficient basic personal tax credit to offset the tax on the interest. She cannot use any basic personal credit against dividend income subject to TOSI.

In 2023, Jane will pay tax at the graduated tax rates, in this case the lowest rate of 25% on the interest income as the attribution rule will no longer apply. The basic personal credit will entirely offset the tax on this interest. In 2023 the “TOSI” will continue as it is unlikely the dividend would meet the definition of an excluded amount. Jane will be pay tax at 50% on the income. Only the dividend tax credit can be used against TOSI.

Identify risks including missing information, assumptions and uncertain research positions Can he claim the capital gains exemption? −

Are the shares QSBC shares?

−

Has he used his CGE in the past?

There may be minimum tax depending on the amount of Mr. Bilodeau’s other income.

Reach a conclusion on each issue See above

Evaluate the strengths and weaknesses of your conclusions None identified

Advise/Recommend: Advise your client, integrating your conclusions on each of the issues with the client’s objectives, giving priority to the most important issues −

Mr. Bilodeau should consider waiting until 2023 to establish the trust to avoid attribution. However, since he is in the top tax bracket the amount of tax will be the same.

−

There are still benefits to transferring the shares to the trust in 2022 if the shares are expected to appreciate in value in 2022 to minimize the tax on the taxable capital gain on the settlement of the trust. Although TOSI applies to dividends distributed from the trust to the daughter, there is still a benefit to holding the shares in trust for Mr. Bilodeau’s daughter as she may be able to use her capital gains exemption against a capital gain on a future disposition of the shares if the shares are QSBC shares. Also, a future taxable capital gain on the disposition of the shares will not be subject to TOSI if the shares are QSBC shares at the time of disposition.

Solutions to Chapter 19 Assignment Problems

Solution 7: Estate Freeze A. Assess the Situation: 1.

Draw a diagram identifying all stakeholders, e.g., corporate org charts

Identify the relationships among the stakeholders e.g., related, affiliated, associated, connected − Gordon and his three children are related − Gordon is related and affiliated with Amazing

Identify the profile of each stakeholder e.g., tax features, risk profile − Gordon 1.

Presumed resident of Canada

Has never used his CGE

Divorced

− Amazing 1.

CCPC

Small business corporation

Shares are QSBC shares

Potential for significant future growth

− Wendy Works in Amazing and being groomed to take over − Wayne Artist − Winona In a PhD program and wants an academic career

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Introduction to Federal Income Taxation in Canada

Understand the decision maker and their objectives − Gordon is the key decision maker

Wants to freeze the value of Amazing at today’s value to limit his tax liability

Wants Wendy to get the future growth in value

Wants to retire in 10 years

Wants continuing income of $200,000 in his retirement

Wants to maintain control over Amazing after freeze

Wants to leave his estate equally among his children

How much tax would his estate pay on his death?

Ensure sufficient cash to pay tax on death.

Use his capital gains exemption

Identify the relevant past transaction/events or planned future transactions/events and create a timeline − No transactions planned yet, although a structure has been proposed

B. Identify the Issues: −

Identify all the major tax issues and any non-tax issues − Determine the high-level technical steps needed to achieve the structure − Determine if the proposed structure meets Gordon’s goals

−

Identify missing information or assumptions made − Need support for FMV of common shares

C. Analyze the Issues: 1.

Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act Determine the high-level technical steps needed to achieve the structure (1) Amazing will undergo a reorganization of capital −

Gordon will exchange all of his common shares of Amazing for preference shares

−

Use s. 86

−

Preference shares will be retractable

−

Preference shares will be voting

−

Dividend rate of up to 6%

(2) Wendy will buy common shares of Amazing for a nominal amount (3) Gordon will transfer his preference shares of Amazing to Holdco and elect under s. 85(1). -

His consideration will be common shares of Holdco

He will elect proceeds that will use his CGE

He will limit boot to avoid a deemed dividend under s. 84.1

Note that it may be possible to take advantage of paragraph 84.1(2)(e). If Wendy controls Holdco before the transfer of Amazing’s preferred shares to the holding company, Gordons’ transfer of the shares to Holdco could be deemed to be arm’s length and 84.1 will not apply (if the below conditions are met). If the conditions could be met thiswould allow Gordon to take back non-share consideration of $971,290 on the transfer of the shares to Holdco without a

589

Solutions to Chapter 19 Assignment Problems deemed dividend resulting and also allow him to use his $971,290 capital gains exemption. The calculation of the paid up capital of the share consideration on the transfer would be determined using subsection 85(2.1) instead of 84.1(1) which means that the paid up capital of the share consideration will be equal to the elected amount less nonshare consideration received i.e. $0. The March 28, 2023 Federal Budget provided clarification on the application of par .84.1(2)(e) to ensure it applies only to situations where there is a genuine intergenerational business transfer. For par. 84.1(2)(e) to apply the following conditions must apply; • • •

• • •

The shares must be QSBC shares at the time of transfer. MET The purchaser corporation (Holdco) must be controlled by one or more persons each of whom is an adult child of the Transferor (Gordon) Not MET as Gordon will control Holdco. One of two transfer options must be chosen; 1. An immediate intergenerational business transfer (3 year test). Gordon would need to immediately and permanently transfer both legal and factual control. Wendy would need to obtain more than 50% of the voting shares and the remaining voting shares would need to be transferred to her within 36 months. Gordon would need to relinquish economic and other influence allowing for effective control of Amazing. 2. A gradual intergenerational business transfer (5 to 10 year test) i.e. Gordon’s fixed value preferred shares must be gradually diminished through the corporation repurchasing the shares over time. Gordon would have to immediately and permanently transfer legal control (the right to elect the majority of the directors of a corporation) to Wendy. Wendy would need to obtain more than 50% of the voting shares and the remaining voting shares would need to be transferred to her within 36 months. Gordon would need to within 10 years of the initial sale reduce the economic value in Amazing to 30% of the value of the interest in the corporation. NOT MET as Gordon plans to continue to control. Management of the business must be transferred to Wendy within a reasonable time (36 months) MET. Wendy has to retain legal control of the business for 36 months following the share transfer. Not MET as Gordon plans to continue to control. At least one child remains actively involved in the business for the 36 months following the share transfer for option 1 above and the greater of 60 months or until the business transfer is complete under option 2 above. |MET.

Option 2 above would be best for Gordon. One or more of the three children would need to have a controlling interest in Holdco when the preferred shares of Amazing were transferred to Holdco. The preferred shares issued to Gordon on the section. 86 reorganization would need to be non-voting shares and there would need to be a plan to repurchase the shares to bring his interest in Amazing to 30% or less within 10 years. Determine if the proposed structure meets Gordon’s goals 1.

Wants to freeze the value of Amazing at today’s value to limit his tax liability -

Wants Wendy to get the future growth in value -

Wendy owns the only common shares of Amazing

Wants to retire in 10 years -

Holdco will only own retractable preference shares of Amazing; they will not increase in value

Not part of the tax plan

Wants continuing income of $200,000 in his retirement -

Can earn dividends on the preference shares of Amazing

$8,000,000 x 6% = $480,000

Dividends can be paid tax free from Amazing to Holdco and invested in Holdco or paid out to Gordon with a tax cost. TOSI will need to be considered but as long as the dividends are derived directly to indirectly from an excluded business of Gordon the dividends will be excluded amounts and TOSI will not apply

For the first 10 years while Gordon is still working he can receive a salary from Amazing (see below). Holdco would charge management fees to Amazing for Gordon’s services (not PSB income as the companies are associated.)

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Introduction to Federal Income Taxation in Canada

Wants to maintain control over Amazing after freeze -

Legal control through the Class A preference shares held by Holdco

“de facto” control through the retraction feature

Alternatively, a second class of Class B voting shares can be issued for a nominal amount to provide control and these could be automatically redeemed on death

Note that if Gordon would like to take advantage of 84.1(2)(e) and Option 2 above to allow him to take back non -share consideration on the transfer of the preferred shares to Holdco the preferred shares must be non-voting shares. Also the preferred shares will need to be repurchased to bring the FMV of his interest in Amazing to 30% or less within 10 years

Wants to leave his estate equally among his children -

He can leave his preferred shares in Holdco and personal investments (using funds obtained through the repurchase of his preferred shares) equally to his three children in his will

How much tax would his estate pay on his death? -

To be determined below

Where would the cash come from to pay the tax? -

From Holdco/Amazing

Use CGE Will be used on transfer of PSs to Holdco and electing under Section 85

How will he continue to receive income from Amazing in retirement? Salary -

Gordon could have his pre-retirement salary paid from Amazing to Holdco but the two companies would have to share the small business deduction since they are associated o

The personal services business rules would not apply since they are associated

After retirement a salary may be considered to be unreasonable and denied as a deduction

Retiring allowance paid from Amazing

Note that if Gordon would like to take advantage of par. 84.1(2)(e) and Option 2 above to allow him to take back non -share consideration on the transfer of the preferred shares to Holdco, he will need to transfer management of the business to Wendy within a reasonable timeDividends −

Dividends can be paid from Amazing to Holdco without Part IV tax since they are connected [186(2)]. These dividends can be accumulated in Holdco for the future − 6% x $8,000,000 = $480,000 − $200,000 = 2.5% x $8,000,000 − Use “up to” to provide flexibility − It can be anywhere from zero to $480,000

Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format

Technical details of the plan Gordon exchanges his 100 common shares of Amazing for 8,000 Class A preference shares. Characteristics of 8,000 Class A shares − Redeemable and retractable at $1,000 each

591

Solutions to Chapter 19 Assignment Problems − Non-voting − Non-cumulative dividend of up to 6% per annum

Section 86 Reorganization Issuance of New Shares PUC New Shares LSC before reduction

8,000,000

S86(2.1) (a) PUC reduction (A) Increase in LSC of all shares

8,000,000

(B) PUC old

100

Less: Boot

PUC reduction

100 7,999,900

PUC after reduction

100 A

ACB New Shares ACB Old Shares

100

Less: Boot

ACB New Shares

100 B

Redemption of Old Shares PUC New Shares

100 A

Boot

Redemption Proceeds

100

PUC Old Shares

100

Deemed Dividend

ACB New Shares

100 B

Boot

Proceeds of Disposition

100

ACB Old Shares

100

Capital Gain/Loss

− Gordon will sell his Class A shares of Amazing to Holdco in exchange for 100 common shares of Holdco. He will elect under ssec. 85(1).

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Introduction to Federal Income Taxation in Canada

Subsection 85(1) election:

Asset

Tax Value

FMV

Elected Amt

PSs of Amazing

100

8,000,000

Consideration "Boot" - Non-share Assumed New Debt Debt

971,290

Income/CG

8,000,000

Proceeds to Gordon Cost of Amazing common to Holdco

Section 84.1 PUC Share Consideration LSC before reduction

8,000,000 A

84.1(1)(a) PUC Reduction LSC before reduction Less:

8,000,000

Greater of: PUC of shares transferred

100

Modified ACB of shares transferred

100

Less: Boot PUC reduction PUC after reduction (A-B)

100 -

100 7,999,900 100

971,190

Solutions to Chapter 19 Assignment Problems

593

Gordon 100 Common FMV $8,000,000 ACB $971,290 PUC $100

Holdco

C lass APreferred FMV $8,000,000 PUC $100 ACB $971,290

Amazing

Holdco will then purchase 1,000 Class B preference shares for $1,000 to provide voting control of Amazing to Holdco. −

Characteristics of the Class B shares −

Redeemable and retractable at $1 each on the death of Gordon

−

Voting

−

No dividends

Wendy purchases 100 common shares from Amazing for $100. −

ACB and PUC is $100

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Introduction to Federal Income Taxation in Canada

Final Result: Gordon 100 Common FMV $8,000,000 ACB $971,290 PUC $100

Holdco

Wendy

1,000 Class B 8,000 Class A

100 Common

FMV $8,000,000 PUC $100 ACB $971,290

Amazing

How much tax would his estate pay on his death? −

Tax payable on death and how this will be paid Tax on Death 100 Common Shares of Holdco ACB Capital Gain Taxable Capital Gain

8,000,000 971,290 7,028,710 3,514,355

Tax in Estate (50%)

1,757,178

Becomes the ACB to the Estate

The assumed tax rate is 50% since he may have dividend or salary income in the year of death.

Where would the cash come from to pay the tax? There may be a cash flow problem in the estate since there is no cash to pay the tax. The only source of funds is the preference shares so either some need to be redeemed or a dividend needs to be paid. The common shares will have an ACB of $8,000,000 after death, which is equal to their FMV. The PUC will remain at $100. The Class A and Class B shares of Amazing held by Holdco would be redeemed on Gordon’s death. The redemption of the Class A shares will result in the following:

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Solutions to Chapter 19 Assignment Problems

Redeem the Class A Shares held by Holdco at time of Death Number of shares Redemption Proceeds PUC Deemed Dividend

8,000 8,000,000 -100 7,999,900

Adjusted Proceeds ACB Capital Loss

100 971,290 (971,190)

Proceeds - Deemed dividend

Cash dividend from Holdco to Estate Tax on deemed dividend After-tax cash in the Estate

8,000,000 (3,400,000) 4,600,000

Assumed non-eligible 42.5% Enough to pay the tax in the estate

Tax free to Holdco

Note: Tax on dividend = 50% x 1.15 - 0.15 = 42.5% The deemed dividend will be received tax-free by Holdco. Part 1 tax doesn’t apply to intercompany dividends and Part IV tax wouldn’t apply as long as Amazing doesn’t have any RDTOH. Note that Amazing may need to borrow funds to redeem the Class A preferred shares. [Alternatively, a plan could be in place to redeem the shares over the 10 years until Gordon’s retirement.] Holdco can pay a dividend to Gordon’s estate sufficient on an after-tax basis to pay the tax liability. The dividend will be a non-eligible dividend and subject to tax in the estate. The estate could be Gordon’s graduated rate estate with a non-calendar year end and subject to graduated tax rates. After the estate files all of the necessary tax returns, i.e., Gordon’s prior year returns, terminal return and any estate returns and pays the tax, a clearance certificate can be obtained from CRA and the properties in the estate including the common shares of Holdco can be distributed to the children. The children can decide whether to retain Holdco or wind up the company with a winding up dividend subject to tax. If the company is wound up in the first taxation year end of GRE, any allowable capital loss on the disposition of the shares on the wind up can be carried back and used on the terminal return for Gordon against the taxable capital gain resulting on the deemed disposition of the shares on death. Subsection 164(6). Corporate-owned life insurance Amazing could enter into life insurance policy for Gordon. On his death, insurance proceeds are received by Amazing and are used to redeem the Class A preferred shares. The deemed dividend will be elected to be paid from the capital dividend account. Then a capital dividend can be paid to the estate tax free to pay the tax liability on death. Premiums will not be deductible to the corporation and may be expensive depending on Gordon’s health. There will not be a shareholder benefit under ss.15(1) if the corporation is the policyholder and beneficiary. Identify risks including missing information, assumptions and uncertain research positions o

The fair market value of the shares may be challenged

Reach a conclusion on each issue The plan accomplishes the following: −

Freezes the value of Amazing with Wendy benefiting from the future growth

−

Provides Gordon with income in the form of dividends of up to $480,000 per year

−

Gordon maintains control through the threat of retracting the preference shares or Class B voting shares

−

Gordon uses his capital gains exemption

−

Leaves the estate equally among his children

−

But, more work needs to be done to provide liquidity in the estate to give Wayne and Winona cash instead of preference shares

596

Introduction to Federal Income Taxation in Canada

Consideration of changes to the above plan to take advantage of par. 84.1(2)(e) and allow Gordon to take $971,290 of non-share consideration out of Amazing tax free without impacting his utilization of the capital gains exemption should be considered Evaluate the strengths/weaknesses/risks of your conclusions No weaknesses identified

D. Advise/Recommend: Advise the decision maker, integrating your conclusions on each of the issues with the client’s objectives, giving priority to the most important issues −

Implement the proposed plan

−

Develop a clear plan to fund the tax liability on death

−

Consider taking advantage of par. 84.1(2)(e) to allow non-share consideration without a deemed dividend for this intergenerational transfer.

Solutions to Chapter 19 Assignment Problems

597

Solution 8: Merging Two Businesses Memo to file: Business Combination Kay Sega: Pharmacy Lamia Savitz: Health Food Store The main objective is to allow the two businesses to combine to achieve greater cost savings and taxdeferral opportunities. It is important to recognize that the businesses could continue to operate under shared quarters, but as separate legal entities. The following alternatives are available to Kay and Lamia. Alternative business combinations: • Incorporate using a section 85 rollover • Partnership • Joint Venture • Corporate Joint Venture Incorporate Using a Section 85 Rollover A section 85 rollover allows an individual or corporation to transfer eligible property, including inventory, to a corporation at an elected amount in exchange for consideration that includes shares and non-share consideration. Since the shareholder should be in the same economic position as he/she was prior to the transfer, the fair market value of the consideration received should equal the fair market value of the property transferred. The rollover can take place on a tax-deferred basis if the amounts elected do not exceed the capital cost of the non-depreciable assets or the UCC of depreciable assets. There are advantages to incorporating a small active business. Firstly, the government encourages incorporation by providing the small business deduction on the first $500,000 of active business income. Secondly, the Canadian income tax system is also designed to integrate corporate and personal taxes such that it prevents double taxation. If profits are left in the corporation, there is the opportunity to defer income tax because the small business deduction provides a c o m b i n e d f e d e r a l / p r o v i n c i a l corporate tax rate of approximately 13%, depending on provincial rates. If Kay and Lamia operated within the same corporation, the small business deduction would not apply to the income in excess of $500,000. Therefore, business income in excess of $500,000 will be subject to a combined federal/provincial tax rate of approximately 27%, depending on provincial rates. Current combined income levels are below $500,000. In addition, both Kay and Lamia could qualify for the $971,190 capital gains deduction on qualified small business shares on any future disposition of their shares. Incorporation results in higher administration and accounting costs. However, these amounts would likely be offset by lower operating costs. Partnership A partnership could also be considered by the two individuals or by two incorporated businesses. The income tax system contains rules permitting assets to be transferred to the partnership on a tax-deferred basis. Given the size of net income, Kay and Lamia should consider incorporation at a minimum to maximize the benefits of the small business deduction. A corporate partnership involves both individuals incorporating their respective business and then each corporation becoming a member of the partnership. However, it is important to realize that the $500,000 annual limit for the small business deduction must be shared between the two corporations. Corporate Joint Venture/Joint Venture Each business retains a distinctive feature. For example, the health food store does not have the authority to fill medical prescription orders and the pharmacist lacks expertise in natural products. A joint venture is a viable alternative because the arrangement is less formal. A joint venture contract could outline the sharing of profits and costs. If the arrangement between the two businesses failed, the joint venture agreement could be terminated without tax consequences. This arrangement is favourable because each business can incorporate independently and operate under the same roof. The pharmacy would be one corporation, and the health food store would be another. The two corporations could then form a venture together to share the costs of a new department and the lease of the store. Since a partnership is avoided, both corporations would maintain the maximum benefit of the small business deduction.

598

Introduction to Federal Income Taxation in Canada

Conclusion Lamia and Kay should each incorporate their own corporation using a tax-deferred section 85 rollover. Following this, each corporation may enter into a joint venture to share the same store and retail some of the same products. It is important that the two businesses retain their distinctive features. For example, the store would have a pharmacy department, health food department, and an accessory department.

Solutions to Chapter 19 Assignment Problems

599

Solution 9: Advice on Estate Plan If Cora elects an amount of $601,000 under section 85, she will have proceeds of $601,000 and, ignoring the implications of sec. 84.1, she would normally have a capital gain of $600,000 ($601,000 – $1,000) and a taxable capital gain of $300,000 (1/2  $600,000), which can be offset by her remaining $300,000 capital gains deduction (1/2  $600,000 available capital gains exemption). The cost of the shares to Holdco Inc. would be $601,000. However, section 84.1 applies because: (a) Cora is a Canadian resident; (b) Cee Ltd. shares are capital property to Cora; (c) Holdco Inc. would be a Canadian resident corporation; (d) Holdco Inc. and Cora do not deal at arm’s length because Cora and her daughters control Holdco Inc; and (e) Holdco Inc. and Cee Ltd. are connected corporations immediately after the transfer because Holdco Inc. controls Cee Ltd. Paragraph 84.1(1)(a) will reduce the PUC of the Holdco Inc. shares from $1,199,000 to $0. The deemed dividend arising due to section 84.1 will reduce the proceeds of disposition to $1,000 and the capital gains exemption will remain unutilized. Note that it may be possible to take advantage of paragraph 84.1(2)(e). As the daughters control Holdco Inc. before the transfer of Cee Ltd common shares to the holding company, Cora’s transfer of the shares to Holdco will be deemed to be arm’s length and section 84.1 will not apply (if the below conditions are met). This will allow Cora to take the non-share consideration of $601,000 on the transfer without a deemed dividend resulting and will allow her to use her remaining $600,000 of capital gains exemption. The calculation of the paid up capital of the share consideration on the transfer will be determined using subsection 85(2.1) instead of 84.1(1) which means that the paid up capital of the share consideration will be equal to the elected amount less non-share consideration received i.e. $0. The March 28, 2023 Federal Budget provided clarification on the application of par. 84.1(2)(e) to ensure it applies only to situations where there is a genuine intergenerational business transfer. For par. 84.1(2)(e) to apply the following conditions must apply; • • •

• • •

The shares must be QSBC shares at the time of transfer. MET. The purchaser corporation (Holdco) must be controlled by one or more persons each of whom is an adult child (including grandchildren) of the Transferor (Cora) MET.. One of two transfer options must be chosen; 1. An immediate intergenerational business transfer (3 year test). Cora would need to immediately and permanently transfer both legal and factual control. The children/grandchildren would need to obtain more than 50% of the voting shares of Cee Ltd. and the remaining voting shares would need to be transferred to them within 36 months. Cora would need to relinquish economic and other influence allowing for effective control of Cee Ltd. 2. A gradual intergenerational business transfer (5 to 10 year test) i.e. Cora’s shares received from Holdco would need to be fixed value preferred shares and must be gradually diminished through the corporation repurchasing the shares over time. Cora would have to immediately and permanently transfer legal control (the right to elect the majority of the directors of a corporation) to the children/grandchildren. The children/grandchildren would need to obtain more than 50% of the voting shares and the remaining voting shares would need to be transferred to them within 36 months. Cora would need to within 10 years of the initial sale reduce the economic value in Cee Ltd to 30% of the value of the interest in the corporation. Management of the business must be transferred to the children/grandchildren within a reasonable time (36 months) MET Jordan and Suzanne could manage the business (they are involved). The children/grandchildren must retain legal control of the business for 36 months following the share transfer. MET as long as trust controls common shares of Cee Ltd. At least one child remains actively involved in the business for the 36 months following the share transfer for option 1 above and the greater of 60 months or until the business transfer is complete under option 2 above. |MET as long as Jordan and Suzanne remain actively involved.

The shares taken back by Cora on the transfer to Holdo will need to be non-voting shares.

600

Introduction to Federal Income Taxation in Canada Section 84.1 PUC Share Consideration LSC before reduction

1,199,000 A

84.1(1)(a) PUC Reduction LSC before reduction Less:

1,199,000

Greater of: PUC of shares transferred

1,000

Modified ACB of shares transferred

1,000

Less: Boot

1,000 601,000

PUC reduction

1,199,000

PUC after reduction (A-B)

Deemed Dividend Sum of: Increase in LSC of new shares

1,199,000

FMV of boot

601,000 1,800,000

Less the sum of: Greater of: PUC of shares transferred

1,000

Modified ACB of shares transferred

1,000

PUC reduction (above)

1,000 1,199,000

Deemed Dividend

1,200,000 600,000

Revised Capital Gain Pof D Deemed Dividend Revised PofD ACB Capital Gain TCG Capital Gain Deduction Net Gain

601,000 (600,000) 1,000 (1,000) -

Unused CGE

600,000

Solutions to Chapter 19 Assignment Problems

601

TOSI applies to split income which includes taxable dividends from a private corporation (including deemed dividends) unless the income meets the definition of an excluded amount. The dividend received by Cora would likely be considered to be derived from a related business carried on by Jordan and Susanne as they are related persons and work in the business. An excluded amount includes income from a property to the extent that the amount is (where the individual has attained the age of 17) derived directly or indirectly from an excluded business of the individual. As long as Cora is actively engaged on a regular, continuous and substantial basis in the activities of the business in either the taxation year of the transfer or any five prior years of Cee Ltd., the section 84.1 deemed dividend would be derived from an excluded business and would not be subject to TOSI. TOSI is levied at the top marginal rate on taxable dividends from shares of private companies such as Cee Ltd. and Holdco Inc. (either received directly or through a trust or partnership) and section 15 shareholder benefits from such companies. The income subject to TOSI is deducted from the individual’s regular taxable income but no deductions or credits can be claimed against this special tax except for the dividend tax credit (and the foreign tax credit, if applicable). TOSI applies to any Holdco Inc. dividends paid or payable to Cora’s grandchildren, Jordan and Susanne through the trust unless the dividends meet the definition of an excluded amount. As Jordan and Susanne appear to be actively engaged in the activities of Cee Ltd., dividends they receive may be excluded amounts as they could be considered to be derived from an excluded business. It would be necessary to assess their involvement in the business to determine if they would be considered to be actively engaged in the business. Dividends paid to the grandchildren would not be considered excluded amounts and TOSI would apply. Jordan and Susanne will each be jointly and severally liable for the tax owing by their respective children since they are each actively involved in the business. The intervivos trust must have a December 31 year end [par. 249(l)(b)]. Any income not paid or payable to beneficiaries at the trust’s year end will be taxed in the trust [ssec. 104(6)] and subject to the top marginal rate without any personal exemptions [ssecs. 122(1), (1.1)]. Tax returns must be filed for the trust within 90 days of the year end [par. 150(1)(c)]. Improvements In order to avoid a section 84.1 deemed dividend, the maximum debt that should be taken back is $1,000. Because total consideration must equal the $1.8 million FMV of the Cee Ltd. shares, Cora should take back Holdco Inc. shares with a fair market value and legal stated capital equal to $1,799,000. If the share consideration is less than this, there will be adverse tax consequences under paragraph 85(1)(e.2). In order to accomplish a “freeze”, the Holdco Inc. shares taken back by Cora must be preference shares. Otherwise, the shares will continue to grow in value. The shares should be also voting and redeemable and retractable at $1,799,000. The $1,799,000 redemption and retraction price is important because it supports the value of the shares. Cora will be able to maintain control of the company if the shares are voting. The retraction feature will also give her some control and liquidity. Paragraph 84.1(1)(a) will reduce the PUC of the Holdco Inc. shares from $1,799,000 to nil, there will not be a deemed dividend arising on the transfer of the shares and Cora will be able to use her remaining capital gains exemption. Cora should elect at $601,000, as before for the transfer of the shares to the holding company. This will result in a $600,000 capital gain eligible for the QSBC capital gains exemption. Cora should change her will because she will now own Holdco Inc. shares rather than Cee Ltd. shares. Cora will have to decide who she wants to leave her Holdco Inc. shares to as well as the other assets she owns. Alternatively, reliance on paragraph 84.1(2)(e) to deem the transfer of the QSBC shares to Holdco Inc. to be an arm’s length transaction should be considered to allow Cora to receive non-share consideration on the transfer of the shares to Holdco without the application of section 84.1. This would allow her to receive $601,000 from the corporation and also use her capital gains exemption. However, she would need to relinquish legal control of the corporation to her daughter’s/grandchildren.

602

Introduction to Federal Income Taxation in Canada

Solution 10: Death of a Taxpayer

Assess the Situation: 1.

Draw a diagram identifying all stakeholders and their relationships, e.g., corporate org charts

Mr Rogozynski RRSP $795K Cdn resident

Mrs Rogozynski Executrix Estate

100 C/Ss QSBC

Beneficiaries Mrs. Rogozynski - all other assets - Cdn resident related, affiliated [Mr R & Deeridge] Daughter - rental properties - related

related, affiliated

Deeridge Ltd CCPC/SBC ACB/PUC $55K FMV $5,750,000

Identify the relationships among the stakeholders e.g., related, affiliated, associated, connected − Mr. Rogozynski, Mrs. Rogozynski, their daughter and Deeridge Ltd. are all related − Mr. and Mrs. Rogozynski and Deeridge Ltd. are affiliated

Identify the profile of each stakeholder e.g., tax features, risk profile − Mr. Rogozynski – died March 1, 2023 •

Individual resident in Canada

•

Not used any of his CGE

•

All assets left to spouse except rental property to daughter

•

RRSP – FMV $795,000

•

Maximized RRSP room 2022 but has not made a 2023 contribution

− Mrs. Rogozynski – spouse, individual resident in Canada − Daughter – only child − Deeridge Ltd. – CCPC/SBC, Shares are QSBC shares, 100 common shares – ACB/PUC = $55,000 FMV at death $5,750,000 4.

Estate – Can elect to treat as a graduated rate estate

Fully understand the decision maker and their objectives − Executrix Mrs. Rogozynski •

Filing final tax returns for Mr. Rogozynski

•

Minimizing tax payable

Solutions to Chapter 19 Assignment Problems • Identify planning opportunities

603

Identify the relevant past transaction/events or planned future transactions/events and create a timeline − 2003 – Incorporation of Deeridge Ltd. − Date of death March 1, 2023

Identify the Issues: 1.

Identify all of the major tax issues and non-tax issues 1.

Advise the Executor of the Estate on filing requirements

•

Identify tax returns to be filed, filing due dates, payment due dates

•

Discuss obligations of executor of the estate

Determine income, taxable capital gains to be included on each of the returns to be filed for Mr. Rogozynski & his estate •

Discuss dispositions on death

•

Discuss tax treatment of RRSP on death

•

Discuss potential utilization of the CGE at time of death.

•

Discuss tax treatment of estate, potential planning opportunities

Quantitative: • •

Calculate tax liability on terminal returns Calculate cost amounts for properties inherited by the beneficiaries i.e. Mrs. Rogozynski, daughter

Identify missing information or assumptions made − Nothing identified

Analyze the Issues: 1.

Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act

Issue 1 Advise the Executor of the Estate on filing requirements − Identify tax returns to be filed, filing due dates, payment due dates − Discuss obligations of executor of the estate Filing requirements i. 2022 Personal Tax Return Mrs. Rogozynski, as executrix, must file the regular personal income tax return for the 2022 taxation year for the later of the normal filing due date of April 30, 2022 & six months from the date of death, i.e., September 1, 2023. Payment due same date ii.

Final/terminal return

604

Introduction to Federal Income Taxation in Canada

Mr. Rogozynski’s 2023 terminal tax return for the period January 1, 2023 to March 1, 2023, must be filed by the normal filing due date of April 30, 2024 [par. 150(1)(b) and (d)]. Payment due same date. iii.

Estate return

A testamentary trust is created by Mr. Rogozynski’s will (“The Estate of Mr. Rogozynski”) on his death effective March 1, 2023. All of the capital properties owned at death that must be distributed to the beneficiaries will flow into the Estate. Mrs. Rogozynski, as executrix of the will, will be required to distribute the properties in accordance with Mr. Rogozynski’s wishes in his will. Mrs. Rogozynski can select any year end for the trust up to 1 year from the date of death. This testamentary trust will be considered to be a graduated rate estate if Mrs. Rogozynski designates the testamentary trust to be a GRE. The testamentary trust must file a trust tax return and pay the tax within 90 days of the selected year end. The GRE designation can be made on the first trust return. If the daughter is in a higher tax bracket that what would apply to the rental income if earned in the trust, it may be beneficial to retain the rental properties in the estate for the 36 months if possible. iv.

Separate returns (Rights & things return)

The “rights or things” return is a separate return from the terminal return and must be filed by the later of one year after death and 90 days after the assessment of the terminal return. Payment is due on the same date as the terminal tax return i.e. April 30, 2024. The executrix may elect to defer payment of taxes, related to rights or things and on deemed dispositions, in the form of ten annual instalments plus interest at prescribed rates. The Minister will require security. Obligations of Executor: Ensure all returns are filed (terminal, R&T etc.) and taxes are paid. Request a clearance certificate from CRA. Once the certificate is received, properties can be distributed. Conclude: The deadline for the 2022 return is extended to September 1, 2023 and the terminal return for Mr. Rogozynski will be due on its “normal” due date of April 30, 2024. A separate return may be filed for R&T which will be due later than the terminal return. A trust return will be required for the Estate of Mr. Rogozynski and Mrs. Rogozynski should designate the trust to be a graduated rate estate. Inquiries regarding the daughter’s income level should be made to consider whether to retain the rental properties in the estate to take advantage of graduated tax rates for 36 months. A tax year end of the estate should be chosen to be December 31, 2023 to take advantage of 4 tax returns for the estate using graduated tax rates to minimize tax on the rental income. Consider the election to pay tax over 10 instalments. Issue 2 Determine income, taxable capital gains to be included on each of returns to be filed for Mr. Rogozynski & his estate.

Calculation of income on final return Income Received/Receivable − Generally, all income earned on a periodic basis must be accrued on a daily basis and included as income in Mr. Rogozynski’s terminal return [par. 70(1)(a)]. Rents, salary, bond interest. − The salary of $12,000 per month is fully taxed in the year received. The January and February salary of $12,000 per month will be taxed in 2023. − The rental income is also taxable in the year in which it accrues. The bond and savings account interest earned must be included in Mr. Rogozynski’s tax return. − Bonus was declared but not yet received – enforceable right – must be included in terminal return unless electing to file optional R&T return. It is not a periodic payment required to be included on the terminal return under par 70(1)(a).

Deemed Dispositions

Solutions to Chapter 19 Assignment Problems

605

Mr. Rogozynski’s capital property is deemed to be disposed of at the fair market value at the time of death, except when such property is left to the spouse [ssec. 70(5)], in which case, a tax-free rollover at adjusted capital cost is available. (a) Identify the assets left to the surviving spouse −

Automatic rollover

Shares of Deeridge Ltd. −

− − −

− −

It is our understanding that all of the shares of Deeridge Ltd. are to be left to Mrs. Rogozynski. As a result, a tax-free rollover is available. Therefore, these shares are deemed to be disposed of at their adjusted cost base on the date of death. Option to elect out of rollover. Determine if the shares of Deeridge are QSBC shares. The shares of Deeridge Ltd. would qualify for the enhanced capital gains deduction if they are considered qualifying small business corporation (QSBC) shares. Generally, the shares must meet the following tests: • The shares must be shares of a small business corporation at the time of Mr. Rogozynski’s death. Based on the information available, it would appear that the shares meet this test. • The assets held by the corporation (with a fair market value in excess of 50% of the total assets) were used principally in an active business carried on primarily in Canada throughout the 24 months that Mr. Rogozynski held the shares. It would appear that the shares meet this test. • The shares were owned by Mr. Rogozynski, throughout the preceding 24 months. Therefore, on filing, the executrix should apply $971,190 of the potential capital gains exemption against these shares. If nothing is done, then Mrs. Rogozynski’s adjusted cost base will be $55,000 (Mr. Rogozynski’s adjusted cost base). However, if the executrix elects, Mr. Rogozynski’s shares can be deemed to be disposed of at their fair market value on a share-by-share basis [ssec. 70(6.2)]. This procedure will enable the executrix to use up the QSBC share exemption of $971,190 and will step up Mrs. Rogozynski’s adjusted cost base accordingly to reduce future capital gains on the disposition of these shares. We should elect on 18 shares to create taxable income to use up all of the capital gains exemption. The taxable capital gain on a share-by-share basis would be $56,950. The executrix should elect on 18 shares to create a capital gain of $1,025,100 and use up the capital gains exemption. This option will result in unsheltered taxable capital gain of $26,955. The ACB of the shares to Mrs. Rogozynski will be higher. The remaining shares will be transferred to Mrs. Rogozynski at Mr. Rogozynski’s ACB.

Rental Property −

The tax-free rollover will not apply to the rental properties as they are being left to his daughter.

RRSP −

Upon Mr. Rogozynski’s death, his RRSP is cancelled and the proceeds will be treated as income (refund of premiums) in Mrs. Rogozynski’s return, since she is the designated beneficiary of Mr. Rogozynski’s RRSP. However, she may defer tax on this income if the funds are transferred into her RRSP within 60 days of the end of the year in which the funds are received [par. 60(l)]. Mr. Rogozynski’s contribution of the lesser of $22,500 (18% of 2022 earned income of $125,000) and the 2023 RRSP limit of $30,780 can be made by his executrix and deducted on the 2023 tax return. This can be made to either his RRSP or a spousal RRSP (since Mrs. Rogozynski is the beneficiary of the RRSP) and must be made within 60 days from the end of the calendar year. Since Mrs. Rogozynski is the beneficiary of all assets other than the rental property this RRSP contribution can be considered as part of her inheritance.

Non-refundable Tax Credits

606

Introduction to Federal Income Taxation in Canada

−

A claim for the full personal tax credit can be made in 2023 even though Mr. Rogozynski died in March. A personal tax credit can also be claimed for his spouse, but all of her income for 2023 would be used in reducing this credit. We would need to determine Mrs. Rogozynski’s income for 2023 to determine if the credit or a portion of the credit is available. Separate returns − Rights & things.

−

The bonus of $50,000 could also be considered an enforceable right; this would be included on a “rights or things” return.

−

The “rights or things” return is a separate return from the terminal return. Including this income on the separate return will result in tax at a lower federal tax bracket than on the terminal return and there is the opportunity to claim the same personal tax credits again.

−

Note that it is possible to assign “rights or things” to a beneficiary, if instructions are provided in the will [ssec. 70(3)]. This would be beneficial, if income splitting could be done with a beneficiary in a lower bracket, since the beneficiary would pay the tax on the assigned income.

− −

Conclude: Mr. Rogozynski will owe $393,596 of tax for the 2023 taxation year if Mrs. Rogozynski does not file any optional returns. If the rights and things return is filed, this tax can be reduced to $377,716 resulting in a tax savings of $15,880 if the bonus is included on that return. These amounts assume that Mrs. Rogozynski will elect out of the spousal rollover on 18 shares of Deeridge Ltd.

−

It may be necessary to have the company redeem some shares held by the estate to pay the tax that will be owing on the terminal tax return. There will be a deemed dividend on redemption and tax will need to be paid on the deemed dividend by the estate. The after-tax funds can be used to pay the tax owing on the terminal and rights & things tax return.

Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format −

Calculate the deemed disposition on death o

−

On assets not left to surviving spouse or spouse trust

For assets left to the surviving spouse o

Determine if the election should be made to have the transfer take place at FMV

Deemed disposition on death or rollover to surviving spouse −

Depends on whether assets are left to surviving spouse or spouse trust.

The taxable portion of the capital gain is calculated as follows if the Deeridge Ltd shares transfer to the spouse using the automatic rollover: Proceeds of disposition.........................................................................................

ACB .........................................................................................................................

55,000 (55,000)

Capital gain ..........................................................................................................

Taxable capital gain (1/2) ......................................................................................

We would instead recommend and advise that the executrix elect out of the automatic rollover option on 18 shares to use Mr Rogozynski’s capital gains exemption.

607

Solutions to Chapter 19 Assignment Problems If they elect on 18 shares then there will be net taxable income of $26,955 related to the share disposition. In determining the ACB of all shares inherited by Mrs. Rogozynski, a weighted average cost is computed as follows:

Total #

100

FMV

5,750,000

ACB

55,000

5,695,000

CG per Share

56,950

971,190 # shares to use

17.05

608

Introduction to Federal Income Taxation in Canada

Election Options Elected

Automatic rollover

Pof D

977,500

1,035,000

ACB

9,350

9,900

968,150

1,025,100

TCG

484,075

512,550

CGE

(485,595)

26,955

(3,040)

Elected shares

977,500

1,035,000

Rollover shares

45,650

45,100

1,023,150

1,080,100

TCG subject to tax

CGE lost

ACB to Mrs Ricky

Rental Property The tax-free rollover will not apply to the rental properties as they are being left to his daughter. As a result, Mr. Rogozynski’s terminal return will need to reflect the following income:

609

Solutions to Chapter 19 Assignment Problems

Unit 1 Land Building PofD ACB Capital Gain

Unit 2 Land Building

600,000 1,100,000 300,000 472,000 300,000 628,000

UCC LCP Recapture

620,000 310,000 310,000

380,000 383,000 1,238,000

350,000 (472,000) (122,000)

352,000 (380,000) (28,000)

Building 1,100,000 1,100,000 1,100,000

Unit 2 Land Building 620,000 380,000 383,000 380,000

(150,000)

Tax cost balances to daughter:

ACB CC 70(5)(c) UCC

Unit 1 Land 600,000

Calculation of income on final return Mr. Rogozynski’s 2023 taxable income will be:

All Salary - 2 months @ $12K Bonus - payable Interest - accrued Rental property - 2 months @ $5K Recapture on rental property TCG 18 shares of Shining Rental property Enhanced CPP RRSP - 18% x $125,000 CGD - Shining $971,190/2

Tax Basic Personal credit Employment credit Base CPP

13,521 1,368 3,123

Final 24,000

24,000 50,000 917 10,000 150,000 512,550 619,000 (631) (22,500) (485,595) 857,741

R&T 50,000

917 10,000 150,000 512,550 619,000 (631) (22,500) (485,595) 807,741

50,000 12,500

398,099

373,099

87,066+0.5*(857,741-235,676)

87,066+0.5*(807,741-235,676)

(3,380) (342) (781) 393,596

(3,380) (342) (781) 368,596

(3,380)

9,120 377,716

The basic personal credit is reduced to $13,521 because income is above $235,676. The enhanced CPP deduction is calculated as $3,754 less base CPP of $3,123. The credit is calculated using the base CPP withheld from Mr. Rogozynski’s pay. 3.

Identify risks including missing information, assumptions and uncertain research positions

Evaluate the strengths/weaknesses/risks of your conclusions

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Introduction to Federal Income Taxation in Canada

Mrs. Rogozynski’s income level is needed to determine the spousal credit. The daughter’s income level is needed for tax planning considerations regarding the graduated rate estate. Confirmation that the capital gains exemption is available (no limitations due to a CNIL balance, prior year’s ABILs) and that all the tests are met.

Advise/Recommend: Advise the decision maker, integrating your conclusions on each of the issues with their objectives, giving priority to the most important issues −

File the rights & things return for the bonus of $50,000.

−

Elect out of the spousal rollover on 18 common shares of Deeridge to use up Mr. Rogozynski’s capital gains exemption on the Deeridge shares.

−

Have the estate make a 2023 RRSP contribution of $22,500 to Mr. Rogozynski’s spousal RRSP for Mrs. Rogozynski before March 1, 2024.

−

Mrs. Rogozynski should also contribute the funds received from Mr. Rogozynski’s RRSP to her own RRSP by March 1, 2024 if she does not need the cash/does not wish to pay tax on the refund of premiums.

−

Mrs. Rogozynski will need to file a trust tax return for the Estate of Mr. Rogozynski. Mrs. Rogozynski should designate the trust to be a graduated rate estate and choose a December 31, 2023 year end.

−

As the GRE will earn rental income and possibly interest/dividends it may be advisable to defer the distribution of property to Mrs. Rogozynski/daughter to take advantage of the graduated tax rates in the estate. (if Mrs Rogozynski/daughter will be in higher tax brackets – have other sources of income).

−

Should also choose a December 31, 2023 year end to result in 4 taxation year ends in the 36 months (and 4 x the lowest tax bracket).

611

Solutions to Chapter 19 Assignment Problems

Solution 11 Part (A) Assess the Situation: Diagram Josephine (66 yrs) 100% 50%

Investmt Holdco Franklin & Jones LLP

Harry (brother) Trustee Beneficiaries Trust

Josephine's Estate

Ali (husband) (67 yrs) Ernie (son) (30 yrs) Natalia (daughter) (25 yrs)

Relationships Josephine/Investment holdco – related, affiliated through control Ali/Investment holdco – related, affiliated through marriage Natalia/Ernie/Investment holdco – related through relationship with mother Josephine, Natalia, Ernie, Harry – related through blood Josephine, Ali – affiliated, related through marriage

Cottage

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Introduction to Federal Income Taxation in Canada

Tax Profile of Stakeholders Investment Holdco – CCPC, not controlled by public cos, non-residents, no listed shares, GRIP $7.8K, ERDTOH $3K, CDA $10K Josephine – individual, 50% partner (ACB Jan 1, 2023 is $350K, drawings of $120K), shareholder Ali – individual, other income sources and in highest tax bracket, beneficiary of estate and spousal trust Natalia – individual, employee of partnership, beneficiary of estate and spousal trust Ernie – individual, highest tax bracket, beneficiary of estate and spousal trust Harry - executor Partnership – LLP, income of $380K Trust (Cottage) – spousal testamentary trust, taxed in highest bracket, December year end Trust (Josephine’s estate) – graduated rate estate, graduated rates, off calendar year end possible Client: Harry Objectives: Harry wants assistance/advice on filing requirements/responsibilities as executor of Josephine’s estate. Harry wants firm to prepare tax returns for Josephine and her estate for 2023 and 2024 Harry and Ernie want to wind up the investment holding company and want to know how much tax will be paid on the wind up. Partner wants a memo addressing above, explain tax returns to be filed, identify income/TCGs to be included/filing due dates, identify tax saving opportunities, information needs to be collected, summary of tax cost amounts/ACB calculation for partnership interest. Timeline: 2015 – cottage purchase 2021 – rental condo purchase/investment holdco incorporated January 1, 2023 – ACB partnership interest $350K November 25, 2023 – dividend declared $5K December 1, 2023 – Josephine’s death December 31, 2023 – eligible dividend paid December, 2023 – life insurance $100K January, 2024 – RRSPs $472K paid to estate February 1, 2024 – Now Future – rental of cottage, wind up of corporation Part (B) Identify the Issues: Issue 1 What tax returns is Harry responsible for as executor for Josephine and what are the filing due dates for those returns • Terminal • Rights & things • Estate • Investment holding company • Spousal testamentary trust return Issue 2 What income amounts are included on each of the returns identified in Issue 1 • Partnership income • Rental income – condo • Dividends from investment company • RRSPs • Life insurance proceeds • Future rental income – cottage

Solutions to Chapter 19 Assignment Problems

613

Issue 3 What taxable capital gains are included on each of the returns identified in Issue 1 • • • •

Partnership interest held by Josephine at the date of death Rental property Cottage (to be held in trust) Common shares in investment company

Issue 4 Wind up of investment holding company •

Describe the tax treatment of a future winding up of the investment holding company. o Prepare a quantitative analysis of the disposition of the assets of the company on wind up and the cancellation of the common shares using the values provided. o Determine the tax liability on the wind up of company.

Part (C) Analyze the Issues Issue 1 What tax returns is Harry responsible for as executor for Josephine and what are the filing due dates for those returns Terminal • Filing due date – later of 6 months from date of death – June 1, 2024 or normal filing due date (June 15, 2024) (if the partnership income is on the R&T return the normal due date is Apr 30th and the filing due date would be June 1, 2024. ) • Tax payment due date – June 15, 2024 (if the partnership income is on the R&T return the payment due date would be June 1, 2024). Rights & things • Filing due date – later of 1 year after date of death December 1, 2024 and 90 days after assessment of any return for the year of death (terminal return) • Tax payment due date – June 15, 2024 if partnership income is on the R&T return. Estate • • • •

Designate as GRE Taxed at graduated rates Can choose an off calendar year end if desirable Filing/tax payment due date – 90 days after year end

Investment holding company • Filing due date – June 30, 2024 • Tax payment due date – February 28, 2024 – company is not eligible for 1-month extension because the SBD is not available Testamentary Spousal Trust • Calendar year end • Taxed at highest marginal tax rate • Filing due date/tax payment due date – 90 days after year end

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Issue 2 What income amounts are included on each of the returns identified in Issue 1 Partnership income • The stub period income to the date of death of $174,167 ($380,000 x 11/12 x 50% can be included on a separate rights and things return. • This is beneficial to take advantage of graduated tax credits and duplicate personal creditsThe December partnership income allocation of $15,833 would be reported on the GRE return. (calculation assumes distribution of partnership interest to Natalia by January 1, 2024) • Note: The $15,833 of partnership income may be included on Natalia’s return if the partnership interest is transferred directly to her on Josephine’s death. • Rental income - condo • 11 months of rental income of $160,600/2 = $80,300 must be included on Josephine’s terminal tax return • Not possible to deduct CCA on the terminal return as property is deemed disposed of on death (see below) • December rental income and any future rental income before the property is distributed to Ali (net of CCA) must be included on the GRE return. Dividends from investment company • The declared/unpaid dividend of $5,000 can be included on the rights and things or the terminal return • It is an eligible dividend and would be grossed up by 1.38. A DTC equal to the gross up will be available on the return • The tax on the dividend will be minimized if included on terminal return as a marginal tax rate of 18.6% rather than 25.5% will apply (because the stub period partnership income will be on the R&T return. Life insurance proceeds • Life insurance proceeds received by Josephine’s estate are not taxable. Rental Income - cottage • Taxable on spousal testamentary trust return at highest marginal tax rate or if income is distributed to Ali then taxed on Ali’s return. • CCA can be deducted. • Cottage will be included in Class 1 at the $350,000 ACB/CC and can be depreciated at a CCA rate of 4%. Neither accelerated CCA or the ½ year rule will apply as the cottage is acquired from Josephine who is a non-arm’s length person. However, as Ali is likely to want to use his PRE in the future, CCA should not be claimed. RRSPs • Included on Josephine’s terminal return unless a joint election between the executor (Harry) and the beneficiary (Ali) is filed – Form T2019 • If the election is filed, the FMV of RRSP of $472,000 will be included on Ali’s 2024 personal tax return. • If the election is filed, Ali can receive an offsetting deduction under paragraph 60(l) on his 2024 personal tax return as long as the funds are transferred to his own RRSP by March 1, 2025. • This will not impact Ali’s RRSP contribution room.

615

Solutions to Chapter 19 Assignment Problems

Quantitative:

Terminal Return Income Stub period partnership income ($380Kx11/12x50%) Rental income ($14,600x 50% x 11 months) Taxable dividend from Holdco ($5,000x1.38) RRSP (joint election with the estate) Investment company wind up dividend x 1.38 TCGs/(ACLS) Partnership interest ($300,000 - $404,167)x.5 Disposition of Rental Property Cottage Disposition of Shares in Investment holding company

2023 Rights & Things Return

2024 Estate Return (GRE) - choose November 30, 2024 yr end

174,167

15,833 87,600

80,300 6,900 0

71,053 -$52,083 0 22,100 57,217

174,167

Allowable capital loss (wind up) (only available against TCGs in GRE or can carryback to terminal return)

174,486

(22,100)

Conclude: Executor is responsible for filing Josephine’s terminal return and the rights and things return and to make the tax payments prior to distributing the properties in the estate. A clearance certificate should be requested and received from CRA before properties are distributed. The estate should be designated as a GRE. A calendar year end could be chosen for income received in December, 2023 to take advantage of graduated tax rates. Alternatively, a November 30, 2024 year end i.e. 1 year from the date of death can be chosen. The November 30, 2024 year end allows a carryback of the loss under SS 164(6) on the wind up of the investment holding company to the terminal return. Tax can be minimized by filing a R&T tax return to include the stub period partnership income. The dividends are best included on the terminal return instead of the rights and things return as a lower tax rate will apply. A joint election between Harry and Ali should be filed to ensure the RRSP is not taxed on the terminal tax return. Ali needs to ensure he transfers the amount into his RRSP to receive an offsetting deduction on his 2024 personal return.

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Introduction to Federal Income Taxation in Canada

Issue 3 What taxable capital gains are included on each of the returns identified in Issue 1 Partnership interest held by Josephine at the date of death •

A deemed disposition at FMV of $300,000 at the time of death because property is to be distributed to Natalia (daughter) The ACB of the partnership interest must be determined to calculate the capital gain on death. Drawings reduce the ACB and partnership income allocated to Josephine increase the ACB There is an allowable capital loss of $52,083 [$300,000 - $404,167] x 50% The ACB of Josephine’s partnership interest at the time of death is calculated as follows:

• • • •

ACB Partnership Interest ACB Drawings Income

• • •

$350,000 -120,000 174,167 $404,167

Allowable capital losses can be used against any source of income in the year of death. As a result, it is possible to use the loss against the TCG on the disposition of shares of the investment holding company as well as the net rental income reported on the terminal return. The ACB of the partnership interest as of December 31, 2023 will be the FMV at the date of death of $300,000 + partnership income for December of $15,833 = $315,833.

Rental property • • •

Ali is the beneficiary of the jointly owned rental property Deemed disposition at tax cost to Josephine Disposition of Rental Land PofD ACB CG TCG UCC LCP Recap/TL

•

190,000 190,000 -

Building 175,000 - transfer to Ali on death at ACB (50%) 325,000 no CL on depreciable property 175,000 - transfer to Ali on death at UCC - 175,000 - no CCA in year of disposition -

Ali will own a rental property with land and building with an ACB/CC of $380,000 and $650,000 respectively. The UCC of the rental property for Ali will be $350,000 for purposes of calculating future CCA deductions.

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Solutions to Chapter 19 Assignment Problems

Shares of investment holding company disposition • •

Ernie is the beneficiary of the shares in the investment holding company. A deemed disposition at FMV occurs on Josephine’s death and a TCG of $25,000 will be reported on the terminal return.

Shares of Holding Co. PofD ACB CG

- transfer to Ernie on death at FMV

74,200 30,000 44,200

Ernie’s ACB will be $74,200 and will be relevant when calculating a capital gain/loss on the disposition of the shares on winding up. Cottage (to be held in trust) • •

• •

The cottage to be transferred to a spousal testamentary trust A spousal testamentary trust as long as under the terms of the trust; o Ali is entitled to receive all of the income of the trust that arises before his death (this should be verified) o No person other than Ali can receive or obtain the use of the income or capital of the trust i.e. the cottage or cottage rental income. The trust will have a calendar year end and be subject to the top tax rate. Deemed disposition at the adjusted cost base as follows; Disposition of Cottage

PofD ACB CG •

350,000 350,000 -

The ACB of the cottage to the spousal trust will be $350,000. On Ali’s death, the property will be deemed disposed of at FMV and the resulting TCG can be included on Ali’s terminal return or the trust return. The PRE should be considered at that time.

Conclude: The dispositions impacting Division B income on Josephine’s terminal return relate to the disposition of her interest in the partnership and the disposition of the shares in the investment holding company. An allowable capital loss results and can be deducted against the rental income for the year and the TCG on the disposition of the shares of the investment holding company. All of Josephine’s other capital properties will transfer to Ali and the spousal trust at tax cost. It would not make sense to elect out of the automatic rollover on either the cottage or the rental property as a significant tax liability would result on the terminal return.

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Introduction to Federal Income Taxation in Canada

Issue 4 Wind up of investment holding company Describe the tax treatment of a future winding up of the investment holding company. o

On a wind up of the investment holding company, there will be a deemed disposition of all of the investments at FMV at that time. We have used $81,000 as an estimate of the FMV of the investments on wind up (per the most recent investment statement). The cash in the corporation will be used to pay off the liabilities including the tax liability in the corporation. The deemed disposition of the investments will result in a taxable capital gain, increase in the capital dividend account and non-eligible RDTOH balance.

The cancellation of the shares is a disposition of the shares of the corporation treated as a share redemption. There will be a deemed dividend on wind up and capital loss on the cancellation of the shares. As the company has GRIP, part of the dividend can be designated as an eligible dividend and will be subject to a lower marginal tax rate. The rest of the dividend will be a non eligible dividend.

If the wind up happens before the distribution of the shares to Ernie, the taxable dividend on wind up will be taxed in the GRE at graduated tax rates. If the wind up occurs after the shares are distributed to Ernie, the dividend will be taxed in the highest tax bracket.

Prepare a quantitative analysis of the disposition of the assets of the company on wind up and the cancellation of the common shares using the values provided.

(A) Opening balance Cash Cash Investments Inventory Land, Note 2 Building, Note 3 Dividend income (January) Liabilities Income tax, Note 4 Dividend refund

(B) Funds available for distribution Less: paid-up capital Deemed dividend on winding-up (s. 84(2)) Less: capital dividend elected under s. 83(2) (s. 88(2)(b)(i)) Deemed taxable dividend (sufficient to clear RDTOH balances)

Proceeds

Business Income

20,000 81,000

1,560 1,100 6,186 6,864 $102,138

Investment Income

Capital Dividend 10,000

10,650

ERDTOH 3,000

NERDTOH

598 $3,598

3,266 $3,266

1,560 -

102,138 30,000 72,138 20,650 51,488

12,210 6,186 50.67%

$20,650 9,386 8,520 Dividends needed to clear GRIP 7,800 31-Dec-23 1,560 Jan dividends 9,360

619

Solutions to Chapter 19 Assignment Problems

Determine tax on the wind up of the company. (B) Funds available for distribution

102,138

Less: paid-up capital Deemed dividend on winding-up (s. 84(2)) Less: capital dividend elected under s. 83(2) (s. 88(2)(b)(i)) Deemed taxable dividend (sufficient to clear RDTOH balances)

30,000 72,138 20,650 51,488

(C) Calculation of taxable capital gain on the disposition of shares on the winding-up: Actual proceeds from distribution Less: deemed dividend Proceeds on disposition (s. 54) ACB Capital gain Taxable capital gain (allowable capital loss)

102,138 -72,138 30,000 -74,200 -44,200 -22,100

Net cash retained subsequent to winding-up: Funds distributed on wind-up Eligible dividend designated $9,360 @ 31% Non eligible dividend ($51,488-$9,360) @42.5%

$20,806

$102,138 2,902 $17,904

After-tax cash from wind up $81,332 [uses highest marginal rates which assumes wind up after distribution to Ernie who is in the highest tax bracket. Amount is lower if wind up (as recommended) before the distribution of properties to beneficiaries]

Conclude: The wind up of the corporation will result in a tax liability of $20,806 if the wind up dividend is taxed in Ernie’s highest tax bracket using our FMV estimates for the investments. If the wind up occurs prior to the distribution of the shares to Ernie from the estate, the tax rates applicable to the wind up dividend will be lower as much of the dividend will fall into the second highest instead of the top tax bracket. The choice of year end for the GRE and the timing of the wind up should be considered to ensure the wind up dividend is taxed at lower marginal rates. [Ideally an off calendar year end should be chosen so that the wind up dividend is taxed in the Estate at graduated tax rates and the loss on wind up can be carried back to the terminal tax return.] Part (D) Recommendations/Advice: • • • •

• • •

Harry should file a terminal, rights and things and estate return for Josephine, pay the tax and obtain a clearance certificate from CRA. To minimize tax, the stub period partnership income should be reported on the rights and things return. The dividend should be reported on the terminal return. The estate should be designated as Josephine’s graduated rate estate and should be maintained for the 36 months to take advantage of graduated tax rates on rental income. The rental property should be held in the estate for the 36 months. The year end for the GRE could be chosen to be December 31, 2023 to minimize tax through the use of graduated tax rates. Once the final income information and wind up dividend for the investment holding company is determined we can finalize the optimal year end date choice for the GRE to minimize tax (ideally November 30, 2024 to allow for the carryback of the loss from the windup of the investment holding company). Harry as executor and Ali as beneficiary should file a joint election to have the RRSP’s taxed on Ali’s personal return. Ali should transfer the RRSP amount into his own RRSP by March 1, 2025 to obtain the 60(1) deduction. The investment holding company should be wound up into the GRE before the shares are

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Introduction to Federal Income Taxation in Canada distributed to Ernie, to take advantage of the lower marginal tax rates applicable to the wind up dividend if the wind up occurs before properties are distributed to the beneficiaries. And to also allow a carryback of the loss to the terminal return. A capital dividend election should be filed to ensure part of the wind up dividend is treated as a capital dividend. The timing of the wind up when the value of the shares is low would ideally minimize the tax on the deemed disposition of the investments on wind up and reduce the winding up dividend and related tax liability.

CHAPTER 20

International Taxation in Canada Solution 1: Canadian Income of Non-Resident Individual Jaileah will be taxable on taxable income earned in Canada in 2023 because she will be deemed to have been employed in Canada under p aragraph 115(2)(c.1). Taxable income earned in Canada will be computed under subsection 115(1) and taxable under Part I. She will need to file a Canadian income tax return to report the signing bonus of $25,000. For 2024, Jaileah will not be deemed a resident as she will not sojourn in Canada 183 days or more. Her $55,000 salary will be included in taxable income under subsection 115(1) and taxable under Part I. Both years she will be entitled to the personal tax credits for CPP and EI. She will not be entitled to personal tax credits available to residents, such as the basic personal amount, since less than 90% of her world income is from a Canadian source. Employment income for Canadian tax purposes will consist of the $55,000 salary from the Toronto Metros and the $25,000 signing bonus received under subsections 5(1) and 6(3), respectively. The $5,000 paid to the agent is not deductible for Canadian tax purposes, as there is no provision for such a deduction in section 8 of the Income Tax Act. The $100,000 earned in England will not be subject to any Canadian tax. In addition to federal income taxes, she will also be liable for provincial taxes in Ontario.

617

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Introduction to Federal Income Taxation in Canada

Solution 2: Sale of Property by Non-Resident Individual (A) As Kresna is non-resident and has disposed of taxable Canadian property, she is required to file Form T2062 either before the proposed transaction is completed, or within 10 days of its completion unless the property is excluded property. [Excluded property includes treaty-exempt property.] The Canada–Kenya Tax Convention should be referred to in order to determine whether the property is treaty exempt. Payment of a withholding tax, computed at 25% of the difference between the sale price and the ACB of the property, must accompany the T2062. Proceeds ACB Gain Tax Withheld S. 116 (25%)

$100,000 35,000 $ 65,000 $ 16,250

Generally, the lawyer handling the transaction will pay the withholding tax from the proceeds she receives in trust from the purchaser. Under subsection 2(3), Kresna is taxable in Canada because she has disposed of taxable Canadian property. She should file a Canadian non-resident return as soon as is practical after the end of the year. She will declare a taxable capital gain on the sale of the property and claim a credit for the 25% withholding tax against the taxes owing. Kresna will be liable for additional federal tax of 48% of the federal tax in lieu of provincial/territorial tax per subsection 120(1). Proceeds of Disposition Selling Costs Net Proceeds Adjusted Cost Base Capital Gain Taxable Capital Gain

100,000 (

Federal Tax (15%) Additional Fed Less: T Re (B) In all probability, Kresna’s agent has not been remitting the 25% non-resident withholding tax to the federal taxation authorities on the rents. The withholding tax is required under paragraph 212(1)(d). For example, assuming the property was rented for $1,000 a month, the annual withholding tax is $3,000. Kresna should be advised to pay the assessment, but then file tax returns for the current and the past two years, reporting the net rental income. She is entitled to do this under subsection 216(1). The time limit to file is two years from the end of the taxation year, so returns can be filed for all three years. Her actual tax liability will in all likelihood be less than the withholding tax, and she is entitled to a refund of any excess tax paid. Should the assessment be for more than three years, then any withholding tax for preceding years cannot be recovered.

Solutions to Chapter 20 Assignment Problems

619

Solution 3: Canadian Income of Non-Resident Corporation (A) Section 253 will deem USCO to be carrying on business in Canada in the year because it currently solicits orders through an agent (three employees) in Canada through the office. The U.S. company solicits sales in Canada, has inventory in Canada, and has an office and employees in Canada. Under common law, it is likely that USCO would be considered to be carrying on business in Canada because the Toronto office would be considered to be a “location of the operations from which profits arise”. As a result, USCO will be required to file a tax return and be taxed on its taxable income earned in Canada as calculated under subsection 115(1) and under paragraph 4(1)(b). This income will be subject to the general federal corporate tax rate of 38% under subsection 123(1), which applies to all corporations. Furthermore, the general deduction from tax of 13% will apply in 2023. (B) The provincial abatement of 10% will apply if the corporation has taxable income earned in a province. Regulation 402(3) indicates that where a corporation had a permanent establishment in a particular province and no permanent establishment outside that province, the whole of its taxable income for the year is deemed to have been earned therein. The definition of permanent establishment is in Regulation 400(2) and indicates that it means a fixed place of business of the corporation including an office. As USCO had a loss in the previous year of $4,000, the loss can be used to reduce the taxable income to $256,000 under paragraph 115(1)(d). All of the $256,000 of taxable income would be considered taxable income earned in a province. As a result, the federal tax rate applicable to the income would be 15% and the provincial rate would be 12% for a total rate of 27%. Therefore, the tax owing will be $69,120. USCO will also be required to pay branch tax under subsection 219(1) of the Act. Per subsection 219(1), the tax applies to every non-resident corporation. It will only result if the non-resident corporation earned taxable income in Canada and only if the income less taxes is not reinvested back into Canada in the form of an investment allowance as defined in Regulation 808. Subsection 219(1) would calculate branch tax at $2,000 equal to: 25% of $8,0001 calculated as: Corporation’s taxable income earned in Canada Prior year’s investment allowance Less: Income taxes payable under Part I and provincial tax Investment allowance for the year (see below)

$256,000 2,000

$258,000

$ 69,120 180,880

250,000 $ 8,000

Investment Allowance per Regulation 808 Cost amount of each depreciable property owned in Canada used to produce income Cost amount of each property that was described in the corporation’s inventory Cost amount of each debt owing to it for a transaction by virtue of which an amount has been included in computing its income for the year Cost amount of “allowable liquid assets” Less: Amount owing to purchase depreciable assets/inventory Amount owing for an outlay or expense made or incurred by the corporation to the extent it was deducted in computing income for the year Amount of tax payable under Part I and provincially

$200,000 400,000 150,000 50,000

800,000

$150,000 400,000 69,120

619,120 $180,880

“Allowable liquid assets” is computed as the lesser of 1) cash at the end of the year and 2) 4/3 of the average of cash balances at the end of each month in the year.

The calculation represents the income earned by the corporation for the year that was not reinvested into the branch operation.

Introduction to Federal Income Taxation in Canada

620

(C) USCO has an office in Canada. An office is a permanent establishment under paragraph 2, Article V of the treaty if it is a fixed place of business under paragraph 1. Three conditions must be met: 1) 2) 3)

There must be a place of business. The office is under the control of the U.S. company and it is at its constant disposal. The place of business must be fixed. The office appears to be permanent. The business of the non-resident must be carried on through the fixed place of business. Employees are carrying on the U.S. company’s business through the office.

Impact on Canadian Return There is no impact on the corporation’s Part I tax liability. The Canada–U.S. Tax Convention confirms Canada’s right to tax the income from carrying on business in Canada where the business is carried on through a permanent establishment. Article X, paragraph 6 of the Canada–U.S. Tax Convention indicates that nothing in the convention prevents Canada from imposing a branch tax on earnings of a company attributable to a permanent establishment in Canada provided that the tax does not exceed 5% of the amount of earnings not subject to branch tax in prior years. Earnings would be calculated as: Business profits attributable to permanent establishments in Canada in the year and previous years Less: Business losses attributable to such permanent establishments in the year or previous years Less: Taxes imposed on such profits Profits reinvested in Canada determined in accordance with the provisions of the laws of Canada regarding the computation of the allowance in respect of investment in property in Canada Exemption

$260,000 (4,000)

256,000

$69,120

180,880 500,000

(750,000) $0

Therefore, USCO would not have a branch tax liability. The treaty exempts the first $500,000 of earnings not reinvested in Canada from branch tax. A treaty disclosure note would be attached to the Canadian tax return to recognize this fact (See Schedule 91 and 97 of the T2).

Solutions to Chapter 20 Assignment Problems

621

Solution 4: Canadian Income of Non-Resident Individual Sally Juarez appears to be a non-resident for Canadian tax purposes. Sally’s Canadian income tax return using 2023 figures and tax rates: Business income (from partnership) (Note 1) Business income from sale of raw land (Note 2) Taxable capital gain on sale of real estate (Note 3) Total income

$ 7,000 60,000 $67,000 15,000 $82,000

Federal tax (Note 5)

$13,875

Personal tax credits (Note 4) Additional federal tax (Note 5) Provincial tax (Note 6)

— 1,218 6,973

Total income tax

$22,067

Income tax withholdings Balance of tax owing

$(7,500) $14,567

Other tax requirements (Note 7) Part XIII withholding taxes at 25% (or tax treaty rate) on: Dividends Tax at 25% $ 1,250

(50%)

$5,000

Notes: 1. Robinson, 98 DTC 6065 (F.C.A.), held that partners carry on the business of a partnership. 2. Per paragraph 253(c), a person who disposes of property (other than capital property) that is real property situated in Canada is deemed to have been carrying on business in Canada in the year. 3. The gain of $15,000 on the Public Co Ltd. shares is not taxable in Canada as these sh a r es are not taxable Canadian property assuming more than 50% of the value of the shares is not derived from real property situated in Canada. The real estate is taxable Canadian property. 4. Sally is not entitled to any personal tax credits as less than 90% of her worldwide income is included in computing her taxable income earned in Canada for the year and there is no indication that she otherwise qualifies for personal tax credits that may be claimed by non-residents. 5. Federal tax is calculated as 15% of $53,359 plus 20.5% of ($82,000 - $53,359). Additional federal tax is calculated as 48% of ($15,000/$82,000 × $13,875 [ssec. 120(1)]. 6. 10% of $53,359 plus 12% of ($67,000 - $53,359). 7. No withholding tax on interest or any other Canadian tax liability.

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Introduction to Federal Income Taxation in Canada

Solution 5: Individual Becoming a Non-Resident The following details the Canadian compliance and planning issues related to Cal’s move to Indonesia. Child Support Child support is not included in taxable income in Canada. There will be no withholding tax required from this income, nor any other Canadian tax liability. RRSP If Cal deregisters the RRSP before leaving Canada, the $75,000 will be included as income in his final (departure) income tax return. The income taxes on the $75,000 will be based on his marginal tax rate in that return. There is no deemed disposition of the RRSP on emigration. If he deregisters the RRSP after leaving Canada, there will be a 25% withholding tax on the $75,000, and that represents his complete tax obligation to Canada on the RRSP. He would have an option to elect to file a Part I return [ss. 217(2)] if beneficial. This would be beneficial if the tax on the return were lower than the withholding tax. GIC The interest is not subject to withholding tax or any other Canadian tax liability [par. 212(1)(b)]. Shares of CCPC Any dividends that he receives from the shares while non-resident are subject to a 25% withholding tax. Cal will be deemed to have disposed of the CCPC shares upon emigration for their fair market value of $145,000, which will lead to a capital gain of $144,000 and a taxable capital gain of $72,000 that will be included in his departure year tax return. However, Cal can elect to defer paying the tax that results from the deemed disposition rule. The election must be made on or before the balance due date for the departure year. Security is required with the election because his capital gains resulting from the deemed disposition rule are more than $100,000. Cal will be required to post security with the CRA. If the election is made, the payment of the tax in respect of the departure capital gain will be deferred without interest until the shares are actually sold. The adjusted cost base of the shares will be increased to the deemed departure amount of $145,000, so any gain or loss on the actual sale of the shares will be computed by reference to this new adjusted cost base for Canadian tax purposes. When Cal sells the shares in the future, the shares will be taxable Canadian property if more than 50% of the value of the shares is derived from real property situated in Canada in the preceding 60-month period. In such case, the gain will be taxed in Canada and 116 withholdings will apply unless the gain is exempt from tax in Canada under a treaty. Principal Residence The real estate will not be subject to the deemed disposition rule upon emigration. When he rents the property, there will be a deemed disposition at fair market value because of the change in use to an income-producing property unless an election is f i led to deem the change in use not to have occurred. I f he does not f i le the e lection, he will be required to include any taxable capital gain on change in use on a Canadian return under subsection 115(1) as the property is taxable Canadian property. If he is a non-resident at the time, he will be required to file a T2062 request and remit a 25% withholding tax on the gain. This withholding tax is then used as a credit against any actual tax as calculated in the Canadian tax return. He will be able to claim the principal residence exemption for the years prior to emigration. On the sale of the property, he will be required to include any taxable capital gain or allowable capital loss on a Canadian return as the property is taxable Canadian property. The gain will be calculated using an adjusted cost base equal to the fair market value at the time of the deemed disposition from the change in use. He will be required to file a T2062 request and remit a 25% withholding tax on the gain.

ITA: 45(1)(2)

ITA: 116(1)

ITA: 115(1)(a)-(d) ITA: 45(1), 116(1)

Solutions to Chapter 20 Assignment Problems The ongoing rental income is taxable when paid/credited to him. There is a 25% withholding tax on the gross rents. Alternatively, Cal can file a Canadian tax return pursuant to section 216, reporting the rental income (net of expenses including CCA), and pay taxes at the marginal rate. This return is separate from any other tax return he may be required to file and is due within two years of the relevant taxation year. The tax calculated in that return is likely to be substantially less than the 25% withholding tax (due to recognition of expenses). He will receive a refund of the difference. Note that CCA would only be claimed if the gain was realized on the change in use when he began renting it, i.e., a subsection 45(2) election was not filed. Another alternative is for Cal to file an undertaking (NR6) before the first rental payment for each year to file a Canadian tax return within six months of the relevant taxation year. If he does this, then his brother can remit the withholding tax based on 25% of the amounts available (after expenses excluding CCA). If Cal does not file the required tax return, his brother is liable for the full 25% withholding tax (i.e., on the gross rents), although he can legally recover that from Cal. Effective January 1, 2022, a non-resident owning Canadian residential real estate that is considered vacant or underused is required to complete an annual declaration and pay a 1% Underused Housing Tax (UHT). As Cal is a Canadian citizen he is an excluded owner and would not be required to file the declaration or pay the tax. Provincial Tax As there is no Canadian business or employment income, there is no provincial or territorial tax due on any of the above noted income returns. Cal will pay additional federal taxes at the rate of 48% of federal tax instead of provincial tax.

623

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Introduction to Federal Income Taxation in Canada

Solution 6: Transfer Pricing Transactions with SNI Section 247 of the Act requires that transactions between non-arm’s length persons be made under arm’s length terms and conditions. CRA requires a taxpayer to choose a pricing methodology that will reflect the arm’s length principle and provides a hierarchy of methodologies to be considered. Note that the OECD transfer pricing guidelines recommend the method that is most appropriate in the circumstances but indicates that traditional transaction methods are preferable to transactional profit methods. Transactional profit methods are to be used when traditional methods cannot be reliably applied to applied at all. The following webpage provides CRA administrative guidance in regards to transfer pricing. https://www.canada.ca/en/revenue-agency/services/tax/international-non-residents/information-beenmoved/transfer-pricing.html Comparable Uncontrolled Price (CUP) Method The method that provides the highest degree of comparability is the comparable uncontrolled price (CUP) method. This method is used when it is possible to find a sale of the same product by the taxpayer, or another member of the group, in similar quantities and under similar terms to arm’s length parties in similar markets. There are several possible CUPs in this circumstance: 1) The sale of drawer slides by SI to European distributors before the AOC; 2) The sale of drawer slides by SI to arm’s length distributors in Canada; 3) The sale of drawer slides by SUSI to arm’s length distributors in the U.S.; 4) An external comparable if one could be found; and/or 5) The sale of ergonomic products to SUSI by SI before the AOC of SUSI. The following information would need to be verified to determine if any of these transaction streams could be used as a CUP: 1) Are the sales in similar quantities and under similar terms as sales to SNI? Could reasonable adjustments be made for differences? 2) Is SUSI selling a comparable product? Ergonomic products are unlikely to be similar enough to provide a CUP. 3) Is a competitor selling the same product to distributors? Could information be obtained on prices charged/paid by the competitor/distributor? 4) Does SNI purchase drawer slides arm’s length? 5) There appears to be a market level difference. Currently SI sells to Canadian distributors who likely sell to end-users. In the non-arm’s length transaction, SI is selling to SNI who is selling to distributors who sell to end-users. Therefore, it is unlikely that these transactions could be used as a CUP as it would be difficult to make appropriate adjustments for market differences. It would be necessary to confirm whether SI’s distributors and SUSI’s distributors sell to other distributors (this information may be difficult to obtain). It is unlikely that any of these transaction streams are suitable internal CUPs due to market level differences. You should also check with the client to see if there is any information available on external CUPs. For example, is a competitor selling to an arm’s length distributor in Europe that sells to other distributors. It would be very unlikely that the client would have this information. Note that in the future when SNI acts as a distributor of product to the end-user, the market level difference will no longer be a factor. If the other attributes of the transactions are comparable, these streams may be an appropriate CUP in future years. Resale Price Method The resale price method establishes a gross margin that a taxpayer may expect as a reward for the functions performed, assets used, and risks assumed. Product differences are less important. The resale price method is more appropriate if the least complex party is a distributor. A functional analysis would likely show that SNI’s distribution division is the least complex party in the transaction between SI and SNI as its activities are likely restricted to selling activities, it does not own intangibles and risk is limited to collection risk. To determine an appropriate gross margin for SNI, it would be necessary to find a margin earned by a member of the group or an arm’s length enterprise in comparable uncontrolled transactions. The only apparent transaction stream in the SI group per the facts above that would provide this margin would be the purchase and resale of curtain rods by SNI. The following information would need to be verified to determine whether the gross margin percentage of 35% earned by SNI on this transaction stream would be appropriate to use for the purchase and sale of drawer slides from SI:

Solutions to Chapter 20 Assignment Problems

625

1) Are curtain rods sufficiently similar to drawer slides to be able to justify the use of this transaction stream as comparable? 2) Does SNI perform the same functions and assume the same risks for the distribution of the curtain rods? If not, is it possible to make adjustments to the margin for this? 3) Are the quantities of curtain rods sold similar to drawer slides or is the curtain rod distribution business just an insignificant side business? Cost-Plus Method The cost-plus method usually applies when the supplier of the product is the least complex party to the transaction. As SI is a full-fledged manufacturer that performs development activities, it would not be considered the least complex party suitable for the application of the cost plus methodology. It is likely that SI owns valuable manufacturing intangibles. Profit-Split Methods If, after further investigation, you are not satisfied that the uncontrolled transactions would provide sufficient comparability to apply the CUP or resale price methods, it would be appropriate to consider the use of a profitsplit methodology. This method should be used where the operations of two or more non-arm’s length parties are highly integrated making it difficult to evaluate their transactions on an individual basis and the existence of valuable and unique intangibles in both parties makes it impossible to establish the proper level of comparability with uncontrolled transactions to apply a one-sided method. As in this case, the operations of SI and SNI are not highly integrated and SNI does not appear to own any valuable intangibles, the profit-split method would not be appropriate. Transactional Net Margin Method (TNMM) This method appears to be more appropriate than the profit-split method, as SNI does not own valuable intangibles and a one-sided analysis could be performed. With TNMM, you are attempting to compare the net profit margin of SNI to the net profit margin that would be realized by arm’s length parties from similar transactions. If the curtain rod distribution transaction stream is determined to be an appropriate comparable, the resale price method should be used over this method. If not, this method may be considered. Sales would be the appropriate base for the measure of operating profit percentage as SNI would have few costs and assets due to the nature of its operations. The client should be asked if there is any industry data/information available on operating profit margins of distributors in the furniture industry. If not, databases are available to assist in finding comparable data. Four steps would be followed in applying this method: 1) Database search of entities with similar industry classifications. 2) Screening of entities to determine if there are comparable transactions to the tested party. For example, if any of the companies incur research and development expenses, these entities should be excluded. 3) Review detailed information (financial and textual) to determine if entities have comparable transactions. 4) Make adjustments for material differences. Recommendation: Use of the resale price method would be preferred. If the comparability of the uncontrolled transactions is questionable, it may be prudent to also perform a TNMM analysis in support. Transactions with SUSI SUSI does not appear to incur any comparable uncontrolled transactions to the distribution transactions of ergonomic product for SI as it does not distribute product for any other entity. The sales of ergonomic products by SI to Canadian distributors could provide a CUP. It would again be necessary to obtain information on the quantities sold, comparability of the market etc. to support the use of this CUP.

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Introduction to Federal Income Taxation in Canada

If SI is selling the ergonomic product to SUSI at the same prices and under the same terms as prior to the acquisition of the company, these pre-acquisition transactions could provide a CUP as pre-acquisition, the companies were arm’s length. It would be necessary to determine if any functions, risks etc. changed after the acquisition of control to determine whether the pre-acquisition prices would be suitable CUPs at least in the short term. The resale price method could only be applied if information on gross margins of a distributor with similar functions, assets used and risks assumed in the industry were available. The cost plus method is inapplicable as SUSI is the least complex party and SI is the supplier of the product. The profit split method is not appropriate per discussion above. The TNMM should be used if the potential comparable transactions noted above are not appropriate. Information on profit margins earned by companies in the same industry would need to be obtained.

Solutions to Chapter 20 Assignment Problems

627

Solution 7: Transfer Pricing If the CRA was to audit Ergold Ltd., the following adjustments and tax liabilities would result: Year Ended December 31

Adjusted Taxable Income

2021 2022 2023

$150,000 $325,000 $475,000

Adjustment

Tax Liability

$ 350,000 $ 725,000 $ 1,325,000 $2,400,000

$40,500 $87,750 $128,250 $256,500

10% of Gross Revenue

Penalty 10% of Adjustment

$300,000 $650,000 $950,000

$35,000 $72,500 $132,500 $240,000

The 10% penalty will apply because the transfer pricing adjustment for each year is greater than the lesser of 10% of gross revenue and $5,000,000, per subsection 247(3). Furthermore, if Ergold Ltd. is not using transfer prices that are based on the arm’s length principle and cannot support those prices through documentation, the company is subjecting itself to potential audit and substantial tax ($256,500), interest and penalty liabilities. [Note that within the multi-national group this tax could be offset and double taxation prevented if adjustments to reduce income in Sweden are accepted by the Swedish equivalent of the CRA]. Furthermore, if there is a tax audit, the company could incur considerable professional expenses defending itself, and the time involved in going through the competent authority process. Furthermore, it should be pointed out that the tax returns for Ergold would have required the company to file T106 forms that would be used by the CRA to determine if a tax audit should be performed. The company’s losses along with the T106 form indicating that all purchases are non-arm’s length would very likely trigger an audit. Anytime the CRA audits a company that has non-arm’s length transactions, field auditors will request contemporaneous documentation at the outset of the audit. It should also be pointed out to the taxpayer that the normal reassessment period is extended by 3 years ITA: 152(4)(6) for a reassessment related to a transaction between a taxpayer and a non-arm’s length non-resident. The Canadian company has effectively overpaid for goods it received. The overpayment, i.e., the transfer pricing income adjustment would be deemed to be a dividend to the Swedish parent immediately before the end of the taxation year of the adjustment. It will be subject to Part XIII ITA: 2 4 7 ( 1 2 ) tax unless the CRA agrees to waive the withholding tax. The Canada–Sweden tax treaty would reduce the withholding tax rate to 5% ($120,000 = 5% of $2,400,000). If the Swedish company pays an amount to Ergold Ltd. (e.g., 2,400,000 repayment) with the concurrence of the Minister, the amount of the dividend can be reduced by the amount that the Minister considers appropriate having regard to all the circumstances. Interest applies to the Part XIII tax from the time of the ITA: 247(13) deemed dividend payment to the repayment date unless reduced under subsection 247(14) to an ITA: 227(8.3) amount the Minister considers appropriate having regard to all the circumstances. If Ergold Ltd. has intercompany payable balances owing to the Swedish parent that can be used to affect the repayment through a reduction in the balance, any interest deduction on the intercompany balance would need to be adjusted to reflect the lower balance. If a shareholder loan were created instead of an actual repayment taking place, subsections 15(2) and 15(9) would need to be considered in relation to the shareholder loan. Advantages of a Transfer Pricing Study 1) Minimize interest and penalties of prior years if a voluntary disclosure is made. 2) Minimize future tax liabilities by correcting transfer pricing problems now. 3) Increase the efficiency of a CRA audit.

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Introduction to Federal Income Taxation in Canada

Solution 8: Foreign Affiliate, Surplus Balances [ITA: 12(1)(k), 95(1), 95(4), 113(1), 113(1)(b), 113(1)(c), 126(1), ITR: 5900(1), 5900(1)(d), 5901, 5907(1), 5907(11), 5907(11.2)] Part A A foreign affiliate is a non-resident corporation in which the taxpayer’s equity percentage is not less than 1%, and the total of the equity percentages in the corporation of the taxpayer and each person related to the taxpayer is not less than 10%. Equity percentage is the total of the person’s direct equity percentage plus the person’s equity percentage in any corporation multiplied by the corporation’s direct equity percentage in the corporation. Direct equity percentage is the percentage determined by looking at the percentage of issued shares of each class owned by the person and taking the highest percentage. U.S. Co. is a foreign affiliate of A Co. A Co. has an equity percentage in U.S. Co. of 6% (direct equity percentage) plus 8% (100% × 8%) (equity percentage × direct equity percentage) = 14%. Therefore, A Co.’s equity percentage in U.S. Co. is not less than 1%. The total equity percentages in U.S. Co. of A Co. and related taxpayer B Co. is 14% and, therefore, not less than 10%. U.S. Co. is a foreign affiliate of B Co. B Co. has an equity percentage in U.S. Co. of 8% (direct equity percentage). Therefore, B Co.’s equity percentage in the company is not less than 1%. The total of B Co. and A Co.’s equity percentages in U.S. Co is 14% and, therefore, the equity percentage in U.S. Co. of B Co., and each person related to B Co., is not less than 10%. No Treaty Co. is a foreign affiliate of A Co. but not C Co. A Co. has an equity percentage in No Treaty Co. of not less than 1% and not l ess than 10%. No Treaty Co. is not a foreign affiliate of C Co. because although C Co. has an equity percentage of not less than 1% in No Treaty Co.; in combination with related companies (none) C Co. has less than 10% ownership in No Treaty Co. Part B Dividends from a share of a foreign affiliate of a Canadian corporation are included in Division B income. Offsetting Division C deductions in computing taxable income will be available to A Co. for dividends received from U.S. Co. and No Treaty Co. Similarly, offsetting Division C deductions will be available to B Co. for dividends received from U.S. Co. No Treaty Co. is not a foreign affiliate of C Co, and, therefore, a Division C deduction will not be available to C Co. The dividends will be included in income and a foreign tax credit for the withholding tax can be claimed. Part C Dividends from US Co. Exempt surplus is computed as the exempt earnings less exempt losses of an affiliate for any of its taxation years ending in the period starting with the first day of the taxation year in which it last became a foreign affiliate. Exempt earnings include an affiliate’s net earnings for the year from an active business carried on in a designated treaty country. A country is a designated treaty country where Canada and the country have entered into a comprehensive agreement or convention for the elimination of double taxation or a comprehensive tax information exchange agreement (TIEA). A company must be a resident of the designated treaty country under both Canadian common-law principles (mind and management) and under the treaty. U.S. Co. appears to meet both criteria and would be a resident of the U.S. Net earnings are defined as the earnings for the year from that active business minus the portion of any income or profits tax paid in respect of those earnings. As Canada has a treaty with the U.S., U.S. Co. has exempt earnings and its exempt surplus at the time the dividend was received would have been $720,000 ($900,000 − $180,000). (It would be necessary to ensure that the earnings of the company meet the definition of earnings, i.e., computed in accordance with U.S. law, and appropriate adjustments are made. Also note that surplus balances are maintained/accumulated in the foreign currency. A Division C deduction is available to both A Co. and B Co. for the dividends received from U.S. Co., as 100% of the dividends would be considered to have been paid out of exempt surplus. (Note that if some of the whole dividend had been paid from taxable surplus, the dividends received by A Co. and B Co. would have each had an exempt surplus and taxable surplus portion.) A Co. B Co. Dividend Income Inclusion $36,000 $48,000 ITA: 12(1)(k) Division C Deduction (36,000) (48,000) ITA: 113(1)(a) Impact on Taxable Income 0 0

Solutions to Chapter 20 Assignment Problems

629

The dividends received by each of A Co. and B Co. would have been subject to withholding tax at a rate of 15% under the Canada–U.S. treaty, as neither company owned at least 10% of the voting stock of the company paying the dividends. A foreign tax credit for non-business foreign tax withheld on dividends from a foreign affiliate paid to the taxpayer is not available where the taxpayer is a corporation. Dividends from No Treaty Co. No Treaty Co. is not a resident of a designated treaty country. As a result, the exempt surplus of the company will be zero. The taxable surplus of the affiliate consists of its taxable earnings for any taxation year ending in the period beginning with the first day of the taxation year of the affiliate in which it last became a foreign affiliate. Taxable earnings include an affiliate’s net earnings for the year from an active business it carried on in a country. Net earnings are defined as earnings from the active business less any income or profits tax paid in respect of those earnings. Therefore, No Treaty Co.’s taxable surplus when the January 31, 2024 dividends were paid would have been $400,000 ($500,000 − $100,000) and the associated underlying foreign tax would have been $100,000. The whole dividend of $222,000 would have been paid out of taxable surplus, and the dividends received by A Co. would be entirely from taxable surplus. The Division C deduction for A Co. for the underlying tax is the lesser of: a) The underlying foreign tax applicable to the dividend of $26,640 [$222,000/$400,000 × $100,000 = $55,500 × $35,520/$222,000 × (1/.25 − 1)], and b) The dividend out of taxable surplus of $35,520 The Division C deduction for the withholding tax is the lesser of: a) The non-business income tax paid by the corporation applicable to the dividend of $4,262 [$35,520 × 3% × 1/.25], and b) The dividend out of taxable surplus less the deduction for the underlying tax per above of $8,880 [35,520 − $26,640] A Co. will have had the following income inclusion for 2024: Dividends received $35,520 113(1)(b) Deduction (26,640) 113(1)(c) Deduction ( 4,262) Taxable income $ 4,618 Federal tax at 25% $ 1,155 The income from which the dividends are paid is effectively taxed at the Canadian corporate tax rate when distributed. Double tax is eliminated by providing a deduction for the underlying and withholding tax paid to No Treaty. Rather than using a credit mechanism, the elimination of double tax is achieved through a deduction from income for the underlying and withholding tax converted using the relevant tax factor. The result is equivalent to what would have occurred under a credit system if A Co. was taxed on the pre-tax income out of which the dividend was paid with credits for the underlying and withholding taxes as follows: Pre-tax business earnings in No Treaty ($35,520/80%) $44,400 Federal tax at 25% 11,100 Less FTC underlying tax (20% of $44,400) ( 8,880) Less FTC withholding tax ( 1,065) Net Canadian tax $ 1,155 Note that if the foreign tax exceeds the Canadian federal tax, no excess deduction is allowed and no carryforward or carryback is available. Similar to the credit system, the income is taxed at the higher of the Canadian and foreign tax rates. Because No Treaty Co. is not a foreign affiliate of C Co., no Division C deduction is available in relation to the dividends received. As a result, the $19,980 of dividends will be included in income and subject to regular corporate tax rates. A foreign tax credit would be provided for the withholding tax paid of $599. No foreign tax credit is available for the underlying tax. Note that for taxation years beginning after April 7, 2022 a proposed amendment to subsection 95(1) will amend the definition of relevant tax factor. The RTF used for the above calculations will be 1.9 instead of 4 (1/(.38-.13)) because the Canadian corporations are CCPCs. As well, the deductions for dividends received from taxable surplus will not increase the general rate income pool for the corporation. Instead, the capital dividend account will be increased by the 113(1)(b) and 113(1)(c) (net of the withholding tax) deductions and can then be distributed to a shareholder tax free as a capital dividend. The impact will be a higher income inclusion for A Co for the taxable surplus dividend received.

630

Introduction to Federal Income Taxation in Canada

Part D Dividends received from U.S. Co. The Division C deduction available for dividends from a foreign affiliate paid out of exempt surplus reflects an exemption method to eliminate double taxation. Jurisdiction to tax the dividend rests exclusively with the U.S. The rationale for this method is that it presumes that countries that have a treaty or TIEA with Canada have taxed the income from which the dividend was paid at an equivalent rate of tax to the tax that would have been paid in Canada had the income been earned in this country. Therefore, the system should do exactly what the credit system would do, but it is an easier system to implement than providing an indirect tax credit for the underlying tax of the U.S. company. As some of Canada’s treaty/TIEA partners do not impose tax rates as high as Canada, this can cause incentive to invest in lower tax countries. A credit system would prevent this possibility but is more difficult to administer. Canada only allows an exemption method for dividend income arising from active business income of a foreign affiliate in a treaty country or a country with which Canada has entered a TIEA. Many TIEA countries are low-tax jurisdictions. The exempt surplus treatment for active business income earned in a TIEA country is provided by Canada in exchange for the free-flow of information provided through a TIEA. Dividends Received from No Treaty Co. by A Co. The mechanism used in Part B above is a credit method of eliminating double taxation achieved by using the relevant tax factor to convert foreign tax to a deduction that is equivalent to the amount of income that has already been taxed in the foreign jurisdiction. The resulting Division C deductions are equivalent to providing a tax credit for the underlying tax and withholding tax related to the dividend received through the formula provided using a relevant tax factor. This method is complex as it is necessary to determine the underlying tax for each dividend that is paid. Dividends Received from No Treaty Co. by C Co. The mechanism used in Part B above is a credit method of eliminating double taxation. There is a credit provided for the withholding tax but not for the underlying tax. This results in double tax as the income from which the dividend is paid is taxed in the foreign country and is taxed again in Canada when paid out as a dividend. Part E A subsection 113(1) deduction is only available to a corporation. If individuals had received the dividends from U.S. Co., there would have been a Division B income inclusion for the dividends and a foreign tax credit for the withholding tax on the dividends. No credit for the underlying foreign tax would be available.

Solutions to Chapter 20 Assignment Problems

631

Solution 9: Surplus Balances The surplus calculations are as follows: Exempt Surplus Exempt surplus consists of exempt earnings less exempt losses of the company from the date of incorporation to the end of the last taxation year of Trotter ending in Mallot’s December 31, 2023 year end, i.e. October 31, 2023. Exempt earnings (EE) include the affiliate’s net earnings for the year from an active business carried on by it in Canada or a designated treaty country (d). A designated treaty country is defined in 5907(11) to include a country with which Canada has entered into a tax treaty or a comprehensive tax information exchange agreement (TIEA), i.e., entered into force for that taxation year. Net earnings of an FA is the amount of its earnings from active business for the year minus the taxes in respect of those earnings. Exempt losses include an affiliate’s net loss for the year from an active business carried on in Canada. Net loss is defined as the loss from the active business minus the tax refunded in respect of the loss. Sale of Trotter Inc. Equipment EE includes capital gains less taxable capital gains on property other than excluded property, i.e., the full capital gain from dispositions of excluded properties are included (5907(1)(a)(i)—definition of exempt earnings). EE includes capital gains less taxable capital gains for property used to earn ABI in a non-designated treaty country (5907(1)(a)(ii)—definition of exempt earnings refers to 5907(1)(c)(i) of the definition of net earnings). The tax associated with the capital gain reduces EE. Excluded property per subsection 95(1) consists of property of an FA that is used or held principally for the purpose of gaining or producing income from an active business and shares of the capital stock of another FA where all or substantially all of the property of the other FA is excluded property. The equipment sold by Trotter would be considered excluded property for the purpose of subsection 95(1). The full gain on the disposition of the equipment would be included in EE. Taxable Surplus Taxable surplus of a company includes the portion of any dividend received in the period from another FA of the company that was paid out of taxable surplus less any tax paid by the US company in relation to the dividend A(iii) and B(iii). As N is located in a country that is not a designated treaty country, the active business income earned by that company would be considered taxable surplus, and therefore, dividends received by Trotter would be considered to have been paid out of taxable surplus of another FA. Taxable surplus includes FAPI. FAPI includes net earnings (taxable capital gains less tax) from the disposition of shares of another foreign affiliate that are not excluded property of the affiliate (5907(1)(b)(ii))—of the definition of taxable earnings).

Exempt Surplus Share Issuance

Taxable Surplus

Pre-Acquisition Surplus $100,000

Oct. 31, 2019 net earnings from AB

$150,000

Oct. 31, 2020 net earnings from AB

$75,000

Oct. 31, 2020 CG on disposition of excluded property

$80,000

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Introduction to Federal Income Taxation in Canada

Oct. 31, 2020 dividend

($100,000)

Oct. 31, 2021 net earnings from AB

$75,000

Oct. 31, 2021 dividend from N

$150,000 (Tax = $50K)

Oct. 31, 2022 net loss from AB

($150,000)

Oct. 31, 2023 net earnings from AB

$37,500

Total Surplus

$167,500

$150,000

$100,000

Solutions to Chapter 20 Assignment Problems

633

Solution 10: Foreign Affiliate, Surplus Balances Part A Ragyun is not a foreign affiliate of Ms. Ambrose; although her equity percentage is not less than 1%, the total equity percentage with related persons is less than 10%. Ragyun cannot be a controlled foreign affiliate without being a foreign affiliate. [The definitions of "foreign affiliate" and "controlled foreign affiliate" are in subsection 95(1).] Part B Ragyun is a foreign affiliate of Mr. Frank because his equity percentage is not less than 10%. Ragyun is a controlled foreign affiliate of Mr. Frank because the corporation is a foreign affiliate of Mr. Frank that he controls with not more than four arm’s length Canadian residents (Mr. Thomas, Mr. Hassan, Mr. Poinot, and Ms. Ambrose). Note that, even though the shareholders are not related to Mr. Frank, their shareholdings are considered in the determination of the CFA status of Ragyun. Part C Foreign accrual property income (FAPI) [defined in subsection 95(1)] includes income less losses for the year from property, from a business other than an active business, and from a non-qualifying business. It also includes taxable capital gains less allowable capital losses on dispositions of property other than dispositions of excluded property. Ragyun’s FAPI for its October 31, 2023 year end is as follows: Gain on sale of Maya Inc. Dividend and interest income Royalties

$20,000(1) 5,000(2) 25,000(3) $50,000

The taxable capital gain on the disposition of the shares of Tech Inc. would not be included in FAPI as it appears that the shares would be excluded property assuming that all or substantially all of the fair market value of the property of Tech Inc. is excluded property (i.e., used principally for the purpose of gaining or producing income from an active business carried on by it). ["Excluded property" is defined in subsection 95(1).] A taxpayer resident in Canada must include the percentage of FAPI of any CFA equal to the taxpayer’s participating percentage in respect of the affiliate. Participating percentage [defined in subsection 95(1)] is defined as $0 where the FAPI of the affiliate is $5,000 or less. Where FAPI exceeds $5,000, the participating percentage equals the taxpayer’s equity percentage in the corporation. Mr. Frank’s equity percentage in Ragyun is 20%. Mr. Frank’s net income inclusion for 2023 would be: $10,000(4) (2,280)(5) $ 7,720

ITA: 91(4)

The adjusted cost base of Mr. Frank’s shares in Ragyun would increase to $27,720. [par. 92(1)(a)] —NOTES TO SOLUTION (Part C) (1) Income from property includes income for the year from an adventure in the nature of trade. The disposition of the share interest in Maya Inc. appears to be in the nature of income rather than capital due to the short-term speculative nature of the investment. (2) Income from property. (3) Income from property includes income from an investment business [definition in subsection 95(1)]. An investment business includes a business whose principal purpose is to derive income from property (including royalties). An exception is available where the business is the licensing of property and the affiliate employs more than five full-time employees. Ragyun has two employees. (4) 20% of $50,000. (5) Lesser of: (a) $2,280, computed as $7,200 × $50,000/$60,000 × 20% × 1.9 (the relevant tax factor for an individual); and (b) $10,000.

Introduction to Federal Income Taxation in Canada

634 Part D

The January 31, 2024 dividend of $10,560 paid to Mr. Frank affects his 2024 tax return as follows: $10,560(1) (7,720)(2) $ 2,840

ITA: 91(5)

A foreign tax credit would be available for the $1,584 of withholding tax paid on the dividend to Mr. Frank. The adjusted cost base of Mr. Frank’s shares in Ragyun would decrease back to $20,000. Note that the rules work to ensure that the passive income earned by Ragyun in 2023 that was not paid as dividends to shareholders in the year is taxable to any Canadian resident shareholder who has a controlling interest in the corporation. Because of the definition of CFA, Mr. Frank is considered to have a controlling interest in Ragyun. The FAPI rules prevent the deferral of tax on this income. As soon as a dividend is paid, the deduction is available for prior FAPI inclusions to ensure double taxation does not occur. Note that, overall, Mr. Frank has paid tax on a dividend of $10,560 and received a foreign tax credit for the withholding tax on the dividend. Note that only income considered FAPI is taxed on an accrual basis. The taxable portion of the gain on the sale of the Tech Inc. shares is only taxed in Canada when a dividend is received from hybrid surplus of Ragyun Co. —NOTES TO SOLUTION (Part D) (1) $52,800 × 20%. (2) Lesser of: (a) $10,560, computed as 20% of $52,800, the portion of the dividend received by Mr. Frank, and (b) $7,720, the total of net amounts added to the adjusted cost base of the shares before the dividend was received. Part E Ms. Ambrose will receive a dividend of $2,640, which will be included in income in 2024. A foreign tax credit will be available for the $396 of withholding tax on the dividend. She will not have an FAPI inclusion for 2023.

CHAPTER 21

Goods and Services Tax (GST)/Harmonized Sales Tax (HST) Solution 1 : GST/HST Implications (A) Since the corporation is carrying on business, it is engaged in a commercial activity to the extent the sales figures relates to taxable supplies and not exempt supplies which are excluded from the definition of commercial activity. [ETA: ssec. 123(1)] Therefore, the corporation is required to register and collect HST on its supplies, i.e., sales of goods, which are “taxable supplies.” As a registrant, the corporation is entitled to a full input tax credit (ITC) in respect of HST paid or payable on goods and services that it purchases for use in its commercial activity. [ETA: ssec. 169(1)] If HST collected or collectible on its sales exceeds its ITCs, the corporation must remit the difference. On the other hand, if ITCs exceed HST collected or collectible, a refund of the excess is available. Since the corporation’s annual revenue is less than $6 million but greater than $500,000, it will be required to file HST returns on a quarterly basis. It may, however, elect to file HST returns on a monthly basis. (B)(1) The following items listed in the additional information notes represent costs incurred for taxable supplies, eligible for an ITC (if the company makes exempt supplies ITCs would only be allowed in proportion to the taxable supplies): (a) landscaping costs incurred for goods and services (b) costs of arranging a shareholder agreement, which may include, for example, legal fees which are subject to HST (c) legal and accounting fees related to the issue of shares (d) costs of meals and entertainment deducted (i.e., only 50% of the HST paid gives rise to an ITC) [ETA: sec. 236] (e) appraisal fees incurred for service (f) current SR&ED expenditures incurred that would likely be for goods and services (2) The following items listed in the additional information notes represent costs incurred for exempt supplies, not eligible for an ITC, since no HST was paid: (a) employer contributions to a registered pension plan (b) interest on a bank loan that results from a financial service which is an exempt supply [ETA: ssec. 123(1)] (c) interest paid on late municipal taxes that results from a financial service (d) donations involve a transfer of money without consideration [ETA: ssec. 123(1)] (e) insurance premiums are exempt supplies of financial services (f) a bond discount, which is a cost incurred in respect of a financial service and is an exempt supply (g) interest and penalties charged by governments (C) Appropriate HST treatment of other items: • Net income according to financial accounting statements is comprised of revenues and costs (expenses). HST would have been charged on the revenue items (with respect to taxable supplies) and HST would have been paid on the expenses. HST charged net of ITCs from HST paid or payable must be remitted. • There are no HST implications for the provision for income taxes. • A charge to customers for a warranty would be subject to HST, which must be remitted by the corporation collecting it. Expenses incurred under the warranty may be subject to HST, which will provide the corporation with an ITC. Increasing the reserve, by itself, will have no HST consequences. • HST paid on the purchase of depreciable property provides an ITC, as discussed in Chapter 5. When the cost of the asset is subsequently written off through depreciation or capital cost allowance, there are no further HST implications. • The capitalization of SR&ED expenses would not have any HST consequences.

637

638

Introduction to Federal Income Taxation in Canada • As the issue of shares is a financial service, an ITC would not normally be available to the corporation. However, where HST has been paid on services, relief is available [ETA: sec. 185], since the financial service is related to the commercial activities of the corporation. This provision would allow the payer corporation to claim an ITC. • Golf membership fees do not give rise to an ITC, because HST paid on golf membership is not deductible as an expense [ETA: par. 170(1)(a)]. • Amounts paid to employees as remuneration are not supplies, since these amounts are excluded from the definition of services in subsection 123(1) of the ETA. As a result, remuneration is not subject to HST. • Items included in financial accounting statements: i) Insurance premiums are paid in respect of a financial service which is an exempt supply. An amount received from an insurance company under a policy also involves an exempt supply of a financial service. ii) Dividends received involve an exempt supply of a financial service on which no HST is collected. iii) Cash discounts reduce the cost of goods on which HST is paid only where the customer is invoiced for the net amount. However, if the invoice is for the full amount and a cash discount is subsequently taken, the cost of goods on which HST is paid is not reduced. Thus, the payer may claim a full ITC. [ETA: sec. 161] Adjustments made to reflect changes in the consideration payable for a supply arising from volume rebates will allow the supplier to refund the excess HST charged, provided a credit note is issued. Thus, the payer’s ITC will be reduced. [ETA: sec. 232]

Solutions to Chapter 21 Assignment Problems

639

Solution 2: HST Rebate HST rebate 13/ 113 of section 8 deductions excluding zero-rated and exempt items: Car expenses deducted under pars. 8(1)(h) and (j) ................................................................ Less: Acquired car costs with no HST, and CCA: Insurance (exempt) ....................................... Licence (exempt) .......................................... Interest

CCA (see below) $

2,650

667 30 697



35,000 km = 40,000 km



18,000 km = 20,000 km



Add: CCA on car...........................................................

11,222

1,333 90 20 1,207

Leased car costs with no HST: Insurance (exempt) ......................................... Licence (exempt) ............................................

1,207

(2,319)

(627) 8,276

$ $

1,056 9,332 1,074

35,000 km = 40,000 km

HST rebate = 13/113  $9,332 ......................................................................................... Employment income inclusion in year of receipt of rebate [par. 6(8)(c)]: $8,060/$9,116 x $1,049 = $927 Capital cost reduction in year of receipt of rebate [par. 6(8)(d)]: $1,056/$9,116 x $1,049 = $122 The GST employee rebate is claimed by filing form GST370. Notes to Solution (1) Car expense calculations Lease costs (see Note (a)) ........................................................ Gasoline and oil ....................................................................... Insurance.................................................................................. Maintenance............................................................................. Licence..................................................................................... Interest (see Note (b)) .............................................................. CCA.......................................................................................... Deductible car expenses [pars. 8(1)(h) and 8(1)(j)] Acquired car 35,000 km $5,930 = 40,000 km

5,189

Leased car 18,000/20,000 x $6,703 Total car expenses

$ $

6,033 11,222

Acquired car N/A $ 2,880 1,333 400 90 20 1,207 $ 5,930

Leased car $ 4,326 1,440 667 240 30 N/A N/A $ 6,703

640

Introduction to Federal Income Taxation in Canada

Note (a): The car lease costs are subject to the restrictions in section 67.3. Lease cost — Lesser of: (a) ($950  1.13  122/30) – $0 = $ 4,366 (b) ($1,243 x 4 months) x $34,000 x 1.13 = $ 4,326 85% of the greater of (i) $36,000  1.13  100/85 = $47,859 (ii) $55,000 Note (b): The imputed amount of interest is deductible by virtue of section 80.5. The amount is subject to the restriction under section 67.2 that is the lesser of $900 (i.e., $300  90/30) and the $20 deemed paid. The lesser amount is $20.

Solutions to Chapter 21 Assignment Problems

641

Solution 3: HST Rebate GST Rebate The potential GST rebate and subsection 6(8) employment income inclusion: Automobile operating expenses: Deductible car expenses ................................................................. Less: prorated exempt supplies: ................................................ Insurance ($1,050  22500/36000).................................. $ 656 Licence ($120  22500/36000)........................................ 75 Travelling expenses: Meals .............................................................................................. Accommodation .............................................................................

$ 8,031(1)

Rebate: 5/105, therefore, and income inclusion in year of receipt ............

Notes to solution

(1) Automobile expenses: Lease cost(2) ................................... Gasoline and oil ............................. Insurance ....................................... Maintenance .................................. Licence .......................................... Subtotal.......................................... Employment use 22,500/36,000 .... (2) Deductible lease costs [sec. 67.3] lesser of: $950 × 1.12 × 549 (a) 30

(b)

− $4,585

(12 × $850) × $36,000 × 1.12 85% of the greater of:

10,200 1,300 1,050 180 120 12,850 8,031

= $ 14,886 = $ 10,200

(i) $36,000  1.12  100/85 = $47435 (ii) $33,000

731

7,300

$ $

15,600 22,900 1,090

3,600 12,000

642

Introduction to Federal Income Taxation in Canada

Solution 4: GST/HST Author’s Note: This problem addresses the GST/HST implications for problem 6, Chapter 6. The GST/HST solution may be used in conjunction with the solution in Chapter 6 or as a separate assignment. To the extent that property and services are purchased for use in commercial activities, input tax credits in respect of the HST paid on those purchases may be claimed. The expenditures are given the following HST treatment. Expenditure GST treatment Amount ITC @ 13% Land ................................................................. Taxable $ 405,000 $ 52,650 Building ........................................................... Taxable 1,348,000 175,240 Architect and engineer fees .............................. Taxable 9,300 1,209 Building insurance ........................................... exempt: financial service — — [ETA: ssec. 123(1)] Landscaping costs ............................................ Taxable 15,500 2,015 Maintenance..................................................... taxable (unless salaries or wages) 2,500 325 Utilities............................................................. Taxable 6,300 819 Mortgage insurance premium .......................... exempt: financial service — — [ETA: ssec. 123(1)] Relocation expenses......................................... Taxable 34,100 4,433 Property taxes................................................... exempt [Sched. V, Part VI, 21] — — Soil testing ....................................................... Taxable 1,825 237 Utilities service connections ............................ Taxable 3,800 494 Interest on mortgage......................................... exempt: financial service [Sched. V, Part VII] — — Dividends on preferred shares.......................... exempt: financial service [ETA: ssec. 123(1)] — — exempt: financial service Discount on bonds............................................ — — [ETA: ssec. 123(1)] Legal and accounting fees................................ Taxable 18,450 2,399 Commissions.................................................... exempt: financial service [ETA: ssec. 123(1)] — — Articles of amendment ..................................... exempt: financial service [ETA: ssec. 123(1)] — — Total ITC .............................................................................................................. $ 1,844,775 $ 239,821

Note that the ITC in respect of capital expenditures can be claimed for the period in which the tax is paid or becomes payable. As a result, there is no requirement for amortization. Since an ITC represents a recovery of the cost of HST, the amount of HST paid, if any, does not become part of the capital cost of a capital asset such as the building in this case. Similarly, the HST paid is not deductible as an expense because it is recovered through an ITC.

Solutions to Chapter 21 Assignment Problems

643

Solution 5: HST Treatment of Schedule 1 adjustments Author’s Note: This problem addresses the GST/HST implications for problem 24, Chapter 7. The GST/HST solution may be used in conjunction with the solution in Chapter 7 or as a separate assignment. HST treatment: Overview: Since the corporation is carrying on business, it is engaged in a commercial activity [ETA: ssec. 123(1)]. Therefore, the corporation is required to register for and collect HST on its supplies, i.e., sale of goods or other property which are taxable supplies. As a registrant, the corporation is entitled to a full input tax credit (ITC) in respect of HST paid or payable on goods and services that it purchases exclusively for use in its commercial activities [ETA: ssec. 169(1)]. If HST collected or collectible on the company’s sales exceeds its ITCs, the corporation must remit the difference. On the other hand, if ITCs exceed HST collected or collectible, a refund of the excess is available. Specific Items Presented: Land and building — Real property that is capital property [ETA: ssec. 123(1)] of a registrant is referred to as capital real property. Acquisitions of capital real property generate proportional ITCs based on the extent of use in a commercial activity. The capital real property at issue was acquired after 1990, likely, for at least 90% use in a commercial activity. An ITC of 100% of the HST paid or payable on acquisition was available. If capital real property were used exclusively for residential purposes, no ITC would have been available. On the sale of capital real property used in a commercial activity, HST must be charged by the vendor unless the purchaser is a registrant, in which case the vendor is relieved of its obligation to collect tax under subsection 221(1). In such a situation the registered purchaser is required to self-assess (and may be entitled to an equivalent ITC if the capital property is used exclusively in commercial activity. Securities — Securities are financial instruments, the supply of which is considered to be a financial service [ETA: ssec. 123(1)]. A supply of a financial service is exempt from HST. Trademark — A trademark is intangible personal property. On its purchase, the corporation would have paid HST and claimed an ITC. On the sale, the corporation must charge HST on the sale price of $70,000 if the trademark may be used in Canada and the purchaser is resident in Canada or a registrant. (The purchaser, if a registrant, would be eligible for a full ITC in the year that the HST is incurred with no amortization requirement.) Depreciation — Equipment is considered capital personal property. A full ITC is available where capital personal property is purchased after 1990 for use primarily (i.e., more than 50%) in commercial activities. On the sale of such property, the vendor must charge HST. Since ITCs on capital property are not matched with revenue over time, there are no HST consequences to either depreciation for accounting purposes or CCA for income tax purposes. Interest on unpaid income taxes — Interest on unpaid income taxes is a cost incurred in respect of a financial instrument which is an exempt supply. No HST is paid and, hence, no ITC is available. Donations — Donations involve a transfer of money without consideration. No HST is charged on the donation and, hence, no ITC is available. Employee dinner-dance(1) — ITCs in respect of HST-paid expenses on food, beverages and entertainment are allowed in full in the reporting period in which they are incurred. If the expenses had been subject to the 50% limit in section 67.1 of the Income Tax Act, there would be a recapture of 50% of the total ITCs at the end of the registrant’s fiscal year. The amount recaptured would be included in the registrant’s HST return for the first reporting period in the next fiscal year [ETA: sec. 236]. Bad debt — HST relief is available in respect of bad debts [ETA: sec. 231]. Where HST is remitted but not collected on a debt that is subsequently written off, a registrant is permitted to deduct an amount equal to 13/113 of the amount written

644

Introduction to Federal Income Taxation in Canada

off. The $5,000 bad debt must be in respect of a supply made to an arm’s length party which the supplier has actively unsuccessfully attempted to recover . If the debt is subsequently repaid, 13/113 of the recovered amount must be added to net tax by the registrant.

—NOTES TO SOLUTION (1) The $14,000 spent on the annual employee dinner-dance is not restricted by the 50% limitation under section 67.1, since the party was for all employees at a particular location providing the number of similar events is limited to six such events per year.

Solutions to Chapter 21 Assignment Problems

645

Solution 6: GST/HST Implications of a Windup Author’s Note: This problem addresses the GST/HST implications for exercise 8, Chapter 15. The GST/HST solution may be used in conjunction with the solution in Chapter 15 or as a separate assignment. Where a corporation is wound up and the general winding-up rules of the Act apply, the supply of property on the wind-up is subject to GST/HST. GST/HST is payable on any taxable supplies of property. However, an election may be available, in which case the payment of GST/HST is not required. In order to qualify, a registrant must have sold or transferred all or substantially all of the assets used in a commercial activity that is part of a business carried on. Since Dwight Ltd. Is being wound up by Mr. Warren it would qualify for this election. The s. 167 election may apply if all or substantially all of the assets are sold to a recipient under an agreement whereby the recipient will carry on the business (or part of it).

ETA: 167(1)

646

Introduction to Federal Income Taxation in Canada

Solution 7: GST/HST – Sale of Assets Author’s Note: This problem addresses the GST/HST implications related to the sale of assets in Problem 6, Chapter 15. The GST/HST solution may be used in conjunction with the solution in Chapter 15 or as a separate assignment. J. Tilkenhurst Limited (JTL) is selling the assets and winding up the corporation. The supply of a business through an asset sale may result in GST implications. The Excise Tax Act (ETA) provides from some relief in situations where the supply of a business occurs, providing the criteria are met. Section 167 of the ETA exempts the supply of a business if the following conditions are met; (1) The supplier (seller) makes a supply of a business or part of a business carried on by it or by a person from which the supplier acquired the business or part thereof. (2) Under the agreement for the supply, the recipient (purchaser) acquires ownership, possession or use of all, or substantially all, of the property necessary to carry on the business or carry on part of a business as a business. The form to elect to exempt the transaction from GST/HST is Form GST44, “Election Concerning the Acquisition of a Business or Part of a Business.” It is a joint election between the purchaser and vendor. The election form must be filed with the CRA by the recipient, no later than the due date of the recipient’s GST return for the reporting period in which the transaction took place. If the transfer occurs between two non-registrants, the election form need not be filed with the CRA but must still be completed and kept on file by the vendor and the purchaser. The election cannot be filed if the vendor (supplier) is a registrant and the purchaser is not a registrant for GST purposes. The first step in determining the tax implications of the supply of a business is to determine which assets are exempt from GST (not considered a taxable supply): •

GST exempt assets: Accounts Receivable, Goodwill and Marketable Securities

•

GST taxable supplies: Customer list, Inventory, Land, Building and Equipment

Our next step is to determine if the criteria under section 167 are met to eliminate the need of the recipient to pay GST on the supply of the business assets. •

The business has been carried on by the supplier JTL.

•

The recipient (unrelated) acquires ownership or use of all or substantially all of the property needed for the recipient to carry on the business

•

Since JTL is a GST registrant, the recipient needs to be a registrant.

Assuming the recipient is a GST/HST registrant, the supply of the business would qualify for exemption under section 167. The two parties should jointly elect using form GST 44. The election needs to be filed by the due date for the recipient’s GST/HST return in which the supply of the business occurred.

Solutions to Chapter 21 Assignment Problems

647

Solution 8: GST/HST – Sale of Assets Author’s Note: This problem addresses the GST/HST implications related to the sale of assets in Problem 8, Chapter 15. The GST/HST solution may be used in conjunction with the solution in Chapter 15 or as a separate assignment. Chow Enterprises Limited (CEL) is selling the assets and considering winding up the corporation. The supply of a business through an asset sale may result in HST implications. The Excise Tax Act (ETA) provides from some relief in situations where the supply of a business occurs, providing the criteria are met. Section 167 of the ETA exempts the supply of a business if the following conditions are met; (1) The supplier (seller) makes a supply of a business or part of a business carried on by it or by a person from which the supplier acquired the business or part thereof. (2) Under the agreement for the supply, the recipient (purchaser) acquires ownership, possession or use of all, or substantially all, of the property necessary to carry on the business or carry on part of a business as a business. The form to elect to exempt the transaction from GST/HST is Form GST44, “Election Concerning the Acquisition of a Business or Part of a Business.” It is a joint election between the purchaser and vendor. The election form must be filed with the CRA by the recipient, no later than the due date of the recipient’s HST return for the reporting period in which the transaction took place. If the transfer occurs between two non-registrants, the election form need not be filed with the CRA but must still be completed and kept on file by the vendor and the purchaser. The election cannot be filed if the vendor (supplier) is a registrant and the purchaser is not a registrant for HST purposes. The first step in determining the tax implications of the supply of assets is to determine which assets are exempt from GST (not considered a taxable supply): •

GST exempt assets: Accounts Receivable and Goodwill

•

GST taxable supplies: Land, Building and Equipment

The supply of the land, building and equipment would result in HST without an election. If purchaser is a registrant vendor would not be required to collect the tax on land or building ( 2. 221(1) –purchaser would self assess and claim ITC. Our next step is to determine if the criteria under section 167 are met to eliminate the need of the recipient to pay HST on the supply of the business assets. •

The business has been carried on by the supplier CEL,

•

The recipient (unrelated) acquires ownership or use of all or substantially all the property needed for the recipient to carry on the business,

•

Since CEL is an HST registrant, the recipient needs to be a registrant as well.

648

Introduction to Federal Income Taxation in Canada

Solution 9: GST/HST – Section 85 The Handyman Shop Inc. (Handyman) is considering transferring all of the business assets, other than the land and building to a new subsidiary, Tool Man Inc. (Tool Man). The land and building will be retained by Handyman and leased to Tool Man for use in earning business income. Assuming the supplier (Handyman) and the recipient (Tool Man) are related as defined by s. 128, two elections are available that would work to ensure no HST is payable on the supply of the business assets: •

Section 156 election – done on form RC 4616, “Election or Revocation of an Election for Closely Related Corporations and/or Canadian Partnerships to Treat Certain Taxable Supplies as Having Been Made for Nil Consideration for GST/HST Purposes.”

•

Section 167 election – done on form GST44, “Election Concerning the Acquisition of a Business or Part of a Business.”

The first step in determining the tax implications of the supply of assets is to determine which assets are exempt from HST (not considered a taxable supply): •

HST exempt assets: Cash and Goodwill

•

HST taxable supplies: Inventory and Furniture & Fixtures

The next step is to review the two elections available in this case. Section 156 Election This election is a common election for closely related corporations and partnership which deems certain taxable supplies to be made for nil consideration. The question becomes are the two corporations in this transaction closely related. Handyman would control Toolman therefore the two corporation would form a qualifying group eligible for the election. Assuming the section 156 election is made prior to the supply of the business assets, all asset subject to HST listed above would be deemed to have been made for nil consideration, thus eliminating the need for Handyman to collect and remit HST. If the election is made, there would be no need for Handyman to collect and remit HST on the lease of the land and building to Toolman. The section 156 election will continue to be in effect until both parties jointly revoke the election. It should be noted that a section 156 election does not apply to sale of real property such as land and building. In this case, the land and building are not being transferred to Toolman.

ETA: 156

Section 167 Election This election would eliminate the requirement of the recipient to pay HST on the supply of business assets. We would need to determine if the criteria are met in this case: •

The business has been carried on by the supplier Handyman,

•

The recipient (unrelated) acquires ownership or use of all or substantially all the property needed for the recipient to carry on the business. While the land and building are being retained by Handyman, the recipient Tool Man would be acquiring the use of the land and building through a lease. Therefore this requirement would be met. It should be noted that the supply of property by lease is excluded from application of s. 167 ( not a sale); accordingly the leases for the land and building would be taxable. Since Handyman is an HST registrant, therefore we need to ensure that the recipient, Tool Man becomes an HST registrant as well.

•

Assuming the recipient is an HST registrant, the supply of the business would qualify for exemption under section 167. The two parties should jointly elect using form GST 44. The election needs to by the due date for the recipient’s HST return in which the supply of the business occurred. The section 167 election would not eliminate HST implications of leasing the property to Tool Man. Under this election, and without filing a section 156

ETA: 167

ETA: 167(1.1)(a)(ii)

Solutions to Chapter 21 Assignment Problems

election, Handyman would be required to charge HST on the lease of the land and building to Tool Man. Handyman could claim input tax credits (ITCs) for expenses related to the leased property. Toolman would pay HST on the lease payments and could claim ITCs for the space used in the business. In this case, since the land and building are not being transferred, the election under section 156 would remove the HST implications of the transfer of the supplies to Tool Man (since the land and the building are not being transferred) as well as the future HST implications on the leasing of the land and the building. Therefore, if conditions for 156 are met, it would be more advantageous than the s. 167 election as it would avoid the need to collect the tax on leases amount for the land and building.

649

650

Introduction to Federal Income Taxation in Canada

Solution 9: GST/HST – Section 85 Ms. Hart is considering incorporating her sole proprietorship through the use of a Section 85. Under the Excise Tax Act, this is considered the supply of a business. The supply of a business through an asset sale may result in HST implications. The Excise Tax Act (ETA) provides from some relief in situations where the supply of a business occurs, providing the criteria are met. Section 167 of the ETA exempts the supply of a business if the following conditions are met; (1) The supplier (seller) makes a supply of a business or part of a business carried on by it or by a person from which the supplier acquired the business or part thereof. (2) Under the agreement for the supply, the recipient (purchaser) acquires ownership, possession or use of all, or substantially all, of the property necessary to carry on the business or carry on part of a business as a business. The form to elect to exempt the transaction from GST/HST is Form GST44, “Election Concerning the Acquisition of a Business or Part of a Business.” It is a joint election between the recipient (purchaser) and vendor (seller). The election form must be filed with the CRA by the recipient, no later than the due date of the recipient’s HST return for the reporting period in which the transaction took place. If the transfer occurs between two non-registrants, the election form need not be filed with the CRA but must still be completed and kept on file by the vendor and the purchaser. The election cannot be filed if the vendor (supplier) is a registrant and the purchaser is not a registrant for HST purposes. The first step in determining the tax implications of the supply of assets is to determine which assets are exempt from HST (not considered a taxable supply): •

HST exempt assets: Accounts receivable, goodwill and public company shares (not being transferred)

•

HST taxable supplies: Land, building, prepaids and inventory

The supply of the land, building, prepaids and inventory would result in HST without an election. Our next step is to determine if the criteria under section 167 are met to eliminate the need of the recipient to pay HST on the supply of the business assets. •

The business has been carried on by the supplier, Ms. Hart,

•

The recipient, Hart Ltd. acquires ownership or use of all or substantially all the property needed for the recipient to carry on the business,

•

Since Ms. Hart is an HST registrant, the recipient, Hart Ltd. needs to be a registrant as well.

Solutions to Chapter 21 Assignment Problems

651

Solution 11: Ceasing to be a small supplier 1.

The limit was exceeded over 3 quarters (see below), not in a single quarter, so Jean-Claude Poitras ceases to be a small supplier at the end of the month following the quarter in which the $30,000 limit is exceeded. In this case, this limit was exceeded in the July to Sept 2023 quarter; therefore, he must begin collecting GST/HST on the first day of the second monthafter the quarter in which the limit was reached. In this case it would be November 1, 2023. Per s. 240(2.1) Jean-Claude must apply for registration to collect GST/HST within 29 days (before 30 days) of November 1, 2023. (Nevertheless, the effective date of registration must match the date when Jean-Paul is required to start collecting tax) Calendar Quarter

Sales

Jan–Mar, 2023

7,500

April to June, 2023 July to September, 2023

Running total

8,500

16,000

32,000

The limit was exceeded over 2 quarters, not in a single quarter, so TiCha ceases to be a small supplier at the end of the month following the quarter in which the $30,000 limit is exceeded. In this case, this limit was exceeded in the October to December 2023 quarter; therefore, The corporation must begin collecting GST/HST on the first day of the second monthafter the quarter in which the limit was reached. In this case it would be February 1, 2024. Per s. 240(2.1), JTiCha must apply for registration to collect GST/HST within 29 days (before 30 days) of February 1, 2024. (Nevertheless, the effective date of registration must match the date when Jean-Paul is required to start collecting tax )

3. Calendar Quarter July to September, 2023 October to December, 2023 January to March, 2024 April to June, 2024

Sales

Running total

10,500 22,500

33,000

19,875

52,875

22,300

75,175

652

Introduction to Federal Income Taxation in Canada

Solution 12: GST/HST Remittance

The HST payable would be calculated as follows: HST collected: Sales ($176,000 x 13%)

22,880

5,871 17,009

Input tax credits Lease costs (24,180 x 13%)

3,143

Office supplies (1,275 x 13%)

166

Laptops (5,950 x 13%)

774

Software (1,250 x 13%) New office furniture (12,500 x 13%) HST payable for the year

163 1,625

Solutions to Chapter 21 Assignment Problems

653

Solution 13: GST Remittance – Quick Method and Regular Method 1.

Calculate JAG’s net GST remittance or refund for the current year assuming no election to use the Quick Method. GST Collected ($85,000 + 140,000) x 5%

11,250

Input tax credits: Inventory purchases ($115,000 x 5%)

Other operating expenses ($16,800 x 5%) Capital expenditures ($215,000 x 5%)

5,750 840 10,750

GST Payable (refundable)

(17,340) $

(6,090)

Salary and wages, along with the interest expense are not taxable supplies and therefore no GST would have been paid. JAG cannot claim an input tax credit on these two expenses. Depreciation expense is not eligible for an input tax credit but the capital expenditures made in the years meet the criteria would therefore be eligible to claim an input tax credit. Under the regular filing format, JAG would received a GST refund of $6,090. 2.

Calculate JAG’s net GST remittance or refund for the current year assuming JAG elects to use the Quick Method. Sales, including GST are: ($85,000 x 1.05)

Services, including GST are ($140,000 x 1.05)

89,250 147,000

GST on sales ($89,250 x 1.8%)

1,607

GST on Services ($147,000 x 3.6%)

5,292

less the $30,000 reduction of 1% ($30,000 x 1%) Less the capital expenditures ($215,000 x 5%) GST Payable (refundable)

(300) (10,750) $

(4,151)

The GST refund is less under the quick method. The input tax credit on the capital expenditures may be claimed under both method, assuming the criteria is met. The capital asset in this scenario is solely used for taxable supplies, therefore the asset would qualify for the input tax credit.

654

Introduction to Federal Income Taxation in Canada

Solution 14: Single vs Multiple Supplies The facts of this problem are based on the case Victus s. The Queen 2020 GTC 28. In the case, the taxpayer argued that the school’s hockey program was as a separate commercial activity and that the ITC’s for the related expenses should be allowed. CRA argued instead that the supplies provided by the school constituted a single exempt supply. The school provided exempt educational services. Exempt suppliers are not required to charge HST and also cannot claim ITC’s for the related expenses. The court concluded that either a single exempt supply including both the educational and hockey program was provided by the school or alternatively, the supplies could be considered separately but this would not change the result because both would be exempt supplies. The supply of the educational program would be and educational service which would be an exempt supply. The supply of the hockey program would be a service made by a school authority primarily to elementary or secondary students during the course of extra-curricular activities organized under the authority and responsibility of the school.

CHAPTER 22

Data Analytics and Information Systems in Tax Solution 1 Friendly Patio Furniture Inc. (FPFI) Sample Solution Using MS Excel Data Analysis Tools Stage 1: Business Understanding Tax Issue Identified: We are to prepare the T2 Schedule 5 Tax Calculation Supplementary-Corporations for the company for 2023. Context: This schedule is the corporate tax return schedule which is used to allocate federal taxable income to provinces and other jurisdictions in which the company has a permanent establishment (PE) as defined in the Income Tax Regulations (ITRs). To prepare this schedule, we need to determine in which jurisdictions the company had PEs during the year. Then, we will need to analyze the company’s data to allocate its gross revenues and salaries and wages to those jurisdictions consistent with the ITRs. Plan for Analysis: 1) Identify ITRs relevant for determining the PE jurisdictions. 2) Determine the PE jurisdictions. 3) Determine the gross revenues allocable to the PE jurisdictions. 4) Determine the salaries and wages allocable to the PE jurisdictions. 5) Allocate the federal taxable income to those PE jurisdictions based on the formula in the ITR’s.

Stage 2: Data Understanding Data Identification To determine where PEs are located, we will need to review where the company has fixed places of business. In addition, we will need to review the activities of its employees and independent contractors to determine their functions and activities. We will also need to gather data files on the company’s gross revenues and salaries and wages paid for the allocation process. Data Collection We gathered information on fixed places of business and the activities of its employees and independent contractors to determine their functions and activities. We were provided with the following data files to do our analysis:

o o o o o

The database schema of the company’s files needed for this problem with “FK” denoting “foreign key”. A foreign key acts as a cross-reference between tables that links to the primary key of another table. tSales file (this file shows the company’s 2023 sales transactions) tPayroll file (this file shows the salary and benefits of the employees in the year) tCustomer file (this shows customer billing and shipping addresses) tEmployees file (this file shows extracts from the employee master file) tProducts file (this file shows the company’s products sold in the year and related prices) 655

Introduction to Federal Income Taxation in Canada

656

o tLocationsfile (this file shows the company’s production and head office locations) Data Explored All the data files were reviewed for errors by visually scanning the data files. In addition, the files were converted to tables in Excel to filter the data fields which facilitated the review of high observations, low observations, missing data and duplicates. Stage 3 Data Preparation Data Cleaning As per the instructions provided, no actual follow-up was done at this stage and so no data was “cleaned”. All the data was retained as provided. The following items were identified for follow-up in the tSales file: B)The following represent items for which we should follow up to determine if there are errors in the data before we finalize the results shown in this analysis for use in the preparation of the tax return for the year: (all the data files were reviewed for errors by visually scanning the data files and doing summary statistics such as high obvservations, low observations, missing data and duplicates in the table drop downs.) tsales file i)

ii)

iii)

iv)

vi)

First step is converting the file to a table There were missing invoices from 3101 to 3201 -this issue was located by determining that the difference between the invoice numbers at beginning of the year and the end of the year was higher than the number of invoices in the year. To find actual missing invoices, we added a column "change in salesid" to table and used conditional formating to locate > 1 for each line There is a duplicate invoice #3100 which was located using the conditional formatting function in excel. Or use "analyze data" function and ask about duplicate salesid numbers. Or, we could use above added field for change in salesid in tsales file and conditionally format where answer is 0. See result below salesID customerID salesDate productID locationID Quantity WholesalePric employeeID 87 45132 8 3 5 2400 35 3100 3100 13 45132 8 4 18 2400 37 There are a few invoice numbers with no data. An example is the first one shown below: salesID customerID salesDate productID locationID Quantity WholesalePric employeeID 2239 2023-01-04 The following invoices have negative sales quantities: salesID customerID salesDate productID locationID Quantity WholesalePric employeeID 3317 81 2023-08-23 4 3 1225 21 -1 3332 77 2023-08-27 3 4 1000 24 -2 3345 58 2023-08-30 4 4 -3 1225 21 The following invoices have significantly higher sales quantities and sales amounts compared to the rest of the sales in the year: salesID customerID salesDate productID locationID Quantity WholesalePric employeeID 2801 10 2023-04-30 6 3 1800 27 88 2807 45 2023-05-01 6 4 61 1800 32 The following invoices do not have salespeople assigned to them: salesID customerID salesDate productID locationID Quantity WholesalePric employeeID 2382 15 2023-02-10 8 4 9 2400 NA 2433 39 2023-02-25 7 4 7 2000 NA 2479 15 2023-03-07 10 4 8 2500 NA 2580 15 2023-04-01 7 3 10 2000 NA 2833 38 2023-05-09 6 4 3 1800 NA 2879 38 2023-05-22 4 3 19 1225 NA 3087 15 2023-07-21 3 4 17 1000 NA 3204 39 2023-07-25 2 4 6 780 NA 3240 38 2023-08-04 9 4 15 2500 NA 3313 45 2023-08-21 6 4 11 1800 NA 3409 38 2023-09-15 2 3 17 780 NA 3420 15 2023-09-19 7 4 11 2000 NA 3461 39 2023-09-30 1 4 5 600 NA 3606 38 2023-11-08 6 3 3 1800 NA 3675 39 2023-11-30 8 4 19 2400 NA

This appears to be the only file with follow up items and potential errors.

Constructing and Integrating Data a) To proceed with the salaries and wages per PE, the following steps were necessary in Excel:

Solutions to Chapter 22 Assignment Problems

657

1. create a copy of the tPayroll file for analysis so the original data is not affected by the analysis to be done 2. calculate gross salary and wage by employee 3. use ““vlookup”” function from the tLocation file to allocate employees to provinces The following shows the first 2 lines of this new table: PayrollID employee periodStar periodEnd salaryWagbonus taxableBe jobDescrip gross salary and work locatlocation p 235 Arliene M 1/1/2023 12/31/2023 79999 15999.8 3999.95 salesPerso $ 99,998.75 St. Stephe NB 236 Lek Batho 1/1/2023 12/31/2023 91899 16379.8 4094.95 salesPerso $ 112,373.75 St. Stephe NB

b) To proceed with the gross revenues per PE, the following steps were necessary in Excel: 1. tSales file was copied into a new Excel file for analysis so the original data is not affected by the analysis activities 2. gross revenue was calculated for each invoice 3. tCustomer file was copied into this Excel file in a new tab, and the “vlookup” function was used to determine “ship to addresses” for each invoice required for the allocation process 4. t Employees file was copied into this Excel file in a new tab and the “vlookup” function was used to determine their reporting location for customer invoice allocation by reporting location, as necessary 5. tLocation file was copied into this Excel file in a new tab, and the “vlookup” function was used to determine where each invoice’s products were produced as necessary The following shows the first 2 lines of this updated sales analysis file: salesID customerI salesDate produ locatioQuant Wholesaleemployee gross revenues ship country ship prov report to where pro 2226 3 2023-01-01 4 4 10 1225 21 $ 12,250 Canada NB NB BC 2227 2 2023-01-01 7 4 9 2000 33 $ 18,000 Canada NB ON BC

Stage 4 – Modeling Firstly, we need to determine the jurisdictions where the company had PEs. It appears that the company had PEs in BC, NB and BC where it had fixed places of business. The company’s employees located in other jurisdictions and/or performing functions in other jurisdictions did not appear to have the contracting authority or to have inventory from which they fulfilled customer orders, so there do not appear to have been any other PEs than in those three provinces. Given these three PE jurisdictions, we use Excel’s pivot table function to determine the salaries and wages and gross revenues attributable to each PE jurisdiction. A) For salaries and wages, the analysis shows the following results:

Row Labels BC NB ON Grand Total

Sum of gross salary and benefits 1416402.1 1857610.05 2357312.12 5631324.27

B) For gross revenues, the analysis provides the following results depending on where the products were shipped:

Introduction to Federal Income Taxation in Canada

658 Shipments for Canadian Provinces Row Labels Sum of gross revenues 0 10761420 AB 1346250 BC 3214730 NB 2006860 NL 363005 NS 657885 ON 4194210 QC 1990490 SK 907935 Grand Total 25442785

Note that row “0” represents non-Canadian province shipments (i.e., exports).

Below, we use a pivot table to show the sales in non-PE provinces attributable to salespeople reporting to locations in PE provinces. Again, foreign sales are shown as 0 below. Salesperson Reporting Provinces for Non-PE Provinces Row Labels Sum of gross revenues 0

10761420

1346250

BC NB ON BC

232595 824200 289455 3214730

2006860

363005

NB NS

363005 657885

BC ON ON

298040 359845 4194210

1990490

BC NB ON SK

753595 865935 370960 907935

BC NB ON

573050 274760 60125

Grand Total

25442785

Below, we see sales to US customers and the PE province in which those sales were produced since the company does not have a PE in the US.

Solutions to Chapter 22 Assignment Problems

659

US shipments Province Produced Row Labels Sum of gross revenues 0 0 0 0 Canada 14681365 US 10761420 BC 5307245 NB 5454175 Grand Total 25442785 The gross revenues can then be allocated as follows based on the above 3 pivot table results:

PE Province BC ON NB Total

Ships to Provi Ships to Non- For Ships Sou Total Sales Allocated 3214730 1857280 5307245 10379255 4194210 1080385 5274595 2006860 2327900 5454175 9788935 9415800 5265565 10761420 25442785

Finally, the company’s taxable income would be allocated as shown below as per the ITR’s: A)T2-Schedule 5 Federal Taxable Income

480,000

BC ON NB

Salaries and Wag % $ 1,416,402 $ 2,357,312 $ 1,857,610

Gross Revenues % 25% $ 10,379,255 42% $ 5,274,595 33% $ 9,788,935

Average % 41% 33% 21% 31% 38% 36%

Allocation of Taxable Income $ 158,272 $ 150,221 $ 171,507

Total

100% $

100%

5,631,324

25,442,785

100%

480,000

Stage 5 – Evaluation The results of our analysis above appear to be reasonable based on the factors the ITRs set out. We do need to ensure that we follow up on the items noted above in the data preparation process before we incorporate this information in the company’s 2023 tax return. Stage 6 – Deployment As noted above, we need to complete the follow-up on the tSales items noted above before using this information in the tax return. Assuming the ITRs do not change in the future and the organization’s PEs do not change a similar analysis can be used in future years.

Introduction to Federal Income Taxation in Canada

660 Solution 2:

New Wave Computers Inc. (NWC) Suggested Solution Using MS Excel Data Analysis Tools A) Types of Supplies and POS Rules

Types of Supplies All sales of products (computers) and services (tech support) are considered taxable supplies, and all USA sales (computers and services) are zero-rated export supplies with all other sales fully taxed supplies. Provincial “Place of Supply” (“POS”) rules are not required for sales to US customers since no tax is payable on exports. Place of Supply Notes We have summarized below Canada’s Place of Supply (“POS”) rules as set out in various Canada Revenue Agency (CRA) publications. Most importantly, we note that the rules related to collecting GST/HST on sales are different for sales of goods and sales of services. NWC sells both computers and customer support services. To do this analysis, we only require customer address information at the province/state and country level, and not customer name and street address information so the information provided in the files is sufficient for the analysis. For sales of goods and services to customers in Canada, sellers need to look to the POS rules for sales for products and services. Those POS rules determine the rate of GST/HST that should be charged to customers in different provinces. GST is charged at 5% for nonparticipating provinces (Quebec, BC, Saskatchewan, Manitoba, and BC) and the Territories while HST is charged in participating provinces at 13% in Ontario and 15% in Nova Scotia, New Brunswick, Newfoundland and Prince Edward Island. NWC supplies goods (computers) and services (tech support -customer assistance calls and emails are considered services here as are any remote assistance is done by phone/email/chat). For the sale of goods like computers, the rules are quite straightforward-the rate of tax is determined by the province where the computers are delivered as the delivery and transfer of ownership occurs in that province. For the sale of services, the rate of tax is determined by what information the company has on the customer as part of its normal order entry practices. The POS rules for services indicate that where the company has one address for a customer from its normal information collection process, that address can be used for purposes of determining the province and related tax rate for GST/HST purposes. Where more than one address is gathered for a customer, the address related to the “contracting decision” should be used. This is the home address for customers. Where no address is obtained from a customer, the POS rules look at where the service is performed. For NWC sales to customers with no addresses, we have determined that all services are performed at the Etobicoke, Ontario location and products are delivered from that location as well. B) Use of CIRSP-DM Method to Assess GST/HST Reporting and Remittances Stage 1: Business Understanding Tax Issue Identified

Solutions to Chapter 22 Assignment Problems

661

We are to determine the excess or deficient GST/HST amounts the company billed to and collected from its customers for the 2023 fiscal year. Context The determination to be made is part of the 2023 fiscal year audit. We have been provided with the amount of revenue and GST/HST charged to customers by relevant jurisdiction in the 2023 year. To perform this analysis, we will compare the amounts reported and collected by the company with amounts that should have been reported and collected based on the company’s files and currently existing GST/HST laws. Plan for Analysis 1) Obtain information on the GST/HST rules relevant for determining the amount of GST/HST that should be collected on the sale of goods and services in Canada and for export. 2) Determine the GST/HST that should have been charged on sales of computers by NWC by jurisdiction. 3) Determine the GST/HST that should have been charged on sales of services by NWC by jurisdiction. 4)Prepare of summary of GST/HST that should have been charged in total by jurisdiction and compare those amounts to those actually billed and collected from customers.

Stage 2: Data Understanding Data Identification We will need to gather data files on the company’s sales for the year, its customer addresses and GST/HST rates for each jurisdiction in which the company sold products and services in the year. Data Collection We were provided with the following data files to do our analysis:

o o

Sales for 2021 to 2023 (“tSales”) that have been agreed to the general ledger and the GST/HST returns for the years Customer file (“tCustomer”) that provides information gathered by the company for all customers as part of its normal revenue generation process. Customer-specific information has been encrypted except for province/state and country information that is required to complete this analysis. Product file (“tProducts”) that provides the company’s products for the 2021 to 2023 years. This file is used to generate the sales price charged to customers in each year. GST/HST rates by province (“tRates_01”) with the appropriate 2-letter provincial abbreviation used in various data files.

Data Explored All of the data files were reviewed for errors by visually scanning the data files. In addition, the files were converted to tables in Excel to facilitate a review of high observations, low observations, missing data and duplicates. Students may have used visualization tools available in programs such as Tableau or MS Power BI to explore the data at this stage. Stage 3 Data Preparation Data Cleaning As per the instructions provided, no actual follow-up was done at this stage and therefore no data was “cleaned”. All the data was retained as provided. See the response to part (C) of the required issues for follow up. Constructing and Integrating Data To proceed with the analysis, the following steps were necessary in Excel to construct and integrate the data provided (Students could use other tools such as MS Access, Tableau, Power BI or programming languages such as R or Python to construct, integrate and analyze the data): 1. create an Excel file for the sales data so the original data is not affected by the analyses undertaken 2. convert the data to a table 3. use a filter on transaction date so we are only using the 2023 sales data 4. calculate the sales amount per transaction

Introduction to Federal Income Taxation in Canada

662

5. use the vlookup function of tCustomer file to determine the country of each customer. 6. for US customers, we know that the sales are zero-rated and not subject to GST/HST, so we can focus from here on only Canadian customers and assign 0 to all USA transactions GST/HST Owing on Product Sales 7. for Canadian customers, we can look at product sales GST/HST by using “if” statements and the “vlookup” function to determine the province where the products were delivered for each sale as this is the allocation factor as per the GST/HST Place of Supply (POS) rules 8. we can now use the “vlookup” function to set the rate of tax that should have been charged on each product sale based on the province of delivery as per the tRates_01 file 9. the transaction sale amount determined as per above for each Canadian product delivery is multiplied by the rate of tax to calculate the GST/HST that should have been billed for each product sale The following shows the first 8 lines of the updated sales analysis file showing the GST/HST that should have been charged by sales transaction (computer product sales) with USA customers showing no tax owing: SalesDate year 2023-01-15 2023-01-13 2023-01-02 2023-01-25 2023-01-02 2023-01-22 2023-01-30 2023-01

month category product SKU

2023 2023 2023 2023 2023 2023 2023

1 sales 1 sales 1 sales 1 sales 1 sales 1 sales

small large small small small lar

price

44feffa8 bc42f84b 44feffa8 44feffa8 44feffa8

2 3 2 2

custType custID

1359.99 Corp 6739.99 Corp 1359.99 Corp 1359.99

Sales $

1627 1566 16

Cust Cou ntr del prov 2719.98 CAN 20219.97

prov tax r tax d

GST/HST Owing on Service Sales 10. for Canadian customers, we can look at techSupport sales GST/HST by using “if” statements and the “vlookup” function to determine the province of the head office/home address for each customer sale consistent with the POS rules for services provided in Canada 11. we can now use the “vlookup” function to set the rate of tax that should have been charged on each techSupport sale based on home address province as per the tRates_01 file 12. the transaction sale amount determined as per above is multiplied by the rate of tax to calculate the GST/HST that should have been billed for each service sale The following shows the first 8 lines of the updated sales analysis file showing the GST/HST that should have been charged by service transaction (tech support sales) with USA customers showing no tax owing: SalesDate year

month category product SKU

2023-01-14 2023-01-11 2023-01-08 2023-01-21 2023-01-29 2023-01-22 2023-01-29 2023-01

1 techSuppor medium 1 techSuppor medium 1 techSuppor medium 1 techSuppor large 1 techSuppor large 1 techSuppor med

2023 2023 2023 2023 2023 2023 2023

10ebbb57 10ebbb57 10ebbb57 31cd4dcd 31cd4dcd

price 2 2 2 3

custType custID 150 Corp 150 Corp 150 Corp 150 C

1460 1032 1629

Sales $

Cust Countr serv home off ser prov tax tax SK

300 CAN 300 CA

13. for transactions where no province of sale for services is available in the system, the POS rules indicate that the rate of tax applicable in the province where the services were provided should be applied. In this case, that would be ON where the tech support service team is located and thus where the services are provided by phone, email, chat, and remote access. Some product (computer) sales did not have a delivery address. We have assumed that the products were delivered to customers in Ontario from the head office. We will need to confirm how these products were actually delivered without any addresses. 14. for Canadian customers without delivery addresses for product sales, we can use the “if” function to determine sales amounts for transactions without a delivery address 15. for Canadian customers without a home address for service sales, we can filter the tCustomer file to determine if those customers have any other address in the system. In this case, the customers without a

Solutions to Chapter 22 Assignment Problems

663

home address do not have any address in the system. For these transactions, we can use the “if” function to determine sales amounts for these transactions knowing that they have no address in the system 16. for these Canadian sales of goods and services with no addresses in the system, we can multiply the sales amounts for these transactions by the rate of GST/HST for ON per the tRates_01 file to determine the GST/HST owing on these transactions The following shows all of the lines in the updated sales analysis file showing the GST/HST that should have been charged for Canadian goods and services transactions without any address in 2023: SalesDate year month category product 2023-02-01 2023 2 sales medium 2023-02-10 2023 2 techSuppor large 2023-02-25 2023 2 techSuppor medium 2023-04-08 2023 4 sales small 2023-04-24 2023 4 sales small 2023-04-05 2023 4 techSuppor medium 2023-05-31 2023 5 techSuppor small 2023-06-05 2023 6 sales small 2023-07-31 2023 7 sales small 2023-08-07 2023 8 sales large 2023-09-16 2023 9 sales medium 2023-10-07 2023 10 techSuppor medium 2023-11-27 2023 11 sales small 2023-11-05 2023 11 sales small

SKU q 3e7d929d 31cd4dcd 10ebbb57 44feffa8 44feffa8 10ebbb57 7d959cc9 44feffa8 44feffa8 bc42f84b 3e7d929d 10ebbb57 44feffa8 44feffa8

5 3 3 3 2 2 2 2 4 3 2 2 2 3

price custType 2099.99 Corp 150 Corp 150 Corp 1359.99 Corp 1359.99 Corp 150 Corp 150 Corp 1359.99 Corp 1359.99 Corp 6739.99 Corp 2099.99 Corp 150 Corp 1359.99 Corp 1359.99 Corp

custID Sales $ Cust Countr No prov pro dNo prov serv ON taxes du e 1348 10499.95 CAN 10499.95 0 1364.9935 1331 450 CAN 0 450 58.5 1172 450 CAN 0 450 58.5 1621 4079.97 CAN 4079.97 0 530.3961 1221 2719.98 CAN 2719.98 0 353.5974 1621 300 CAN 0 300 39 1221 300 CAN 0 300 39 1163 2719.98 CAN 2719.98 0 353.5974 1621 5439.96 CAN 5439.96 0 707.1948 1621 20219.97 CAN 20219.97 0 2628.5961 1221 4199.98 CAN 4199.98 0 545.9974 1262 300 CAN 0 300 39 1104 2719.98 CAN 2719.98 0 353.5974 1633 4079.97 CAN 4079.97 0 530.3961

Stage 4 – Modeling We can use Excel’s pivot table function on the updated sales analysis file to determine the revenues and GST/HST amounts for the year. A) Determine the total Canadian and USA sales for 2023 as shown below knowing the USA sales will not have any GST/HST tax amounts due:

Row Labels 2023 CAN USA Grand Total

Sum of Sales $ 38455973.63 30845919 7610054.63 38455973.63

B) Determine product sales by province in 2023 and related GST/HST owing for those sales (note that row “0” represents USA sales and service sales which are excluded from this part of the analysis and row “NA” represents Canadian product sales where there was no address for the customer):

Row Labels 2023 0 ON BC NS AB NA QC NB SK Grand Total

Sum of Sales $ Sum of tax due sales 38455973.63 #N/A 9255059.63 0 13395661.67 1741436.018 4381735.9 219086.795 642896.44 96434.466 4239056.51 211952.8255 56679.74 #N/A 5613468.42 280673.421 381217.74 57182.661 490197.58 24509.879 38455973.63 #N/A

test rates

13.00% 5.00% 15.00% 5.00% 5.00% 15.00% 5.00%

Note that the GST/HST amounts are tested to the right to ensure they are consistent with the rates for those provinces, and they are consistent. C) Determine service sales by province in 2023 and related GST/HST owing for those sales (note that row “0” represents USA sales and computer product sales which are excluded from this part of the analysis and row “NA” represents Canadian sales where there was no address for the customer):

Introduction to Federal Income Taxation in Canada

664 Row Labels 2023 0 ON QC AB BC NA SK NB NS Grand Total

Sum of Sales $ Sum of tax due serv 38455973.63 #N/A 36810968.63 0 748725 97334.25 340800 17040 237000 11850 241830 12091.5 1800 #N/A 26550 1327.5 23100 3465 25200 3780 38455973.63 #N/A

Note that the GST/HST amounts are tested to the right to ensure they are consistent with the rates for those provinces, and they are consistent.

D) Determine the sales for the year and related HST owing for which there are no addresses in the system for products delivered or services provided. These sales will be allocated to ON as shown below:

Note that the HST amounts in ON are shown properly above at 13% of the sales. E) Aggregating the results of the models and allocating the NA row for non-address sales to ON as per above, we arrive at the following summary of the actual results for 2023: NWC Summary of Taxes Due by Jurisdiction by Sales Type 2023 Year Sales Product Sales Service Sales Non-Address Total AB $ 4,239,056.51 $ 237,000.00 $ 4,476,056.51 BC $ 4,381,735.90 $ 241,830.00 $ 4,623,565.90 NA $ 56,679.74 $ 1,800.00 -$ 58,479.74 $ NB $ 381,217.74 $ 23,100.00 $ 404,317.74 NS $ 642,896.44 $ 25,200.00 $ 668,096.44 ON $ 13,395,661.67 $ 748,725.00 $ 58,479.74 $ 14,202,866.41 QC $ 5,613,468.42 $ 340,800.00 $ 5,954,268.42 SK $ 490,197.58 $ 26,550.00 $ 516,747.58 All USA Sales $ 7,610,054.63 $ $ 7,610,054.63 Total

$ 36,810,968.63 $ 1,645,005.00 $ Note 1

Taxes Product Sales Service Sales Non-Address Sales Total $ 211,952.83 $ 11,850.00 $ 223,802.83 $ 219,086.80 $ 12,091.50 $ 231,178.30 $ $ $ $ 57,182.66 $ 3,465.00 $ 60,647.66 $ 96,434.47 $ 3,780.00 $ 100,214.47 $ 1,741,436.02 $ 97,334.25 $ 7,602.37 $ 1,846,372.63 $ 280,673.42 $ 17,040.00 $ 297,713.42 $ 24,509.88 $ 1,327.50 $ 25,837.38 $ $ $ -

$ 38,455,973.63 $ 2,631,276.07 $ 146,888.25 $ agreed to total sales for year Note 1:Non-Address sales have been allocated to Ontario where services are provided to customers and where computers manufactured

7,602.37 $

2,785,766.68

Note that the GST/HST amounts are tested to the right to ensure they are consistent with the rates for all jurisdictions, and they are consistent. Finally, we provide a summary of the actual results for the year above compared to the amounts reported by the company in its accounts as shown below:

checks 5.00% 5.00% 0.00% 15.00% 15.00% 13.00% 5.00% 5.00% 0.00%

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NWC Overall Summary of Sales and GST/HST Taxes Due

AB BC NB NS ON QC SK USA

Actual Sales GST/HST Billed $ 4,476,056.51 $ 223,802.83 $ 4,623,565.90 $ 231,178.30 $ 404,317.74 $ 60,647.66 $ 668,096.44 $ 100,214.47 $ 14,202,866.41 $ 1,846,372.63 $ 5,954,268.42 $ 297,713.42 $ 516,747.58 $ 25,837.38 $ 7,610,054.63 0

Submitted to CRA Sales GST/HST Billed $ 4,496,056.84 $ 224,802.84 $ 4,657,887.44 $ 232,894.37 $ 515,749.85 $ 77,362.48 $ 680,417.66 $ 102,062.65 $ 14,078,562.29 $ 1,830,213.10 $ 5,925,507.88 $ 296,275.39 $ 491,737.04 $ 24,586.85 $ 7,610,054.63 0

Sales Under/ GST/HST Billed (Over) Reported Deficiency/(Excess) -$ 20,000.33 -$ 1,000.02 -$ 34,321.54 -$ 1,716.08 -$ 111,432.11 -$ 16,714.82 -$ 12,321.22 -$ 1,848.18 $ 124,304.12 $ 16,159.54 $ 28,760.54 $ 1,438.03 $ 25,010.54 $ 1,250.53 $ $ -

Total

$ 38,455,973.63 $ 2,785,766.68

$ 38,455,973.63 $ 2,788,197.68

0.00 -$

2,431.00

Stage 5 – Evaluation The results of our analyses indicate that the company has over-reported its GST/HST obligation by $2,431.00 for the year. This is a relatively small amount and is likely not material. We need to ensure that we follow up on the items noted above in the data preparation process before we finalize our assessment. Stage 6 – Deployment As noted above, we need to complete follow-up on the tSales file and tCustomer file items noted above and update the analyses before including the results of this analysis in the audit file. Assuming the CRA POS rules do not change in the future and the organization’s sales transaction types do not change a similar analysis can be used in future years as part of the audit file. C)Issues for Follow Up Sales transactions for 2023 were filtered in the updated sales file table. The total sales figure was calculated for 2023 per the tSales file by using a pivot table on sales in the file and this figure was agreed to the total sales for the year reported in the summary information provided by jurisdiction. The following unusual items were identified for follow up in the tSales file in Excel by filtering the columns in the file (note that students may use other analysis tools such as Python, R, MS Access for this part and the other parts of the solution):

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Potential Errors in the tSales file from use of Summary Statistics and Data in Dropdown Table Review (for example of data table review, screen prices in price column in 2023 compared to price list -no unapproved prices noted as only 4 prices appear in price dropdown of table) Negative unit sales SalesDate year month category product SKU q price custType custID 2023-03-15 2023 3 sales medium 3e7d929d -1 2099.99 Corp 1174 2023-05-07 2023 5 techSuppomedium 10ebbb57 -2 150 Corp 1405 2023-06-12 2023 6 sales small 44feffa8 -3 1359.99 Corp 1136 2023-09-16 2023 9 sales large bc42f84b -2 6739.99 Corp 1223 2023-09-10 2023 9 sales small 44feffa8 -2 1359.99 Corp 1049 2023-10-28 2023 10 sales small 44feffa8 -3 1359.99 Corp 1479 2023-10-14 2023 10 sales small 44feffa8 -2 1359.99 Corp 1185 2023-03-27 2023 3 sales small 44feffa8 -1 1359.99 Indi 147828 2023-03-02 2023 3 sales small 44feffa8 -2 1359.99 Indi 148093 2023-04-30 2023 4 sales small 44feffa8 -1 1359.99 Indi 151900 2023-06-25 2023 6 sales medium 3e7d929d -1 2099.99 Indi 157404 2023-07-02 2023 7 techSuppomedium 10ebbb57 -2 150 Indi 160134 2023-08-06 2023 8 sales small 44feffa8 -1 1359.99 Indi 161169 0 unit sales SalesDate

year

category product 2 sales small 5 sales small 8 sales small 8 sales small 8 techSuppomedium 9 sales medium 11 sales large 12 sales small 12 techSuppomedium 11 sales medium 11 sales small 11 sales medium 11 sales medium 11 sales medium 11 techSupposmall 11 techSupposmall 11 techSuppolarge 12 sales small

SKU q 44feffa8 44feffa8 44feffa8 44feffa8 10ebbb57 3e7d929d bc42f84b 44feffa8 10ebbb57 3e7d929d 44feffa8 3e7d929d 3e7d929d 3e7d929d 7d959cc9 7d959cc9 31cd4dcd 44feffa8

0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

category product 6 techSuppomedium 7 techSuppomedium 5 techSuppolarge 5 techSuppomedium 5 techSupposmall 7 sales small 8 techSupposmall 9 techSuppomedium 12 techSupposmall

SKU q 10ebbb57 10ebbb57 31cd4dcd 10ebbb57 7d959cc9 44feffa8 7d959cc9 10ebbb57 7d959cc9

0.5 0.5 0.5 0.3 0.75 0.6 0.45 0.5 0.5

High unit and dollar sales invoice SalesDate year month category product 2023-03-13 2023 3 sales large 2023-05-15 2023 5 sales large 2023-05-08 2023 5 sales medium 2023-05-20 2023 5 sales large 2023-05-07 2023 5 sales large 2023-07-24 2023 7 sales small 2023-08-06 2023 8 sales large 2023-09-10 2023 9 sales large 2023-09-03 2023 9 sales large 2023-09-29 2023 9 sales large 2023-10-29 2023 10 sales small 2023-10-19 2023 10 techSuppolarge 2023-12-18 2023 12 sales medium

SKU q bc42f84b bc42f84b 3e7d929d bc42f84b bc42f84b 44feffa8 bc42f84b bc42f84b bc42f84b bc42f84b 44feffa8 31cd4dcd 3e7d929d

12 11 22 11 11 100 51 11 11 11 14 10 12

2023-02-05 2023-05-12 2023-08-25 2023-08-05 2023-08-13 2023-09-24 2023-11-25 2023-12-11 2023-12-20 2023-11-27 2023-11-27 2023-11-27 2023-11-06 2023-11-29 2023-11-22 2023-11-15 2023-11-04 2023-12-17 Fractional unit sales SalesDate

month 2023 2023 2023 2023 2023 2023 2023 2023 2023 2023 2023 2023 2023 2023 2023 2023 2023 2023

year 2023-06-02 2023-07-20 2023-05-04 2023-05-06 2023-05-27 2023-07-09 2023-08-31 2023-09-30 2023-12-14

month 2023 2023 2023 2023 2023 2023 2023 2023 2023

price custType custID 1359.99 Corp 1618 1359.99 Corp 1606 1359.99 Corp 1599 1359.99 Corp 1262 150 Corp 1158 2099.99 Corp 1104 6739.99 Corp 1611 1359.99 Corp 1245 150 Corp 1125 2099.99 Indi 137943 1359.99 Indi 137965 2099.99 Indi 138031 2099.99 Indi 138119 2099.99 Indi 138427 150 Indi 140011 150 Indi 140077 150 Indi 140231 1359.99 Indi 141199

price

custType custID 150 Corp 1554 150 Corp 1552 150 Indi 155223 150 Indi 155334 150 Indi 155423 1359.99 Indi 158835 150 Indi 163370 150 Indi 165593 150 Indi 143003

price custType custID Sales $ 6739.99 Corp 1001 80879.88 6739.99 Corp 1185 74139.89 2099.99 Corp 1614 46199.78 6739.99 Corp 1289 74139.89 6739.99 Corp 1298 74139.89 1359.99 Corp 1575 135999 6739.99 Corp 1612 343739.5 6739.99 Corp 1419 74139.89 6739.99 Corp 1003 74139.89 6739.99 Corp 1341 74139.89 1359.99 Corp 1101 19039.86 150 Corp 1130 1500 2099.99 Corp 1467 25199.88

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Invoices with 0 or negative sales quantities and dollar amounts generally do not appear in sales summaries but rather credit files, so these should be reviewed. Fractional sales of a computer would indicate an error as would fractional sales of service hours of less than one hour when the company’s policy is that a minimum of one hour must be charged for each customer. The high unit/high dollar invoices are significantly higher than all other invoices in the year, and as such, should be reviewed for correctness. The following items were identified for follow-up in the tCustomer file: 71 customers had no addresses for the 3-year period-this could be expected possibly from individual customers that paid by eft, but some corporate customers had no addresses. In addition, some product (computer) sales customers had no delivery address.

Problem 3

memo Zelda Inc. To: CFO From: CPA Date: September 4, 2023 RE: Upcoming CRA Audit

I am writing to respond to your questions related to the upcoming CRA Audit. I show your questions (in bold) and my responses below. If you have any questions or concerns, please do not hesitate to contact me. CPA a) What years will CRA be able to audit? As Zelda Inc. (“Zelda”) is a CCPC, the normal reassessment period is 3 years. The 2018 tax year was assessed on May 20, 2019, so that year is “statute barred” and likely will not be subject to audit unless CRA alleges fraud or gross negligence. All other tax years were assessed after the date that is 3 years before the start of the audit date, so they may be subject to audit. The 2019 year was assessed on December 5, 2020, so the CRA auditor will likely focus on that year first as they will not have very much time to propose reassessments before the 3-year reassessment window ends on December 5, 2023. b) What visualization technique would you use to screen for expense accounts that appear to be risky from an audit point of view? Please show the results of the visualization technique you would use.

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Many visualization techniques may be used to screen for “risky” expense accounts given the GIFI information we are using. Visualization tools could include Tableau, Power BI, Microsoft Excel or one of many other software packages or programs that present data as visualizations. Below, I provide 2 visualization techniques from Excel looking at trends over years:

Sparklines of Expenses by Tax Year in Dollars (sparklines are small graphs below) GIFI Code and Name 2018 2019 2020 2021 2022 Assessment ** GIFI code 8000 – Amount – Trade sales of goods and services 3,500,345 6,230,922 8,769,034 12,450,986 18,456,234 GIFI code 8300 – Amount – Opening inventory 700,069 1,246,184 1,753,807 2,490,197 GIFI code 8320 – Amount – Purchases/cost of materials 1,225,121 2,180,823 3,069,162 4,357,845 6,459,682 GIFI code 8340 – Amount – Direct wages 350,035 623,092 876,903 1,245,099 1,845,623 GIFI code 8350 – Amount – Benefits on direct wages 35,003 62,309 87,690 124,510 184,562 GIFI code 8450 – Amount – Other direct costs 175,017 311,546 438,452 622,549 922,812 GIFI code 8500 – Amount – Closing inventory 700,069 1,246,184 1,753,807 2,490,197 3,691,247 GIFI code 8520 – Amount – Advertising and promotion 140,014 249,237 350,761 498,039 738,249 GIFI code 8522 – Amount – Donations 5,000 7,000 8,000 10,000 GIFI code 8523 – Amount – Meals and entertainment 35,003 62,309 87,690 124,510 184,562 GIFI code 8570 – Amount – Amortization of intangible assets 12,500 25,000 25,000 25,000 25,000 GIFI code 8620 – Amount – Employee benefits 35,003 62,309 87,690 124,510 184,562 GIFI code 8670 – Amount – Amortization of tangible assets 156,000 310,000 325,000 350,000 606,000 GIFI code 8690 – Amount – Insurance 11,345 18,000 20,000 24,000 29,000 GIFI code 8691 – Amount – Life insurance on executives 14,000 14,000 GIFI code 8711 – Amount – Interest on short-term debt 35,780 67,098 GIFI code 8714 – Amount – Interest on long-term debt 121,321 231,456 GIFI code 8715 – Amount – Bank charges 6,543 13,444 13,234 78,904 14,567 GIFI code 8761 – Amount – Memberships 23,456 24,556 26,789 32,123 GIFI code 8762 – Amount – Business taxes 11,200 11,424 11,652 11,886 12,123 GIFI code 8811 – Amount – Office stationery and supplies 4,567 6,909 7,254 7,617 7,998 GIFI code 8813 – Amount – Data processing 17,890 97,890 32,123 35,335 38,869 High risk GIFI code 8861 – Amount – Legal fees 12,098 45,654 18,909 178,654 23,456 High risk GIFI code 8862 – Amount – Accounting fees 24,557 30,998 32,322 121,321 34,565 GIFI code 8863 – Amount – Consulting fees 120,000 123,433 224,566 128,900 GIFI code 8871 – Amount – Management and administration 350,000 350,000 350,000 350,000 CRA focus area GIFI code 8911 – Amount – Real estate rental 60,234 125,000 125,000 125,000 125,000 GIFI code 8912 – Amount – Occupancy costs 23,002 46,789 48,193 49,638 51,128 GIFI code 8914 – Amount – Equipment rental 13,456 28,909 29,776 30,670 31,590 GIFI code 9010 – Amount – Other repairs and maintenance 11,232 145,321 34,543 38,908 42,321 High risk GIFI code 9014 – Amount – Garbage removal 35,003 62,309 87,690 124,510 184,562 GIFI code 9060 – Amount – Salaries and wages 385,038 685,401 964,594 1,369,608 2,030,186 GIFI code 9061 – Amount – Commissions 35,003 63,000 88,000 125,000 185,000 GIFI code 9063 – Amount – Bonuses 25,000 45,000 90,000 150,000 450,000 CRA focus area GIFI code 9065 – Amount – Management salaries 78,654 201,330 234,322 254,321 489,087 CRA focus area GIFI code 9130 – Amount – Supplies 17,502 31,155 43,845 62,255 92,281 GIFI code 9131 – Amount – Small tools 2,356 56,766 3,433 2,321 4,532 High risk GIFI code 9180 – Amount – Property taxes 14,543 28,908 30,353 31,871 33,465 GIFI code 9200 – Amount – Travel expenses 52,505 93,464 131,536 186,765 276,844 GIFI code 9220 – Amount – Utilities 34,211 68,000 84,678 124,000 185,000 GIFI code 9270 – Amount – Other expenses 1,232 13,432 98,765 12,456 14,656 High risk GIFI code 9273 – Amount – Selling expenses 122,512 218,082 306,916 435,785 645,968 GIFI code 9274 – Amount – Shipping and warehouse expense 115,161 204,997 288,501 409,637 607,210 GIFI code 9275 – Amount – Delivery, freight and express 107,100 190,648 268,306 380,963 564,705 GIFI code 9276 – Amount – Warranty expenses 35,003 62,309 87,690 124,510 184,562 GIFI code 9281 – Amount – Vehicle expenses 12,455 32,123 38,548 46,257 55,509 GIFI code 9284 – Amount – General and administrative expen 17,654 36,786 42,322 47,887 58,900 Total Expenses 1,665,578 3,871,360 4,643,638 6,492,594 9,045,034 Net income before tax 752,002 300,305 189,918 1,163,446 1,239,335 **-High risk determined based on visual assessment of "spikes" in any one year or trend not matching trend of increasing expenses with sales increases (except for fixed expenses not tied to sales such as depreciation, rent, management fees) "CRA focus area" are areas that represent high value, discretionary epxenses that CRA reviews to ensure amounts are reasonable and/or paid within 180 days of end of tax year

Solutions to Chapter 22 Assignment Problems Conditional Formatting of Year over Year Change in Expenses as Percentage of Sales

c) From the visualization results in (b) above, how would you screen for risky expense accounts? Sparklines Visualization

High risk determined based on visual assessment of "spikes" in any one year or expense trends each year not matching trend of sales increases (except for fixed expenses not tied to sales such as depreciation, rent, and management fees). Conditional Formatting Visualization

High risk assessed based on the degree of red for the conditional formatting of the change in expense amounts percentage compared to the prior year. Infinity items omitted as they represent new expenses in the year rather than risky expense changes. Note that since this visualization assesses changes from year to year, 2018 would not be

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considered in this visualization and risk assessment should be considered for that year differently.

d) Based on your screening process discussed in (c ) above, what are 5 specific expense accounts and which taxation year(s) for those specific accounts do you believe may be audited by CRA? “High Risk” expense accounts resulting from the screens for both visualizations include the following 5 expense accounts for the noted taxation years:

Data processing (2019) Legal fees (2021) Other R & M (2019) Small tools (2019) Other expenses (2020) For each of those 5 accounts, provide the following:

A visualization of that account specifically that you believe supports your view more clearly that CRA will audit that account specifically during the audit period.

The following visualizations show simple vertical line graphs for each of these expense accounts for the 5 tax years identified for those accounts to reinforce visually why these accounts will likely attract the CRA auditor’s attention for the years noted above:

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High-risk accounts as a percentage of sales Data processing

Legal fees

1.80%

1.60%

1.40%

1.20%

1.00%

1.00% 0.80% 0.80% 0.60%

0.60% 0.40%

0.40%

0.20%

0.00%

0.00% 2018 2019 2020 2021 2022

2018 2019 2020 2021 2022

Other R & M 2.50%

Small tools 1.00% 0.90%

2.00%

0.80% 0.70%

1.50%

0.60% 0.50%

1.00%

0.40% 0.30%

0.50%

0.20% 0.10%

0.00%

0.00% 2018 2019 2020 2021 2022

Other expenses 1.20% 1.00% 0.80% 0.60% 0.40% 0.20% 0.00% 2018 2019 2020 2021 2022

2018 2019 2020 2021 2022

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Another approach would be to present these expense accounts in vertical bar charts as follows for the 5 tax years. To contrast with the line graph visualizations above, I have shown the 5 expense accounts in one combined bar chart. This could have been done as individual bar charts as well like the vertical line graphs above. Either way, the bar charts also reinforce visually why these accounts will likely attract the CRA auditor’s attention for the years noted above.

ii) iii)

A potential reason for CRA to review that account. That is, what is a potential tax adjustment CRA is looking to make and why? A potential reason that would explain the account situation such that CRA would be satisfied that the expense amounts were properly deducted in the year.

I will address (ii) and (iii) together below by expense account. Data Processing ii) CRA will likely look to determine if there are any capital expenses in this account like computer hardware or software purchases, upfront software fees or website development costs. CRA would propose to add those expenses back to the company’s schedule 1 for the year as non-deductible capital costs, though it would accept that those non-deductible costs could be added to the company’s schedule 8 (capital cost allowance schedule). iii) The company may have incurred amounts all of which are reasonable in the circumstances to earn its business income in the year for this expense type such as website hosting fees, internal wage costs for staff working on its data processing activities, annual cloud computing fees, etc. Legal Fees ii) CRA will likely look to determine if there are any capital expenses in this account like fees paid for legal services in areas such as corporate organization/reorganization, buying or selling assets, and obtaining financing for the company. CRA would propose to add those expenses back to the company’s schedule 1 for the year as non-deductible capital costs, though it would accept that those non-deductible costs could be added to the company’s schedule 8 (capital cost allowance schedule), cost of its assets, or its S.20(1)( e) amounts, as applicable.

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iii) The company may have incurred significant legal amounts in the year all of which are reasonable in the circumstances to earn its business income in the year for this expense type such as negotiating contracts or dealing with employee departures, etc.

Other R&M ii) CRA will likely look to determine if there are any capital asset betterment costs in this account like adding a new roof to the company’s building or significantly improving some equipment. CRA would propose to add those expenses back to the company’s schedule 1 for the year as non-deductible capital costs, though it would accept that those non-deductible costs could be added to the company’s schedule 8 (capital cost allowance schedule) iii) The company may have incurred significant amounts all of which are reasonable in the circumstances to earn its business income in the year for this expense type such as repairing (rather than replacing) the roof of its building or restoring (rather than upgrading) a major piece of equipment.

Small Tools ii) CRA will likely look to determine if there are any capital asset purchases in this account. CRA would propose to add those expenses back to the company’s schedule 1 for the year as non-deductible capital costs, though it would accept that those non-deductible costs could be added to the company’s schedule 8 (capital cost allowance schedule) iii) The company may have incurred significant amounts all of which are reasonable in the circumstances to earn its business income in the year for this expense type such as repairing some of its small tool capital assets (rather than replacing these assets).

Other Expenses ii) CRA will likely look to determine if there are any non-deductible costs in this general expense account like capital asset purchases, shareholder personal expense amounts, or large upfront club membership fees. CRA would propose to add those expenses back to the company’s schedule 1 for the year as non-deductible capital costs, though it would accept that capital costs related to the business could be added to the company’s schedule 8 (capital cost allowance schedule) iii) The company may have incurred significant amounts all of which are reasonable in the circumstances to earn its business income in the year for this expense type such as contract settlement payments made to suppliers or customers.

e) What would you do as a next step in this risk assessment process for each of the 5 expense account risk areas you have identified? I recommend that we get the detailed general ledger account activity reports for these accounts to review the number of transactions in these accounts and the amount of the transactions. We could then focus on the largest amounts in the accounts to review the invoice(s) or supporting document for the amount recorded to determine the nature of the amount incurred and included in the expense accounts. This will allow us to determine if there are specific non-deductible amounts in the accounts in preparation for CRA’s audit.

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f) Are there any other significant expense accounts that you believe CRA may audit even though your visualization screening process did not flag these accounts? If yes, what is the issue CRA would be auditing? As shown in the sparklines screening visualization above, the following accounts will likely be reviewed by CRA in detail as they are usually “CRA focus areas”): Management and administration fees Bonuses Management salaries As amounts included in these accounts are often determined at the discretion of the owner/manager of the CCPC, CRA will review these accounts to determine the reasonableness of the amounts deducted from the company. Amounts not considered reasonable will be denied by CRA even though they would still be included in the income of the recipient, thereby resulting in double taxation of those income amounts. Amounts paid to family members other than Shannon (who would generally be able to draw fees, bonuses or salaries without restriction as she is the founder of the company and presumably the creator of the sales and profits in the company) would receive special scrutiny to ensure there is not inappropriate income splitting with low-income family members. Management and administration fees will also be reviewed to ensure that any amounts paid to companies of related individuals and potentially subject to the Specified Corporate Income Rules are treated appropriately for the Small Business Deduction of those companies. CRA will also review the bonuses and management salaries to ensure that all amounts were paid in the year or within 180 days of the end of the year.

g) Are there any revenue accounts that you believe may present an opportunity to reduce the company's taxable income as reported in those years? Which account(s) and year(s) for those accounts may present such an opportunity, briefly explain the opportunity and how would you assess this opportunity. The following revenue accounts would present an opportunity to determine possibilities to reduce the company’s taxable income in the tax years noted:

GIFI code 8090 – Amount – Investment revenue (2022) GIFI code 8210 – Amount – Realized gains/losses on disposal of assets (2019) GIFI code 8230 – Amount – Other revenue (2021) For investment revenue, we would review if there are any ”taxpreferred income” items received in the year like dividends from other taxable Canadian corporations which would be deductible in Division C or foreign income that would be eligible for foreign tax credits. For realized gains/losses on disposal of assets and other revenue, we would review if there are large gains in the relevant year that may be considered to be on account of capital based on the company’s intention when it acquired those assets. Resulting capital gains would only be subject to tax at the 50% inclusion rate and 50% of the capital gain would be added to the capital dividend account. That CDA amount could be paid to Shannon tax-free as a capital dividend if a resolution is prepared and the appropriate CRA form is filed. Much like I recommended for the risky expense accounts above, as a follow up, we should get the detailed general ledger account activity reports for these revenue accounts to review the number of transactions in these accounts and the amount of the transactions. We could then review the amounts recognized in these revenue accounts, related source documents and transaction history to determine if there are opportunities for lower income inclusion amounts or Division C deductions.

APPENDIX

Short Questions and Discussion Notes CHAPTER 2 Liability for Tax Short Questions (1) Will Canadian residents who earn investment income in another country be taxed in both countries on the same amount of income? (2) Mr. Smith went to Kuwait to work in the oil fields for an American company. He left his family (wife and three minor children) in Canada, and was away for three years. During this period he would visit Canada for vacations but would not stay more than four weeks during any one year. Is Mr. Smith a non-resident? (3) Ms. Jones and her family have decided to move to Arizona in order for her to take up a lucrative oneyear contract. They have sold their house and possessions in Canada and are renting a house in the U.S. They have also indicated to the bank, their clubs and their friends that they are becoming non-residents of Canada. At the end of the one-year contract they plan to travel for six months before returning to Canada. Will they be non-residents? (4) If an individual were to leave Canada on September 30 of this year (breaking all ties with Canada) for a five-year contract in the U.K., then would he or she still be considered to be a resident of Canada throughout this year since he or she lived here for over 183 days in the year? (5) If an individual were to leave Canada on September 30 of this year (breaking all ties with Canada) and move to Buffalo, then would he or she be considered to be a non-resident even though he or she continued to carry on his or her business in St. Catharines through a company incorporated in Ontario after he or she left? (6) A client, who is resident in Canada, decides to set up a company in the U.S. to carry on business there. In doing so she wants to maintain control over the operations and, therefore, she is the President and the sole director and makes all important decisions. All other employees are resident in the U.S. Is this U.S. company resident in Canada or the U.S.? (7) If a person is considered to be resident in Canada by the Canadian authorities and in the U.S. by the U.S. authorities, then will that person be subject to tax in both countries?

Discussion Notes for Short Questions (1) Yes. They will pay tax in the foreign jurisdiction based on the investment income earned there and also include the same amount in their Canadian income. However, they can obtain a foreign tax credit in Canada [ssec. 126(1)] for the income tax paid in the foreign country. (2) Probably not. It appears that Mr. Smith has not made a “clean break” from Canada. He has a “continuing state of relationship” in Canada since his wife, children and family home are still here. (3) Probably. Significant residential ties involving dwelling, spouse and dependants have been cut and so have some secondary ties. If there is evidence that her return to Canada was foreseen at the time of her departure (e.g., a contract for employment upon return to Canada), the CRA will presume that she did not sever all residential ties on leaving Canada [Income Tax Folio S5-F1-C1. par. 1.17]. (4) No, he or she would be considered a part-year resident [sec. 114]. The sojourning rules [ssec. 250(1)] only apply to persons who sojourn in Canada for 183 days or more during a period in a year in which they are a non-resident. (5) Since the business is being carried on in Canada by a corporation, the individual is not carrying on business in Canada. Therefore, he or she will be subject to the part-time resident rules [sec. 114] and taxable on his or her world income up to September 30. From October 1, he or she would only be taxed in Canada on his or her income from employment, carrying on business and from the sale of taxable Canadian property [ssec. 2(3)].

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(6) Under the common law principles the “central management and control” would reside with the directors and officers and, therefore, be in Canada. Reference to the Canada–U.S. tax treaty would be necessary to avoid any double taxation. (7) No. Paragraph 2 of Article IV of the Canada–U.S. tax treaty provides tie-breaking rules to follow when a person is considered to be resident of both countries. This prevents double taxation.

CHAPTER 3 Employment Income Short Questions (1) When determining whether a person is employed or self-employed, one of the tests used is the “economic reality test.” What does this test involve? (2) A director of a corporation is considered to be an employee of the corporation for tax purposes and the director’s fees are income from employment. Comment. (3) If an employer were to pay the premiums for an individual disability policy (i.e., for the president of the company), then there would not be a taxable benefit as a result of subparagraph 6(1)(a)(i) and any disability benefits received from the plan would not be taxable under paragraph 6(1)(f). Comment. (4) Mr. Chow is the VP Marketing for Compusale Inc., a computer company. He and his wife are taking a company-paid trip to a trade show in Hawaii at which he will be working. His wife is not an employee of the company but she will be in charge of hospitality for Compusale Inc. at the show. She will spend the hours from 1:00 p.m. until 9:00 p.m. each day on this assignment getting things organized while her husband is in the company booth. She will spend the mornings on the beach. Do you think that Mrs. Chow’s expenses will be a taxable benefit to Mr. Chow? (5) Mr. Benton, the President of Publicco Ltd., travels extensively on company business. It is the company policy to pay him a meal allowance of $100 per day and $200 for hotel while he is on the road. The standard salesperson’s allowances are $40 for meals and $100 for hotel. Comment on the reasonableness of the President’s allowances. (6) XYZ Co. leases a car for its salesperson at a monthly lease cost that includes insurance. How should the company deal with the insurance cost when calculating the taxable benefit for the salesperson? (7) Mr. Tse is a stock broker working in downtown Toronto. He arrives at the office early in the morning to read the papers and organize his day. Throughout the day he is on the telephone calling clients and prospective clients. He occasionally takes clients out for lunch or dinner while he is downtown. He is required by his employer to pay his own entertaining expenses. Can he deduct these entertainment expenses on his personal tax return? (8) Name and describe the two basic types of pension plans. (9) Ms. Betty is a salesperson for XYZ Ltd. She is paid a travel allowance of $250 per month with a reconciliation done at the end of the year to make sure that it is actually calculated based on the company policy of $0.61 per km. How will this be treated for tax purposes? (10) Ms. Jones is a salesperson for an office supply company. She has bought a computer for the client management aspect of her business. It is a portable, so she can take it with her to the office and home. Assuming she otherwise meets the conditions to claim expenses under paragraph 8(1)(f), can she deduct CCA on this computer?

Discussion Notes for Short Questions (1) The economic reality test examines several economic factors and draws from them an inference as to the nature of the relationship. In particular, four dimensions have been advanced involving: (a) control, (b) ownership of the tools, (c) chance of profit, and (d) risk of loss. In cases where the taxpayer supplies neither funds nor equipment, takes no financial risks, and has no liability, an employer-employee relationship is implied. (2) The definition of “employee” in subsection 248(1) includes an “officer” and the definition of “officer” includes a corporate director. Paragraph 6(1)(c) includes director’s fees in income under Subdivision a.

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(3) The exclusion under paragraph 6(1)(a) provides for “group” sickness or accident insurance plans. A plan taken out for one individual would not qualify for this exclusion of the premium paid by the employer. However, any disability benefit the president receives under this plan would not be taxable since the contributions are paid by the president through the fact that he or she paid tax on the taxable benefit [IT-428, par. 20]. (4) Given that she has specific responsibilities to carry out and that she will be working a full day (8 hours) performing her duties, it is unlikely that her travel costs will be a taxable benefit. Income Tax Folio S2-F3-C2, indicates that there is no employment benefit to the employee if the spouse was, in fact, engaged primarily in the business activities on behalf of the employer. (5) The word “reasonable” is not defined in the Act and, therefore, must be applied to the particular facts of the situation. It is not unreasonable that the President should receive a larger allowance while on the road than a salesperson, since he is representing the company and must present a certain image. The difficulty is determining when the “reasonable” amount is exceeded. If the allowance is in excess of what top-rate meals and hotel rooms cost, then it would be considered unreasonable and the full allowance would be included in his income [spar. 6(1)(b)(vii)]. He would then be able to claim his expenses [par. 8(1)(h)]. (6) The cost of the insurance should be excluded from the calculation of the standby charge [ssec. 6(2)]. However, the operating cost benefit [par. 6(1)(k)] would cover the insurance. (7) In order to meet the conditions of paragraph 8(1)(f), he must “ordinarily be required to carry on the duties of his employment away from his employer’s place of business.” In this case it does not appear that there is such a requirement since he spends virtually all of his time in his office. Therefore, he would not be able to deduct his expenses. (8) Defined benefit plans guarantee a predetermined amount of retirement income based on a flat amount per year of service or a percentage of the employee’s earnings over a defined period. These plans are funded by actuarially determined contributions by the employee and/or the employer. Money purchase plans provide whatever pension income the contributed funds in the plan can purchase through the acquisition of an annuity. No predetermined amount of pension income is guaranteed under these plans. Benefits will depend upon the actual contributions, the investment return of the plan and annuity rates at the date of purchase. (9) According to IT-522R, this method is acceptable and she will not have an income inclusion if: (a) there is a beginning-of-the-year agreement stating that she will get a stated amount per kilometre for business travel; (b) there is a year-end accounting for the difference between the payments and the business travel times $0.61; and (c) the amounts paid are reasonable. Generally, the per kilometre charges will be considered reasonable as long as they are within the rates set out by the CRA, i.e., $0.61 for the first 5,000 km and $0.55 on the remaining. (10) Paragraphs 8(1)(j) and (p) are the only provisions that will allow an employee to deduct CCA. These paragraphs are restricted to automobiles, aircraft and musical instruments. It does not allow the deduction of CCA on computers. Therefore, according to subsection 8(2), CCA on the computer will not be allowed.

CHAPTER 4 Income from Business: General Concepts and Rules Short Questions (1) In their manufacturing process, Canco uses specialized parts. These parts are identical, but each has its own serial number. As they are received, they are put into storage compartments in front of the existing inventory. As they are used, the ones closest to the front are taken first. When Canco calculates its year-end inventory it uses the LIFO method in arriving at the inventory value. Canco uses the same for tax purposes and feels that this is correct. Comment. (2) ServiceCo is in the business of selling service contracts to customers and then providing the service as needed over the term of the contract. The customers pay for the service contract at the beginning of the contract. ServiceCo believes that it does not have to record these receipts as income when the cash is received but only over the term of the contracts. Comment. (3) A client is about to relocate to a new office tower. The new landlord is offering large incentives to attract long-term tenants and has offered your client a cash payment of $100,000 in order to move in. The tenant is then

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required to do his or her own leasehold improvements. Your client has heard from some friends that the inducement will be treated as a tax-free receipt and that the courts have accepted this position. Comment. (4) A client is in the business of developing and selling tax shelters. In order to market his products he has joined the local golf club most frequently used by doctors and dentists. As a result of the contacts made there he has been able to double his sales volume. Based on these results, he feels that his club dues are deductible as a business expense. Comment. (5) During the year, a business client who is a self-employed individual made donations to both charities and to political parties. Both types of donations yielded additional business to the client. The client’s accountant has advised it that all donations must be added back to income to arrive at net income for tax purposes. Comment. (6) In order to fund the buy-sell provisions of a shareholder agreement the company has taken out a life insurance policy on the lives of each of the shareholders and is paying the premiums on a monthly basis. Since it is a business expense the premiums are deductible. Comment. (7) In order to support its bank loan, the company is required by the bank to provide life insurance as collateral. Since the premiums are a business expense they are deductible. Comment. (8) A client went to a convention that cost her $3,000 for three days. The cost was inclusive of all meals and accommodation. Since nothing was separated in the convention fee for meals and accommodation, she can deduct the full cost. Comment. (9) A client had an employee who stole $30,000 of cash from it over a period of six months. Is this a deductible expense to the business? Comment. (10) Based on past experience, your client has found that 10% of its sales are returned for a refund within 60 days. At the end of each month an accounting reserve is set up for these returns. History has shown the reserves to be accurate. Can these same reserves be claimed for tax purposes? Comment. (11) Any reserve that is allowed as a deduction in one year must be taken into income in the next year. Comment. (12) If your client pays a fee to an accounting firm to help it prepare cash flow projections and a proposal to successfully obtain bank financing for expansion, is the fee deductible? Comment.

Discussion Notes for Short Questions (1) While the LIFO method is generally not acceptable as an assumption about inventory values for income tax purposes, it is acceptable if this method actually best matches the flow of inventory through the business. Alternatively, by using the specific identification method Canco could arrive at the same inventory value. Refer to IT-473R. (2) The cash receipts must be included in income in the year received [par. 12(1)(a)]. A reserve may then be claimed for amounts that relate to services to be provided in a future period [par. 20(1)(m)]. (3) The amount will have to be included in income [par. 12(1)(x)], unless an election to reduce capital cost [ssec. 13(7.4)] or cost [ssec. 53(2.1)] is available. (4) Even though the club dues were incurred to earn income from his business, they are not deductible since they are specifically disallowed [par. 18(1)(l)]. (5) The charitable donations are disallowed to the extent they were not incurred to earn income. [par. 18(1)(a)] So, if they were incurred to earn income, then they will be deductible. The political donations, on the other hand, are specifically disallowed [par. 18(1)(n)] and, therefore, are not deductible in computing income for tax purposes, regardless of the fact that they were incurred to earn income. An individual taxpayer would be able to receive a limited tax credit that is allowed for federal political contributions. (6) Since life insurance proceeds are not included in income on death, the premiums are not an expense incurred to earn income and are, therefore, not deductible, [par. 18(1)(a)]. (7) Paragraph 20(1)(e.2) permits a deduction in respect of life insurance premiums where the policy is assigned as collateral to a lender who is in the business of lending money. The deduction is based on the lesser of the premiums paid and the net cost of pure insurance. The deduction is calculated as the lesser of: (a) the premiums paid under a life insurance policy in respect of the year where: (i) the policy is assigned to the institution in the course of borrowing; (ii) the interest on the loan would be deductible; (iii) the assignment is required by the institution; and (b) the net cost of pure insurance.

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The deduction, further, must reasonably be considered to relate to the amount owing from time to time under the borrowing. (8) If meal costs are not specified, then subsection 67.1(3) deems the cost to be $69 per day for meals. This is then subject to the 50% limitation [ssec. 67.1(1)]. (9) In Income Tax Folio S3-F9-C1, the CRA allows employee thefts as expenses unless it is a senior employee who committed the theft. However, in the court case, Cassidy’s Limited (formerly Packer Floor Coverings Ltd.) v. M.N.R., 89 DTC 686 (T.C.C.), defalcation by a senior employee was allowed. (10) Paragraph 18(1)(e) specifically disallows reserves of any kind unless they are specifically allowed somewhere else in the Act. There are no reserves in section 20 which would allow a deduction for this reserve since it is based on a contingency and not a known liability. (11) Each reserve allowed under subsection 20(1) has a corresponding income inclusion under subsection 12(1). In subsequent years a new reserve may be claimed depending on the provisions of the reserve provision itself and the facts of the situation. (12) Paragraph 20(1)(e) would not allow an immediate deduction. Instead, the fees would be deductible evenly over a 5-year period including the year the expense was incurred.

CHAPTER 5 The Capital Cost Allowance System for Depreciable Property Including Intangibles Short Questions (1) Whenever an asset is sold, the full amount of the proceeds is credited to the CCA class. Comment. (2) If a CCA class is in a negative balance at any time in the year, then this negative balance will have to be brought into income. Comment. (3) On December 1, Mr. Luigi buys his first rental property and immediately begins to rent it out. The CCA that he is otherwise entitled to claim will be prorated for the fact that he only owned the building for 31 of the 365 days in the year. Comment. (4) A construction corporation moved some heavy equipment into northern Ontario for a special project. At the end of the project they abandoned the equipment at the site since the cost of removal exceeded the cost of replacement. The equipment will forever remain in its class since it has not been disposed of. Comment. (5) There can be no recapture or terminal loss on automobiles that cost over $34,000 plus HST. Comment. (6) CCA is a discretionary deduction and, therefore, may be claimed or not claimed at the discretion of the taxpayer. However, if it is claimed, then the full amount must be claimed. Comment. (7) If a building is sold for less than its capital cost, then a capital loss will be realized. Comment. (8) A business made some leasehold improvements, costing $10,000, to their offices in year 3 of a five-year lease. There is one renewal period of five years. What is the maximum CCA that they can claim in year 3 based on these additions? (9) A corporation bought a franchise on June 1, for $20,000. The franchise term is for 10 years. The yearend of the corporation is December 31. What class is this asset in and how much CCA can be claimed? (Ignore the effects of leap years.) (10) A corporation bought a franchise on June 1 of the current year , for $20,000. The franchise is for an indefinite term. The year-end of the corporation is December 31. What class is this asset in and how much CCA can be claimed? (11) A client had a fire in their warehouse. They received insurance proceeds of $50,000 of which they used $45,000 to repair the damage and the balance of $5,000 was taken into income. Their controller agreed that this was the proper treatment. Comment. (12) A personal tax client has come to you and told you that she cannot afford to buy a house based on her own income. However, she has bought a duplex and is living in one half and renting out the other half. On the sale of the duplex she thinks she will be able to claim it all as her principal residence. Comment.

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Discussion Notes for Short Questions (1) The proceeds, up to a maximum of the original cost, are credited to the class. If proceeds exceed original cost then there will be a capital gain. (2) The negative balance will only have to be brought into income if the balance is still negative at the end of the fiscal year. If a new asset is acquired at a cost high enough to bring the class into a positive balance then CCA can be claimed in the year on this positive balance. (3) As an individual earning property income, Mr. Luigi is considered to have the full calendar year as his taxation year. Thus, there is no proration of CCA. However, he will be eligible for the accelerated investment incentive. (4) In IT-460, the CRA takes the position that property that is abandoned is actually disposed of for proceeds equal to nil. This becomes important when trying to claim a terminal loss on the disposal of the last asset since, if all the assets of the class have not been disposed of, a terminal loss cannot be claimed. (5) Subsections 13(2) and 20(16.1) provide that recapture and terminal loss rules do not apply to automobiles costing over $36,000 plus HST. Each of these autos is in a separate class, Class 10.1 [Reg. 1101(1af)]. (6) The word “may” in paragraph 20(1)(a) makes it a discretionary deduction. However, in Regulation 1100(1) the phrase “not exceeding” is used to allow any amount of CCA from nil to the maximum to be claimed at the discretion of the taxpayer. (7) Subparagraph 39(1)(b)(i) denies a capital loss on depreciable property. When the proceeds are less than the capital cost they are credited to the CCA class. (8) Regulation 1100(1)(b) and Schedule III provide for CCA on leasehold improvements as follows: 50%  the lesser of: (a) 1/5  $10,000 = $2,000 (b) $10,000/(3 + 5) = $1,250 CCA = $1,875 (i.e., 150% of $1,250 due to the accelerated investment incentive) (9) Franchises with limited lives are in Class 14. CCA is claimed based on a proration of the cost over the life, in days (ignoring leap years), of the franchise. Therefore, the CCA would be: $20,000

(365 10)

 214 = $1,173 x 150% = $ 1,760

(10) Since the franchise is for an indefinite term, it is a Class 14.1 asset and is depreciated at 5% on the declining balance. (11) The $45,000 should be treated as an offset to expenses or effectively as an income inclusion [par. 12(1)(f)]. The extra $5,000 that was not spent should not be treated as income. Instead, it should be treated as proceeds of disposition paragraph (f) of the definition of “proceeds of disposition” in subsection 13(21). (12) She will be deemed to have disposed of the rental portion of the duplex for proceeds equal to the proportion of use that was rental [par. 13(7)(d)]. This will give rise to potential recapture and capital gain. As she did not ordinarily inhabit the rental property, the rental portion of the duplex is not eligible for the principal residence exemption.

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CHAPTER 6 Income from Property Short Questions (1) The dividend gross-up and tax credit were introduced to provide an incentive to Canadian individuals to invest in the stock market. Comment. (2) “Income from property” includes capital gains since they arise from the sale of property. Comment. (3) Individual taxpayers have three options for reporting interest income. They can report it on the cash basis, the receivable method or the accrual method. Comment. (4) Mr. Watson sold a piece of property to Mr. Holmes in an arm’s-length transaction at fair market value. Mr. Watson took back a note with no interest being charged and is concerned that subsection 16(1) will apply to deem part of the repayment to be interest income. Comment. (5) Mr. Smith borrowed $300,000 at the bank to buy common shares in Smith Ltd., which in turn bought 30 acres of raw land for development at some time in future. Is the interest fully deductible to Mr. Smith? (6) A tax client has just told you that she has sold a rental property that she has owned for a number of years. Because of the large amount of recapture that she was faced with, she decided to buy another apartment to bring the class back into a positive balance. Comment.

Discussion Notes for Short Questions (1) The gross-up and tax credit mechanism was introduced to integrate corporate and personal income to leave the individual indifferent as to whether he or she earned business or investment income through a corporation or directly. See Chapter 12 of the text. (2) Capital gains are specifically excluded from income from property [ssec. 9(3)]. Also, capital gains and income from property are under two different subdivisions of the Act. (3) For investment contracts, interest income must be reported on the accrual basis annually under subsection 12(4). (4) Since the transaction took place at fair market value and assuming that Mr. Watson and Mr. Holmes are dealing at arm’s length, it is doubtful that the CRA would be successful in imputing an interest component under subsection 16(1). If the purchase price were in excess of fair market value then the CRA would have a greater chance of successfully converting some of the capital gain into interest income. (5) The Act denies interest expense that can reasonably be considered as interest on borrowed money used in respect of or for the acquisition of land, but the disallowed interest is added to the cost base of the shares [par. 18(3)(b), 53(1)(d.3)]. (6) Regulation 1101(1ac) requires each rental building purchased after 1971 and costing $50,000 or more be placed in a separate CCA class. Thus, if those two conditions are met, the new building she is buying will not go into the same pool and the recapture will not be deferred.

CHAPTER 7 Capital Gains Short Questions (1) Mr. Trent retired a number of years ago and decided that he did not want to spend winters in Canada. He sold his house in Waterloo and moved into an apartment for seven months of the year. For the other five months he lived in a villa in Spain that he bought after he sold his house. He now wants to sell the villa and buy a property in Arizona. He has come to you to see whether he can claim the principal residence exemption on the villa. Comment. (2) Mr. Platzer, who has been saving coins since he was a child, has now decided to sell a particularly valuable set that he bought for $100 many years ago. There are five coins in the set and each is worth $800 for a total selling price of $4,000. The coin dealer that he is selling them to suggested that he sell him each coin for $800 instead of the set for $4,000, in order to avoid a capital gain. What do you think? (3) Mrs. Amos likes to buy old books and furniture. She very rarely sells any of her pieces and is not considered to be a trader. However, this year she has sold an antique stool for a loss of $2,000 and an old 1917

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Income War Tax Act for a gain of $4,000. Her only previous transaction was the sale of another old book for a loss of $3,000 six years ago. What will her capital gain be for the year from these transactions? (4) Mr. Evans has been investing in the stock market for many years. It is now December and he is trying to minimize his tax liability for the year. In July he sold some public-company shares to realize a capital gain of $20,000. He does not want to pay tax on this gain so he wants to sell his shares of another public company, PubCo., that are doing poorly and realize an offsetting loss. However, he is certain that the PubCo. shares will increase in value again and wants to buy them back again in early January. Comment. (5) How are stock dividends treated for tax purposes? (6) Ms. Rose bought a summer cottage in 2008 and used it herself for the next 10 years. In the years 2019 to 2023 she travelled extensively and was unable to use her cottage at all. In fact, she rented it out to an unrelated family for the entire four years. In 2023, she again began to use the cottage personally. Comment on the tax issues involved. (7) When her husband died suddenly, Mrs. Jones found that she needed extra income to support herself. She proceeded to make a permanent apartment on the second floor of her house. She added a separate entrance, a bathroom, a kitchen and had the utilities separately metered. The costs were considerable but she was confident she would be able to make a profit very quickly. Comment on the tax issues. (8) Mr. Carter has worked all his life to build up the value of his privately-owned company. Having started from nothing, his shares are now worth $10 million. He would like to leave the country but does not feel that he can because of the huge amount of tax that he would have to pay on the accrued gain on the shares. Discuss. (9) Mr. King has been a non-resident of Canada and just last month moved to Canada to live. While abroad, he bought some shares on the New York Stock Exchange at a cost of $10,000 and now wants to sell them for $50,000. However, he is concerned about the amount of tax that he will have to pay on his $40,000 gain. He has come to you for advice. Can you help him? (10) Mrs. Reilly has sold shares that she owned to her husband. She elected under subsection 73(1) not to have the rollover apply and he paid her cash for the shares. She originally paid $6,000 for the shares; they are now worth $16,000 and he paid her $15,000 in cash. What are the tax consequences to Mr. and Mrs. Reilly? (11) Opco, which has a December 31 year-end, sold the warehouse it used in its business this year and started to use rented space. How long do they have to replace the warehouse in order to defer the tax on the one that was sold? (12) Opco has been operating in downtown Toronto for the past 25 years. It has decided to sell its land and building and move its operations to London, Ontario where it is less expensive. They sold their land for $2 million and the building for $500,000. These had a cost of $100,000 in total. The property they bought in London cost $1 million for the land and $1.5 million for the building. It would appear that they will have a significant capital gain on both the land and building with the only full deferral available on the building. Can you suggest a method that will give them the full deferral on both the land and the building? (13) Dealco originally bought its land and building for $500,000 each. The land has now gone up in value to $1.3 million while the building has no value in its current location. No CCA has ever been claimed on the building. A purchaser has now come along and has offered Dealco $1.3 million if they will demolish the building and leave the land clear. Dealco thinks that this is a great idea since, of the $800,000 gain on the land, only $400,000 is taxable and this will be offset by the $500,000 terminal loss on the building. What do you think? (14) Your friend Ralph bought a rental property some years ago. He paid $50,000 for the land and $150,000 for the building. Unfortunately, the property values in the area have not gone up and, due to the recession, have in fact gone down. He has to sell the property to meet other commitments and his proceeds will be $40,000 for the land and $130,000 for the building. Since he has been operating at a loss he has not claimed any CCA yet. He is upset that all he will get is a capital loss on the sale and he will not be able to use this loss to reduce his income and help reduce his tax. Comment. (15) Acme Co. has just bought a new piece of equipment in the U.S. for use in its Canadian plant. The equipment cost $75,000, the shipping cost $10,000 and the installation cost $5,000. The controller wants to capitalize the $75,000 and expense the balance of the costs for tax purposes. As the auditor on the engagement you have been asked for your views on how the expenditures should be treated for tax purposes. (16) Ms. Andrews has just sold her rental property for a capital gain of $200,000. However, in order to do so she has had to take back a demand promissory note of $300,000 until the purchaser can get mortgage financing which the purchaser expects to do early next year. Can Ms. Andrews do anything to defer her tax liability? (17) Earlier in the year Mr. Barnes had sold the shares of his small business corporation to his son and had taken back a term note for equal principal payments over 15 years. Mr. Barnes has already used up his capital gains

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exemption and is glad that he took back the note since he can now defer tax on the gain over the next 15 years. Comment. (18) Mrs. Blidge has sold her shares in her qualified small business corporation and realized a gain of $300,000. In the process she took back a term note that is payable equally over five years. She does not know whether to claim the capital gains exemption to eliminate the full amount of the gain now or to claim a reserve to bring the gain into income over the next five years and use her exemption in each of the next five years. She has come to you for your expert advice. (19) Ms. Sleigh had taken advantage of the housing market in her city by putting $10,000 down on a new house which was to be built in two years. By the time the house closed it had gone up in value by $60,000. She and her family moved into the house for one month and then sold it and realized the gain. They then moved back into their old house. When she came to have you prepare her personal tax return she said that she could claim the principal residence exemption on the new house. Comment.

Discussion Notes for Short Questions (1) The definition of principal residence [sec. 54] does not restrict the location of a principal residence to Canada. The claim of the principal residence exemption is restricted to Canadian residents [spar. 40(2)(b)(i)]. In this case, Mr. Trent has not changed his resident status and therefore he would be able to claim the principal residence exemption on the Spanish villa. (2) Subsection 46(3) provides that, when the coins are all sold to the same person or related people, they will be treated as being sold as a set and he will have a capital gain of $3,000 on the transaction. If he sold each coin to a separate arm’s length dealer then he would have been able to use the $1,000 rule to eliminate the full gain. (3) The antique stool is not listed personal property (LPP) according to the definition in section 54. However, it is still PUP and, as such, the loss is disallowed [spar. 40(2)(g)(iii)]. The rare book, on the other hand, does meet the definition of LPP and the gain is subject to tax. However, in determining Division B income, the current gain of $4,000 is reduced by the previous loss of $3,000 and 1/2 of this net amount is considered to be the “taxable net gain” from listed personal property [ssecs. 41(1) and (2)]. Losses on LPP can be carried back three years and forward seven years to be applied against gains from LPP. It should be noted that these carryovers are applied within the calculation of the capital gain in Division B and not under Division C as other loss carryovers are. (4) If Mr. Evans buys the shares of PubCo. back within 30 days of selling them in December, then he will have a superficial loss [sec. 54]. This loss will be denied [spar. 40(2)(g)(i)] and added to the cost base of the replacement shares [par. 53(1)(f)]. (5) The stock dividend is treated in the same way as a cash dividend. The increase in paid-up capital is considered to be a dividend [ssec. 82(1)] and the grossed-up amount is included in income. The cost base of the shares received is equal to the increase in paid-up capital [ssec. 52(3)]. (6) When she began to rent out the cottage in 2019, she had a change in use [ssec. 45(1)] and the deemed disposition and potential capital gain (unless the cottage was her principal residence) that go along with it. Then in 2022 she had another change in use that would cause her to have another deemed disposition and potential capital gain. However, she could have elected under subsection 45(2) not to have a change in use in 2019. This would have left the property as personal-use property without the deemed disposition. As a result, when the property was changed back to personal use in 2023, there would not have been a change in use at that time either. In order to have the rules in subsection 45(2) apply she would have had to elect in 2019 when the first change in use occurred (unless the cottage was her principal residence) and, under subsection 45(4) and regulation 1102(1)(c), she could not have claimed any CCA on the cottage. (7) Since she has made significant structural changes to the house, the CRA takes the position [Income Tax Folio S1-F3-C2, par. 2.57], that she will have a partial change in use of the house and a disposition [par. 45(1)(c)] of that portion of the house represented by the second floor. She will be able to claim CCA on the rental space. On the eventual disposition of the entire property the principal residence exemption will only apply to the portion she lives in. The second floor will be disposed of in the same manner as a rental property. (8) The rules causing a deemed disposition on leaving the country do apply to an unlisted share of the stock of a corporation resident in Canada [ssec. 128.1(4)]. He will pay tax on this gain when the shares are sold. (9) Mr. King is deemed to acquire the shares at their fair market value at the time he entered the country [ssec. 128.1(1)]. This should give him a cost base of $50,000 and eliminate his accrued capital gain.

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(10) Since Mrs. Reilly elected out of the rollover in subsection 73(1) she will be taxed on the $10,000 capital gain (subsection 69(1) applies to deem the proceeds to be equal to fair market value). However, since she did not meet the condition of paragraph 74.5(1)(a), i.e., she did not receive fair market value consideration, the attribution rules will continue to apply. The cost base of the shares to Mr. Reilly will be the $15,000 that he paid for the shares since section 69 does not adjust his cost base. Therefore, there will be double taxation on the $1,000 difference between $16,000 and $15,000. (11) They have to replace the warehouse before the later of 12 months after the initial year and the end of the first taxation year after the initial year [par. 44(1)(d)]. If the sale closed this year, then they have until December 31 of next year to replace the property. The initial year is the year that the “amount has become receivable as proceeds of disposition” [ssec. 44(1)]. (12) An election is allowed to reallocate proceeds from land to building [ssec. 44(6)]. In order to obtain a full deferral, $1 million of proceeds could be reallocated from land to building to defer the full gain. (13) The proceeds will be reallocated from the land to the building to the extent of the terminal loss (TL) [ssec. 13(21.1)]. As a result, the proceeds on the building will be $500,000 and the proceeds on the land will be $800,000. Under the proposal the effect on taxable income was ($100,000) ($400,000 TCG — $500,000 TL) whereas the effect is now $150,000 ($150,000 TCG — nil TL). (14) The Act does not allow a capital loss on the sale of depreciable property [spar. 39(1)(b)(i)]. Instead, he will be able to claim a terminal loss of $20,000 on the sale of the building [ssec. 20(16)] and a capital loss of $10,000 on the sale of the land. Even though there is a terminal loss on the building, there is no reallocation of proceeds since there is not a capital gain on the land [ssec. 13(21.1)]. As the terminal loss would be considered to be a property loss, the loss may be used to offset other sources of income and help reduce his tax. (15) “Cost” is not defined for tax purposes but it would normally include all of the costs necessary to obtain the equipment, deliver it and install it in the plant. All of these costs relate to getting the equipment ready for use. (16) As the note is payable on demand, it may become due to the taxpayer before the end of the year. For purposes of the reserve, the demand note would not meet the definition of deferred proceeds. As a result, she cannot claim a reserve [spar. 40(1)(a)(iii)] based on amounts that are payable to the taxpayer after the end of the year. (17) Where shares of a small business corporation are transferred to a child, the reserve rules change so that the 1/5 is changed to 1/10 to allow the gain to be brought into income over 10 years instead of five years [ssec. 40(1.1), spar. 40(1)(a)(iii)]. (18) She can either claim the full exemption now or, if she claims the reserve, claim the exemption each year as she brings the gain into income. However, there is usually no advantage to claiming the reserve if the full amount of the gain will be exempt from tax. (One exception may be if she will be subject to alternative minimum tax (discussed in Chapter 10) by bringing the full amount of the gain into income in the first year.) (19) The CRA stated [Income Tax Folio, S1-F3-C2, par. 2.10] that a taxpayer may designate any residence as his or her principal residence as long as he or she lives in the home for a short period during the year and his or her intention is not to make a profit on the residence’s disposition. In this case her intention seems to be to make a profit since she moved in for such a short time and then moved back to her old house. The issue then becomes whether the gain is an income or a capital gain. This transaction could well be considered an adventure in the nature of trade and fully taxed.

CHAPTER 8 Non-Arm’s Length Transactions and Other Special Circumstances Short Questions (1) Bill and Betty have been living together for 15 years and have three children together. They have never married. Bill has loaned Betty $50,000 interest free from an inheritance he received so she can earn some investment income. Comment. (2) Ms. Jones owns all of the shares of Jones Co. She has had the company valued and 50% of the shares are worth $100,000. Since her husband has inherited that amount she is going to sell him 50% of her shares for $100,000 cash. She intends to report the gain on her tax return and have her husband pay tax on any dividends paid by the company. Comment.

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(3) A client has just come up with what he thinks is a clever plan for avoiding the attribution rules. He is going to lend his mother, who lives in the U.K., $100,000 and she in turn will lend the money to his 12-year-old son. His son will invest the money and earn interest income that will be taxed in his son’s hands. Comment. (4) Mrs. Campbell has heard that she can make the attribution rules work for her. She proposes to start up a company and wants to own all the shares herself but she also wants to split income with her husband. She thinks that she can buy 50% of the shares herself and have her husband buy the other 50% of the shares with his own money. He would immediately give her the shares for no consideration. Once dividends are declared, 50% of her dividends would be attributed to her husband under section 74.1. What do you think? (5) Mr. O’Malley wants his wife to benefit from and pay tax on the future appreciation in the value of some shares that he owns. These shares originally cost $5,000 and are now worth $12,000. He is going to sell them to her in exchange for a note for $12,000 with interest at 4%. At the time of the loan, the prescribed rate was 3% and the market rate of interest for similar loans was 6%. Discuss whether he can achieve his goal.

Discussion Notes for Short Questions (1) Attribution will apply to this loan since Betty is Bill’s spouse or common-law partner [ssecs. 74.1(1), 248(1)]. (2) In order to avoid the attribution rules, subsection 74.5(1) requires that she and her husband will not only have to complete the transaction at fair market value but they will also have to complete a joint election under subsection 73(1) not to have the rollover apply in order to avoid the attribution rules. (3) On the surface, the attribution rules of subsection 74.1(2) will not apply since the grandmother is not resident in Canada. However, subsection 74.5(6) provides an anti-avoidance rule that will catch this “back-toback” loan arrangement and have the interest income earned by his son taxed in your client’s hands. (4) On the surface, it works. But the artificial transaction rules in subsection 74.5(11) would apply to cause the attribution rules to be ignored since one of the main reasons for this transaction is to reduce the amount of tax that would be paid. (5) In order to transfer property to his wife and avoid the attribution rules he must follow the attribution rules [ssec. 74.5(1)] and have the sale take place at fair market value, have interest charged at the lesser of the prescribed rate and the commercial rate, and elect [ssec. 73(1)] not to have the spousal rollover take place. In this case the interest rate appears to have met the criteria as it is in between the prescribed and market rates. However, there is no mention that they made the [ssec. 73(1)] election out of the rollover. Therefore, the attribution rules are not avoided and income splitting is not achieved, unless it can be established that the interest rate is at least equal to the lesser amount, above, and that the [ssec. 73(1)] election was made not to have the automatic rollover apply.

CHAPTER 9 Other Sources of Income and Deductions in Computing Income Short Questions (1) Mr. Jones had been fired from his job as controller of a large manufacturing company for consistently not performing his duties. Mr. Jones admitted that he had not performed his job up to the necessary standard but he still took his former employer to court for wrongful dismissal. In court, he won his case on a technicality and was awarded $50,000 as damages for loss of office with no award for back pay. Mr. Jones was delighted with the award since he would not have to include damages in income, whereas he would have had to include an award for back pay in his income. Comment. (2) Andy and Sara agreed to a separation agreement that requires Andy to pay $1,500 per month to Sara as an allowance for her maintenance. Even though it is not specifically stated in the written agreement, Andy will also pay $500 per month directly to the financial institution that holds the mortgage on her home. Comment on the deductibility of these payments. (3) Sally received a loan from her employer to pay for her expenses while she returned to university. The agreement was that if she returned to work for her employer when she graduated the loan would be forgiven. If she did not return to work for her employer the loan would have to be repaid in full. How would this be treated for tax purposes?

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(4) Hugo was in an accident last year and has been receiving payments from Workers’ Compensation. He is now trying to complete his tax return and is going to ignore these payments and not include them in his return at all. Is this correct? (5) Last year Wally, age 20, received a personal injury award settlement of $1,500,000 for a car accident he was in two years earlier. He earned $45,000 of interest income on this award during the year and now he wants to know how much tax he will have to pay on it. (6) What are the major advantages of an RRSP? (7) Joe can contribute up to $12,000 to his RRSP for the year. He does not have that much cash but he does have stocks worth that much. He has heard that he can contribute these shares into his RRSP. Given that he wants to keep the same stocks and that these particular shares qualify, what are some of the tax consequences of this transfer? (8) For normal RRSP contributions, an individual has until 60 days after December 31 to make his or her contribution and still have it deductible for the year. Why does the same 60-day extension not exist for the year in which the individual turns 71?

Discussion Notes for Short Questions (1) The definition of “retiring allowance” [ssec. 248(1)] includes an amount received “in respect of a loss of an office or employment of a taxpayer, whether or not received as, on account or in lieu of payment of, damages or pursuant to an order or judgment of a competent tribunal.” So, even though he received damages, the amount must be included in income [spar. 56(1)(a)(ii)]. This amount is eligible for transfer to an RRSP assuming he has the contribution room. (2) Under this agreement, the monthly fees paid to the financial institution do not qualify as an allowance since Sara does not have any discretion as to the use of the amount and the amount is in addition to the spousal maintenance payment specified in the agreement. (3) According to Income Tax Folio S1-F2-C3, the loan would not be included in income when received. Instead, it would only be included in employment income in the year that it is forgiven [ssec. 6(15)]. Presumably, Sally would be assessed a deemed interest benefit [ssec. 80.4(1)] during the period of the loan. Then, if the principal amount of the loan is included in her income, she could amend prior years’ returns to exclude the deemed interest benefit from income [par. 80.4(3)(b)]. (4) Workers’ Compensation payments are included in net income for tax purposes [par. 56(1)(v)]. Therefore, the payments should be included on his tax return. However, the same amount is deducted in arriving at taxable income [par. 110(1)(f)]. Thus, there is no effect on taxable income. However, the income inclusion may reduce the amount of the personal tax credit that a related person might try to claim. (5) Income earned or capital gains realized on a personal injury award settlement is not taxable until the year after the year in which the individual turned 21 years of age [par. 81(1)(g.1)]. (6) The two major advantages of an RRSP relate to tax deferral. One major advantage of an RRSP is that the income earned on the funds within the plan can be accumulated tax free until the funds are withdrawn from the plan. A second advantage is the deduction for the contribution of the funds to the plan. While this initial deduction may be offset to some extent by the tax on the withdrawal of the funds from the plan, the tax is deferred for what may be a long period of time. (7) The following are some of the tax consequences of transferring shares to an RRSP: (a)

the plan will need to be a self-administered plan in order to accept the assets being transferred, and

(b)

the shares will be deemed to be disposed of at fair market value on the transfer to the RRSP. Any capital gains will be recognized at the time of the transfer. Any capital losses will be denied [spar. 40(2)(g)(iv)].

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(8) By the end of the year in which an individual turns 71, he or she has to either cash in the plan, transfer it to a RRIF, or purchase a retirement annuity. As a result, as at December 31 of that year, the RRSP ceases to exist and there is nothing to which a contribution can be made within the 60 days following the year.

CHAPTER 10 Computation of Taxable Income and Taxes Payable for Individuals Short Questions (1) Ms. X earns $20,000 of employment income and has come to you to talk about her investment income. She earns $1,000 of dividend income from a Canadian-resident public corporation in the year. She wants you to tell her what her marginal tax rate is on this dividend income. Assume the provincial tax rate is 10%. (2) Mr. Y earns $20,000 of employment income and has come to you to talk about his investment income. He earns $1,000 of interest income in the year. He wants you to tell him what his marginal tax rate is on this interest income. Assume the provincial tax rate is 10%. (3) Ms. Z earns $20,000 of employment income and has come to you to talk about her investment income. She realized $1,000 of capital gain in the year. She wants you to tell her what her marginal tax rate is on this capital gain. Assume the provincial tax rate is 10%. (4) Art Smith is an executive in the top tax bracket who collects antique cars. These antiques are capital property, not inventory, to him. He is planning to donate one of these cars to a local charity to be used in one of their fund-raising events. The value of the car is $20,000 and his cost of the car is $2,000. He knows there are special rules for the donation of capital property, but he does not know if these rules will help him. He has already made donations of $5,000. What is your advice? Your advice should discuss the federal tax implications only (i.e., ignore the provincial tax). (5) Ms. Lee found that when she did her personal tax return her personal credits far exceeded her federal tax. Her federal tax was $900 and yet she had a basic personal credit of $1,656 as well as charitable donation credits of $400. Is there anything she can do to maximize her potential benefits from this situation?

Discussion Notes for Short Questions (1) Her marginal tax rate on dividend income would be: Cash dividend................................................................................................................ Gross-up @ 38% ........................................................................................................... Taxable dividend ........................................................................................................... Federal and provincial tax @ 25% Dividend tax credit ((6/11 + 5/11) of $380)....................................................................... Total tax ........................................................................................................................ Marginal tax rate on dividends is nil/$1,000 = nil. The excess dividend tax credit of $35 (i.e., $380 − $345) can be used to reduce income tax on other sources of income. (2) His marginal tax rate on interest income would be: Interest earned ............................................................................................................... Federal and provincial tax @ 25% (15% + 10%).......................................................... Marginal tax rate on interest is $250/$1,000 = 25%

$ 1,000 380 $ 1,380 $ 345 (380) $ Nil

$ 1,000 $ 250

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(3) Her marginal tax rate on capital gains would be: Capital gain ................................................................................................................... Taxable capital gain (1/2) ............................................................................................... Federal and provincial tax @ 25% (15% + 10%).......................................................... Marginal tax rate on capital gain is $125/$1,000 = 12.5%.

$ 1,000 $ 500 $ 125

(4) Subsection 118.1(6) allows an individual to designate the proceeds of the capital property at anywhere between the cost and the fair market value, in this case between $2,000 and $20,000. Looking at the alternatives: (a) If he designates $2,000 he will report no net income on the disposition since his proceeds equal his cost. However, he will receive a donation receipt for $2,000 which is worth an incremental federal credit of $2,000  29% = $580. (b) If he designated $20,000 as the proceeds, he would report a capital gain of $18,000 and include 1/2 or $9,000 in income as a taxable capital gain. He would have additional federal tax of 29% x $9,000 = $2,610. He will also receive a donation receipt for $20,000 which will generate a federal credit of $20,000  29% = $5,800. On a net federal basis he would have a net federal credit from this alternative of $3,190 (i.e., $5,800 – $2,610). On a net basis, he would be further ahead to designate the full $20,000 as the proceeds. (5) Under the ordering rules for personal credits [sec. 118.92], the basic credit must be claimed before the charitable donation credit. Since neither of these credits is refundable, Ms. Lee will be unable to receive a refund for this year. However, she can carry her donations forward for five years so she should not claim any donations this year, but carry them forward to see if she can claim them at a later time.

CHAPTER 11 Computation of Taxable Income and Tax After General Reductions for Corporations Short Questions (1) In its current fiscal year, Smithco has had a business loss of $20,000 and a taxable capital gain of $30,000. The corporation also has the following loss carryovers from the previous year: a non-capital loss of $20,000 and an adjusted net capital loss of $20,000. The owner-manager has asked you to explain to him how he has to apply the losses and what the company’s loss carryforward will be. (2) Holdco had bought 25% of the shares of Opco five years ago for $500,000. Over the period of ownership it has received dividends of $150,000, including $40,000 of capital dividends. Holdco has just sold these shares for $300,000 and is using the $200,000 capital loss to offset a $300,000 capital gain on another sale. Comment on the tax effects in the year the shares are sold. (3) Hi Tech is a company that has recently gone to the public market for financing and its shares are now trading over-the-counter in Toronto. The majority of the shares are still held by the founder who is a resident of London, Ontario. The controller has just panicked when he realized that the company needs to be a CCPC in order to get the SR&ED investment tax credits. He has asked you to determine whether it is still a CCPC. What do you think?

Discussion Notes for Short Questions (1) Under Division B, the business loss is applied against the taxable capital gain to bring Division B income down to $10,000. Then either the net capital losses or the non-capital losses can be applied against this net income. The choice is based on which carryover is the more restrictive, given the circumstances and future expectations of the company. If non-capital losses are the better choice, then the $20,000 of net capital losses carried forward can be deducted against the $30,000 of net taxable capital gains in the year. Although this procedure would have no effect on taxable income, the non-capital losses will be increased by the net capital loss claimed, thereby reinstating $10,000 of the $20,000 business loss in the year. As a result, net capital losses would be fully absorbed and noncapital losses available for carryforward would equal $30,000 (i.e., $20,000 + $10,000). (2) Although Holdco has held these shares for greater than 365 days (i.e., 5 years), Holdco owns more than 5% of the shares of Opco. Subsection 112(3) would apply to cause the capital loss on the sale to be reduced by both the dividends deductible under subsection 112(1) and the capital dividends. In this case, the capital loss of $200,000 would be reduced by $150,000 to $50,000. This reduced loss could then be applied to the $300,000 capital gain otherwise realized.

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(3) In order to be a CCPC, the company has to be Canadian-controlled. In this case, Hi Tech qualifies, since it is controlled by an Ontario resident. In addition, Hi Tech also has to be a private corporation which is defined in paragraph 89(1)(f) where one of the criteria is that it is not a public corporation. A public corporation is defined [par. 89(1)(g)] to include any company which has any class of shares trading on a designated stock exchange in Canada. Section 262 provides for a list of these stock exchanges. However, in this case, Hi Tech is not listed on a designated stock exchange since its shares are only trading over the counter. Therefore, Hi Tech would not be considered to be a public corporation, unless it has elected to be one [par. 89(1)(g)], and would still be considered to be a CCPC.

CHAPTER 12 Integration for Business and Investment Income of the Private Corporation Short Questions (1) Ms. Jones inherited $2 million from her mother and has transferred the capital to a company that she has incorporated. Her intention is to spend 40 hours a week investing this money to earn interest income on first and second mortgages. Given the high level of activity, will this income qualify for the small business deduction? (2) Mr. X owns 100% of Holdco Ltd. which in turn owns 100% of three operating companies. Each of these operating companies carries on an active business primarily in Canada. Holdco Ltd. employs Mr. X and charges each of the operating companies $40,000 as management fees for Mr. X’s time. Mr. X gets paid from Holdco Ltd. and is the president and chairman of each of the operating companies as well as Holdco Ltd. Discuss how Holdco Ltd. will be taxed. (3) Describe the three different types of control found in the association rules. (4) Mr. Al owns 45% of the shares of Holdco which in turn owns all the shares of Opco. Discuss whether Mr. Al owns any shares in Opco for purposes of the associated company rules. (5) What is the relevance of the term “specified class” in section 256? (6) When considering whether to incorporate, one should determine whether there will be any tax savings or tax deferral. If someone is considering the incorporation of active business income, how can he or she achieve tax deferral through the use of a company? What will be the amount of the deferral assuming he or she is in the top tax bracket? Also assume a provincial rate of 4.5% for corporations and 17% for individuals. (7) What tax rules prevent an individual from deferring a significant amount of tax on interest income by flowing it through a corporation? (8) Mr. Boss owns all the shares of Opco Ltd., a CCPC carrying on an active business in Canada. In recent years Opco Ltd. has done very well and its income is well in excess of the business limit. Last year he incorporated Rentco Ltd. to own land and building that is rented to Opco Ltd. The rent charged to Opco Ltd. amounts to $80,000 per year. How will this rental income be taxed in Rentco Ltd.? (9) Why did the government introduce the rules in subsection 129(6) to deem what would otherwise be investment income to be active business income? (10) Comment on the statement that “no tax is payable on dividends received from connected corporations.” (11) A number of years ago a reorganization was undertaken and now Aco Ltd. owns voting preferred shares in Bco Ltd. These preferred shares have 70% of the votes and are now only worth 7% of the value. The other shares of Bco Ltd. are owned by an unrelated party. Are Aco Ltd. and Bco. Ltd. connected? (12) A number of years ago a reorganization was undertaken and now Cco Ltd. owns voting preferred shares in Dco Ltd. These preferred shares have 10% of the votes and are now worth 20% of the value. The other shares of Dco Ltd. are owned by an unrelated party. Are Cco Ltd. and Dco Ltd. connected?

Discussion Notes for Short Questions (1) Since the corporation is earning interest income and does not have more than five full-time employees throughout the year it will be considered to be a “specified investment business” [par. 125(7)(e)]. Even though she spends all of her time on this activity it will still not qualify for the small business deduction. However, the income will qualify for the refundable tax treatment. The refundable tax will generally be from the ‘non-eligible’ refundable dividend tax on hand (RDTOH) pool with the exception of income generated from the receipt of eligible dividends which will generate refundable tax in the ‘eligible’ RDTOH account.

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(2) Holdco Ltd. could be considered to be a “personal services business” since Mr. X performs the services and is a specified shareholder of the corporation. However, there is an exception from this definition if Holdco Ltd. is associated with each of the payer companies. In this case they are associated. Therefore, Holdco Ltd. is not a “personal services business” and, since it is not a “specified investment business,” it will be eligible for the small business deduction. Keep in mind that it will have to share the small business deduction with all of the operating companies since they are associated. (3) (a) Legal (“de jure”) control means the ownership of such a number of shares as carries with it the right to a majority of the votes in the election of the Board of Directors. Legal control flows through a corporation. For example, if Mr. X controls Holdco with 55% of the votes and Holdco in turn controls Opco with 55% of the votes, then Mr. X controls Opco. (b) Actual (“de facto”) control extends the concept of control to situations where “at any time the controller has any direct or indirect influence that, if exercised, would result in control in fact of the corporation” [ssec. 256(5.1)]. (c) Deemed control extends the meaning of “de jure” and “de facto” control. Paragraph 256(1.2)(b) extends the meaning of control to a group of persons even though one of the group may have de jure control already. Paragraph 256(1.2)(c) also extends the meaning of control to a person who owns more than 50% of the fair market value of all the outstanding shares of the corporation or more than 50% of the fair market value of the common shares of the corporation. Subsection 256(1.4) deems both control and ownership where certain options and rights are in place to acquire shares or cause the corporation to buy back shares of the corporation. Often these rights are found in the shareholder agreement. (4) Paragraph 256(1.2)(d) deems Mr. Al to own his proportionate share of the shares of Opco that he owns through Holdco. In this case, Mr. Al would be deemed to own 45% of the shares of Opco. The proportions in paragraph 256(1.2)(d) are based on the proportion that the fair market value of the shares that Mr. Al owns in Holdco is of the total fair market value of all shares of Holdco. (5) This term is defined in subsection 256(1.1) and is applicable to subsection 256(1) where this type of share is excluded from consideration when determining ownership of shares. One might then be concerned that subsection 256(1.2) could apply to deem control. However, subsection 256(1.6) deems the specified class of shares to be ignored for purposes of subsections 256(1.2) and (1.4) and instead to be considered as debt of the corporation. This, however, still leaves the question of whether control in fact [ssec. 256(5.1)] applies. (6) Tax deferral is what is achieved by having the income taxed in the company and leaving the after-tax cash in the company rather than taking it out as dividends. In order to determine the amount of the deferral you need to compare the tax paid in the company with the tax he or she would have paid if he or she had earned the income directly. On income eligible for the small business deduction (using a theoretical provincial tax rate of 3.5%) the corporation would have paid 12.5% tax. If one had earned this income personally and been taxed at the top rates, the individual would have paid 50% (i.e., 33% + 17%)). Thus, he or she will achieve a tax deferral of 37.5% (50% – 12.5%) by leaving the after-tax cash in the company instead of taking it out as a dividend. (7) By initially taxing interest income at the top corporate tax rates the Act minimizes the tax deferral available. If, for example, the highest personal tax rate is 50% (see (6) above) and the highest corporate tax rate hovers around 38% plus the 102/3% ART, then there is no deferral available. (8) Ordinarily the rental income would be taxed as investment income at the full rates (i.e., 38% + 10 2/3%) with part of this being classified as refundable Part I tax (i.e., 30 2/3%) and added to the Non-Eligible Refundable Dividend Tax on Hand account resulting in a theoretical rate of 18% after a dividend refund of 30 2/3%. However, since the two companies are associated and the rent is being deducted against the active business income of Opco, an associated corporation, subsection 129(6) will deem the rental income to be active business income and not eligible for the refundable tax treatment. Opco and Rentco are associated since they are both controlled by Mr. Boss [par. 256(1)(a)]. (9) The government is concerned that companies earning active business income in excess of the business limit of $500,000 will convert active business income that would otherwise be taxed at the top corporate rates into property income eligible for the refundable tax system through interest and rental charges. (10) Dividends received from corporations resident in Canada are included in net income [ssec. 82(1)] and are deducted [ssec. 112(1)] in arriving at taxable income. As a result, they are not taxable under Part I.

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However, Part IV tax applies to dividends that are deducted [ssec. 112(1)], other than dividends from connected corporations, unless the payer corporation received a dividend refund. If the payer corporation received a dividend refund then the recipient corporation will pay Part IV tax equal to its proportion of the dividend refund. Thus, the only time Part IV tax is payable on dividends from connected corporations is when the payer received a dividend refund. (11) Aco Ltd. and Bco Ltd. are connected [ssec. 186(4)]. While Aco Ltd. does not own more than 10% of votes and value, Aco Ltd. does control Bco Ltd. [ssec. 186(2)], as a result of its having 70% of the votes. (12) Cco Ltd. and Dco Ltd. are not connected [ssec. 186(4)]. Cco Ltd. does not own more than 10% of votes and value and Cco Ltd. does not control Dco Ltd. [ssec. 186(2)].

CHAPTER 13 Shareholder-Manager Remuneration and Tax Planning for the Owner-Manager Short Questions (1) Mr. Big is the sole shareholder of a very successful private corporation. In order to prevent double tax he has just declared a bonus from the company to himself in the amount of $800,000 which is in addition to his salary of $72,000. Discuss the deductibility of this bonus. (2) Discuss whether there are any benefits to having the ability to declare a bonus in one calendar year and not pay it until the following calendar year. (3) Ms. Leeper owns all the shares of Opco Ltd. and has declared and paid a large bonus to herself in each of the past five years. She has taken the money and personally bought a building that she is renting back to the company at an annual rent of $50,000. The company has a December 31 year-end. Is there any way that Ms. Leeper can defer the reporting of the $50,000 per year of rental income while the company is deducting the rent expense annually? Explain why or why not. (4) Dad owns all the shares of both Opco Ltd. and Realco Ltd. Opco Ltd. is carrying on an active business and Realco Ltd. owns the real estate and rents it to Opco Ltd. Is there any way that Realco Ltd. can defer the reporting of the rental income while Opco Ltd. is deducting the rental expense annually? Explain why or why not. (5) On December 31 of last year, the fiscal year-end of the company, a bonus was declared payable to the plant managers in the amount of $10,000 in total. This is considered to be a reasonable amount. However, since the company did have some cash flow constraints the directors’ resolution stated that the bonus was only payable if, as or when the cash was available in the corporation. On May 31 of this year, the cash became available and the bonus was paid. Discuss the deductibility of the bonus accrual at the December 31 year-end of the previous year. (6) Mom and Dad did an estate freeze four years ago and all three of their adult children became common shareholders along with a long-time employee. Two of the three children are active in the company and the third lives in another province and has no interest in the company. The long-time employee has just retired and the three children have bought her shares with the help of an interest-free loan from the company. Discuss the tax implications of the loan to the children. (7) On May 31, 2021, Opco Ltd. loaned its sole shareholder, Mr. Bolt, $100,000 to buy a boat. $50,000 of this loan was repaid on May 31, 2022 and the balance was repaid on May 31, 2023. Opco Ltd. has an April 30 year-end. With hindsight, what are the tax implications of this transaction? (8) Mr. Moyer, as president, decided to move his corporation from Dundas to London, Ontario in order to improve his quality of life. As a result of the move he decided to borrow $100,000 from the corporation to buy a house in Arva, just outside the city. The loan is to be repaid over 15 years with no interest being charged. None of the other employees received such a loan. What are the tax implications to Mr. Moyer from this loan? (9) Ms. Shaker borrowed $100,000 from her company on February 1 of last year to invest on the stock market. She repaid the loan on December 1 of this year. The year-end of the company is December 31. What are the tax implications to Ms. Shaker? (10) Mr. Shantz, who owns a construction company, has used a slow period in the construction industry to have some of his men build a boathouse at his cottage. Most of the materials were those left over from other construction jobs and the men were otherwise not busy. Mr. Shantz did not reimburse the company for any of the costs on the basis that it really did not cost the company anything extra. Comment. (11) Mr. Scott, who is the President and sole shareholder of Scott’s Tax Practice Inc., has taken a loan from the company to buy a cottage for use by himself and his family during the summer months. He has had a note

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drawn up to repay the loan over 20 years with no interest. All other employees of the corporation are eligible for similar loans on similar terms. Comment. (12) Ms. Kelly is the sole shareholder and President of her own company which has a December 31 year-end. She has borrowed money from the company over the past year for personal purposes and cannot afford to repay the loan by the end of the fiscal year. She decides that she will take out a short-term loan at the bank, repay the shareholder advances in December and then reborrow from the company in January to pay off the bank. Comment. (13) If a holding company is used to collect tax-free dividends from a connected small business corporation, what impact might this have on the ability of the individual shareholders of Holdco to claim the $ 971,190of capital gains exemption? (14) Big Bob started a company 20 years ago and built up the value of the family business which is a small business corporation. On his death, he left all the shares to his daughter, Little Bobbi. After one year of struggling she decided that she would like to start a different business, so she sold shares of the family business. Will the shares she is selling be qualifying small business corporation shares? (15) Mrs. Jones owns all the shares of an SBC, Opco Ltd. Five years ago her husband incorporated a separate company, Rentco Ltd., that bought the land and building that is now used in the business. Rentco Ltd. charges rent to Opco Ltd. for the use of the property. Rentco Ltd. and Opco Ltd. are not associated. Mr. Jones has just received a generous offer for all the shares of Rentco Ltd. and he has come to you to see how much capital gains exemption he is entitled to. Advise him.

Discussion Notes for Short Questions (1) No expense is deductible unless it is reasonable in the circumstances [sec. 67]. In this case it may be argued that the bonus is of such a magnitude that it is unreasonable compared to his normal salary. On the other hand, you could argue that his normal salary is kept unreasonably low and his bonus is part of his regular compensation. In addition, the CRA may not care since he will end up paying more tax on the bonus than the corporation would have paid on the same income. The deduction may also be challenged if there is no legal obligation to pay the bonus. The legal liability might occur if the bonus is calculated based on a written company compensation system. The liability might also be established if there was a directors’ resolution approving the bonus in the first place. (2) The major benefit would be the ability to choose to have the bonus taxed in whichever year the personal tax rate is lower. In addition, there may be a tax deferral advantage in that the corporation gets the benefit of the deduction in the fiscal year it is accrued and the bonus is subject to tax in the return for the calendar year in which it is paid. However, this advantage would be reduced by the fact that tax is required to be withheld at the corporate level at the time the bonus is paid. (3) The company may deduct the rent expense annually as long as the accrued liability is paid before the end of the second taxation year after the end of the fiscal year in which it is accrued [ssec. 78(1)]. Alternatively, the corporation and Ms. Leeper can file an election (by the due date of the tax return for the third taxation year) to treat the accrued amount as income to Ms. Leeper on the first day of the third taxation year. (4) Since the rental income is being earned by a corporation, the rental income has to be reported on the accrual basis by Realco. Therefore, there is no way to defer the reporting of the rental income. (5) As at December 31, there was no legal liability for the bonus since it was only payable “if, as or when the cash is available.” Therefore, the accrual is not deductible. In order to be deductible, a liability must be established and the liability cannot be contingent on some future event. (6) Since the two children are shareholders, subsection 15(2) would apply to include the loans in their income in the year the loans were made, unless they were repaid within one year from the end of the Opco Ltd. year-end [ssec. 15(2.6)]. The exception in paragraph 15(2.4)(c) does not apply, since the shares were acquired from a longtime employee and not issued by the corporation. In addition, that exception would not apply if the children were acting in their capacity as shareholders, rather than as employees [par. 15(2.4)(e)]. (7) For 2021, Mr. Bolt may be permitted by administrative practice to include $50,000 in income [ssec. 15(2)] through an amended return, since this part of the loan was not repaid within one year of April 30, 2022 (the corporation’s year-end), as required by subsection 15(2.6), and the loan did not meet one of the exceptions in subsection 15(2.4). In addition, section 80.4 will apply to deem an interest benefit based on the $100,000 for the days outstanding in 2021. A similar calculation would be required for 2022, based on the outstanding amount during the particular time period (i.e., $100,000 and $50,000). However, when the amended return is filed for 2021 for the subsection 15(2) inclusion of $50,000, the imputed interest thereon can be reversed out [ssec. 80.4(3)]. Mr. Bolt would get a deduction in 2023for the $50,000 repaid on May 31, 2023 [par. 20(1)(j)]. If the full amount of the loan is required to be included in income in 2021, then there will not be any imputed interest benefit to include.

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(8) Although the exception in paragraph 15(2.4)(b) is met and bona fide arrangements have been made for repayment within a reasonable time and he is an employee, it appears that Mr. Moyer received the loan in his capacity as a shareholder since no other employee received a similar loan. Therefore, the loan must be included in income [par. 15(2.4)(e)]. (9) Even though the exceptions in paragraphs 15(2.4)(c) and (e) are not met, this loan will not have to be taken into income since it was repaid on or before December 31 of the year following the year in which the loan was made. However, section 80.4 will apply to deem an interest benefit in each of the two years. This deemed interest benefit will also be eligible for a deduction as interest expense since she borrowed to earn investment income. This deduction is provided through section 80.5 and paragraph 20(1)(c). (10) Mr. Shantz will likely have a benefit added to his income under subsection 15(1) equal to the value of the work that was done and the materials that were used, since it is clear that he did receive a benefit from his company. This will be income from property and not a dividend. (11) Since Mr. Scott is a shareholder who received a loan, subsection 15(2) needs to be considered. Since he owns all of the shares, he is a specified employee, he cannot use the exception in paragraph 15(2.4)(a). However, paragraph 15(2.4)(b) provides an exception for loans to “employees” who borrow to acquire a dwelling for their habitation. As President, Mr. Scott is an employee and the cottage does qualify as a dwelling for his habitation under IT-119R4. Therefore, he will not have to include the principal amount of the loan in income, since he can be considered to have received the loan because of his employment rather than his shareholdings, other employees are eligible for similar loans, and bona fide arrangements were made at the time of the loan for repayment within a reasonable period (i.e., 20 years). There will be a deemed interest benefit under section 80.4. (12) These transactions will probably be considered to be a series of loans and repayments and if the loan were effectively outstanding over two year ends it would be included in her income under subsection 15(2). Although the loan was paid off by the end of the fiscal year and did not show up on the financial statements, the intention was that the loan remains outstanding. Subsection 15(2.6) contemplates a series of loans and repayments and IT119R4 comments on it. (13) The accumulation of cash in a holding company without using that cash to invest in active business assets or shares or debt of connected small business corporations may cause the holding company to no longer qualify as a “small business corporation” since the corporation may not have “all or substantially all of the fair market value of its assets” invested in qualified assets. (14) The shares must meet the Holding Period Test in order to be QSBC shares. In this case they will qualify since, even though she only held the shares for one year, a related person, her father, owned the shares for 20 years before that. See paragraph (b) of the QSBC share definition in subsection 110.6(1). (15) The definition of small business corporation includes assets used in an active business carried on by a corporation related to it [ssec. 248(1)]. In this case, even though Opco and Rentco are not associated, they are related [par. 251(2)(b)]. Therefore, since he has held the shares for over two years and all the assets are used in an active business of a related corporation for the past five years the shares should qualify as QSBCS.

CHAPTER 14 Rights and Obligations Under the Income Tax Act Short Questions (1) Mr. Lyons has come to you to prepare his personal tax return. After you have finished, he tells you that he probably will not file the return by April 30 since he does not have the money to pay his tax liability. He does not have any proprietorship business income. What advice do you have for him and why? (2) Mr. Kuntz was required to make quarterly instalments for last year. However, due to poor cash flow he was unable to make any payments until he filed his tax return in April of this year. What interest charges and penalties will he be faced with? (3) Four, five and six years ago, Mr. Cameron had a number of real estate transactions. He did not report any of these since he could not bring himself to pay all the tax that was owing. He is now breathing a sigh of relief since these transactions are now beyond the three-year reassessment period. What do you think? (4) One of your dentist clients has overpaid her instalments for the year and has come to you in January of the following year to see if she will be able to collect interest from the CRA on these overpaid instalments. What do you think?

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(5) On the Edge Inc. has lost money in past years and now some of the non-capital loss carryforwards are about to expire. It has always been in the manufacturing business and its bad debts have been high. Is there anything On the Edge Inc. can do to preserve some of those losses that are about to expire? (6) Ms. Chai is in serious cash flow trouble in her company Red Inc. In order to prevent exceeding her bank line of credit she is planning to defer payment of the employee payroll withholdings to the CRA. What advice do you have for her?

Discussion Notes for Short Questions (1) While he will be charged interest on the unpaid taxes [sec. 161], by filing the return he will be able to avoid the late filing penalty of 5% of the unpaid taxes plus 1% per month for up to 12 months [ssec. 162(1)]. Therefore, he should file by April 30 to avoid these penalties. He can pay his tax liability later. (2) Interest is imposed on deficient instalments from the day the instalment should have been made until the earlier of the day it was actually made and April 30 of the following year [ssec. 161(2)]. In addition, a penalty may be imposed equal to 50% of the amount by which the interest charged under section 161 exceeds the greater of $1,000 and 25% of the interest that would have been charged under section 161 in respect of all instalments if no instalments had been made for that year [sec. 163.1]. (3) The CRA is allowed to reassess at any time if there is any misrepresentation attributable to neglect, carelessness or wilful default [par. 152(4)(a)]. In this case they would be able to reassess those years given that he knew about the income and chose not to report it. (4) Interest is levied at the prescribed rate plus an additional 2% on overpayments of tax by non-corporate taxpayers [ssec. 164(3)] from the latest of: (a) the day the overpayment arose, (b) 30 days after the day on which the return was or would have been due (i.e., April 30th), and (c) 30 days after the day the return was actually filed. Therefore the recommendation to your client should be to file her tax return by April 30 in order to start the clock. (5) In order to reduce the loss carryovers it may be possible to go back to those prior years and amend the returns to reduce the discretionary deductions such as CCA [par. 20(1)(a)] and the allowance for doubtful debts [par. 20(1)(l)]. This action will take these “accrued losses” and allow them to be effectively carried forward indefinitely within the CCA pools and the accounts receivable. However, the CRA will only allow these prior year revisions to take place if there is no change to the taxes payable in those prior years. This policy is outlined in IC 84-1. (6) Any person who fails to remit the employee withholding is liable for a penalty of 10% of the tax that should have been remitted together with interest [ssec. 227(9)]. If there is a second or further occurrence, then the penalty increases to 20%. In addition, the directors may be personally liable for the unpaid withholding taxes [sec. 227.1].

CHAPTER 15 Purchase and Sale of a Business – Share Transactions Short Questions (1) In 2008, Ms. Jones incorporated Jones Co. and contributed $100 for 100 common shares. There were no other shares outstanding. In the current year, she wanted to expand but did not have enough capital so she convinced Ms. Smith to buy 100 common shares from treasury in exchange for $50,000. Calculate the adjusted cost base and paid-up capital of the shares held by each of Ms. Jones and Ms. Smith. (2) Mr. Smith has just bought the shares of a company that has a non-capital loss carryover. This carryover includes a loss on a rental property. He is anxious to amalgamate the loss company with his company to use up these losses. Comment on the plan. (3) Mr. Elliott owned all the outstanding common shares of XYZ Co. until May 1 of this year, when he sold 50% of these shares to Mr. Ng as part of his plan to retire. There are no other shares outstanding. Does subsection 249(4) apply to deem a year-end at the time he sold the shares? Explain. (4) Retail Co. has been having difficulty making money lately and the owner, Mr. Ed, has decided to sell the company to a competitor. One of Mr. Ed’s problems is that his inventory has declined in value due to cheap imports. However, the purchaser sees this as a benefit since Mr. Ed valued his inventory at cost for both accounting and tax

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purposes. Once the purchase takes place, the purchaser will implement a tax plan to use these accrued inventory losses as a deduction against the income of his profitable company. Comment on the tax issues. Ignore any accounting issues. (5) Pop Eye has the largest spinach store in the province. In order to assure himself of a constant supply of the best spinach, he has bought a spinach processor that has been in financial difficulty in recent years and has some non-capital losses that are about to expire. Pop plans to combine the two companies on a tax-free basis two months after the acquisition in order to use the losses of the processor against his retail profits. Comment on the plan. (6) On December 31 of last year, all the shares of RustyCo were acquired and a deemed year-end took place. RustyCo has non-capital losses of $50,000 being carried forward. During this year, the company realized profits of $20,000 from the same business, a rental profit of $10,000 and a taxable capital gain of $15,000. How much of the loss carryover balance can be applied this year? Explain why.

Discussion Notes for Short Questions (1) The adjusted cost base is calculated at the shareholder level and the paid-up capital is calculated at the corporate level. Therefore, Jones and Smith will each calculate their own ACB based on what they each paid for their shares. However, the paid-up capital will be calculated based on the total paid-up capital of that class of shares divided by the number of shares outstanding. Ms. Jones ................................................................................ Ms. Smith ...............................................................................

ACB

PUC

100 50,000

$25,050 25,050

(2) On the acquisition of control any loss from property expires since this loss is not a loss from a business [par. 111(4)(a)]. His only hope is that the acquired company has some assets with accrued gains to which paragraph 111(4)(e) could apply to create income to offset this property loss in the deemed year-end. (3) A deemed year-end takes place when there has been an acquisition of control over the voting rights of the corporation. In this case there has been a change in control since Mr. Elliott used to control the company and now it is controlled by both Mr. Elliott and Mr. Ng. However, even though Mr. Ng has not acquired voting control of the corporation, which is a requirement for subsection 249(4) to apply, the group of Mr. Elliott and Mr. Ng has acquired control and, thus, the acquisition of control rules could apply. (4) On the acquisition of control, a year-end is deemed to have occurred on the day immediately before the acquisition of control. Since there is a deemed year-end the inventory has to be valued for tax purposes. Inventory has to be valued at the lower of cost and market or in any other manner as allowed by regulation [ssec. 10(1)]. Regulation 1801 allows inventory to be valued at market as long as all inventory is valued this way. Since the value of the inventory has gone down in value Retail Co. will have to recognize the inventory loss in the deemed year-end immediately before the acquisition of control. Unless Retail Co. can offset this loss through a paragraph 111(4)(e) election, the loss will form part of the non-capital losses and can only be used against income from the “same business” or from the sale of similar products. (5) At the time Pop acquired control there was a deemed year-end of the processing company [ssec. 249(4)]. This would cause one year of the non-capital loss carryover period to expire. Also, consideration has to be given to whether the two companies sell similar products. IT-206R, paragraph 3, indicates that these two businesses could be considered to be one business since they are vertically integrated businesses and, therefore, the losses of the processor could be applied to the income of the retailer. Keep in mind that in cases of significant dollar value, you may not want to rely totally on the Interpretation Bulletin to justify “a similar product or service.” You will want to also build up a business case for this position. (6) Pre-acquisition losses can only be applied against income from the “same business” or from the sale of similar products [par. 111(5)(a)]. In this case, the only income from the same business is the $20,000. The rental profits and the taxable capital gain are not income from a business and therefore cannot be offset.

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CHAPTER 16 Corporate Distributions, Asset Sales and Winding-Up Short Questions (1) In the nineteen nineties, Ms. Jones incorporated Jones Co. and contributed $100 for 100 common shares. There were no other shares outstanding. In the current year, she wanted to expand but did not have enough capital so she convinced Ms. Smith to buy 100 common shares from treasury in exchange for $50,000. Calculate the adjusted cost base and paid-up capital of the shares held by each of Ms. Jones and Ms. Smith. (2) You have been asked to review the previous financial statements of a new client for tax issues. During your review you noticed that the equity portion of the balance sheet contained a surplus account called “contributed surplus” which contained $50,000. Upon investigation, you found out that this account arose in 2001 when shares were issued to an arm’s length person for cash. At that time, the jurisdiction in which the company was incorporated only allowed par value shares so this was the excess of the money received by the company for the shares over the par value. What tax issues do these facts bring to your mind? (3) Ms. Kelly originally paid $100 to buy 100 common shares from Kelly Co. on incorporation. This represented all of the common shares of the company. These shares are now being redeemed for $5,000. What tax events take place and what are the consequences to Ms. Kelly? (4) Last year Holdco Inc. had a large capital loss of $100,000. This year Holdco received $30,000, net of ACB, as proceeds from an insurance policy on the life of one of its shareholders. The surviving shareholder now wants to use the life insurance proceeds to buy out the shares of the deceased for $30,000. The surviving owner has explained to the widow that not all the deemed dividend on redemption will be tax free since the capital dividend account, at $20,000, is not big enough. She asks you for advice. What can you tell her? (5) Calculate the effect on the capital dividend account as a result of the sale of goodwill this year for $100,000. The only other transactions in impacting Class 14.1 took place 10 years ago when a customer list was purchased for $10,000. The balance in Class 14.1 is now $3,630. (6) During this year, Mr. Scott received a stock dividend from a Canadian public company. How will he determine the effect on his taxable income as a result of this dividend? (7) Mr. Bill owns all the shares of a CCPC called Billco Inc. The company owns a non-depreciable property that originally cost $20,000 and is now worth $40,000. He wants to get the property out of the company as cheaply as possible, so he decided to declare a “dividend in kind” of the property in order to keep the dividend to $20,000 and to have the capital gain taxed in his own hands when it is eventually sold. What are the tax implications of what he is proposing? (8) Mr. Cheng owns all the shares of Craft Co. and is in the process of selling 30% of his shares to employees. In order to make the company look more attractive and to justify the high price he is asking, he decided to convert $100,000 of his retained earnings into share capital. To do this he asked his controller to make the adjusting entry and he asked his local lawyer to handle the legal side. As his accountant, what do you think of his proposal? (9) Mr. Summers, the sole shareholder of Simple Co., decided that he wanted to reduce the complexity of his corporate balance sheet. The Class A and the Class B shares each had total PUC of $100,000 ($200,000 in total). He had bought these shares from an arm’s length party when the company was doing poorly so his ACB was very low at $100 for the Class A shares and $100 for the Class B shares. He asked his lawyer to switch all the PUC of the Class B shares, except for $100, to the Class A shares. The Class B shares were then to be redeemed for $100 leaving only the Class A shares with PUC of $199,900. What are the tax consequences of his proposal? Assume the eventual redemption of the Class A shares. (10) Jones Co. had a capital gain of $100,000 this year on the sale of some land and wants to pay a dividend out of the capital dividend account in the amount of $50,000. They file the appropriate election form on a separate dividend of $50,000. However, two years later the CRA reassesses the sale as an income transaction and the capital gain is eliminated. They are then assessed under Part III of the Act for tax of $30,000. What can they do? (11) GLC Co. is a CCPC that is in the process of being wound up under subsection 88(2). One of its assets is a capital property that has an accrued capital loss. The lawyer has suggested that subsection 40(3.4) will apply to deny the capital loss on wind-up. What do you think?

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their shares. However, the paid-up capital will be calculated based on the total paid-up capital of that class of shares divided by the number of shares outstanding. Ms. Jones ................................................................................ Ms. Smith ...............................................................................

ACB

PUC

100 50,000

$25,050 25,050

(2) The contributed surplus of $50,000 that arose on the issuance of shares after March 31, 1977, can be converted into paid-up capital without causing a deemed dividend to arise under subsection 84(1) [par. 84(1)(c.3)]. This would give the current shareholders the ability to withdraw that $50,000 as a reduction of paid-up capital [ssec. 84(4)] or on the redemption of shares [ssec. 84(3)] without a deemed dividend. However, they may still have a capital gain or loss as a result of this transaction. On the redemption of shares [ssec. 84(3)] there is a disposition of shares [ssec. 84(9)]. On the reduction of capital [ssec. 84(4)] there is no disposition but the ACB of the shares is reduced [par. 53(2)(a)] and if this causes the ACB to become negative then an immediate capital gain results [ssec. 40(3)]. (3) The redemption of shares causes a deemed dividend to the extent that proceeds exceed PUC. In this case, the deemed dividend [ssec. 84(3)] is $4,900 (i.e., $5,000 – $100). In addition, the shares are disposed of [ssec. 84(9)] with the proceeds of disposition being calculated, as defined in section 54, as the proceeds on redemption minus the deemed dividend or $100 (i.e., $5,000 – $4,900). This would give rise to no capital gain (i.e., $100 – $100). The end result will be a deemed dividend of $4,900 and no capital gain. (4) The last year’s capital loss does not have any effect on the life insurance proceeds received this year for purposes of calculating the capital dividend account. Under the calculation related to capital gains and losses under paragraph (a) of the definition [ssec. 89(1)], this sub-balance in the CDA calculation cannot be negative. Therefore, it is $0. The balance in the capital dividend account related to the life insurance is $30,000 under paragraph (d) of the definition [ssec. 89(1)]. Therefore, the balance in the total capital dividend account is $30,000, not $20,000. (5) In this case 50% of the capital gain ($100,000 - $10,000 = $90,000) or $45,000 will be added to the capital dividend account. Even though the goodwill does not relate to the customer list, the two are both included in the same calculation as long as they both relate to the same business. (6) The amount included in income is 138% of the “amount” of any “dividend” received from a corporation resident in Canada [ssec. 82(1) and par. 12(1)(j)]. The definition of “dividend” [ssec. 248(1)] includes a stock dividend. Reference is then made to the definition of “amount” [ssec. 248(1)]. There, the “amount” of any stock dividend is the amount by which the paid-up capital of the corporation is increased by reason of the payment of the dividend. (7) When a dividend in kind is declared, the property in question is deemed to have been disposed of at fair market value [ssec. 69(1)] and the capital gain would be realized and taxed at that time in the corporation. The amount of the dividend to Mr. Bill would then be the full fair market value of the property he receives as a dividend in kind plus the gross-up. (8) By following his proposal, he will cause a deemed dividend of $100,000 since he increased his paid-up capital without a corresponding increase in assets or a decrease in liabilities [ssec. 84(1)]. (9) On the conversion of the PUC of the Class B paid-up capital to Class A there was no deemed dividend since the PUC increase of one class was offset by the PUC decrease of another [ssec. 84(1)]. The redemption of the Class B shares will not result in a deemed dividend [ssec. 84(3)] nor will it result in a capital gain or loss [sec. 40] since the ACB equals the PUC and the proceeds. If the Class A shares are later redeemed for $199,900 then there will not be a deemed dividend since the PUC is equal to the proceeds. There will be a capital gain, since the proceeds [sec. 54] will be the PUC of $199,900 and the ACB will be $100. (10) An election allows the corporation to avoid the 60% penalty [ssec. 184(3)]. This election allows the corporation to separate the dividend into a part that does not exceed the balance in the capital dividend account and a part that can be considered as a taxable dividend. In this case, the full amount will be a taxable dividend. The election must be made not later than 90 days after the day of mailing of the notice of assessment in respect of the 60% penalty imposed under subsection 184(2). (11) On the winding-up of the corporation, subsection 40(3.4) does not apply [par. 69(5)(d)]. Therefore, the loss will be realized.

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CHAPTER 17 TaxDeferredTransactions:Section85RolloveronaTransfertoaCorporation, Section 86,andEstateFreeze Transactions, Amalgamationsand Wind Ups Short Questions (1) Mr. Yu, a resident of Buffalo, wants to transfer real estate that is capital property to him to Canco Ltd., a taxable Canadian corporation, using section 85. Is there any reason why he cannot? (2) Ms. Bell, a resident of Florida, has some equipment that she wants to transfer to Canco Ltd., a taxable Canadian corporation under section 85, in exchange for shares of the company. Can she do it? (3) Depreciable property with a fair market value of $1,000, an original cost of $800 and a UCC of $300 is transferred on a tax-free basis to a corporation using section 85. What are the tax characteristics of this asset in the corporation? What would happen if the corporation sold the asset for its FMV shortly after it is transferred? (4) Mr. Wright decided to sell his business and retire. However, he has been operating as a sole proprietor and now wants to take advantage of the QSBC share capital gains exemption available to shareholders. Accordingly, he transfers all the assets used in the business to a small business corporation and takes back common shares. The next day he sells the shares to an arm’s length purchaser. His accountant thinks back to his first tax course and wonders whether the sale of the shares will be considered to be an income transaction since his intention was to sell the shares at a profit immediately. Do you think this will be assessed as an income transaction? (5) Ms. Alice has shares that have gone down in value in CMW Ltd., a small business corporation. Her problem is that she cannot sell the shares because there is no market. She then decides that she will sell the shares to her husband’s company, SP Ltd., claim an ABIL and at least be able to withdraw from SP Ltd. the fair market value of the shares of CMW Ltd. She does not own any shares in SP Ltd. Since there is no gain to defer, she will not elect under section 85. Comment on her strategy. (6) Mr. Stan has shares in Loss Ltd., a small business corporation that have gone down in value. His problem is that he cannot sell the shares because there is no market. He then decides that he will sell the shares to his own company, Stan Ltd., claim an ABIL and at least be able to withdraw from Stan Ltd. the fair market value of the shares of Loss Ltd. He owns all the shares in Stan Ltd. Since there is no gain to defer, he will not elect under section 85. Comment on his strategy. (7) Assume that a depreciable asset with an FMV of $50,000, an original cost of $40,000 and a UCC of $15,000, were transferred to a corporation using section 85. Also assume that in exchange for this asset the transferor received only common shares and that the elected amount was chosen to maximize the tax deferral. What are the ACB and PUC of the common shares? (9) Ms. Dettmer owns all of the issued and outstanding shares of both Dettmer Ltd. and Firefly Ltd. Dettmer Ltd. has had recurring non-capital losses and now some of them are about to expire. Firefly Ltd. has been earning income. Dettmer Ltd. has land and building with accrued gains that it is proposing to sell, without the use of section 85, to Firefly Ltd. in order to generate income in Dettmer Ltd. and allow a higher CCA to be claimed in Firefly Ltd. The land has a cost of $100,000 and a fair market value of $150,000. The building has a UCC of $30,000, a cost of $50,000 and a fair market value of $100,000. What are the tax consequences to Dettmer Ltd. and Firefly Ltd.? (12) Bill Ltd. wants to sell all of its business assets including its accounts receivable to another company, Purchase Ltd. Under what conditions might Purchase Ltd. not want to file a section 22 election with Bill Ltd.? (13) Freda wants to incorporate her proprietorship by transferring all the assets including her accounts receivable to a company that she will own. Under what conditions might she not want to file a section 22 election? (14) This year, Mr. Scott decided that he wanted to take advantage of his QSBC share capital gains exemption. He originally started his corporation about 20 years ago with $100,000 of share capital. Today the shares are worth $900,000. He is going to transfer the shares to Holdco Ltd., which he will own himself, and elect at $900,000 under section 85. What consideration should he take back to optimize this transaction? (15) This year, Mr. Ralph decided to sell the shares of his corporation to his brother for $892,218 cash. The PUC and ACB of these shares is $100. Mr. Ralph will use his QSBC share capital gains exemption of $892,218 to reduce the tax on this transaction. On the advice of his accountant, his brother is using a holding company to buy the shares from Mr. Ralph. The negotiations were long and hard and the price they arrived at was clearly the fair market value of the shares. As Mr. Ralph’s adviser, what are your comments?

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(16) Bill Brother owns all the shares of Opco Ltd. which has post-71 retained earnings of $500,000 and is worth $1,000,000. He is planning to sell the shares of Opco to his brother, Bart. In order to do so, he is going to set up a holding company, Holdco Ltd., and transfer his shares under section 85 to Holdco on a tax-free basis. He will then have Opco borrow $1,000,000 from the bank and pay a dividend to Holdco of $1,000,000. Then Holdco will sell its shares of Opco to Bart for $1. The net result will be that Holdco will have $1,000,000 in cash that it received through a tax-free dividend and Bart will own all of Opco for $1 which is its fair market value after the dividend. Comment on this arrangement. (17) Mr. Jones is about to transfer all of his shares of his CCPC, Jonesco Ltd., to another Canadian company, Canco Ltd., in exchange for shares of Canco Ltd. Mr. Jones paid $50,000 for the shares of Jonesco and the PUC of these shares is $100. He has come to you to determine whether he should make the transfer using section 85.1 or subsection 85(1) assuming that the conditions for use of each provision can be met. Which would you recommend and why, referring specifically to the ACB and PUC of the shares Mr. Jones receives and Canco Ltd. buys? (18) Ms. Smith owns shares in a CCPC called Smithco Ltd. She bought these shares about 20 years ago for $100,000 and today they are worth $1 million. The shares have a PUC of $10,000. Ms. Smith wishes to establish an estate freeze for the benefit of her nieces. Her consideration on the exchange will only be shares. If she uses section 86, then what will her ACB and PUC be in the shares she takes back? If she uses section 85, then what will her ACB and PUC be in the shares she takes back? (19) Mr. Hill owned 1,000 shares of Hill Ltd., a CCPC. He wanted to do a Holdco estate freeze to allow his children to participate in the ownership of the business. In order to do so he decided to convert 900 of his common shares into preference shares and have his children subscribe for 100 common shares. Do you see any problem with using section 86 to defer tax in this case? (20) When using section 86 to defer tax on a reorganization of capital, how could a deemed dividend under subsection 84(3) ever arise? (22) What is the difference in the availability of non-capital losses between the amalgamation rules and the winding-up rules? (23) A subsidiary company has the following balance sheet on acquisition: Cash .................................................................................................................... $100,000 Shares at cost (FMV of $60,0001)................................................................. 10,000 Paid-up capital .............................................................................................. 10,000 Retained earnings ......................................................................................... 100,000 The parent company paid $130,000 for the shares of the subsidiary. Subsequent to the acquisition, a dividend is paid from the subsidiary to the parent in the amount of $100,000, leaving $0 retained earnings in the subsidiary. Then it is decided that the subsidiary should be wound up in order to get the “bump” in the value of the shares. What is the amount of the bump that is available? ( (25) Mr. Michaels owns all the shares of Michaels Ltd., a small business corporation, which he incorporated 25 years ago for $1 and is now worth $1.5 million. Mr. Michaels has just found out that he has terminal cancer and is doing some estate planning. He wants to leave the shares of his company to his wife and he wants to minimize his tax liability on death. Mr. Michaels has never claimed a capital gains deduction. Can you advise him on the best way to deal with the shares of Michaels Ltd.? (26) Ms. Duong incorporated her company, Duong Ltd., 20 years ago for $100. Since that time the company has bought real estate for use in the business. Now Ms. Duong finds that one of her children wants to be involved in the business and the other does not. In order to equalize her estate she wants to do an asset freeze on the real estate by transferring it to a company owned by the child who is not active in the business. Assuming that the freeze is done properly and that the child is 16 years old, what attribution rule problems, if any, might there be?

Discussion Notes for Short Questions (1) The real estate is not “eligible property” since it is owned by a non-resident person [par. 85(1.1)(a)].

At the time the shares of the subsidiary were acquired.

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(2) The only limitation pertaining to a non-resident in the definition of “eligible property” is on real property owned by a non-resident person [ssec. 85(1.1)]. In this case the equipment would not be real property; therefore, it would qualify for the use of section 85. (3) The corporation is in the same position as the transferor [ssec. 85(5)]. The asset has an FMV of $1,000, an original cost of $800 and a UCC of $300. Since the corporation is deemed to have claimed the difference between cost and UCC as CCA, the subsequent sale of the asset would result in recapture of $500 if it is the only asset in the class. In addition, there would also be a capital gain of $200. (4) On review of the primary and secondary intention of Mr. Wright, it is clear that it could be considered an income transaction. However, section 54.2 provides that where all or substantially all of the assets used in an active business carried on by that person are disposed of to a corporation for consideration that includes shares of the corporation, the shares shall be deemed to be capital property of the transferor and thus eligible for the capital gains exemption as long as the conditions of section 110.6 are met. Subparagraph 110.6(14)(f)(ii) exempts Mr. Wright from the 24-month holding period. (5) Normally, the sale of shares in an SBC would allow her to claim the loss as a business investment loss. However, the ABIL is denied, since she must sell to an arm’s length person [par. 39(1)(c)]. She is not doing that since she is selling to a related person, being her husband’s corporation [spar. 251(2)(b)(iii)]. Therefore, the loss will be a capital loss. Subsection 84.1(1) could apply and result in a deemed dividend to Ms. Alice if the sale proceeds exceeds the greater of the PUC and ACB of the CMW Ltd. shares. The provision applies where an individual transfers shares that are capital property to another non-arm’s length corporation and the companies are connected after the transfer. Since she is transferring the shares to a corporation her husband controls and, hence, an affiliated person, paragraph 40(2)(g) will deny the superficial loss to her. In this case the benefit of the loss will be transferred with the shares to SP Ltd. through an increase in the ACB of the shares held by SP Ltd. [par. 53(1)(f)]. Paragraph 40(2)(g) does not require an election under subsection 85(1) in order to apply. Paragraph 40(2)(g) applies whenever a taxpayer disposes of capital property to an affiliated person, including a corporation that was controlled, directly or indirectly in any manner whatever, by the taxpayer, by the spouse of the taxpayer or by other affiliated persons. (6) Normally, the sale of shares in an SBC would allow him to claim the loss as a business investment loss. However, the ABIL is denied, since he must sell to an arm’s length person [par. 39(1)(c)]. He is not doing that since he is selling to a related person, a corporation which he controls. Therefore, the loss will be a capital loss. Since he is transferring the shares to a corporation that he controls and, hence an affiliated person, paragraph 40(2)(g) will deny the superficial loss to him and add it to the cost base of the Loss Ltd. shares owned by Stan Ltd. Paragraph 40(2)(g) does not require an election under subsection 85(1) in order to apply. Paragraph 40(2)(g) applies whenever a taxpayer disposes of capital property to an affiliated person, including a corporation that was controlled, directly or indirectly in any manner whatever, by the taxpayer, by the spouse of the taxpayer or by other affiliated persons. (7) The elected amount would be chosen at $15,000 in order to maximize the deferral [sec. 85]. The ACB of the common shares would be equal to the elected amount of $15,000 since there is no boot [par. 85(1)(h)]. The PUC of the common shares would also be $15,000 [ssec. 85(2.1)]. As a result of both the ACB and the PUC being $15,000, the shareholder can draw this amount out of the corporation tax free. This amount represents the amount of original cost of the asset transferred that has not been written off by CCA or recovered through boot. (9) Dettmer Ltd. will realize a capital gain on the land of $50,000 and on the building of $50,000. The building will also generate recapture of $20,000. Thus, Dettmer Ltd. will have $50,000 of taxable capital gain and $20,000 of recapture to offset the current year’s losses and then loss carryovers. Firefly Ltd. will have a cost for capital gains purposes in the land of $150,000. However, in respect of the building, paragraph 13(7)(e) will only allow the UCC to increase by the amount of the original cost plus ½ of the capital gain since that is all that has been taxed. Thus, the UCC of the building will be $75,000 ($50,000 original cost + $25,000 TCG). (12) If no election is filed then the accounts receivable are treated as capital assets to Purchase Ltd. If the price paid by Purchase Ltd. is less than what they eventually expect to receive for the accounts receivable and Purchase Ltd. is in the high corporate tax bracket, it will want to avoid the election and realize a capital gain when the receivables are all collected. (13) If she does not file a section 22 election then the accounts receivable will be capital property to her. She will be required to bring the allowance for doubtful accounts claimed last year back into income. If she expects to receive the full face amount of her accounts receivable from the corporation, then she will not care whether she files the election. If she expects to realize a loss, then she will want to file the election, since paragraph 40(2)(g) will deny a superficial loss and add it to the cost base of the receivables held by the transferee corporation, whereas a business loss will be allowed.

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(14) Normally, he would take back boot of $900,000. However, in this case he meets the conditions of section 84.1 and must not take boot in excess of the greater of the ACB and PUC of the shares of $100,000. Mr. Scott and the corporation can transfer the shares at fair market value of $900,000 to make use of the QSBC share capital gains exemption.The shares he takes back will have an ACB of $900,000 minus the $100,000 of boot or $800,000. The PUC of the shares taken back will start out at $800,000 and be reduced to nil under section 84.1 since the old PUC was taken out in $100,000 of boot. (15) This transaction falls within the rules of section 84.1 since Mr. Ralph is related to his brother’s holding company. As a result, the capital gain that Mr. Ralph is expecting will become a deemed dividend [par. 84.1(1)(b)]. The capital gains exemption will remain unused and Ralph will be required to pay tax on the deemed dividend. (16) Normally, there is an exception for transactions between related persons [ssec. 55(2)]. Since Bill and Bart are brothers they are related [sec. 251]. However, in this case subsection 55(2) will apply since brothers are considered to be unrelated [par. 55(5)(e)]. As a result, the $1,000,000 dividend will be deemed to be a capital gain and, therefore, taxable in Holdco. Since the $500,000 of retained earnings is post-71 income, they can first pay a dividend equal to that amount without triggering subsection 55(2). Then the second dividend of $500,000 would trigger a capital gain. In the facts given they did not identify the post-71 portion of the dividend and, therefore, the full amount of the dividend would be treated as a capital gain.. It is no longer relevant whether Bill is related to the purchaser of the shares. Subsection 55(2) applies anytime one of the purposes of the dividend payment is to reduce the capital gain that would be realized on a fair market value disposition of the share. The exception to 55(2) for related party transactions in 55(3)(a) only applies where a dividend is received on redemption, retraction or cancellation of shares and as part of a transaction resulting in a disposition to a person who is related. (17) By using subsection 85(1), Mr. Jones could elect to have the transfer take place at the $50,000 ACB in order to protect both the cost base of the shares which Mr. Jones takes back and the cost base of the shares of Jonesco which will be owned by Canco. In addition, he would be able to increase the PUC of the shares that he takes back to the elected amount of $50,000 as long as boot is not received. Section 84.1 would have no effect if it applies since he is allowed to use the higher of his arm’s-length ACB or the PUC to determine the PUC of the new shares. If he were to use section 85.1, then Canco would have a cost base in the shares of Jonesco equal to $100 which is the lower of the ACB and the PUC of the Jonesco shares. This would mean that Canco would lose $49,900 of cost base in the shares of Jonesco. In addition, he would have a PUC and ACB in the shares he takes back equal to the PUC and the ACB, respectively, of the shares he gave up. He would not be able to increase his PUC under section 85.1 as he can using section 85. Thus, the transfer would be better done through the use of subsection 85(1). (18) If she uses section 86, then the ACB of the new shares received will be $100,000 which is equal to the ACB of the shares turned in under paragraph 86(1)(b), since no boot was taken back. For the same reason, the final PUC should also be the same as the old PUC, $10,000. If she uses section 85 and elects at $100,000, then the ACB of the new shares received will be $100,000 which is equal to the ACB of the old shares transferred by virtue of paragraph 85(1)(h). However, the PUC of the new shares received can be set at $100,000 since no boot was received. Section 84.1 will not cause an immediate deemed dividend since no boot was accepted as consideration. There will be no reduction in PUC as long as the PUC of the new shares does not exceed the greater of the PUC of the old shares or the modified ACB of the old shares (i.e., $100,000). (19) One of the conditions that has to be met in order to use section 86 is that all of the shares of a particular class owned by the shareholder are exchanged [ssec. 86(1)]. This condition is not met in this case. Therefore, section 86 cannot apply and the exchange will take place at fair market value unless they elect under section 85. (20) A capital reorganization under section 86 is considered to involve a redemption, acquisition or cancellation of shares as envisaged by subsection 84(3). Paragraph 84(5)(d) values the redemption amount paid as the reduced PUC of the new shares plus any non-share consideration received. Therefore, the subsection 84(3) deemed dividend would arise where the redemption amount paid is greater than the PUC of the old shares. For example, if boot greater than the PUC of the old shares was received, a deemed dividend would arise. (22) Under the amalgamation rules, the non-capital losses of the predecessor companies are available in the first year after the amalgamation to offset the income of the new company. Under the winding-up rules, the noncapital losses of the subsidiary are not available to the parent until the first year after the fiscal year in which the winding-up took place.

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(23) The bump, as calculated under paragraph 88(1)(d), is as follows: Parent’s cost base of the subsidiary’s shares ..................................................................... $ 130,000 minus: Cost amount of subsidiary’s assets net of liabilities (after $100,000 cash dividends) ....... (10,000) Dividends paid to the parent .............................................................................................. (100,000) Maximum bump available ................................................................................................. $ 20,000 The maximum bump is reduced by the amount of the dividends since these dividends, if unpaid, would have increased the “cost amount of the subsidiary’s assets net of liabilities” and resulted in the same “bump.” It also represents a recovery of the cost of the subsidiary’s shares by the parent which is a reason for the bump. The ACB of the shares owned by the subsidiary, being non-depreciable property owned at the time the parent acquired control of the subsidiary, can be increased by $20,000 to $30,000. The upper limit for the bump in the shares would be their $60,000 FMV. (25) On the transfer of property on death through a will to a surviving spouse, subsection 70(6) applies automatically to transfer it at its ACB and, thereby, provide a rollover to the surviving spouse. In this case Mrs. Michaels would receive the shares with an ACB of $1 and a FMV of $1.5 million. While this will minimize his tax liability, it does not minimize her tax liability as well. In order to minimize the overall tax liability, it would be best for the estate to elect under subsection 70(6.2) not to have the rollover apply on 55.7% of the Michaels shares. This would trigger a capital gain of $971,190 in his final return in order to allow him to use up his QSBC share capital gains exemption. Then, if Mrs. Michaels were to sell the shares after his death she would be able to claim her QSBC share capital gains exemption on the remaining $528,809 of gain and the full capital gain would be exempt from tax (assuming the shares are sold for $1.5M). If the full rollover under subsection 70(6) is applied then she will have a capital gain of $1.5 million and only $971,190 of capital gains exemption. This would leave an extra $528,809 of capital gain to pay tax on when she sells the shares. (26) One might immediately think of the corporate attribution rules in [ssec. 74.4(2)]. However, that provision only applies “where an individual has transferred or loaned property.” In this case the corporation transferred the property and not Ms. Duong herself. Therefore, the corporate attribution rules should not apply. However, dividends paid to a minor child on the shares held in the corporation would be subject to the tax on split income [ssec. 120.4(2)].

Short Questions Discussion Notes for Short Questions CHAPTER 19 Partnerships, Trusts, and Death of a Taxpayer Short Questions (1) Compare the features of a partnership and a joint venture. (2) Comment on the statement “taxable income is calculated at the partnership level”. (3) Ms. A and Ms. B are partners in a partnership, AB. They have been arguing about whether they should use some of the excess cash in the partnership to buy publicly listed stocks on a stock exchange. Ms. B wants to but she would rather invest the money personally in order to take advantage of the dividend gross-up and tax credit and the lower income inclusion rate on capital gains. What do you think of Ms. B’s position? (4) Assume that you are a partner in a partnership and you are entitled to 25% of the income. How would your income allocation and adjusted cost base of your partnership interest be affected by a $1,000 charitable donation made at the partnership level? (5) Mr. X and Mr. Y are equal partners in a partnership and are carrying on business. They recently admitted a new partner who contributed $50,000 of capital. Each of Mr. X and Y then withdrew $25,000. This caused the adjusted cost base of their partnership interests to have a negative balance of $10,000 each. What are the immediate tax implications to Mr. X and Y? (6) Mr. Harris is about to transfer some equipment to a partnership in which he will hold a 55% interest at fair market value. The equipment is worth $50,000, it has a UCC of $100,000 and an original cost of $200,000. It is the only equipment in the class. What are the results of this transaction to Mr. Harris and the partnership?

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(7) What is a “spousal trust”? What conditions does it have to meet and how does it work? (8) Compare inter vivos, testamentary and testamentary trusts that has been designated to be a graduated rate estate (GRE) on the basis of: (a) fiscal year ends, (b) tax rates, and (c) personal tax credits. (9) Mr. Bob had an income interest in a trust set up on his father’s death. He needs capital to pay off shopping debts. The trust distributes to him, in full satisfaction of Mr. Bob’s income interest in the trust, shares that have a cost of $15,000 and an FMV of $25,000. What are the tax implications to the trust and to Mr. Bob? (10) Ms. Sally had a capital interest in a trust set up on her father’s death. She needs capital to pay off gambling debts. The trust distributed shares to her in full satisfaction of her capital interest. The shares have a cost of $10,000 and an FMV of $45,000. What are the tax implications to Ms. Sally?

Discussion Notes for Short Questions (1) The following is a brief comparison of the features of a partnership with a joint venture: (a) a partnership is a separate legal entity that owns the partnership property; in a joint venture the coventurers retain an ownership interest in the property used in the venture; (b) a partnership calculates income at the partnership level, while in a joint venture each co-venturer calculates income separately. For example, in a partnership, capital cost allowance is calculated at the partnership level while in a joint venture it is calculated by each of the co-venturers; (c) assets can be transferred to a partnership on a rollover basis; assets transferred to a joint venture or registered in joint names will result in a deemed disposition of all or part of the asset at fair market value; and (d) partnerships are generally long-term in nature, while joint ventures are generally of limited life and are generally restricted to one project. (2) Taxable income is not calculated at the partnership level. Division B (or net) income is calculated at the partnership level and is then allocated out to the partners based on the partnership agreement. Taxable income is calculated at the partner’s level. (3) The advantages that Ms. B wants are available through the partnership. Subsection 96(1) provides the general rules for the allocation of income. The capital gains and the dividends would retain their character on the flow-through of the partnership income to the individual partners. Thus, Ms. B will be able to take advantage of the dividend gross-up and tax credit and the lower inclusion rate on capital gains. (4) Since the partnership calculates income at the net income or Division B level, the $1,000 charitable donation would be added back to income at the partnership level and your share of income would increase by $250. This increase in your share of the partnership income would result in an increase in your adjusted cost base [par. 53(1)(e)]. The adjusted cost base of your partnership interest is then reduced since the donation is available for a credit on your personal tax return [par. 53(2)(c)]. (5) A negative adjusted cost base in respect of capital properties is deemed to be a capital gain as soon as it arises even when there is no actual disposition of the property [ssec. 40(3)]. However, there is an exception for a partnership interest. A partnership interest may have a negative adjusted cost base without giving rise to a capital gain, unless it is a partnership interest of a limited partner. The negative adjusted cost base will only be included in income as a capital gain when X and Y dispose of their partnership interest. A further issue is whether the substance of the transaction is such that X and Y disposed of part of their partnership interest to the new partner. If they did then they would realize an immediate capital gain or loss. (6) The issue is whether any of the stop-loss rules in the Act would apply. Subsection 13(21.2) operates to deny a terminal loss where a depreciable property is transferred by a person to an affiliated person. A partnership is an affiliated person to a majority interest partner. Mr. Harris will not be entitled to claim the terminal loss but will carry a UCC balance of $50,000, equal to the accrued terminal loss. He will be able to deduct CCA from the balance until the partnership sells the asset, at which time he may deduct the remaining UCC as a terminal loss. The partnership will acquire the equipment for $50,000 and add that amount to UCC. (7) A spousal trust can be an inter vivos trust or a testamentary trust. An inter vivos spousal trust is defined in subsection 73(1) and a testamentary spousal trust is defined in subsection 70(6). In either case, under the terms and conditions of the trust:

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(a) the spouse must be entitled to receive all of the income of the trust that arises before the spouse’s death; and (b) no person except the spouse may, before the spouse’s death, receive or otherwise obtain the use of any of the income or capital of the trust. In addition, for an inter vivos trust to qualify as a spousal trust both the settlor and the trust must be resident in Canada at the time of transfer. In the case of a testamentary trust there is a further requirement that the property must vest in the trust within 36 months after the death of a taxpayer, or a later period where a written application has been made to the Minister. The most commonly used spousal trust is the testamentary spousal trust; in this case, one spouse leaves all his or her property to the surviving spouse during his or her lifetime and thereafter to their children or other beneficiary (say, a charity). A spousal trust defers the tax on capital gains until the death of the surviving spouse. It also provides an opportunity for income splitting. (8) The following is the comparison of inter vivos, testamentary and testamentary trusts designated as a graduated rate estate. (a) All trusts must have a year-end of December 31 except for a testamentary trust that is designated as a graduated rate estate. Such a trust can have a fiscal period end at any time within the first 12 months after the date of death of the testator for the first 36 months. A December 31 year-end must be adopted at the end of the 36 months. (b) All trusts are taxed at the top federal marginal tax rate of 33% [ssec. 122(1)] unless it is a graduated rate estate. The income of a testamentary trust designated as a graduated rate estate is taxed for the first 36 months from the date of death in the same way as an individual with the various incremental tax rates [sec. 117]. (c) Trusts are not allowed to claim the personal tax credits provided under section 118 [ssec. 122(1.1)]. (9) The trust is deemed to have disposed of the shares at fair market value and realized a capital gain of $10,000 [ssec. 106(3)]. The adjusted cost base of the shares to Mr. Bob is $25,000. (10) In general, if the beneficiary of the personal trust receives a distribution of property from the trust in satisfaction of all or part of his capital interest, the trust is deemed to dispose of the property for its cost amount and the beneficiary is deemed to acquire the property at its cost amount [ssec. 107(2)]. In this case, Ms. Sally would receive the shares at a cost of $10,000. Then, if she sells the shares to pay off her debts she will realize a capital gain of $35,000 of which one-half will be included in her income and be subject to tax.

CHAPTER 21 Goods and Services Tax (GST)/Harmonized Sales Tax (HST) (1) What is the benefit for business of a province converting their sales tax to HST? (2) Kyla Lowry began her retail business on March 1, 2023 in Edmonton, Alberta. The quarterly sale of taxable supplies are as follows: Calendar Quarter March 2023 (one month) April to June, 2023 July to September, 2023 October to December, 2023 January to March, 2024

Sales $1,500 5,000 12,500 14,000 35,000

Determine the date that Ms. Lowry is required to register and start collecting GST.

Discussion Notes for Short Questions (1) The main benefit of HST relative to a sales tax is the that tax on business expenditures under an HST system generally generate input tax credits that the business can claim for a refund whereas a sales tax does not generate input tax credits.

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(2) The sale of taxable supplies in Ms. Lowry’s retail business accumulated to more than the $30,000 threshold in the fourth calendar quarter (October to December, 2022). As a result, the business is no longer considered a small supplier and is required to collect the GST starting February 1, 2024, which is the first day of the second month after the end of the fourth quarter. Formal registration as a GST registrant is required by the 29th day after the day the entity is required to begin collecting GST. In this case, registration is required by March 1, 2024 (29 days after February 1, 2023).

Sample Course Outlines Two-Course Sequence The following course outlines are based on those used by the authors in a two-course sequence. Experience has taught us that students learn technical tax materials best when they have to apply them, rather than listening to lectures. Therefore, the prime teaching method in these courses is the class discussion of assigned problems. We encourage class discussion with a participation mark based on our assessment of a student's willingness to prepare and participate, not on the correctness of the student's answers. During the class discussion of an assigned problem, we will make overview comments, explain the underlying concept or rationale of the material being applied and emphasize a systematic approach to problems. We will also ask students to think through the effects of variations in the facts of a problem to enable more generalized conclusions. However, our comments are directed to problems that attempt to simulate practice. We do not provide extended lectures on materials that students can read and understand through applications. If instructors wish, they can post the PowerPoint summaries for each chapter covered in the course on their course website for students to access. The assignment problems listed in these sample course outlines have been chosen to cover the broadest possible range of issues in tax, allowing some reinforcement through repetition. While the solutions for the exercises are available, they are still used in class to review single concept questions. TAXATION I Sample Course Outline Course objective This is the first of two introductory courses in federal income tax law which are designed to achieve the following objectives: (1) to explain the theoretical concepts behind the specific provisions of the law, (2) to apply knowledge of the law within the context of practical problems and case settings, (3) to interpret the law, taking into account the specific wording of the provisions, judicial decisions, and the position of the Canada Revenue Agency (CRA), (4) to identify, advise and effectively communicate the tax implications to a taxpayer, within the context of the facts presented, and (5) to identify, advise and effectively communicate basic tax planning concepts through problem and case-based application. Evaluation The student's achievement of the objective will be evaluated in a mid-term and a final exam and on classroom contribution. The exams will present fact situations in which the student will be required to identify potential tax problems and opportunities and to resolve these situations by reference to the Income Tax Act with labelled tabs, underlining and/or highlighting, but no other annotations. vii

viii

Introduction to Federal Income Taxation in Canada

Examination dates (1) Pre-classroom preparation submissions ............................................... . [2] Personal Tax Project (2) Mid-term: (in class as indicated on the outline) ......................................... . (3) Final: (out-of-class time of three hours and specific date TBD by exam registrar) ... .

Exam values 10% 15% 30% 45%

Text material The required text is: N. Johnstone, D. Mescall and J. Robson: Introduction to Federal Income Taxation in Canada, 2023-2024, 44th Edition, Wolters Kluwer Limited, Toronto, Ontario, 2023 (with Study Guide).

Taxation I Class Schedule & Topics (2 - 80 minutes classes a week over 13 weeks): The following is a tentative schedule for the course and may change as a result of unforeseen circumstances. Any changes to the schedule will be communicated to everyone via the course website (i.e. D2Learn or BlackBoard). Students should come to class prepared by reading the assigned chapter, attempting the problems and staying informed on current business issues. Please note that the solutions to the problems taken up in class will not be posted on the course website (i.e. D2Learn or BlackBoard) due to copyright issues. They will be available for review during office hours. If you miss a class please attempt to get the materials from another student. Note to instructors: Advanced topics outlined in each chapter are not covered in this example outline. Advanced topics have been identified by the authors to be topics beyond the CPA Entry level requirements. CLASS

3, 4, 5, 6

TOPIC

Introduction to the Tax System and The Income Tax Act Liability for Tax

Employment Income And related GST rebate discussion

7, 8, 9

Income from Business

Chapter assigned as reading

Chapter 2

Chapter 3 All except Advanced content

Chapter 21 Paragraphs ¶21,600 Chapter 4 All except

In-class Questions Note: all are located in your study guide Ex = Exercise problem, P = Assignment Problem None assigned ahead of time

2: Ex 1

CPA Competency Map

Competency Map reference 6.1.1 Discusses general concepts and principles of income taxation

6.3.1 Evaluates general tax issues for an individual 6.2.1 Evaluates general tax issues for a corporate entity 6.5.1 Analyzes residency of a taxpayer 6.5.2 Analyzes the taxation of Canadian sources of income for non-resident and part-year resident

3: Ex.1 and Ex 8 4: P 12 and P 14 5: P 10 and P 20 6: P 22 (pre-class assignment submission required). Attempt problem and submit to the course website by xx hour on xx date.

6.3.2 Evaluates income taxes payable for an individual

7: Ex. 5, P 7 and P 13, Ex 3 (time permitting) 8: P 1 and P 17

6.2.2 Advises on taxes payable for a corporation

6.3.3 Analyzes specific tax-planning opportunities for individuals

Entry level C

B B C-

C/B

Advanced content

10, 11

Depreciable Property

12 13, 14,

15, 16, 17

18, 19, 20

Chapter 5 All except Advanced content

9: P 16 (pre-class assignment submission required). Attempt problem and submit to the course website by xx hour on xx date. P 28 (not a hand-in but will be covered in class) 10: P 7, Ex 7 and P 12 11: P 8 P19 (pre-class assignment submission required). Attempt this problem and submit to the course website by xx hour on xx date.

6.3.2 Evaluates income taxes payable for an individual

6.2.2 Advises on taxes payable for a corporation

6.3.2 Evaluates income taxes payable for an individual

B C (for special rules)

Midterm Exam (covering Chapters 1 to 5) Chapter 6 All except Advanced content

13: Ex 1, Ex 6 and P 1 14: P 5, P9 15: P11 (pre-class assignment submission required). Attempt this problem and submit to the course website by xx hour on xx date.

6.2.2 Advises on taxes payable for a corporation

6.3.2 Evaluates income taxes payable for an individual

Other Sources of Income and Deductions in Computing Income

Chapter 9 All except Advanced content

6.3.2 Evaluates income taxes payable for an individual

Capital Gains

Chapter 7 All except Advanced content

15: Ex 6 and P 2 16: Ex 4 and P 5 17: P 10 (pre-class assignment submission required). Attempt this problem and submit to the course website by xx hour on xx date. and P 13 (not a hand-in but will be covered in class) 18: Ex 4, P6 and P11 19: Ex 1, Ex 3 & P1 20: P 23 (pre-class assignment submission required). Attempt this problem and submit to the course website by xx hour on xx date.

Chapter 8

21 : Ex 8, 5 and 11

6.3.1 Evaluates general tax issues for an individual

Income from Property

Non-Arm’s Length Transfers and other Special Circumstances

6.3.3 Analyzes specific tax-planning opportunities for individuals

6.2.2 Advises on taxes payable for a corporation 6.3.2 Evaluates income taxes payable for an individual

6.3.2 Evaluates income taxes payable for an individual

B/C

B C - for change in use and replacement property B

B/C

6.6.1 Analyzes income tax implications of death

22, 23, 24

TBA

Computation of Taxable Income and Taxes Payable for Individuals

Chapter 10 All except Advanced content

22: P 2, P 4 and P 8 23: Ex 4, P 5 and P 14 24: P 12and P 23 (pre-class assignment submission required). Attempt this problem and submit to the course website by xx hour on xx date. P3: applying data analytics to: Visualizatino to asses risks in a tax audit

6.3.2 Evaluates income taxes payable for an individual

C B C – for AMT, FTC, political tax credit and OAS clawback C

6.1.2 Assess reporting systems, data Data Analiytics Chapter 22 requirements and business processes to and Information support reliable tax compliance Systems in Tax FINAL EXAM (Comprehensive) The Examinations Department of Student and Enrolment Services schedules the final exam. Do not make travel plans prior to the final examination date. The last day for first-term final examinations is xx date.

TAXATION II Sample Course Outline Course objective This is the second of two introductory courses in federal income tax law which are designed to achieve the following objectives: (1) to explain the theoretical concepts behind the specific provisions of the law, (2) to apply knowledge of the law within the context of practical problems and case settings, (3) to interpret the law, taking into account the specific wording of the provisions, judicial decisions, and the position of the Canada Revenue Agency (CRA), (4) to identify, advise and effectively communicate the tax implications to a taxpayer, within the context of the facts presented, and (5) to identify, advise and effectively communicate basic tax planning concepts through problem and case-based application. . Evaluation The student's achievement of the objective will be evaluated in a mid-term and a final exam and on classroom contribution. The exams will present fact situations in which the student will be required to identify potential tax problems and opportunities and to resolve these situations by reference to the Income Tax Act with labelled tabs, underlining and/or highlighting, but no other annotations. Classroom contribution evaluation will be based on class participation in presenting and discussing assigned problem material. The classroom contribution component of the total mark for the course is an integral part of that mark and will not be waived. Examination dates (1) Pre-classroom preparation submissions ............................................... . (2) Corporate Tax Project (Due date outlined on the course website) (3) Mid-term: (out-of-class time of 1.5 hours and specific date indicated here, (3) Final: (out-of-class time of two hours and specific date TBD) ... .

Exam values 10% 15% 25% 50%

Taxation II Corporate Taxation and Tax Planning (2 - 80 minutes classes a week over 13 weeks): The following is a tentative schedule for the course and may change as a result of unforeseen circumstances. Any changes to the schedule will be communicated to everyone via D2Learn or Blackboard. Students should come to class prepared by reading the assigned chapter, attempting the problems and staying informed on current business issues. Please note that the solutions to any problems taken up in class will not be posted on D2Learn or Blackboard due to copyright issues. They will be available for review during office hours. If you miss a class, please attempt to get the materials from another student. CLASS

TOPIC

Chapter assigned as reading

1, 2

Introduction and Review of Tax 1 – Business income

Chapters 4 & 5

3,4

Computation of Taxable Income and Tax for Corporations

Chapter 11 – All except Advanced content

In-class Questions located in your study guide Ex = Exercise problem, P = Assignment Problem

CPA Comp Map Reference1

Chapter 4 – P19 Chapter 5 – P15

6.2.2 Advises on taxes payable for a corporation

Ex 1, 7 & 9 P4&6

6.2.1 Evaluates general tax issues for a corporate entity

6.2.2 Advises on taxes payable for a corporation

B B

5,6,7

Integration of Business and Investment Income for the Private Corporation

Chapter 12 – All except Advanced content

Ex 2, 5, 6 & 10 P 6, 10 & 14

6.2.1 Evaluates general tax issues for a corporate entity

8, 9

Planning the Use of a Corporation and Shareholder-Manager Remuneration

Chapter 13 – All except Advanced content

Ex 6 & 10 P 1, 4 & 6

6.2.1 Evaluates general tax issues for a corporate entity 6.6.2 Analyzes income tax implications of compensation planning between a shareholder and a closely-held corporation

B C C

Midterm Exam (all materials to date)

11, 12

Rights and Obligations Under the ITA

Chapter 14 – All except Advanced content

13, 14

Purchase and Sale of a Business – Share Transactions

Chapter 15

15,16

Corporate Distributions, Asset Sales and Winding-Up

17,18, 19

Tax Deferred Transactions: Section 85 Rollover on a Transfer to a Corporation, Section 86 and Estate Freeze Transactions Partnerships,Trusts and Death of a Taxpayer

20, 21,

CPA Comp. Map Entry or Core Level

P 1, 5 & 6

6.4.1 Evaluates adherence to compliance requirements

Ex 1, 4, P1 and P5

6.6.3 Analyzes income tax implications of the purchase and sale of a CCPC

C/B

Chapter 16 – All except Advanced content

P 2, 3, 6 & 9

6.6.3 Analyzes income tax implications of the purchase and sale of a CCPC

C/B

Chapter 17 – All except Advanced content

P 1, 2, 6, 8 & 10

6.6.4 Explains the basic tax considerations of reorganizations.

Chapter 19– All except

P 1, 2, 5 & 12

6.6.1 Analyzes income tax implications of death

1 Provided for reference to those who plan to continue on to earn their CPA designation. This indicates the level of understanding required to enter into the CPA PEP or MPAcc program. The CPA Competency map and knowledge supplement can be found at: https://www.cpacanada.ca/en/become-a-cpa/pathways-to-becoming-a-cpa/national-education-resources/the-cpa-competency-map

Advanced content 22, 23, 24

Goods and Services (GST)/ Harmonized Sales Tax (HST)

Chapter 21

Ex 2, 5, 7 P 2, 5, &7

6.7.1 Discusses the GST system in Canada 6.7.2 Analyzes GST obligations of a person 6.7.3 Calculates net tax for a person 6.7.4 Discusses GST compliance requirements 6.7.5 Analyzes GST implications from tax planning for shareholders and their closely held corporations 6.7.6 Explains GST obligations arising from other transactions.

C C C B C

Data Analiytics and Information Systems in Tax

Chapter 22

P2: Applying data analytics to: Analyze GST excess or deficiency

6.1.2 Assess reporting systems, data requirements and business processes to support reliable tax compliance

26 TBA

Review and/or catch up FINAL EXAM (Comprehensive) The Examinations Department of Student and Enrolment Services schedules the final exam. Do not make travel plans prior to the final examination date. The last day for second-term final examinations is xx date.

Study Guide

Solutions Manual Part 2

Introduction to Federal Income Taxation in Canada

44th Edition,2023– 2024 Nathalie Johnstone Devan Mescall Julie Robson

Table of Contents Page About This Study Guide .............................................................................................................................. iii Acronyms ............................................................................................................................................................. xi Reading the Income Tax Act ................................................................................... xv Problem-Solving Process for Tax .......................................................................................................... xxv Chapter 1

Introduction .............................................................................................. 1 Learning Goals, Learning Chart ..................................................... 1 Exercises and Assignment Problems............................................. 4 Solutions to Exercises ..........................................................................8

Chapter 2

Liability for Tax .................................................................................... 11 Learning Goals, Learning Chart .................................................. 11 Review Questions, Exercises, and Assignment Problems .................................................................................................. 14 Solutions to Review Questions and Exercises ...................... 28

Chapter 3

Employment Income.......................................................................... 35 Learning Goals, Learning Chart .................................................. 35 Review Questions, Exercises, and Assignment Problems .................................................................................................. 39 Solutions to Review Questions and Exercises ...................... 69

Chapter 4

Income from Business: General Concepts and Rules

Learning Goals, Learning Chart .................................................. 81 Review Questions, Exercises, and Assignment Problems .................................................................................................. 85 Solutions to Review Questions and Exercises ....................109 Chapter 5

The Capital Cost Allowance System for Depreciable Property, Including Intangibles ..................................................117 Learning Goals, Learning Chart ................................................117 Review Questions, Exercises, and Assignment Problems ................................................................................................121 Solutions to Review Questions and Exercises ....................137

Chapter 6

Income from Property ....................................................................147 Learning Goals, Learning Chart ................................................147 Review Questions, Exercises, and Assignment Problems ................................................................................................150 Solutions to Review Questions and Exercises ....................160 vii

Introduction to Federal Income Taxation in Canada — Study Guide

viii

Chapter 7

Page Capital Gains: Personal . . . . . . . . . . . . . . . . . . . . . . 165 Learning Goals, Learning Chart . . . . . . . . . . . . . . . . 166 Review Questions, Exercises, and Assignment Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

170

Solutions to Review Questions and Exercises . . . . . . 188 Chapter 8

Non-Arm’s Length Transfers and Other Special Circumstances . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

201

Learning Goals, Learning Chart . . . . . . . . . . . . . . . . 202 Review Questions, Exercises, and Assignment Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

205

Solutions to Review Questions and Exercises . . . . . . 214 Chapter 9

Other Sources of Income and Deductions in Computing Income . . . . . . . . . . . . . . . . . . . . . . . . . . 221 Learning Goals, Learning Chart . . . . . . . . . . . . . . . . 222 Review Questions, Exercises, and Assignment Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

225

Solutions to Review Questions and Exercises . . . . . . 241 Chapter 10

Computation of Taxable Income and Taxes Payable for Individuals . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

247

Learning Goals, Learning Chart . . . . . . . . . . . . . . . . 247 Review Questions, Exercises, and Assignment Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

251

Solutions to Review Questions and Exercises . . . . . . 268 Chapter 11

Computation of Taxable Income and Tax After General Reductions for Corporations . . . . . . . . . . . . 279 Learning Goals, Learning Chart . . . . . . . . . . . . . . . . 279 Review Questions, Exercises, and Assignment Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

282

Solutions to Review Questions and Exercises . . . . . . 291 Chapter 12

Integration for Business and Investment Income of the Private Corporation . . . . . . . . . . . . . . . . . . . . . . 299 Learning Goals, Learning Chart . . . . . . . . . . . . . . . . 299 Review Questions, Exercises, and Assignment Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

303

Solutions to Review Questions and Exercises . . . . . . 330 Chapter 13

Shareholder-Manager Remuneration and Tax Planning for the Owner-Manager . . . . . . . . . . . . . . .

349

Learning Goals, Learning Chart . . . . . . . . . . . . . . . . 349 Review Questions, Exercises, and Assignment Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

353

Solutions to Review Questions and Exercises . . . . . . 367

Table of Contents

ix Page

Chapter 14

Rights and Obligations Under the Income Tax Act

379

Learning Goals, Learning Chart . . . . . . . . . . . . . . . . 379 Review Questions, Exercises, and Assignment Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

382

Solutions to Review Questions and Exercises . . . . . . 390 Chapter 15

Purchase and Sale of a Business — Share Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 397 Learning Goals, Learning Chart . . . . . . . . . . . . . . . . 397 Review Questions, Exercises, and Assignment Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

400

Solutions to Review Questions and Exercises . . . . . . 414 Chapter 16

Corporate Distributions, Asset Sales and WindingUp . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

431

Learning Goals, Learning Chart . . . . . . . . . . . . . . . . 431 Review Questions, Exercises, and Assignment Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

434

Solutions to Review Questions and Exercises . . . . . . 448 Chapter 17

Tax Deferred Transactions: Section 85 Rollover on a Transfer to a Corporation, Section 86, Estate Freeze Transactions, Amalgamations and Wind Ups . . . . . . 459 Learning Goals, Learning Chart . . . . . . . . . . . . . . . . 460 Review Questions, Exercises, and Assignment Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

463

Solutions to Review Questions and Exercises . . . . . . 480 Chapter 18

Environmental, Social, and Governance (ESG) Landscape and Tax . . . . . . . . . . . . . . . . . . . . . . . . . . 495

Chapter 19

Partnerships, Trusts and Death of a Taxpayer . . . . .

497

Learning Goals, Learning Chart . . . . . . . . . . . . . . . . 497 Review Questions, Exercises, and Assignment Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

500

Solutions to Review Questions and Exercises . . . . . . 516 Chapter 20

International Taxation in Canada . . . . . . . . . . . . . . . 527 Learning Goals, Learning Chart . . . . . . . . . . . . . . . . 528 Review Questions, Exercises, and Assignment Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

532

Solutions to Review Questions and Exercises . . . . . . 542

Introduction to Federal Income Taxation in Canada — Study Guide

Chapter 21

Page GST/HST . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 549 Learning Goals, Learning Chart . . . . . . . . . . . . . . . . 549 Exercises and Assignment Problems . . . . . . . . . . . . . 552 Solutions to Exercises . . . . . . . . . . . . . . . . . . . . . . . . 568

Chapter 22

Data Analytics and Information Systems in Tax . . . . 571 Learning Goals, Learning Chart . . . . . . . . . . . . . . . . 571 Assignment Problems . . . . . . . . . . . . . . . . . . . . . . . . 574

Comprehensive Section

Learning Goals, Learning Chart . . . . . . . . . . . . . . . . 579 Comprehensive Case Problems . . . . . . . . . . . . . . . . . 582 Solutions to Comprehensive Case Problems . . . . . . . 617

Acronyms Acronym

Meaning

A AB .......................................................................................................................................................... Active business ABI ................................................................................................................................ Active business income ABIL ............................................................................................................... Allowable business investment loss ACB................................................................................................................................................ Adjusted cost base ACL .................................................................................................................................. Allowable capital loss AI ......................................................................................................................... Accelerated investment incentive AII...................................................................................................................... Aggregate investment income AOC ..........................................................................................................................................Acquisition of control ART .................................................................................................................................... Additional refundable tax ATR ........................................................................................................................................Advance tax ruling B BFTC................................................................................................................................Business foreign tax credit Boot (expression)............................................................ Non-share/non-partnership interest consideration C CCA ........................................................................................................................................ Capital cost allowance CCB .................................................................................................................................... Canada child benefit CCPC ....................................................................................................Canadian-controlled private corporation CDA ........................................................................................................................... Capital dividend account CDSB...............................................................................................................Canada disability savings bond CDSG .....................................................................................................................Canada disability savings grant CESG ............................................................................................................ Canada education savings grant CFA ................................................................................................................................... Controlled foreign affiliate CG ................................................................................................................................................................ Capital gain CGD ............................................................................................................................. Capital gains deduction CGE ............................................................................................................................. Capital gains exemption CL .................................................................................................................................................................. Capital loss CLB ................................................................................................................................. Canada learning bond CNIL ...................................................................................................................... Cumulative net investment loss CRA ........................................................................................................................... Canada Revenue Agency CUP........................................................................................................................ Comparable uncontrolled price D DBP..................................................................................................................... Defined benefit pension plan DPSP ...................................................................................................................... Deferred profit sharing plan DTC ................................................................................................................................................ Dividend tax credit E ETA ......................................................................................................................................................... Excise Tax Act F FAPI ..............................................................................................................Foreign accrual property income FCA ...................................................................................................................................... Federal Court of Appeal FHSA ..................................................................................................................... First home savings account FMV .................................................................................................................................................... Fair market value FTC ................................................................................................................................................... Foreign tax credit

xii Acronym

Introduction to Federal Income Taxation in Canada Meaning

G GIS ................................................................................................................ Guaranteed income supplement GRIP .................................................................................................................................. General-rate income pool GST ....................................................................................................................................... Goods and services tax H HBP ................................................................................................................................................ Home buyers’ plan HST ........................................................................................................................................... Harmonized sales tax I IC ................................................................................................................................................. Information circulars IT............................................................................................................................................... Interpretation bulletins ITA ....................................................................................................................................................... Income Tax Act ITAR..........................................................................................................................Income Tax Application Rules ITC .............................................................................................................................................. Investment tax credit ITC ......................................................................................................................................................... Input tax credit ITR ........................................................................................................................................ Income Tax Regulations L LLP .................................................................................................................................... Lifelong learning plan LLP................................................................................................................................... Limited liability partnership LOCP .............................................................................................................................. Lower of cost or proceeds LPP ....................................................................................................................................... Listed personal property LSC ........................................................................................................................................Legal stated capital M M&P .......................................................................................................... Manufacturing and processing MPP ............................................................................................................Money-purchase pension plan N NBFTC .................................................................................................................. Non-business foreign tax credit NCL ...................................................................................................................................................... Net capital loss N-C L ..................................................................................................................................................... Non-capital loss O OAS ............................................................................................................................................ Old age security P PA.......................................................................................................................................... Pension adjustment PE ............................................................................................................................... Permanent establishment PI ..................................................................................................................................................... Partnership interest POD .......................................................................................................................................Proceeds of disposition PRE.................................................................................................................... Principal residence exemption PSB ........................................................................................................................... Personal services business PSBI ........................................................................................................... Personal services business income PUC ............................................................................................................................................... Paid-up capital PUP ........................................................................................................................................... Personal-use property Q QSBCS .................................................................................. Qualifying small business corporation shares R RDSP ............................................................................................................. Registered disability saving plan RDTOH ........................................................................................................... Refundable dividend tax on hand REOP ................................................................................................................... Reasonable expectation of profit RESP ..........................................................................................................Registered education savings plan RRIF................................................................................................................. Registered retirement income fund RRSP ......................................................................................................... Registered retirement savings plan

Study Guide — Acronyms Acronym

xiii Meaning

S SBC ......................................................................................................................... Small business corporation SBD ........................................................................................................................... Small business deduction SCC ................................................................................................................................. Supreme Court of Canada SIB ......................................................................................................................Specified investment business SIBI ..................................................................................................... Specified investment business income T T1 ................................................................................................................................... Personal income tax return T2 .................................................................................................................................Corporate income tax return T3 ................................................................................................................................. Income tax return for a trust TIEA ..........................................................................................................Tax Information Exchange Agreement TCG..................................................................................................................................... Taxable capital gain TFSA ........................................................................................................................... Tax-free savings account TOP..........................................................................................................................................Tax otherwise payable TOSI............................................................................................................................................. Tax on split income TPM ............................................................................................................................... Transactional profit method TTM ........................................................................................................................ Traditional transaction method TV ...................................................................................................................................................................... Tax value U UCC................................................................................................................................ Undepreciated capital cost

Reading the Income Tax Act

Reading the Income Tax Act (the Act) is often avoided by students because they are intimidated by the volume of words and the apparent complexity of the expression of the provisions. However, the ability to interpret and access primary sources of tax information such as the Act, are essential for tax practice and for the evergreen learning principles of being a CPA. Keeping in mind a few simple principles and procedures of statutory interpretation and applying them in your reading of a provision will address the intimidation successfully. For an overview of the development of some of the principles of statutory interpretation in the common law as they pertain to the Act, refer to ¶1,500 of the textbook. This section will take a ‘‘how to’’ approach that should prove helpful in reading the Act. It is broken down into four sections, each framed as a question: How do I find something? How do I read the legislation? What am I missing? Am I reading the provision correctly?

HOW DO I FIND SOMETHING? Before you can interpret a provision of the Act, you need to be able to find it in the Act. In practice, a client will present you with a set of facts, whether complete or incomplete, and you will have to search for the provision or provisions that might apply. Here are some procedures that you should follow to find a provision: 1. Know how the Act is structured in order to recognize where something is most likely to be found. a. Parts (particularly Part I), Divisions, Subdivisions — For example, if the facts suggest that you are dealing with an employee and you need to determine whether an amount must be included in income, you should know that the most likely place to find a provision that would deal with that issue is in Part I, Division B, Subdivision a, subsection 6(1), which contains a number of paragraphs listing possible inclusions. After subsection 6(1), subsection 6(2) to 6(23) are what might be termed ‘‘amplification’’ rules, which provide clarification for a rule in subsection 6(1) or a formula for a calculation of an inclusion, rather than a new inclusion rule. — On the other hand, if the facts of a situation require a determination of whether an amount is deductible from business income, you should know that you should look in Part I, Division B, Subdivision b, subsection 20(1) to see if the expenditure is specifically listed there. Then, if the expenditure is not listed in subsection 20(1), look in subsection 18(1) to see if it is prohibited as a current-year deduction. If it is neither prohibited nor specifically allowed, then it might be allowed on the general principle that it was incurred to earn income. This possibility may have to be researched in court decisions or other interpretations. 1 The materials in this section of the note have benefited from reference to materials prepared as their course notes by Chasma r and by Laiken, as listed in the References section.

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b. Know where to find the definition sections for each Division or Subdivision and for the Act and note the wording used to indicate the scope of a definition or where in the Act the definitions are applicable. For example, see — Subsection 248(1): Note that the opening words, often referred to as the preamble, are ‘‘in this Act’’, indicating that the definition is applicable to the use of the word or term anywhere in the Act. Some terms listed in subsection 248(1) will refer you to another definitions section. For example, the term ‘‘adjusted cost base’’ is listed in subsection 248(1), but you are referred to section 54 for the definition to be used throughout the Act. — Section 54: Here the preamble used is ‘‘in this subdivision’’, indicating that these definitions are applicable to the use of the word or term only in Part I, Division B, Subdivision c, pertains to taxable capital gains and allowable capital losses. — Subsection 74.4(1): The preamble for this definitions provision is ‘‘in this section’’, thereby limiting the scope of the use of these definitions to section 74.4 pertaining to transfers and loans to corporations. 2. Look in the alphabetical Topical Index compiled by the editors of the edition of the Act that you are using. If the word or term is used anywhere in the Act or the Regulations, it may be listed there with a provision reference. 3. Look in the Detailed Table of Sections List provided immediately before the provisions of the Act. Scanning the headings in that list in the area of the Act that you are searching may help you determine a provision that is applicable. For example, if you are searching in subsection 6(1) for a possible inclusion, looking down the list of headings of the paragraphs of subsection 6(1) may identify quickly an appropriate provision. 4. Look at the ‘‘Related Sections’’ and other notes at the end of subsections and paragraphs to see if there are any other provisions or issues to consider. 5. Use the search function to find the area of the Act you need to consider if you are using the electronic version of the Income Tax Act in AnswerConnect.

HOW DO I READ THE LEGISLATION? Having found a provision or provisions that might apply to the facts that you are trying to analyze, the next step is to read the provision to determine if it actually does apply and what it does. 1. Does this provision apply? a. Identify the start and end of the sentence. — Note that, typically, each subsection of the Act is one sentence. Subsection 6(1), pertaining to amounts to be included in income from an office or employment, extends through several pages of paragraphs, each of which ends with a semicolon, until paragraph 6(1)(l ), which ends with a period, indicating the end of subsection 6(1). On the other hand, subsection 6(1.1), pertaining to parking cost, is a much shorter subsection and, hence, a sentence of only a few lines. b. Identify the components of the provision. There will usually be four components, as follows: i. To whom, i.e., an individual, a corporation, a partnership or a trust, does the provision apply? — For example, the preamble to subsection 6(1) indicates that the provision applies to ‘‘a taxpayer’’ who has income from an office or employment. It can be determined from the definition of ‘‘office’’ and ‘‘employment’’ in subsection 248(1) that only an individual can hold these positions.

Study Guide — Reading the Income Tax Act — To keep the specific facts of your situation straight, insert the names of persons in your fact situation into the provision that describes those persons. ii. What is the transaction, activity or event to which the provision applies, and what are the conditions for that provision to apply? — Continuing with the use of subsection 6(1) as an example, the taxpayer must receive or enjoy one or more amounts or benefits listed in the paragraphs of subsection 6(1). Each of those paragraphs contains conditions on or a description of what must be included and some contain exceptions to the inclusion rule. For example, paragraph 6(1)(b) requires the inclusion of ‘‘all amounts received . . . as an allowance’’. This condition is followed by 11 subparagraphs describing exceptions, each with its own descriptions or conditions. — To understand the basics of a provision, on the first read, you might ignore any exceptions. However, on subsequent reading, it is important to see if any of the exceptions apply to your fact situation. iii. What are the consequences of the provision, if it applies, to the person who is involved in the transaction, activity or event? — Under subsection 6(1), the taxpayer/employee must include in his or her income from an office or employment any amount determined to meet the inclusion conditions in one or more of the paragraphs of subsection 6(1). — Other consequences may involve: — charging a person with the responsibility to pay tax (e.g., subsection 2(1) — ‘‘an income tax shall be paid’’), — charging someone with the responsibility to withhold tax (e.g., section 153 — ‘‘every person paying . . .’’), — permitting a deduction (e.g., subsection 8(1) — ‘‘there may be deducted . . .’’), — denying a deduction (e.g., subsection 18(1) — ‘‘no deduction shall be made . . .’’), — changing the nature of income or a deduction (e.g., subsection 55(2) — where a taxable dividend is deemed not to be a taxable dividend, but to be proceeds of disposition of shares or a gain of the dividend recipient), — changing the timing of income or a deduction (e.g., subsection 73(1), which defers an unrealized capital gain on the transfer of a capital property to a spouse or common-law partner), or — changing the person who pays the tax on income (e.g., subsection 74.1(1), which attributes income on property owned by a spouse or common-law partner to the spouse who originally owned and transferred the property to the owner-spouse). iv. What is the timeframe over which the provision applies? — Under subsection 6(1), the inclusion in ‘‘the income of a taxpayer’’ is ‘‘for a taxation year’’ in which the amount is received or the benefit is enjoyed, as specified in one or more of the paragraphs of subsection 6(1). — Under subsection 156(1), individuals must pay quarterly instalments, under specified conditions, on the 15th day of March, June, September and December, i.e., the last month in each calendar quarter.

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— Under subsection 165(1), a deadline is established for filing a notice of objection in respect of an assessment. c. Determine the meaning of the key words used in the provision by following some established principles of interpreting a statute. i. Grammar, including punctuation, sentence structure, and the ordinary sense of words, is important in determining the meaning of words, phrases, clauses and sentences in a provision. — For example, the following question might be asked about the application of paragraph 20(1)(n): does the paragraph apply on a sale of land held as inventory? — The question revolves around whether the exception (within the commas in the provision) applies to the whole provision, meaning that the reserve does not apply on the sale of land held as inventory or whether that exception applies to the two-year payment requirement, such that the two-year requirement does not apply to a reserve on the sale of the land held as inventory. — A reasonable interpretation would suggest that the exception, following the ‘‘and’’ between the two conditions, should apply only to the second condition involving the two-year requirement. ii. What is the intention of Parliament for or the policy purpose of this provision? — Look at the explanatory notes that accompany the introduction of a provision or published practitioner or government commentary to determine why Parliament legislated a provision and used the words that it did. — Paragraph 56(1)(n) requires the inclusion in a student/taxpayer’s income of amounts received in respect of scholarships and similar awards. Within that paragraph is an exception, often referred to as a ‘‘carve-out’’ that would except from the treatment of amounts as scholarships ‘‘amounts received in the course of or by virtue of an office or employment’’ [italics added]. Did Parliament intend the reference to ‘‘an office or employment’’ to be to that of the student/taxpayer or to that of anyone else’s office or employment? The carve-out was legislated to counteract the situation in the Supreme Court of Canada decision in Savage (83 DTC 5409) involving an employee who received a prize for achievement, personally. Apparently, Parliament’s intent in legislating the exception was to make the prize employment income of the recipient as an employee and, therefore, not subject to paragraph 56(1)(n). For example, where an employer offers a scholarship to the child of an employee, is it the employment of the parent that should result in the exception being applied? Would it be reasonable to interpret ‘‘an office or employment’’ in this general way? — It is important to test the reasonableness of the result of your interpretation by comparing that result to your understanding of the purpose of the provision that you are interpreting. — It is important to consider the principle on which the provision is based in addition to the plain meaning of the words. GAAR may apply where the principle has not been properly considered. Harnish (1997) provides a detailed discussion of this consideration.

iii. Are any of the words or terms used in the provision defined in the Income Tax Act?

— A definition contained in the Act overrides the ordinary meaning of a word or term.

Study Guide — Reading the Income Tax Act — Check the ‘‘Related Sections’’ note at the end of a subsection or paragraph. — Be careful to note the scope of the definition by the use of words like: ‘‘in this Act’’, ‘‘in this subdivision’’, or ‘‘in this subsection’’. — Some terms used for different purposes in the Act are defined differently for a particular purpose. — For example, the term ‘‘earned income’’ is defined in subsection 63(3) for the purposes of the child care expense deduction in subsection 63(1). That definition is limited to section 63. The definition reflects the type of income that the government is attempting to encourage by providing a deduction for child care expenses, i.e., employment, business and student income. — The same term, ‘‘earned income’’, is defined differently in subsection 146(1) only for the purposes of section 146, pertaining to the deduction for contributions to Registered Retirement Savings Plans (RRSPs). This definition reflects the type of income that the government is attempting to encourage as the base for tax-assisted retirement savings, i.e., income that requires a certain amount of activity to generate, rather than passive investment income. iv. Are there words used in the Act that are not defined in the Act but that derive meaning from the way in which they are used? — Distinguish between the words ‘‘means’’ and ‘‘includes’’. — Note how the definition of the term ‘‘capital property’’ in section 54 uses the word ‘‘means’’, indicating that this definition is comprehensive and nothing more can be considered. Note also that this definition applies to the use of the term in Subdivision c of Division B in Part I of the Act. — On the other hand, the definition of the term ‘‘personal-use property’’ in section 54 uses the word ‘‘includes’’, suggesting that use of the term is not limited to the property specifically listed in the definition. — Both words, ‘‘means’’ and ‘‘includes’’, can be used in the same definition, as found in the definition of the word ‘‘office’’ in subsection 248(1). — Note the use of the expression ‘‘for greater certainty’’. — For example, this expression is used in paragraph 256(1.2)(b) to expand the meaning of the concept of ‘‘control’’, as used in subsection 256(1), among other provisions in section 256, pertaining to associated corporations. — A deeming rule is often used to change the ordinary meaning of a term under specified facts or conditions. — For example, subsection 250(1) ‘‘deems’’ a person, who may not ordinarily be considered to be a full-year resident of Canada based on the facts, to be deemed to be a resident of Canada for a full year. One condition for that deeming rule to apply is set out in paragraph 250(1)(b), where the person ‘‘was, at any time in the year, a member of the Canadian Forces’’. That person may not have been physically present in Canada at any time in the year but is deemed to be a full-year resident. — Distinguish between the use of the words ‘‘may’’ and ‘‘shall’’. — Where a provision uses the word ‘‘shall’’, the rule is mandatory. For example, subsection 6(1) begins by stating that ‘‘there shall be included . . .’’.

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Introduction to Federal Income Taxation in Canada — Where a provision uses the word ‘‘may’’, the rule is permissive. For example, subsection 20(1), pertaining to deductions from business or property income, indicates that ‘‘there may be deducted’’ specified amounts listed in the subsection. Hence, a deduction for capital cost allowance or a reserve is permissive and need not be taken to the maximum allowed or at all. — Note the use of the words ‘‘notwithstanding’’ and ‘‘except’’. — For example, ‘‘notwithstanding’’ is used in subsection 20(1) to allow certain deductions specified in the subsection despite the fact that certain paragraphs in subsection 18(1) may prohibit their deduction, by stating that ‘‘no deduction shall be made’’ for in respect of specified expenditures. As a specific example, paragraph 18(1)(b) prohibits the deduction of ‘‘an outlay or loss or replacement of capital property’’ or ‘‘ an allowance in respect of depreciation’’. However, paragraph 20(1)(a) provides for the deduction of capital cost allowance, which represents all or part of the capital cost of a property. — Note that paragraph 18(1)(b) also provides an exception to its prohibition, by the use of the words ‘‘except as expressly permitted in this Part’’. Paragraph 20(1)(a) provides for such express permission for capital cost allowance. — Note the use of the words ‘‘and’’ and ‘‘or’’, which are often used to separate conditions in a provision. Usually, these words are used between the second-last and last conditions in a list of more than two. However, they may be inserted between each condition in a list of more than two, as is the case in paragraph 256(1)(c), pertaining to a rule determining associated corporations, where ‘‘and’’ is inserted twice to join three conditions. — Where the word ‘‘and’’ is used, each one of the conditions in the list must be satisfied for the provision to apply. Hence, if one condition in the list is not satisfied, then the provision does not apply. — Where the word ‘‘or’’ is used, only one of the conditions in the list must be satisfied for the provision to apply. See for example, paragraph 256(1)(b) pertaining to a rule determining associated corporations. — If a requirement or condition is stated in the negative, the use of the word ‘‘or’’ may have the same effect as the use of the word ‘‘and’’ in a positive statement of the requirement. For example, look at paragraph 8(1)(f ) pertaining to the deduction of sales expenses by an employee. There are three conditions in subparagraphs (v), (vi) and (vii), joined by the word ‘‘or’’. However, these conditions are preceded, in the midamble (i.e., in the middle of the paragraph), by the words ‘‘to the extent that those amounts were not ’’ This means that none of the three conditions can be satisfied by the facts if the deduction provision is to apply with the effect that the word ‘‘or’’ after the negative statement has the same effect as the word ‘‘and’’ following a positive statement. — Consider the use of limiting terms and their effect on the meaning of words. — Note the use of the phrase ‘‘for the purposes of’’ in subsection 6(2). This subsection provides a formula for calculating a reasonable standby charge for the purposes of the inclusion specified in paragraph 6(1)(e). — Also, note the use of the phrase ‘‘subject to’’ in subsection 9(2), pertaining to a loss from business or property. The rule in subsec-

Study Guide — Reading the Income Tax Act tion 9(2) is subject to the rule in section 31 which limits the loss otherwise determined by subsection 9(2) in the case of certain farming losses. — The word ‘‘prescribed’’ is used throughout the Act to signal the existence of a Regulation that must be considered or a form that must be filed in complying with the provision of the Act. The word is defined in subsection 248(1). — Look at the use of the phrase ‘‘prescribed by regulation’’ in paragraph 110.1(8)(e), pertaining to the deduction of certain donations by a corporation. The notes to that provision contain a section for ‘‘Related Regulations’’, which specifies the particular regulation that is prescribed. — For an example of the use of ‘‘prescribed form’’, look at subsection 8(6.1), pertaining to the deduction for an eligible tool of an employee tradesperson. Paragraph (c) of that provision requires certification in prescribed form. The notes to that provision contain a ‘‘Forms’’ section which indicates that the prescribed form is T2200. — The word ‘‘Idem’’ is often seen as the heading (in bold type) of a provision. It is the Latin word meaning ‘‘the same’’, as in the same heading. — Look at the heading for subsection 13(2), pertaining to recapture of capital cost allowance claimed on certain passenger vehicles. This provision follows subsection 13(1) pertaining to recapture, generally, so subsection 13(2) is headed ‘‘Idem’’ to denote that it deals with more on recapture. v. Can the meaning of general words used in the Act be determined by inference following an established rule of interpretation? — Class words: where a general word, such as the word ‘‘similar’’, follows a list of particular or specific words (i.e., words of a class of words), the general word is to take its meaning from the context of the specific words. — For example, see the definition of ‘‘eligible capital expenditure’’ in subsection 14(5). Subparagraph (f )(iii) lists ‘‘a share, bond, debenture, mortgage, hypothecary claim, note, bill or other similar property’’ [italics added]. A ‘‘similar’’ property would have to fit in the same class as the properties specifically listed. — As another example, consider the definition of ‘‘listed personal property’’ in section 54. Paragraph (a) lists ‘‘print, etching, drawing, painting, sculpture, or other similar work of art’’ [italics added]. A ‘‘similar work of art’’ would have to fit the same class as the listed types of art. Would a poster be similar to a print? vi. Are there words used in the Act that may derive their meaning from other legislation? — Some legal terms used in the Act may derive their meaning from other Canadian statutes. — For example, the word ‘‘corporation’’, by itself, is not defined in the Act. Reference to a corporate law, like the Canada Business Corporations Act, may be necessary. — Similarly, the term ‘‘legal stated capital’’ may be defined in corporate law. — A dictionary of legal terms can be consulted for a consolidation of these definitions.

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Introduction to Federal Income Taxation in Canada vii. What is the role of the Interpretation Act in interpreting undefined words or terms used in the Income Tax Act? — This legislation was enacted to provide a source of defined words or terms used in all federal statutes and regulations, including the Income Tax Act. — Section 16 of the Interpretation Act indicates that words used in a Regulation are to be given the same meaning as the same words used in the Act to which the Regulation relates. — Section 26 indicates that when a deadline falls on a ‘‘holiday’’, the deadline is considered to fall on the next day that is not a holiday. — For example, if the 60-day RRSP deadline, which is usually March 1 in years other than a leap year, falls on a holiday, the deadline is moved to the next business day. The word ‘‘holiday’’ is defined in section 35, the general definitions section of the Interpretation Act, to include Sunday. viii. What is the role of the courts in determining the meaning of words used in the Income Tax Act? — The courts have considered and continue to consider the meaning of words and terms used in the Act. — The meaning of the word ‘‘profit’’ has been considered by the courts over a period of years. In the process, the reliance on accounting principles in the determination of profit has been established. — The basis of the meaning of the word ‘‘control’’, used in the context of legal control, as in provisions pertaining to acquisition of control in subsection 111(4), was established many years ago by the E Xchequer Court of Canada, the intermediate-level court at the time. The same meaning of the word ‘‘control’’ is used in section 256, pertaining to associated corporations, but the concept has been broadened to include ‘‘control in fact’’, as described in subsection 256(5.1), applicable to the use of that phrase anywhere in the Act. — In determining the meaning of a word not defined in the Act, the courts have often attempted to ascertain the ordinary meaning of a word in the context in which it is used in the Act. — In this process of determining the ordinary meaning of a word, the courts have often consulted a standard dictionary. If you are trying to determine the meaning of a word used in the Act, but not defined in the Act or other relevant legislation and not considered in the same context by a court, you could do the same. It is best to consult a Canadian edition of a standard dictionary which is more likely to provide an appropriate meaning in the Canadian context. — The courts attempt to determine the conventional, normal or everyday meaning or usage of a word or term. In the process, the courts follow the presumption that Parliament used words of ordinary or common usage and the more common meaning of the word is used.

WHAT AM I MISSING? 1. Consider the consequences of one provision on another. — For example, consider the impact of your determination of proceeds of disposition of property for a vendor on the ACB of the purchaser and the impact of the relationship between the parties on both proceeds and cost.

Study Guide — Reading the Income Tax Act — Look for related provisions and regulations in the notes to the provision you are attempting to interpret. 2. Look for the existence of and consider the applicability of an anti-avoidance rule that is specific to the provision and/or consider the applicability of the general anti-avoidance rule (GAAR).

AM I READING THE PROVISION CORRECTLY? Look for other sources to confirm your interpretation, such as: — court decisions for the judicial position in common law — CRA publications, including Interpretation Bulletins (ITs), Information Circulars (ICs), technical interpretations, etc. and their replacements in Tax Folios (these do not have the force of law unless they can be shown to have a basis in law, but they can be instructive in helping to understand the CRA’s views and administrative position) — articles in technical publications of the Canadian Tax Foundation, such as the Canadian Tax Journal and Conference Reports, while not the law, provide views of professionals in the field

EXHIBIT: SUMMARY OF READING THE INCOME TAX ACT How do I find something? 1. Know how the Act is structured in order to recognize where something is most likely to be found. a. Parts (particularly Part I), Divisions, Subdivisions b. Know where to find the definition sections for each Division or Subdivision and for the Act, and note the wording used to indicate the scope of a definition or where in the Act the definitions are applicable 2. Look in the alphabetical Topical Index compiled by the editors of the edition of the Act that you are using. If the word or term is used anywhere in the Act or the Regulations, it may be listed there with a provision reference. 3. Look in the Sectional List provided immediately before the provisions of the Act. Scanning the headings in that list in the area of the Act that you are searching may help you determine a provision that is applicable. 4. Look at the ‘‘Related Sections’’ and other notes at the end of subsections and paragraphs to see if there are any other provisions or issues to consider. 5. If you are using an electronic version of the Act, the search function can be helpful in finding the provision you are looking for. As well, once you have found a provision, links to other provisions/definitions can help identify important related provisions.

How do I read the legislation? 1. Does this provision apply? a. Identify the start and end of the sentence. b. Identify the components of the provision. There will usually be four components, as follows: i. To whom, i.e., an individual, a corporation, a partnership or a trust, does the provision apply?

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ii. What is the transaction, activity or event to which the provision applies, and what are the conditions for that provision to apply? iii. What are the consequences of the provision, if it applies, to the person who is involved in the transaction, activity or event? iv. What is the timeframe over which the provision applies? c. Determine the meaning of the key words used in the provision by following some established principles of interpreting a statute. i. Grammar, including punctuation, sentence structure and the ordinary sense of words, is important in determining the meaning of words, phrases, clauses and sentences in a provision. ii. What is the intention of Parliament for or the policy purpose of this provision?

iii. Are any of the words or terms used in the provision defined in the Income Tax Act?

iv. Are there words used in the Act that are not defined in the Act but that derive meaning from the way in which they are used? v. Can the meaning of general words used in the Act be determined by inference following an established rule of interpretation? vi. Are there words used in the Act that may derive their meaning from other legislation? vii. What is the role of the Interpretation Act in interpreting undefined words or terms used in the Income Tax Act? viii. What is the role of the courts in determining the meaning of words used in the Income Tax Act?

What am I missing? 1. Consider the consequences of one provision on another. 2. Look for the existence of and consider the applicability of an anti-avoidance rule that is specific to the provision and/or consider the applicability of the general antiavoidance rule (GAAR).

Am I reading the provision correctly? Look for other sources to confirm your interpretation.

REFERENCES Chasmar, Hugh. TAX 616, Statutory Interpretation, Course Notes, MTax Program, School of Accounting and Finance, University of Waterloo. Harnish, Kerry. "Interpreting the Income Tax Act: Purpose v. Plain Meaning and the Effect of Uncertainty in the Tax Law." Alberta Law Review 35 (1996):687. Laiken, Stanley N. ACC 604, Statutory Interpretation, Course Notes, Master of Accounting Program, School of Accounting and Finance, University of Waterloo.

Problem-Solving Process for Tax A Case Analysis Framework

Introduction As a student progresses from understanding tax to applying tax principles to problems or cases, the importance of understanding the context of the relevant aspects of the fact situation and the objectives of the stakeholders involved is critical to a student’s ability to identify the issues that must be analyzed. The problem-solving process for tax (PSP) used in this textbook is a case analysis framework based on the CPA Way, a case analysis approach endorsed by CPA Canada. The PSP is tailored specifically for tax to assist students in understanding the taxrelevant aspects of a problem or case. The process focuses on the development of problem-solving skills, and assists students with the challenging task of identifying the important tax and non-tax issues relevant to a stakeholder in a problem or case. It is a developmental tool available to students as they progress on to tackling the more challenging multi-issue cases they will face in post-undergraduate studies and professional CPA examinations.

Tax-Related Issues1 What do we mean when we use the term ‘‘tax-related issue’’? A tax-related issue is something that might have positive or negative implications that needs further analysis. Issues may: (1) relate to transactions or events. (2) related to opportunities that can be taken advantage of or penalties to be avoided. (3) be tax specific or related to financial accounting, finance, ethics, governance, sustainability, business or personal matters that relate to the tax matters under consideration. Tax is often transaction-based. The purpose of identifying transactions and events as part of the ‘‘Assess the Situation’’ is to help identify tax-related issues relevant to past or future transactions or events. Issues may be identified early as part of your assessment of the taxpayer’s situation or may be become evident later on as you complete your analysis. Never stop looking for them. Issues that are not identified represent a potential threat either as an opportunity missed or a penalty incurred; neither option is desirable. The Problem-Solving Process for Tax includes 4 steps to help students work through the analysis of a problem or case, and to ensure that they identify and analyze all of the important tax and non-tax issues for analysis. The steps include: 1. Assess the Situation 2. Identify the Issues 3. Analyze the Issues 4. Advise and Recommend The following provides a description of the 4 steps. 1 Barnett, J., & Timmermans, J. (2013)

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Assess the Situation In this first section, the goal is to find out all the information you can, to ‘‘establish the facts’’ and understand the context of the problem or case. You want to know about the parties involved and their relationships to each other and the details of their actual or planned transactions. You want to gain a full understanding of the fact situation before you identify the issues you will need to analyze. This will help you focus your analysis on what is most important to the taxpayer you are advising. You will need to read the problem or case carefully to be able to effectively assess the situation. 1. Draw a diagram identifying all stakeholders, e.g., corporate organization chart Start by drawing a diagram identifying all of the parties involved, their relationships to each other, and, if there is a transaction involved, the structure before and after the transaction. Relationships include parent-child, brother-sister, employer-employee and shareholder-corporation. 2. Identify relevant tax the relationships among the stakeholders, e.g., related, affiliated, associated, connected Important tax relationships need to be identified. Are the parties involved related or affiliated? If there are corporations involved, are they connected or associated? The tax consequences of transactions are often determined by the relationships between or among the stakeholders. Therefore, it is important to identify the tax relationships early. For example, related persons do not deal at arm’s-length, so related-party transactions that are not at fair market value will be adjusted, usually with negative tax consequences. Associated companies share the small business deduction limit. Transactions resulting in losses between affiliated persons may be impact by the stop loss provisions in the Income Tax Act. 3. Identify the profile of each stakeholder, e.g., tax features, risk profile A tax profile is just an organized way of gathering all the tax information you need about your client. Not all of it will be directly related to the particular situation you are analyzing but sometimes it is difficult to determine this in advance. It is best to gather too much information than not enough. Is the taxpayer an individual employee with employment income or an individual earning business income? Does a corporation have tax balances such as a capital dividend account that may become relevant to your analysis? Individual For individuals, you should know their age, significant relationships and, if relevant, their estate plans. Trust If the client is a trust, then determine whether the person who set up the trust was alive at the time (inter vivos trust) or whether the trust was established under someone’s will on death (testamentary trust). Determine if the trust is a graduated rate estate. Corporation Identifying the type of corporation is crucial for determining how the income earned in the corporation is taxed. The main classifications are Canadian-controlled private corporation (CCPC), private corporation or public corporation. Within the CCPC category, consider whether the company meets the conditions to be a small business corporation (SBC), which is important for purposes of the capital gains exemption and the allowable business investment loss provisions. Amount and type of income being earned by each taxpayer, the applicable tax rates/credits and relevant tax balances It is very common for different types of income to be taxed in different ways for both individuals and corporations. As a result, it is important to identify the types of income being earned by the different types of taxpayers identified above. The following is a list to consider when reading through a problem or case:

Study Guide — Problem-Solving Process for Tax

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Individuals Types of income — Employment — Business — Canadian or foreign — Property — Canadian or foreign — Dividends from Canadian corporations — eligible dividends and non-eligible dividends — Dividends from foreign corporations and tax withheld at source — Taxable capital gains and allowable capital losses, including whether QSBC shares or other types of capital property were disposed of — Other income or deductions Tax balances — Net or non-capital losses from other years — Available capital gains deduction, prior year allowable business investment losses, CNIL balance, RRSP, TFSA room Tax rates — Personal tax — graduated tax rates, marginal tax rate, credits applicable Corporation Types of income — Active business income — Canadian and foreign — Personal service business income — Aggregate investment income — Canadian and foreign property income, net taxable capital gains — Dividends from Canadian connected and non-connected corporations — Dividends from foreign corporations and tax withheld at source — Taxable capital gains/allowable capital losses Tax balances — Net or non-capital losses from other years — Capital dividend account (CDA), eligible and non-eligible refundable tax on hand (RDTOH) balances, general rate income pool (GRIP) Tax rates — Corporate tax — basic tax rate, provincial abatement, small business deduction, general rate reduction, foreign tax credit, personal services business income additional tax, additional refundable tax, Part IV tax, refundable Part I tax, dividend refund, ITCs

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Shareholders It is important to have detailed information on shareholders, particularly, shareholders of closely held private corporations. This section applies to all shareholders regardless of whether they are individuals, corporations, trusts or partnerships. Details of shareholdings include such information as number of shares owned, what they paid for the shares (ACB), what the voting and dividend rights of the shares are and what the paid-up capital (PUC) is. It should also be determined whether the shareholder has any financial or other influence that, if exercised, could result in control (de facto) of the corporation. The details of a shareholder agreement may also be important. Liability for tax Are the parties Canadian residents and, therefore, subject to tax on their world-wide income or are they foreign residents and taxed in Canada, in some fashion, on their Canadian-source income? Tax risk profile Before making any recommendation to a client, it is important to understand their risk tolerance, particularly, as it relates to tax. Some taxpayers want to pay the least amount of tax and are willing to accept some risk of reassessment in order to do this. Others want to minimize any risk of reassessment. You also need to assess your own risk tolerance as a professional advisor. There may be some transactions that you are not comfortable supporting because of the risk involved. Risk is not simply the risk of reassessment and potential interest and penalties; it also involves risk to reputation and relationships. A significant reassessment could damage your reputation in the community as well as the relationship between the taxpayer and the professional advisor. 4. Fully understand the decision maker and their objectives a. Who are you advising? b. What objectives have they specifically mentioned and what is the purpose behind these objectives? c. What have they specifically asked you to do? It is important to know who your client is, what ‘‘business’’ they are in and what their short and longer-term goals are. With this understanding it may be possible to find a more tax efficient way for them to achieve their objectives. It is also helpful to understand what they don’t want to do or what their tax risk tolerance is, as this may put some limits on what you might recommend. Identifying the decision-maker’s objectives helps you prioritize issues of most importance. It will also help in devising recommendations. Advice and recommendations should meet the client’s objectives, needs and requests. 5. Identify the relevant past transaction/events or planned future transactions/events and create a timeline Virtually all transactions or events have tax consequences. Create a timeline to identify transactions and events that are completed or proposed. Also, large transactions may be made up of a series of smaller transactions, so identify each component. Do not just consider financial transactions. Events such as marriage and death have significant tax implications as well. Here are some things to consider. Identify all of the completed or planned transactions or events such as a sale, purchase, loan given or received, gift given or received and benefit given or received.

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Draw one or more diagrams showing the transactions or events and all of the parties involved. You may need to draw multiple diagrams if there is a series of transactions. This will help you identify each of the components involved in each of the transactions. Draw a timeline identifying dates of the completed or planned transactions or events. The order of transactions or when they occurred or will occur is often an important detail. Identify the taxpayer’s purpose for the transaction. E Xamples include business expansion, creditor proofing, income splitting, loss utilization and estate planning. Understanding the purpose may help you identify problems or alternatives.

Identif y the Issues 1. Identify all of the major tax issues and any non-tax issues Now that you have gathered the information, you need to condense it into specific issues and determine the issues in light of the taxpayer’s objectives, the transactions involved and the level of risk. It is important to identify the issues and then prioritize and group related issues before you begin your analysis. This will ensure that you target your analysis to what is most important to the taxpayer’s objectives and requests. Remember what we mean when we use the term ‘‘tax-related issue’’. It is something that might have positive or negative implications that require further analysis. Issues may relate to opportunities that can be taken advantage of or penalties to be avoided. They may be tax specific or non-tax issues related to financial accounting, finance, ethics, governance, sustainability, business or personal matters that relate to the tax matters under consideration. Identify all of the issues that are supported by the facts (tax, accounting, finance, ethical, governance, sustainability, business, personal, etc.). Identify compliance (completed transactions) vs. planning (proposed transactions) issues. Be able to explain why these issues are relevant to your client. Use judgement to prioritize and group the issues in terms of importance to your role and importance to the client’s objectives and requests. Considerations include urgency, materiality and risk.

Analyze the Issues Now that you have gathered all the information, the next step is to analyze the transactions or events to determine the tax consequences. 1. Identify and perform the qualitative analysis of the transactions and plans, including an analysis of the applicable provisions of the Act For each important issue or grouping of related issues, identify the provisions of the Act that might apply and determine whether the conditions of each provision are met. Clearly communicate the application of the provision to the relevant issue and its actual or potential implications. Any quantitative analysis should be referred to and its relevance explained as part of the qualitative analysis of each issue. 2. Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format Quantitative analysis should be performed if it is necessary and relevant to the overall analysis of an issue or related group of issues considering the decision-maker’s objectives. Analysis of an issue should always include qualitative analysis. Not all issues will require quantitative analysis and you must use judgement based on the taxpayer’s needs and the sufficiency of the numerical information provided to decide whether quantitative analysis is relevant. Transactions usually involve more than one party. They may be individuals or corporations or partnerships or trusts. The transaction may, for example, be that of vendor/purchaser, donor/recipient or estate/beneficiary.

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Transactions generally have an impact on income or cash flow. It may be important to quantify the income effect on each of the parties involved either now or in the future. It is often important to quantify the impact on the after-tax cash of the parties involved. The time value of money may be important to consider as part of the quantitative analysis where calculations involve future years and comparisons in today’s dollars would be useful. When doing this analysis, judgement is required to determine the format that is appropriate for to the issue you are analyzing, and to ensure it is efficient and understandable to the user. Quantitative analysis should be referenced so that it is easy for the person reviewing the calculation to understand the relevance of the numbers and how they were derived. 3. Identify assumptions and missing information Assumptions, missing or questionable information, and uncertain tax positions all pose risks to the conclusion you reach. Be sure to identify any potential risks, missing information, and information that needs to be verified. Be certain to clearly state assumptions you have made as part of your analysis. Ensure that the assumptions were necessary and are logical. 4. Reach a conclusion on each issue For each issue identified, you need to communicate the results of your qualitative and quantitative analysis in the form of a conclusion. Conclusions explain a result. They differ from a recommendation which involves a future action or plan or next steps. Sometimes a conclusion can be reached on an issue independently from conclusions reached on other issues. Other times, issues are interrelated and you must analyze issues in a logical order to be able to effectively conclude on another issue. It is necessary to consider the objectives and priorities of the taxpayer to determine which issue/conclusion takes priority. It may be necessary to perform additional analysis with respect to an issue because of the impact of a conclusion on a related issue.

Advise/Recommend 1. Advise the decision maker, integrating your conclusions on each of the issues with their objectives, giving priority to the most important issues Your conclusions for each of the issues or groupings of issues you have analyzed should be considered when making recommendations to the client. Advising the client provides the opportunity to integrate all of your knowledge, analysis, and conclusions to provide useful practical recommendations that can be implemented by the client to meet their stated and unstated objectives. This part of your analysis, pulls in everything to advise the client in a manner that will meet the client’s objectives. There are also times when a client’s objectives cannot be met without negative tax consequences. This doesn’t mean they should not be met; it just means that the client needs to assess the costs vs. the benefits. This part of your case or problem analysis is where you can demonstrate your professional advisory capabilities. The advice and recommendations reflect all of the analysis that has been performed and is value-added. As a professional advisor, your advice and recommendations consider everything you know about the taxpayer’s objectives, tax, and risk profile and are value-added. 2. Evaluate the strengths/weaknesses/risks of your conclusions and recommendations Any risks to the advice you are providing should be considered and communicated as part of the advisory service you are providing, including important assumptions. 3. Identify additional information requirements/outline next steps It is important to identify any information concerning a transaction or event that you think is missing that needs to be obtained from the client. Clearly identify this information. Often, further work will need to be performed and these next steps can be highlighted in this summary.

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Exhibit Summary of Problem-Solving Process for Tax Assess the Situation:

Draw a diagram identifying all stakeholders. a. Corporate organization chart.

Identify the important relationships among the stakeholders. a. Related, affiliated, associated, connected.

Identify the profile of each stakeholder. a. Individuals, corporations, partnerships, trusts, etc. b. Business context, income types, tax rates, risk profile.

c. Relevant tax balances (e.g., CGE, RRSP/TFSA room, CDA, GRIP, RDTOH balances). Fully understand the decision maker and their objectives. a. What objectives have they specifically mentioned and what is the purpose behind these objectives? b. What have they specifically asked you to do?

Identify the Issues:

Identify the relevant past transactions/events or planned future transactions/events and create a timeline.

Identify all of the major tax issues and any non-tax issues. a. Stated issues (specific requests). b. Unstated issues (important objectives of the client).

Prioritize and group related issues. a. Alternatives requiring analysis identified.

Plan your analysis. a. Determine type of analysis relevant for each group of issues.

Analyze the Issues:

1. 2. 3. 4.

Advise/Recommend:

1. 2. 3.

Identify and perform the qualitative analysis of the transactions and plans, including an analysis of the applicable provisions of the Act. Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate analysis format. Reach a conclusion on each issue. Identify assumptions, risks and missing or questionable information. Advise the decision maker, integrating your conclusions on each of the issues with their objectives, giving priority to the most important issues. Evaluate the strengths/weaknesses/risks of your conclusions and recommendations. Outline next steps.

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Chapter 1 Introduction

Introduction to Federal Income Taxation in Canada

CHAPTER 1 — LEARNING CHART Problem Descriptions Exercises 1 2 3

Identif y sections of the Act Determine income, taxable income and basic federal tax Identif y components of subsection 212(1)

Assignment Problems 1 Identif y sections of the Act 2 Determine income using ordering rules 3 Identif y and define words/terms found in section 2

Ch. 1/Study Guide — Learning Chart

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EXERCISES

Exercise 1 For each of the following items, identify the appropriate provision of the Act which deals with the item listed. Be as specific as possible in citing the reference to the Act, i.e., Part, Division, Subdivision, Section, Subsection, etc. Use of the Sectional List at the beginning of the Wolters Kluwer edition of the Canadian Income Tax Act with Regulations and/or the Topical Index at the end of the book may be helpful.

ITA: 8, 15, 20, 38, 69, 81, 108, 150

(A) Definition of ‘‘taxable capital gain’’. (B) Deduction for certain annual professional membership dues paid by an employee. (C) Taxability of payments received as income from property acquired as personal injury award. (D) Deductibility of an expense based on its magnitude. (E) Definition of a ‘‘parent’’ under the Act. (F) Definition of an ‘‘inter vivos’’ trust. (G) Deadline for filing of a tax return for a deceased person. (H) Taxability of a benefit received from a corporation by a shareholder. (I) Transaction price in a non-arm’s length disposition of property. (J) Deductibility of fees for investment advice.

Exercise 2

ITA: Divisions B and C

Mr. Malcolm Miller has provided you with a list of various sources of income, losses, deductions, and credits for the purpose of determining his basic federal tax. Income (net): Business income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $10,000 Property income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000 Retiring allowance from a former employer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000 Employment income from new employer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80,000 Taxable capital gains (net of allowable capital losses) . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000 Deduction and Losses: Rental property loss ....................................................................................................................... 4,000 Carry forward Losses and Tax Credits: Canada Pension Plan contributions tax credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Canada Pension Plan contributions enhanced deduction . . . . . . . . . . . . . . . . . . . . . . . . Non-capital losses from a previous year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tuition tax credits transfer from son . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net capital losses from a previous year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Basic personal and spousal tax credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Employment Insurance premiums tax credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tuition tax credit for night course on computer applications . . . . . . . . . . . . . . . . . . . . Charitable gifts tax credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Canada employment tax credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

469 631 4,000 80 5,000 4,500 150 68 550 205

— REQUIRED (A) Determine the income, taxable income and basic federal tax based on the above correct information using the ordering rules in sections 3, 111.1, and 118.92. Assume that federal tax before credits is $22,232 in the year. (B) Cross-reference each amount to the appropriate section of the Act.

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Ch. 1/Study Guide — Exercises

Exercise 3

5 ITA: 212(1)

Identify the following components of subsection 212(1): (A) the person who is the subject of the provision,

CHAPTER 1

(B) the activity, event, or condition that must be met for the provision to apply, (C) the consequences of the activity or event to the person who is the subject of the provision, and (D) the time frame for the application of the provision.

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ASSIGNMENT PROBLEMS

Problem 1 Identify the provision of the Act which deals with each of the following items. Be as specific as possible in citing the reference to the Act (Part, Division, Subdivision, Section, Subsection, etc.). Use of the sectional list at the beginning of the Wolters Kluwer edition of the Act and/or the topical index at the end of the book may be helpful. (A) Definition of a ‘‘person’’. (B) Tax credit for donation made by a Canadian resident individual to a Canadian university. (C) Definition of ‘‘balance-due day’’. (D) Taxability of group term life insurance premiums paid by an employer on behalf of an employee. (E) Definition of ‘‘capital dividend’’. (F) Computation of income tax instalments for individuals. (G) Definition of a ‘‘qualified small business corporation share’’. (H) Prescribed requirement to file an information return for a corporation paying a dividend. (I) Definition of a ‘‘testamentary trust’’. (J) The calculation of a benefit associated with an interest-free loan from an employer to an employee. (K) Definition of a ‘‘disposition’’ of non-depreciable capital property. (L) Limitation on deduction of RRSP administration fees. (M) General limitation on the amount of deductible expenses. (N) Deduction from taxable income for taxable dividends that were received by a Canadian corporation. (O) Tax payable on excess contributions to an RRSP.

Problem 2 Ms. Irene Vanburg had a tumultuous year. She broke her engagement early in the year and quit her job. She moved to a resort area to take a waitress job and to start up a fitness instruction business. She has had the following items correctly calculated and classified as either inclusions, deductions or tax credits for the purposes of determining her taxable income and federal tax. Income (net): Employment Insurance benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Employment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Property income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rental property income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable capital gain (net of allowable capital losses) . . . . . . . . . . . . . . . . . . . . . . . . . Retiring allowance from previous employer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

600 78,400 775 975 100 800

Deductions and Losses: Business loss .................................................................................................................................. (400) Deductions, Losses, and Tax Credits: Charitable gifts tax credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Child care expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Canada Pension Plan contributions tax credits on employment earnings . . . . . . . . . . . . Canada Pension Plan enhanced deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Medical expenses tax credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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26 1,800 469 631 9

ITA: 245; Divisions B and C

Ch. 1/Study Guide — Assignment Problems 1,700 600 2,250 150 205

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Moving expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-capital losses from previous year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Personal tax credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Employment Insurance premiums tax credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Canada employment credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Irene has asked you to determine the income, taxable income, and basic federal tax based on the above correct information using the ordering rules in sections 3, 111.1, and 118.92. Assume federal tax before credits is $12,752 in the year. For your files you should cross-reference each amount to the appropriate section of the Act.

Problem 3

ITA: 2

Many words and terms used in the Act have very specific interpretations. Awareness of these interpretations is fundamental to understanding the scheme and application of the Act. These interpretations come from various sources. The primary source is statutory definition; that is, the term is explicitly defined in the Act. Common law principles also determine interpretations for terms. Many court cases have centred on the interpretation of specific words or phrases which were not explicitly defined in the statute. Once such terms are interpreted by the Courts, that interpretation becomes standard for that term. If a term is neither defined in the statute, nor the subject of a common law definition, the word or term must be assigned the meaning provided by everyday language. The definition is often that which can be found in a common dictionary. Division A of Part I of the Act outlines who is liable for tax. This Division is a fundamental building block for the Act as it defines to whom the Act will apply. Therefore, it is essential that the terms used in this Division are clearly understood. You have been asked to identify and define those words and terms found in section 2 of the Act, in the order of their use, which you believe require definition. Indicate the references in the Act to the source of the definition for those words or terms which you have so identified. You have also been asked to identify the following components of subsection 2(3): (i) the person who is the subject of the provision, (ii) the activity, event, or condition that must be met for the provision to apply, (iii) the consequences of the activity or event to the person who is the subject of the provision, and (iv) the time frame for the application of the provision.

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CHAPTER 1 — SOLUTIONS TO EXERCISES Exercise 1 The following summary is discussed in more detail below: Case Topic (A) (B) (C) (D) (E) (F) (G) (H) (I) (J)

Part Division Subdivision

Taxable capital gain . . . . . . I Membership dues . . . . . . . . I Personal injury award . . . . . I EXpense limit . . . . . . . . . . . I Parent . . . . . . . . . . . . . . . . . XVII Inter vivos trust . . . . . . . . . I Filing deadline . . . . . . . . . . I Shareholder benefit . . . . . . . I Non-arm’s length . . . . . . . . . I Investment fees . . . . . . . . . . I

B B B B — B I B B B

c a g f — k — b f b

Provision paragraph 38(a) subparagraph 8(1)(i )(i) paragraph 81(1)(g.1) section 67 subsection 252(2) subsection 108(1) paragraph 150(1)(b) subsection 15(1) paragraph 69(1)(b) paragraph 20(1)(bb)

(A) Part I, Division B, Subdivision c, paragraph 38(a): — Most definitions applicable to the Taxable Capital Gains and Allowable Capital Losses subdivision of Part I, Division B are found in section 54. However, this definition is set out at the beginning of Subdivision c. Definitions of terms used throughout the Act are found in subsection 248(1). If a term is not specifically defined in subsection 248(1) or in a section elsewhere in the Act, judicial precedents should be consulted for the meaning of the word. (B) Part I, Division B, Subdivision a, subparagraph 8(1)(i )(i): — Employment income and deductions are set out in sections 5 to 8 of Part I, Division B, Subdivision a of the Act. All deductions from this source appear in section 8 with the major list of deductions occurring in subsection 8(1) and further explanation or restriction of these deductions appearing in subsections 8(2) to 8(11). (C) Part I, Division B, Subdivision g, paragraph 81(1)(g.1): — Income from property acquired as personal injury award is one in a limited list of items found in section 81 which are not included in computing income. (D) Part I, Division B, Subdivision f, section 67: — Inclusions and deductions in the computation of income are generally found in Part I, Division B, Subdivisions a, b, c, d or e. In this case, however, the rule is found in Subdivision f dealing with general rules relating to the computation of income from all sources. (E) Part XVII, subsection 252(2): — The word ‘‘parent’’ appears throughout the Act, so the definition is most likely to be in Part XVII on ‘‘Interpretation.’’ (F) Part I, Division B, Subdivision k, subsection 108(1): — Trusts and their beneficiaries are dealt with in Subdivision k of Part I, Division B. The definitions section for this subdivision is section 108. (G) Part I, Division I, paragraph 150(1)(b): This is a procedural matter generally handled in Division I of Part I of the Act dealing with Returns, Assessments, Payment and Appeals. (H) Part I, Division B, Subdivision b, subsection 15(1): — A benefit received by a shareholder, if it is to be taxed, would likely be income from property which is handled in Subdivision b of Division B of Part I. Inclusions from that source are generally listed in sections 12 to 17. (I) Part I, Division B, Subdivision f, paragraph 69(1)(b): — This provision can be found in the set of general rules pertaining to the computation of income in Subdivision f of Division B of Part I because it affects the computation of income from a variety of sources. (J) Part I, Division B, Subdivision b, paragraph 20(1)(bb): — Investments provide income from property and deductions from such income are generally listed in subsection 20(1).

Ch. 1/Study Guide — Solutions to Exercises

Exercise 2 Employment income . . . . . . . . . . . . . . . . . . . . . . . .

$ 80,000

Business income . . . . . . . . . . . . . . . . . . $ 10,000 Property income ......................................... 3,000

13,000

Retiring allowance . . . . . . . . . . . . . . . . . . . . . . . . . . Total par. 3(a) income . . . . . . . . . . . . . . . . . . . . . .

20,000 $ 93,000

Taxable capital gain (net of allowable capital loss)

Par. 3(d ) Subdivision b Ssec. 9(2):

20,000 $113,000

Rental property loss . . . . . . . . . . . . . . . . . . . . . . . .

(4,000)

Par. 3(e)

CPP Enhanced Deduction . . . . . . . . . . . . . . . . . . . .

(631)

Par. 3(b) Subdivision c Sec. 38

Division B income ..............................................................................................................$128,369 DIVISION C Par. 111(1)(a) Non-capital loss . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,000 Par. 111(1)(b) Net capital loss . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000 (9,000) Taxable income ...................................................................................................$119,369 Federal tax after credits: Tax before credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Ssec. 118(1) Ssec. 118(10) Sec. 118.7 Sec. 118.7 Sec. 118.5 Sec. 118.6 Sec. 118.1

Personal credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Canada employment credit . . . . . . . . . . . . . . . . . . . . . CPP contributions credit . . . . . . . . . . . . . . . . . . . . . . EI premium credit . . . . . . . . . . . . . . . . . . . . . . . . . . . Tuition credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tuition credit transfer . . . . . . . . . . . . . . . . . . . . . . . . Charitable donation credit . . . . . . . . . . . . . . . . . . . . .

Basic federal tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 22,232 (4,500) (205) (469) (150) (68) (80) (550) $ 16,210

Exercise 3 Subsection 212(1) is a ‘‘charging provision’’ because it charges someone with the responsibility for paying a tax. The components of subsection 212(1) are as follows. (A) the person who is the subject of the provision ●

‘‘every non-resident person’’

(B) the activity, event or condition that must be met for the provision to apply ●

‘‘on every amount that a person resident in Canada pays or credits or is deemed by Part I to pay or credit to the non-resident person as ..... ’’ [followed by paragraphs (a) to (w) that list types of payments, such as a management fee, interest, rent, etc.]

‘‘shall pay an income tax at 25% on every amount .....’’

●

note the use of the word ‘‘shall’’, indicating a mandatory payment

●

note that the 25% rate can be reduced by a tax treaty which overrides the Canadian Income Tax Act

(D) the time frame for the application of the provision ●

in the year that the amount is paid or credited is implied

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DIVISION B Par. 3(a) Subdivision a Sec. 5, 6, 7, 8 Subdivision b Sec. 9 Sec. 9 Subdivision d Par. 56(1)(a)

Chapter 2 Liability for Tax

CHAPTER 2

Introduction to Federal Income Taxation in Canada

CHAPTER 2 — LEARNING CHART Problem Descriptions Textbook Example Problems 2-1 Resident vs. non-resident — individual 22 Resident vs. non-resident — corporation Exercises 1 2 3 4 5 6 7

Individual residency — multi-part Individual residency — case Corporate residency — multi-part Canadian income of non-resident Individual residency Corporate residency Ceasing residency

Assignment Problems 1 Individual residency — multi-part 2 Individual residency — case 3 Individual residency — case 4 Individual residency — case 5 Corporate residency — multi-part 6 Corporate residency — case 7 Corporate residency — case 8 Corporate residency — case 9 Transfer to France 10 Move to Chile 11 Individual residency 12 Taxation of Indigenous Canadians

Ch. 2/Study Guide — Learning Chart

CHAPTER 2

Introduction to Federal Income Taxation in Canada

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REVIEW QUESTIONS

(1) Canadian citizens pay tax in Canada on their world income. Comment. (2) If a non-resident vacations in Canada for 180 days during the year, then he or she will be considered a Canadian resident for the full year. Comment. (3) If an individual sells his or her house and then leaves the country, the person will be considered to be a non-resident. Comment. (4) Assume that an individual resided in Buffalo and carried on a proprietorship (self-employed) business in St. Catharines. How would he or she pay tax on the business income earned in Canada? (5) An individual who moves to Canada on March 31 of the year will be considered resident in Canada throughout the year since he or she was resident here for more than 183 days. Comment. (6) Since a corporation is an artificial legal entity, it does not ‘‘reside’’ anywhere in the sense that an individual does. Comment on how the residency of a corporation is determined. (7) A company was incorporated in Canada on November 30, 1965, but has been carrying on business in Bermuda since that date and all of the officers and directors have always been resident there. Comment on the company’s tax liability in Canada. (8) A company was incorporated in Canada on November 30, 1964, but has been carrying on business in Bermuda since that date and all of the officers and directors have always been resident there. In the years from incorporation to 1971 the company actively solicited orders in Canada by telephone. It stopped this activity in Canada at the end of 1971. Comment on the company’s tax liability to Canada. (9) A Canadian executive is transferred to the U.S. with his company on a five-year contract. He and his family sell all their Canadian assets and move to the U.S. in December of the year. Due to the lower personal income tax rates in the U.S., he has the Canadian company defer the payment of the bonus of $100,000 that he earned in Canada in the year until the next year when he is resident in the U.S. Comment on whether the executive will be taxed in Canada on this bonus. (10) If a U.S. corporation has an employee located in Canada who is selling goods on behalf of the employer, then would the U.S. company be taxable in Canada? (11) If a U.S. corporation has an agent located in Canada who is selling goods on behalf of the U.S. company, then would the U.S. company be taxable in Canada? (12) If a person is resident in Canada, can that same person also be resident in the U.S.? (13) If a Canadian corporation is carrying on business in the U.S. through a permanent establishment in the U.S., will the Canadian company be considered resident in the U.S. and be subject to tax in the U.S. on the total corporate income? (14) Mr. Smith is an independent consultant who provides his services wherever he can get the work. He has been asked by a U.S. company to go to the U.S. to consult with them. He thinks that he will have to spend 25 days travelling to their many locations in the U.S. over the next year and that he will earn $50,000 for his efforts. His lawyer has told him that he will be taxed in the U.S. on this business income. What do you think?

¶2,800

Ch. 2/Study Guide — Exercises

¶2,825

EXERCISES

Exercise 1

ITA: 2, 114, 115, 250(1)

Determine the form of residence, if any, for each of the following individuals. (A) Alpha had lived all of his life in Vancouver until this year when he left with his family on August 27 to live in Los Angeles. (B) Beta is a Canadian citizen who has lived in the United States with his family for the past nine years. (C) Gamma lives in Niagara Falls, New York, but works Monday to Friday from 9:00 a.m. to 5:00 p.m. in an office in Niagara Falls, Ontario. (D) Delta had lived all of his life in Dallas, Texas. He moved with his family to Calgary, Alberta, early this year to take a job with Dome Petroleum. He moved back to Dallas in the summer of this year. While in Canada he invested in the shares of a private corporation operating in Calgary. These shares were later sold during the year after he left Calgary. (E) Epsilon was born in Philadelphia. He is now 10 years old and has never been to Canada but his mother has been consul in the Canadian Consulate there for the past 12 years.

Exercise 2 The following is a summary of the statement of fact of the situation. ●

Mr. O. MacDonald was about 58 years old in the year under assessment.

●

He was at all material times an American citizen.

●

ITA: 2, 114, 250; Income Tax Folio S5-F1-C1

He is a sea captain and sails tankers around the world. His employer is the Cities Services Corporation of New York and the ships bear United States registry. He is paid in United States currency from New York for the last 12 years he has been Master of the ‘‘S.S. Cities Services, Norfolk’’. Prior to siX years ago, Mr. MacDonald and his wife had always lived in the United States. Until then, they owned a house in Massachusetts. In June, si X years ago, they moved, with their furniture, to Fredericton, NB. Mrs. MacDonald rented a house in her name to live nearer their two youngest sons, who were attending a boarding school in Saint John, N.B. Their two oldest children were married and another was attending the Springfield (Mass.) College. Upon moving, they sold their nine-room house in the United States. About 15 months after their move to Fredericton, Mr. and Mrs. MacDonald purchased a house in Fredericton which was registered in joint tenancy in both their names. On the advice of an American lawyer, Mr. and Mrs. MacDonald tried to purchase a house in Canada within the year in order to avoid the American capital gains tax; unfortunately, they jointly bought this house two months too late and had to pay the tax. Prior to the purchase of the house Mr. and Mrs. MacDonald lived in the rented premises in Fredericton. Mr. MacDonald filed a T1 Income Tax Return for the taxation year immediately prior to the year under assessment on which he stated, ‘‘the above taxpayer and his family are American citizens and are merely residents of Canada. He is a U.S. ship captain and is employed full-time by a U.S. company’’. Mr. MacDonald paid a small amount of Canadian income tax for that previous taxation year after using his foreign tax credit. The routine into which Mr. and Mrs. MacDonald have settled over the past years is as follows: The appellant receives his orders to sail from New York. He may be gone months at a time. He may dock at U.S. ports such as Galveston, Texas, or San Francisco. After Mrs. MacDonald moved to Fredericton, Mr. MacDonald retained two rooms in his sister’s house in Stoneham, Mass., U.S. He gave his sister’s number as his telephone number in the United States.

¶2,825

CHAPTER 2

(F) Mu is a German citizen who is married to a member of the Canadian forces stationed in Germany. She has been to Canada only for brief visits when her husband was on leave.

Introduction to Federal Income Taxation in Canada

●

At all material times, the appellant: — worked for a U.S. company; — was paid in U.S. currency; — was a member of the First Baptist Church at Wakefield, Mass.; — had two children living in the United States; — had a bank account or accounts in the United States; — had investments, including stocks and bonds, in the United States; — had a pension plan with a U.S. company; — intended and still intends to retire in Florida; — banked his pay at the First National Bank in Malden, Mass. and enough to maintain his wife and children was sent to her. The rest stayed in the United States where he still retains a chequing account in Malden.

●

The appellant, during 1964: — had a joint bank account in Fredericton with his wife; — had a family phone number in his wife’s name; — neither applied for nor received family allowance for his children; — neither was employed nor carried on business in Canada; — never belonged to a church or club in Fredericton; — was never a member of a Canadian union; — had no Canadian investments; — owned a car jointly with his wife with a New Brunswick registry.

●

The appellant’s sole connections with Canada during 1964 were: — his wife lived in Fredericton with one son; — he visited Fredericton for a total of 166 days at the following times in the year: January 3 to February 22 ............................................................ 51 days June 1 to August 7 ...................................................................68 days November 14 to December 31 ..................................................47 days 166 days

●

In about a year and a half after the year under assessment the house in Fredericton was sold and Mr. and Mrs. MacDonald moved back to the United States. As already mentioned, during the year under assessment, her husband lived 166 days in Fredericton and spent the rest of the time at sea. While away, his pay cheques were sent directly from the New York office to a bank in Malden, Mass., and his wife received monthly cheques for living expenditures in Canada. During his vacation, his pay cheques were deposited in a joint bank account in Fredericton. His trips usually lasted three to four months, and siX months when bound for foreign ports. When he was unable to come home, his wife would visit him in New York or at his sister’s home in Massachusetts. Mr. MacDonald contended that, in the year under assessment, he resided with his sister and could be reached there at any time, but did not enjoy the exclusive right to the use of rooms and furniture; during that period, his wife stayed there with him for three or four weeks.

— REQUIRED Prepare an analysis of the residence issue. Evaluate in detail the alternatives in the residence issue as they relate to this fact situation for the year under assessment. Discuss each possible degree of residence and its tax consequences. Weigh the relevance of the facts you consider and come to a conclusion on the case.

¶2,825

Ch. 2/Study Guide — Exercises

Exercise 3

17 ITA: 2, 250(4)

Determine the form of residence, if any, for each of the following corporations. (A) Inch Incorporated was incorporated in 1983 in North Dakota. However, its directors are all residents of Saskatchewan where all meetings of the board of directors have been held since incorporation. (B) Foot Limited was incorporated in Manitoba in 1972. However, it is managed in Japan where all directors’ and shareholders’ meetings have been held since incorporation. (C) Yard Incorporated was incorporated in Ohio in 1967, but until five years ago all of the directors’ meetings were held in Ontario and the president of the company was a resident of Ontario. However, five years ago the president moved to Ohio and from then on all directors’ meetings have been held there. (D) Mile Limited was incorporated in Nova Scotia in 1964 where all directors’ meetings were held until 1971 when the directors moved to Boston where they met regularly.

Exercise 4

ITA: 2(3)

CHAPTER 2

Samson Industries Inc. is a small American company located in Minneapolis, Minnesota. Samson sells various items by mail-order, mostly advertising trinkets such as pens, telephone diaries, post-it notes, and similar items, to Canadian businesses. Last year was the first year they did this and profits on its Canadian sales amounted to $76,000. The principals of Samson are worried about their liability for Canadian income tax and have come to you for advice. Advise Samson on their Canadian tax liability. Include an explanation of your rationale.

Exercise 5 The taxpayer was a resident of Canada since birth. He departed from Vancouver in December 2020 and travelled to Australia, where he arrived December 22, 2020. He applied for, and was granted, permanent resident status in Australia at that time. He enrolled in the Masters of Law program at the University of Sydney in 2021 and graduated in March 2023. After completing the law program, he returned to Canada on June 30, 2023, arriving in Vancouver on that date. He then travelled to Toronto, where his parents resided, before returning to Halifax which is where he attended undergraduate law school and now practises law. He had his belongings shipped back from Australia to Halifax after his arrival in Halifax. When he left for Australia, he sold nearly all of his belongings to help finance the trip. He did not own any real property in Canada (i.e., real estate), or keep any residence or bank account in Canada while he was away, as he did not then know when or if he was ever going to return. He did not carry on any business in Canada while he was in Australia. In September 2023, he commenced a nine-month articling period with a law firm in Halifax. During that period he considered himself to be looking over prospects in Canada, until June 2024 when he accepted full-time employment in the office of the Crown Attorney in Halifax. In 2023, he was physically present in Canada for 185 days. Evaluate, in detail, the alternatives in the residence issue for 2023 as they relate to this fact situation. Present your answer by discussing each possible degree of residence and its tax consequences, and by stating your conclusions on the case after appropriately weighing the significance of the facts considered.

Exercise 6 The taxpayer company was incorporated in the Bahama Islands in 1967 as a subsidiary of S Ltd., a public Ontario company. Two other subsidiaries of S Ltd. were engaged in the business of casualty and property insurance in Canada and were experiencing difficulty in complying with Canadian and Ontario government regulations requiring insurance companies to limit their premiums to twice their capital and surplus. To solve this problem, the taxpayer company was incorporated to engage in the reinsurance business. Originally the taxpayer company had five Bahamian directors and four Canadian directors. However, by September, 1969, all the Canadian directors had resigned with the exception of one who subsequently became a Bahamian resident. All meetings of the taxpayer were held in the Bahamas where its books, minutes and shareholders’ registry were kept and where all corporate housekeeping activities were carried out. The taxpayer’s income had not previously been earned in Canada, but was new income which came from new business, and legitimate business reasons existed for its incorporation, i.e., the Canadian subsidiaries did not have to increase their capital. The office, the books, the majority of the directors, the solicitor and the auditor of the taxpayer and the bank accounts were in the Bahamas. The Board meetings, the reports to various government departments, the investment of funds, and the deposits in the bank were all carried out in the Bahamas.

¶2,825

Introduction to Federal Income Taxation in Canada

During the year in question, the taxpayer entered into treaties or contracts of reinsurance with the Canadian insurance companies whereby it assumed certain portions of the risks on insurance contracts in consideration of the receipt of certain portions of the premiums. The contracts were in a standard form used by arm’s length companies engaged in the reinsurance business. Evaluate in detail the alternatives in the residence issue. Determine whether the company was resident in Canada during any year after incorporation in 1967 and provide support for your conclusion.

Exercise 7 Your client, Dundas Valley Machinery Ltd. (‘‘Dundas Valley’’), has asked you to advise Mr. Fern Flaming on his income tax position for this year. Mr. Flaming was born in Moosonee 55 years ago, was educated in Sudbury and has lived and worked in Canada all of his life. Until mid-April of this year, he had been executive vice-president of Dundas Valley, earning an annual salary of $80,000 and a bonus based on the profitability of the corporation that amounted to $8,000 to April 15 of this year. Effective April 15 of this year, Mr. Flaming was promoted to president of the corporation’s wholly owned subsidiary in Mexico. He now earns an annual salary of $100,000 and is eligible for a bonus of $30,000 from April 15 of this year. He also receives a living allowance of $3,000 per month and a travel allowance of $1,200 per month. All of these amounts are paid by the Mexican corporation, including moving costs for his family and household effects, which amount to $29,000. No definite term was placed on his contract with the Mexican subsidiary. He is generally regarded as the leading candidate for the office of president of Dundas Valley when the incumbent retires within the next several years. Mr. Flaming left Canada on April 15 of this year to take up his new position in Mexico. At that time his two minor children were still in high school. As a result, his wife and the two minor children stayed in Canada until June 30, when school was over and when the sale of the Dundas house closed. The Flamings did not sell their cottage in Huntsville, but they did enter into a long-term contract with a realtor to have the cottage rented during the ski season and the summer vacation period, except for the first two weeks in August when they intended to vacation there with their family. The Dundas home was and the Huntsville cottage is owned by Mr. Flaming. The Flaming’s two married children, of course, remained in Canada. Mr. Flaming rented an unfurnished house that was smaller than his Dundas house in Mexico. He rented some basic furniture for the short period to July of this year, when his furniture from Dundas was moved. The Flamings left some of the furnishings from their Dundas home, including, some valuable paintings and pieces of sculpture, with their married children for their use. Title to this property was not formally changed, but the Flamings had listed this property in their wills as being transferable to these children on death. Mr. Flaming maintained his portfolio of investments in Canada with the Canadian broker that he had always used. He did this because of his lack of familiarity with other financial markets. He also decided to maintain his accumulated pension with Dundas Valley, rather than transfer them to the Mexican corporation’s pension plan. However, he did join the Mexican company’s plan for services after April 15 of this year. He closed all of his bank accounts, except for one necessary for the running of the Dundas household until June 30 of this year, at which time this account was also closed. He had funds transferred to that remaining account for the use of his wife and children. He terminated his Canadian health and car insurance and his business and social club memberships, effective April 15 of this year. He sold one car on April 10 of this year and the other on June 25 of this year, but he kept his Canadian driver’s licence in force. The Flamings and their minor children spent about two weeks in Canada during the Christmas period visiting with the married children in addition to their two-week vacation in Canada in August. — REQUIRED Summarize, in point form, Mr. Flaming’s tax situation for this year and the Canadian income tax implications.

¶2,825

Ch. 2/Study Guide — Assignment Problems

¶2,850

ASSIGNMENT PROBLEMS

Problem 1 Identify the criteria you will use to determine residency for individuals and the steps you will use to apply them. For each of the following individuals, apply your criteria and determine and explain their residency status for tax purposes. Where there is a change in resident status in a year, explain how the individual will be taxed in that year and the next. (a) Anthony entered Canada on March 1 of this year, and worked as a domestic on a southern Saskatchewan ranch for the remainder of the year. On December 15 of this year, Anthony’s wife moved to Canada with their three children and all of their belongings. They plan to stay permanently in Canada. (b) Lubie is a U.S. citizen who has lived in Detroit her entire life. For the last 10 years she has been a full-time employee in Windsor, so she commutes across the border every day. She has also traded large volumes of shares and bonds in her own stock account at a broker in Windsor.

CHAPTER 2

(c) Ephran, a computer programmer with Xion Corporation in Toronto, accepted a long-term transfer to Silicon Valley, California. He committed to stay for at least five years. On May 1 of this year, he flew to California and began work on the same day. Most of his belongings remained in Toronto until July 30 of this year. His common-law spouse waited until this day, when the house was sold, the bank accounts were closed, and her contract with the Toronto Public School Board was fulfilled. (d) Julia, a citizen of the United States, moved with her parents in August two years ago to Edmonton, Alberta. From September 1 two years ago to April 30 of last year, she attended the University of Alberta after transferring credits from her U.S. university. Her parents moved to Edmonton as a result of a job transfer. On May 1 of last year, she accepted an employment position as a mountain bike guide in Colorado and resided there until August 30 of last year. Then, she returned to Edmonton to complete her commerce degree. On June 1 of this year, Julia began full-time employment with a public accounting firm in Edmonton. (e) Helen Huang has lived in Florida for many years and is a U.S. citizen. All her children also live in Florida. While she enjoys Florida during the winter months, she prefers the relatively cooler weather in Toronto during the other months of the year. As a result, she owns a condo along Queen’s Quay in downtown Toronto. Last year, she travelled back and forth between Florida and Toronto fairly often, and when she checked her calendar she found that she had stayed in Toronto on 205 nights. Her children would sometimes come up for short visits.

Problem 2 The client was born and raised in Canada. After obtaining his MBA in 2007, he began working as a consultant. In July 2021, the corporation of which he was a major shareholder entered into a contract with a Canadian Crown corporation to furnish consulting advice in Nigeria. Services were to commence July 15, 2022 and end January 14, 2024. A daily rate of fees was set, but total billings were not to exceed a specified maximum. The contract also provided for moving, travel and living expenses for the client and his dependants up to a specified maximum.

ITA: 2, 114, 250; Income Tax Folio S5-F1-C1

All fees and expenses were paid to the client’s corporation in Toronto. He continued to be a shareholder, director and officer of the corporation and he remained very interested in its activities. The corporation paid the client and was instructed to deposit these payments in the client’s Canadian bank account which he continued to maintain for this purpose and for the operation of the rental property that he owned. He felt that the Canadian bank account was necessary because of foreign exchange difficulties that he might otherwise encounter. He instructed the corporation not to withhold any income taxes on these payments because he intended to give up his Canadian residence status to establish an international consulting business abroad upon termination of the Nigerian contract. Since the client had little time before leaving for Nigeria, he quickly rented the unit that he had been occupying in a duplex that he owned, on a month-to-month basis. He intended to sell the property when the market would provide him with a reasonable profit. He arranged to have his corporation manage the renting of this property for a fee which he paid to the corporation. He stored his major furnishings and winter clothing in Canada. His smaller household and personal effects were shipped to Nigeria. He sold his car, cancelled his auto insurance and a gasoline company credit card and obtained an international driver’s licence. He retained credit cards such as American

¶2,850

Introduction to Federal Income Taxation in Canada

EXpress, Visa and MasterCard, as well as his RRSP accounts. Under the contract, he was also required to maintain his provincial health insurance coverage. When he left Canada for Nigeria, he was accompanied by his girlfriend, Martha, who had been a part of his life for over a year before their departure. She had obtained leave from her university program of studies for the fall 2022 term. The couple took up residence in a hotel suite that was converted into an apartment at the Holiday Inn in Lagos, Nigeria. No conventional living quarters were available, because of the housing market. During his stay in Nigeria, the client obtained a Nigerian driver’s licence and maintained two bank accounts and two cars. He joined sports, dining and social clubs in Lagos. He was provided with an office by the Nigerian government and he carried business cards which identified him as a consultant with that government. He promoted the consulting business of his Toronto corporation actively in Nigeria in the hope of establishing the business abroad, but he did not generate sufficient business to stay in Nigeria beyond the period of the existing contract. He did not seek to extend his visa or pay any form of tax on his income in Nigeria. Martha returned to Canada for the winter 2023 term, and then returned to Nigeria for the summer of 2023, but returned again to Canada in September 2023 to begin a new program. By December 2023 the client had billed the limit under the contract. He vacated his apartment, sold his cars, packed up his possessions, including some artwork, textiles and other souvenirs that he had acquired, and returned to Canada. Prepare a memo for the tax person in your firm who will advise the client on the income tax consequences of these facts. Evaluate in detail the alternatives in the residence issue as they relate to this fact situation. Discuss each possible degree of residence and its tax consequences. State your conclusions on the case after weighing the significance of the facts considered.

Problem 3 The client is an electronic engineer. He was born in Erith, England, on July 7, 1981. During the relevant times the client held a valid passport for the United Kingdom of Great Britain and Northern Ireland. The passport declares him a British subject with a residence in the United Kingdom with the right of abode therein. The passport was issued on September 26, 2017 for a 10-year period. Prior to the client’s second marriage in 2021, his parents maintained a bedroom for him in Kent, England. In 2021, the client married Cathy, a Canadian citizen residing in Canada who had no income of her own and was wholly dependent on the client. She has always resided continuously in Canada. In June of 2021, a house near Apsley, Ontario, was purchased by Cathy with money supplied by the client. In September of 2021, Cathy borrowed money by way of a mortgage. The client guaranteed the mortgage which has an affidavit attached dated September 13, 2021 where he swore that he was not then a non-resident of Canada. For a purchase of property in Ontario, he would otherwise have had to pay a 20% non-resident land transfer tax. During the three-year period at issue in this case, 2021 to 2023, the client regularly returned to Canada when he was not working. Each time the client entered Canada, his passport was stamped by Immigration Canada with the majority of the entries setting out a date upon which he must leave Canada. The authorized period of stay varied from five days to 45 days. On some of the stamps the word ‘‘visitor’’ was written in by an immigration official. Throughout the three-year period, the client was employed full-time by a non-resident corporation and all work was performed outside Canada on an oil rig at sea. All income was deposited directly into a Canadian bank. During the three-year period (2021 to 2023), the client indicated or claimed that he: (a) never filed a tax return or paid income tax anywhere; (b) was not allowed to work in Canada; (c) was given a fiXed date to leave Canada on entry (i.e., not allowed to stay in Canada); (d) could not join OHIP, pay EI, maintain an RRSP or join a pension plan; (e) was out of the country more than 183 days per year; (f) had no desire to work in Canada; (g) had a residence in Britain in the home of his mother and father; (h) held a mortgage in Britain on his first wife’s house;

¶2,850

ITA: 2, 114, 250; Income Tax Folio S5-F1-C1

Ch. 2/Study Guide — Assignment Problems

(i) could not live a normal life in Canada as he had to leave every 27 days; and (j) had a bank account with the Royal Bank of Canada both in Canada and the Caribbean. In 2021, the client purchased a car in Canada. In 2022, the client: (a) obtained a Canadian driver’s licence; (b) obtained a Canadian visa; and (c) became a landed immigrant in Canada. Prepare a memo for the tax person in your firm who will advise the client on the income tax consequences of these facts. Evaluate in detail the alternatives in the residence issue as they relate to this fact situation for the period in question. Discuss each degree of residence and its tax consequences as it applies to this fact situation. Note that in this case, residence under the common law principle could only result from a ‘‘fresh start’’ at a point in time in the period in question. Therefore, part-year residence would depend on there being a period of non-residence prior to a ‘‘fresh start’’, if any.

Problem 4 The client is a mechanical engineer, born and educated in England. The client was married in England in 1995 and he and his wife, Dawn, had three sons born in 1997, 1999, and 2004. In 2005, the client and his wife and family moved to Canada where he immediately commenced employment with Imperial Oil in Sarnia, Ontario. With Imperial Oil and/or its parent corporation, EXXon Corporation, the client and his family moved to various locations throughout Canada until 2017. In 2017, while residing and working in Edmonton, Alberta, the client was offered the position as deputy manager of the E XXon refinery at Port Dickson in Malaysia. He accepted the position because it presented the opportunity to likely become manager of this same refinery within a three-year period.

ITA: 2, 114, 250; Income Tax Folio S5-F1-C1

At the time of his acceptance of the above position, the client and his wife were experiencing marriage difficulties. As a result of these difficulties, it was mutually agreed that the client would go to Malaysia on his own. His wife and youngest son remained in the family home in Edmonton. His older sons were living on their own by this time. The client and his employer undertook the following steps in preparation for his move from Canada: ●

his employer obtained a work permit for him in Malaysia;

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he sold his car;

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he cancelled his provincial health plan;

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his employer obtained private health insurance for him;

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he closed all of his existing bank accounts at Royal Bank;

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he opened a savings account at the Bank of Nova Scotia because this bank had a branch in Kuala Lumpur, the capital of Malaysia;

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he allowed his membership in the Edmonton Petroleum Club to lapse; and

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he allowed his participation in the Model Guided Plane Association to lapse.

The client moved to Malaysia in the last few days of September 2017. He stayed in a hotel in Malaysia for the first few weeks and then moved into a company-provided home. His employer charged him with a monthly rent of $1,000 for his use of this house. He took the following items with him from Canada to Malaysia: ● ●

all of his clothes and personal effects; and an airplane kit for model guided planes and a radio control transmitter for his hobby of model guided planes.

Once in Malaysia, the client undertook to establish Port Dickson as his home. To this end, he: ●

purchased a car;

¶2,850

CHAPTER 2

State your conclusion on this case after appropriately weighing the significance of the facts considered. Your conclusion should indicate whether the client became a resident at any point in the period or remained a non-resident throughout the period. If you conclude that he became a resident, indicate the point in time when the ‘‘fresh start’’ was made.

Introduction to Federal Income Taxation in Canada

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obtained a Malaysian driver’s licence;

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joined the Port Dickson yacht club which was, in fact, a social/recreational club;

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joined the petroleum club at Kuala Lumpur;

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opened a chequing account at the Bank of Nova Scotia in Kuala Lumpur;

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opened a chequing account at the Standard Chartered Bank at Port Dickson;

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acquired two Malaysian credit cards;

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became a patient at a Port Dickson medical clinic and, as well, made regular visits to a dentist in Port Dickson; and joined the Port Dickson Golf Club in 2018.

In accordance with EXXon corporate policy, the client remained on the payroll and in the pension plan of the Canadian subsidiary. His monthly pay was deposited into his Edmonton bank account. There was no income tax withheld at source on the client’s salary because the Canadian subsidiary knew that he was working full-time outside of Canada. The total cost of his salary and related benefits (including pension) were charged by the Canadian subsidiary to EXXon Corporation International. The client made only two visits to Canada during the period from 2017 through 2020. He visited for 14 days in 2018 and 14 days again in 2019. On each of these visits, he stayed in the family home in Edmonton. During the same period, the client’s spouse made eight visits to him in Malaysia. She made no visits after January 2020, but prior to that time, the length of her visits ranged from 19 days to 32 days. On each of these visits, she stayed with the client in his Malaysian home. The client and his wife remained married throughout the relevant period. The client maintained the following Canadian investments while he was residing in Malaysia: ● ●

his 50% interest in the family home in Edmonton; a 50% investment in a rental property which his wife purchased after his move to Malaysia, because she thought it would be a good investment;

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his RRSP;

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his company savings plan; and

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a few personal shares in Canadian public companies.

He did maintain his memberships in the Canadian Society of Mechanical Engineers and the Association of Professional Engineers and Geologists of Alberta. The client became manager of the Port Dickson plant in 2021 and eventually retired from EXXon in the summer of 2022 under the terms of an early retirement package. Upon retirement from E XXon, the client returned to Edmonton to the family home. In late 2022 the client started seeking employment in Malaysia and in January 2023 he and his wife went to Malaysia hoping that he would find employment and they would both live there. His wife returned to Canada in February 2023 and he moved on to Thailand where he stayed through July 2024 (working for the 12-month period from August 2023 through July 2024). When the Thailand employment ended, the client returned to Canada. He and his wife then worked out a plan of separation. Prepare a memo for the tax person in your firm who will advise the client on the income tax consequences of these facts. Evaluate in detail the alternatives in the residence issue as they relate to this fact situation for the period October 1, 2017 through the summer of 2024. Discuss each possible degree of residence and its tax consequences. State your conclusions on this case after weighing the relevance of the facts you have considered.

Problem 5 For each of the following corporations, determine and explain the type of residency, for tax purposes for this year. (a) ABI, incorporated in Montreal, Quebec, in 1981, carries on a clothing manufacturing business in Hong Kong. All directors’ meetings and staff meetings are held in Hawaii, United States, each year. (b) Nickel Company, incorporated in the Bahamas in 1966, operates a mining business in Northern Ontario. All profits are paid out as dividends directly into a Swiss bank account. All books and

¶2,850

ITA: 2, 250(1)

Ch. 2/Study Guide — Assignment Problems

records are maintained in the president’s office in Ontario. The company directors all live in Toronto and meet monthly for their directors’ meeting. (c) Saffron Ltd. is a 40% subsidiary of a Canadian corporation located in Houston, Texas. The products manufactured by Saffron are sold directly to the Canadian market. No revenues are earned from U.S. sales.

Problem 6

ITA: 2, 250, 253

Far Eastern Airlines is a company incorporated in Korea in 1975. Its general manager and other active officers of the company are resident in Korea and have their offices there. The directors and corporate officers of the company live in Korea as well. During the year in question, its sole business was operating an international airline which had no landing rights in Canada. However, in that year it had raised capital on the Canadian market for its international operations by selling an issue of its stock through an investment dealer in Vancouver. The vice-president–finance of the company, who believed the stock issue would sell better in Canada, travelled from the head office in Korea to Vancouver to instruct the investment dealer.

CHAPTER 2

The stock issue was highly successful and the proceeds of the issue were accumulated in a bank account in Vancouver. During the several months in the year in question when these funds were being accumulated, the company became aware of an opportunity to purchase a vast quantity of aviation fuel at a very low price. A purchasing agent was dispatched from the head office in Korea to Canada to complete the purchase using some of the funds accumulated from the stock issue. The fuel was stored in Canada temporarily in rented facilities pending shipment to San Francisco, where it could be used by aircraft landing there. Subsequently, the company was unable to make suitable arrangements for shipment. The fuel was sold to a Canadian buyer at a considerable profit. All contracts involved in the purchase and sale transactions were drawn up by a Canadian lawyer under the direction of the purchasing agent who operated from a hotel room in Vancouver during the period of the transactions. Prepare a memo for the tax person in your firm who will advise Far Eastern Airlines on the income tax consequences of these facts. Evaluate in detail the alternatives in the residence issue as they relate to this fact situation. Discuss each possible degree of residence and its tax consequences. State your conclusions on the case after considering the relevant international tax agreement and after appropriately weighing the significance of the facts considered.

Problem 7

ITA: 2, 250, 253

Wong Computer Games Inc. (WCG) was incorporated in the state of Illinois in the last decade. The founding shareholder, Mr. Andrew Wong, is an inventor of computer simulation models. His products include a wide variety of computer games as well as some programs which have industrial applications. Mr. Wong is the controlling shareholder of WCG. His brother owns a minority interest, as does Walter Bends, a long-time associate of Mr. Wong, who often collaborates in the development of new products. All three shareholders are resident in Chicago. In addition to Mr. Wong, the WCG Board of Directors includes George Wolf, who represents the Chicago law firm, which advises WCG, and Tony Aster who represents First National Bank of Chicago, which provides most of the financing for WCG’s operations. The Board meets approXimately every siX months to review financial results, discuss product development and decide on strategic initiatives. The meetings are usually held in the boardroom of George Wolf’s law firm. Two years ago, Mr. Wong achieved an industry breakthrough when he developed his latest game, SuperPilot. SuperPilot is a computer game in which the operator attempts to safely land a disabled airliner. SuperPilot provided special effects which were far beyond those available in any other commercially available product. Although other WCG products were only available in the U.S. market, Wong was convinced that SuperPilot would be a global success. To ensure the competitive advantage would be maintained, Wong Computer Games Inc. took the required legal steps to ensure copyright and patent protection of the program in a variety of countries, including Canada. By last year, SuperPilot was doing very well in the U.S. market and WCG began to launch the product in other markets. Walter Bends was assigned responsibility for the Canadian market and took a short-term lease on a Toronto apartment in March of last year. WCG established a bank account with a Toronto branch of a Canadian bank. This account was to be used by Bends for promotional expenses and other incidentals. All other expenses, including Bends’ salary, continued to be paid from Chicago. Bends attended a number of Canadian trade shows, exhibiting the SuperPilot program. Prospective purchasers were provided with SuperPilot game cartridges as a promotional item. Bends was given the authority to sign supply contracts which would permit the purchaser a one-month supply of cartridges. At the end of the one month, if the distributor was still interested, a longer-term supply contract would

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Introduction to Federal Income Taxation in Canada

be required. Bends was not permitted, however, to sign any of these long-term agreements without receiving prior approval from the WCG Board. All game cartridges, including promotional cartridges, were supplied from Chicago. If the product began to sell well in Canada, the WCG Board had discussed establishing a Canadian warehouse. By January of this year, it became obvious that SuperPilot was not going to be a Canadian success. No distributors had requested a long-term supply contract and only one, Pete’s Gaming Emporium, had agreed to stock the product for one month. At the end of the month, sales had been so slow that Pete’s was not interested in continuing the relationship. Bends returned to Chicago, the bank account was closed, and WCG refocused its marketing efforts on the U.S. market. Prepare a memo for the tax person in your firm who will advise WCG on the income tax consequences of these facts. Evaluate in detail the alternatives in the residence issue as they relate to this fact situation during last year and this year. Discuss each possible degree of residence and its tax consequences. State your conclusions on the case after appropriately weighing the significance of the facts considered.

Problem 8 Capitol Life Insurance Company (‘‘Capitol’’) was incorporated in the U.S. in the state of Colorado at the turn of the century. Its head office had always been in Denver, Colorado. Capitol was a subsidiary of Providence Capitol Corporation which in turn was a subsidiary of Gulf & Western Industries Inc. (‘‘Gulf’’). Gulf owned approXimately 600 subsidiaries, 240 of which were in turn owned by Associates Corporation of North America (‘‘Associates’’). Si X of these latter corporations were Canadian companies. Capitol was in the business of writing individual and group life and health insurance policies. Capitol also wrote creditor’s group life and health insurance policies for the 240 finance companies which were part of the Gulf group of companies. Under a creditor’s group insurance policy, Capitol would pay to the finance company, upon the death or disability of the borrower, the outstanding amount of the loan in the case of death or the required instalment payments in the case of disability. The costs of the insurance were effectively passed on to the borrower, either as a separate charge or as a higher interest rate. About 25 years ago, Capitol planned to expand into Canada and obtained licences in nearly every province and obtained federal registration under the Foreign Insurance Companies Act (‘‘FICA’’). The FICA registration required that Capitol name a chief agent in Canada and that he be given a power of attorney. Capitol was also required to make deposits with the insurance superintendent and maintain assets in Canada. Two bank accounts were opened in Canada. The planned expansion into Canada was cancelled. However, the licences and registration were maintained. This required that Canadian representatives and agents be retained as locations for the licensing authorities to serve legal notices. All reports to the licensing authorities and all inquiries of the licensing authorities were to be passed through the Canadian chief agent. The reports to the licensing authorities were prepared in Denver and all inquiries were passed on to Denver by the chief agent. The chief agent was required to maintain copies of records required by the superintendent of insurance. None of Capitol’s representatives or agents ever solicited insurance or were expected or authorized to do any business. The chief agent countersigned the cheques on Capitol’s general bank account on the requirement of the insurance superintendent. He had no means to verify the legitimacy of the cheques; as all books and records were maintained in Denver where the cheques were prepared. The agent later deposited the premiums received in an effort to streamline the former procedure of having the premiums sent to Denver and then sent back to Canada through the bank for deposit into the Canadian general account to meet licensing requirements. All investments were administered and managed in Denver. Capitol did not have anyone in Canada who solicited insurance business, collected premiums, processed or paid claims, administered investments or countersigned any claim cheques. Capitol had five group insurance contracts under which the lives of Canadian residents were insured. These policies were all issued to affiliated companies without solicitation in Canada. Two of these policies were creditor’s group insurance policies with Associates. They were each drafted in accordance with Denver law and signed in Denver by the president of Associates, who was a resident of Indiana. Associates was shown as the insured company and paid all premiums. On the insistence of the Canadian insurance authorities, the wording of the agreements was amended to reflect ‘‘a premium collection fee’’. The original agreement provided for a retroactive adjustment of premiums based upon past claim experience. Capitol and Associates continued to administer, interpret and apply the agreement in the same manner as the original agreement. Blank insurance certificates were also required to be issued so that they could be provided to borrowers whose loans were insured as a way of informing them of the terms of the coverage. The coverage took place independently of the issuance of a certificate to an individual.

¶2,850

ITA: 2, 250, 253

Ch. 2/Study Guide — Assignment Problems

These certificates listed the Canadian head office of Capitol as being in Don Mills, Ontario, as required by the federal insurance superintendent. This office was never used as a head office. The federal insurance superintendent also required the issuance of a brochure for the information of the Canadian borrowers whose lives and health were insured. The income that Capitol received from the Canadian insurance and investments represented a very small proportion of its total revenue. Canadian operations were not kept separately from U.S. operations, no Denver personnel were charged with Canadian operations, and there were no special Canadian claim forms or procedures. The only separation of Canadian business from U.S. operations to be found in the accounts of Capitol was to comply with the Canadian insurance authorities. All corporate meetings as well as all levels of management took place in the U.S. Prepare a memo for the tax person in your firm who will advise Capitol on the income tax consequences of these facts. Evaluate in detail the alternatives in the residence issue as they relate to this fact situation. Discuss each possible degree of residence and its tax consequences. State your conclusions on this case after weighing the relevance of the facts you have considered.

Problem 9

CHAPTER 2

Sally has just come to you for advice on a possible job transfer to Paris, France. She is currently working for a large private corporation located in St. Catharines, Ontario. It is now April and the president of the company has asked Sally, who is the company’s computer network expert, to move to Paris for at least two years. Her time there may extend beyond two years, but that will depend on the success of the project she will be working on. Sally is married to Harry and they have two daughters, ages siX and eight. The company wants Sally to be in Paris and working by May 15, so she will have to leave by May 10 to get there and settled in time. She is planning to rent a furnished apartment when she arrives. Her children are in school and won’t be done until the end of June. Harry has his own career as a school teacher and is willing to take an unpaid leave of absence for two years, but he can’t leave until the end of June or middle of July at the earliest. Sally and Harry enjoy golf and have recently joined a fairly exclusive club in the St. Catharines area, after an eight-year waiting period and after paying a large initiation fee. They do not wish to give up this membership. Their home is located just outside the city on 20 acres and they are very reluctant to sell it, as they would not be able to replace it on their return. Both Sally and Harry grew up in the St. Catharines area and their families still live there. Sally’s parents and Harry’s parents are retired. Sally and Harry both want to move to Paris, and they have come to you for tax advice on whether they could be considered non-residents of Canada, or what, if anything, they could do to achieve this result.

Problem 10 The plaintiff, Jennifer Marken, is a 21-year-old Canadian citizen and has always lived and worked in Regina except for the last two years. During these two years, she obtained a position as an English teacher for a local school in Osorno, Chile. Originally, the two-year contract could have been extended into a permanent position at Jennifer’s option. However, at the end of the two-year period Jennifer’s brother became suddenly ill and she opted to return to Regina and complete her education degree. She is scheduled to appear in court next week to claim that she was a non-resident of Canada during the two-year period and, therefore, should not be liable for Canadian tax. Both the CRA and Jennifer’s counsel agree on the following facts: ● ●

●

Jennifer is a Canadian citizen and all of her direct family resides in Saskatchewan. Jennifer’s fiancé visited her five times during the two-year period and lived in Chile during his summer vacations. He plans to complete his accounting designation with a Canadian firm in Saskatchewan. All of Jennifer’s income during the two-year period ending in January of this year was paid by the Chilean school. Upon departing for Chile, Jennifer put all of her furniture in storage and leased her car to her younger sister on a month-to-month basis. Her household belongings were shipped to Chile. While in Chile, she maintained her provincial health care policy, her Canadian savings account and a Canadian American EXpress card. She cancelled her Canadian chequing account, and her Canadian Visa card.

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Introduction to Federal Income Taxation in Canada

●

Before leaving, she cancelled all of her club memberships and abdicated her position as the honourary chair of the Beta Gamma Phi sorority. While in Chile she made no attempt to learn the Spanish language and did not join any Chilean organizations. She rented a one-bedroom apartment from another Canadian living in Osorno. Over the two-year period, Jennifer visited Canada each Christmas, at Easter, and for the marriage of her best friend. Her total number of days in Canada over the two-year period amounted to 50 days.

Jennifer’s litigation counsel would like your advice on the income tax options for the two-year period during which Jennifer worked in Chile. Provide your perspective on the facts that support each place of residence and the tax consequences they entail. Weigh the relevance of the facts and conclude on the likely outcome in this situation.

Problem 11 The taxpayer came to Canada in 2000. He stayed in Canada until 2011. Prior to 2000 the taxpayer studied engineering and obtained an engineering degree. He also married. In 2011 the taxpayer went to England for post-graduate studies; he returned to Canada with his wife and two children in 2013. For three years he worked as an engineer in Canada. In 2016 he moved to the United States with his family. He remained there continuously until 2019 when he became a naturalized U.S. citizen. Also, in 2019, following the loss of his job in the United States, he returned to Canada to take a new job. The new job lasted through 2020. During 2021 and most of 2022 the taxpayer remained in Canada, working as a selfemployed consultant. In December 2022, he moved back to the United States. There he worked as an employee for siX months. Thereafter, he practiced his profession on a self-employed basis working for various companies in the United States which required his services. He practiced his profession from an office in his home. An apartment was occupied by the taxpayer under a lease entered into in 2022 and renewed yearly thereafter. When the taxpayer returned to Canada in 2019 he bought a house in Mount Albert, Ontario. A few months later, after the necessary domestic arrangements had been made, the taxpayer’s wife and children joined him, and the family lived in the house at Mount Albert. Marital difficulties arose. The taxpayer’s wife and children remained behind in Mount Albert when the taxpayer returned to the United States in 2022. The taxpayer visited Canada rather infrequently after 2022 and for short durations (less than 7 days). With two exceptions, his post-2022 visits to this country were for the purpose of seeing his children, and were made three or four times a year. Although during those visits he stayed in the Mount Albert home, he appears to have stayed as a visitor only and not a person whose home it was. During the post-2022 period, the taxpayer made monthly payments to his wife for her support and that of the children. The two exceptional post-2022 visits were made in order to fulfill a contract made by the taxpayer with a company that needed the services of an engineer who had expertise in U.S. military specifications. The first such visit, in June and July 2023, lasted for thirty-two days. The second, in August of that year, lasted for siXteen days. In 2023, the taxpayer held what he said was non-resident membership in the Ontario Association of Professional Engineers. He also held membership in the Engineering Institute of Canada and the Canadian Society of Mechanical Engineers. The taxpayer maintained a bank account in Newmarket, Ontario. He mistakenly filed a 2023 tax return with the Canada Revenue Agency, indicating that he resided in Mount Albert. Evaluate, in detail, the alternatives to the residence issue for the taxpayer in 2023. Provide support for your conclusions.

Problem 12 Each of the parts below represent separate scenarios. For each scenario identify if the income would be taxable or exempt from taxation. (A) Mike is a member of the Whitecap Dakota First Nation in Saskatchewan. Mike is registered for Indian status. Mike lives and works on Whitecap Dakota First Nation and earns $100,000 as a manager at the Dakota Dunes Hotel. (B) Perry is a member of Musqueam Indian Band in British Columbia. Perry is registered for Indian Status. Perry lives on Musqueam Indian Band reserve land but works completely off reserve for the Royal Bank in Vancouver and earns $365,000 as an fund manager.

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Ch. 2/Study Guide — Assignment Problems

(C) Cindy is a member of Buffalo Point First Nation in Manitoba. Cindy is registered for Indian Status. Cindy lives in Winnipeg and works for the Canadian Mint earning $120,000 annually. (D) Sherry is Metis and lives in Regina. She is not registered for Indian status. She lives in Regina but works as a teacher on Piapot First Nation and earns $85,000. (E) Ethan is a member of Chippewas of Rama First Nation. Ethan is registered for Indian status. Ethan is a doctor and lives in Barrie but has a clinic in Barrie where he works 40% of the time and a clinic on Cheppewas of Rama First Nation reserve land where he works 60% of the time. He earned $300,000.

CHAPTER 2 ¶2,850

Introduction to Federal Income Taxation in Canada

CHAPTER 2 — DISCUSSION NOTES FOR REVIEW QUESTIONS (1) Canadian individuals are taxed based on residency and not their citizenship. Canadian residents are taxed on their world income.

ITA: 2(1)

(2) He or she will normally only be deemed to be a resident if he or she sojourned in Canada for 183 or more days during the year. This assumes no other factors create residential ties to Canada.

ITA: 250(1)

(3) You need to look at other factors to determine where they have a ‘‘continuing state of relationship’’, such as family and social ties and other personal property. The Income Tax Folio categorizes the type of facts that can be used to establish residential ties.

Income Tax Folio S5-F1-C1 — Determining an Individual’s Residence Status

(4) He or she would be considered to be a non-resident of Canada throughout the year. However, since he or she carried on business in Canada during the year while a non-resident, he or she would be taxable in Canada on his or her Canadian business profits for the year.

ITA: 2(3)

(5) If he or she is establishing a ‘‘fresh start’’ in Canada on March 31 then he or she becomes resident on that date and is taxed in Canada on his or her world income from that date. The sojourning rules would not apply since they only apply to non-residents who are in Canada on a temporary basis. (6) The residency of a corporation is either determined by the common law test of ‘‘central management and control’’, or a corporation is deemed to be a Canadian resident if it is incorporated in Canada after April 26, 1965, or it meets the tests outlined in the Act if it was incorporated before that date.

ITA: 250(4)

(7) A corporation is deemed to be resident in Canada if it was incorporated in Canada after April 26, 1965. Reference to the tax treaty would be the next step but Canada does not have a tax treaty with Bermuda. Therefore, it would be resident in Canada and taxable in Canada on its world income.

ITA: 250(4)(a)

(8) Any company which was incorporated in Canada before April 27, 1965 and which carried on business in Canada in any year after that date is deemed to be resident in Canada. An extended meaning of carrying on business includes soliciting orders in Canada. The facts fit the meaning because of the continuity of the order solicitation over a period of years. Therefore, the company would be resident in Canada and taxable in Canada on its world income.

ITA: 250(4)(a)

(9) Subsection 2(3) refers to ‘‘employed in Canada in the year or a previous year’’. Therefore, section 115 of Division D requires the income from an office or employment to be taxed in Canada.

ITA: 115(2)(c)

(10) The U.S. company is soliciting orders in Canada and, therefore, is carrying on business in Canada. The corporation is, thus, taxable in Canada on the profits related to these sales.

ITA: 2(3), 115, 253

(11) Under the extended meaning of carrying on business, the U.S. company would be a non-resident carrying on business in Canada and liable for tax on its earning in Canada. However, under the Canada–U.S. tax treaty, the U.S. company would probably not be taxable in Canada because its profits are not earned from a permanent establishment in Canada.

ITA: 253

(12) Yes, a person can be a resident of more than one country since residency is determined under the laws of each country. Article IV of the Canada–U.S. tax treaty provides rules for resolving who collects the tax where a person is a resident of both the United States and Canada. (13) Under Article VII of the Canada–U.S. tax treaty, it will only be subject to tax on the income attributable to that permanent establishment. (14) Article XIV of the Canada–U.S. tax treaty will cause him to be taxed in the United States only if he has a ‘‘fiXed base regularly available to him’’ in the United States Therefore, he will only pay tax in Canada on this income.

ITA: 253(b)

Ch. 2/Study Guide — Solutions to Exercises

CHAPTER 2 — SOLUTIONS TO EXERCISES Exercise 1 (A) Alpha is a part-year resident of Canada in the year. He would be a resident until August 27 of the year when he appears to have made a ‘‘clean break’’ with Canada. While in Canada he would not have been sojourning, so the deeming rule would not apply.

ITA: 250(1)(a)

(B) Beta has no residential ties with Canada. Citizenship is not a determining factor in establishing such ties. (C) Gamma is a non-resident of Canada and is taxable only on employment income earned in Canada.

ITA: 2(3)(a), 115(1)(a)(i)

(D) Delta is either a part-year resident of Canada or a non-resident employed in Canada, depending on the facts of his stay in Canada. He is also taxable under paragraph 2(3)(c) because the shares are taxable Canadian property.

ITA: 115(1)(b)(iv)

(E) Epsilon is deemed a resident of Canada because of his relationship to his mother.

ITA: 250(1)

Exercise 2 [See: MacDonald v. M.N.R., 68 DTC 433 (T.A.B.).] (A) The resident option → taxed in Canada on worldwide income for full year: Criterion: residence is a question of fact dependent on the degree of permanency in the relationship between a person and a place; Evidence: (i) factors indicating this relationship between the appellant and Canada, 1. he sold his house in the United States and paid an American capital gains tax for not buying another residence, 2. his wife, upon arriving in Canada, rented premises pending the purchase of a house, 3. she and the children, whom the appellant was supporting to the extent of $600 per month, stayed in Canada all year-round, 4. he stayed in Canada when he was off-duty to the extent of 166 out of 180 days in 1964, — full-time presence is not necessary, 5. other non-determining factors, — joint account in Canada where pay cheques were deposited during his vacations, — joint ownership of a car with New Brunswick registry, — citizenship irrelevant; (ii) factors detracting from a relationship with Canada, 1. a few rooms, without exclusive use, made available for him at his sister’s house in the United States, — not a permanent abode, — an individual can have more than one residence, 2. U.S. citizen and previously and subsequently resided in the United States with a stated intention to return, — but only 1964 in question on the facts, — stated intention must be supported by behavioural facts, — worked for a U.S. company and paid in U.S. currency,

ITA: 2(1)

CHAPTER 2

(F) Mu is not deemed to be a resident of Canada by any of the deeming rules. She has never been resident in Canada. Therefore, she is not a resident of Canada.

ITA: 250(1)(c)(i), 250(1)(f)

Introduction to Federal Income Taxation in Canada

— but not determining because a Canadian resident can be involved in such a situation, providing employment services abroad for a non-Canadian company, — memberships and investments including bank accounts, securities and pension plan in United States, — factors may indicate U.S. residence, but not determining and also possible for a person resident in Canada, — no Canadian memberships or investments and no application for family allowances, — not determining factors and also possible of a Canadian resident, — children living in United States, — married and apparently not dependent, — phone in wife’s name in Canada, — a factor, but hardly determining, — neither employed in Canada nor carrying on business in Canada, — not necessary condition for full-time residence. (This list of factors is longer but there is more substance for full-time residence.) (B) The deemed resident option → taxed in Canada on worldwide income for full year: Criterion: the condition of sojourning an aggregate of 183 days or more;

ITA: 2(1) ITA: 250(1)

Evidence: his total stay in Canada in the year was only for 166 days; therefore, the condition is not met. (C) The part-year resident option → taxed in Canada on worldwide income for part of the year resident in Canada with deductions applicable to the period of part-year residence and nonrefundable tax credits either prorated for or applicable to the period of part-year residence (as long as not resident in Canada during some other part of the year);

ITA: 2(1), 114, 118.91

Criterion: clean break or fresh start during 1964; Evidence: neither occurred. (D) The non-resident option → taxed in Canada on income earned in Canada:

ITA: 2(3)

Criteria: employed in Canada, carried on business in Canada or disposed of taxable Canadian property in the year; Evidence: none of these conditions occurred in the year.

ITA: 2(3)

(E) Conclusion: if the taxpayer is to be found a resident it must be as a full-time resident: — the major factors indicate a relationship with Canada which would warrant a conclusion of such resident status.

Exercise 3 (A) Inch Incorporated is resident in Canada by virtue of the common law principle of central management and control. The corporation cannot be deemed resident in Canada because it was not incorporated in Canada.

ITA: 250(4)

(B) Foot Limited is deemed resident in Canada because it was incorporated in Canada after April 26, 1965.

ITA: 250(4)(a)

(C) Yard Incorporated is not resident this year by virtue of the common law principle of central management and control. Furthermore, the corporation cannot be deemed resident in Canada because it was not incorporated in Canada. (D) Mile Limited is resident in Canada. The corporation was incorporated in Canada before April 27, 1965 and after that time it was resident by virtue of the central management and control rule.

ITA: 250(4)(c)

Ch. 2/Study Guide — Solutions to Exercises

Exercise 4 Canada levies tax on non-residents who carry on business in Canada. Carrying on business in Canada is distinguishable from carrying on business with Canada. While Samson solicits sales from Canadians, it does not have a permanent establishment in Canada, nor does it employ a Canadian salesperson or agent. Given these facts, Samson is not liable for Canadian income taxes on the $76,000 profit originating from within Canada.

ITA: 2(3)

Exercise 5 [See: Warren K. Zimmer v. The Minister of National Revenue, 81 DTC 550 (T.R.B.).] A. Resident — tax on worldwide income for 2023. — requires a continuing state of relationship with Canada based on facts — past history in Canada: born, raised, and educated in Canada — return to Canada after completion of studies in Australia — absence just an extraordinary event in his life (to get degree) — parents live in Canada

— only sold belongings in Canada to help finance trip to Australia B. Deemed resident — same consequences as above. — requires sojourning (temporary stay) in Canada for a total of 183 days or more during 2023 — physically present in Canada for 185 days — but not sojourning for that full period — may have sojourned from arrival in Canada on June 30, 2023 to time of visiting with parents in Toronto and to time of taking articling position in Halifax — but sojourning in Canada stopped when — he began the articling job in Halifax in September 2023 — his belongings arrived in Halifax and he established a permanent home — sojourning did not stop in 2023 when he took the position in the Crown Attorney’s Office, because he had established a permanent home before that time — with respect to sojourning, there was no difference between his employment as an articling law student and his employment as a lawyer — the only difference was professional status which does not affect sojourning. C. Part-year resident — tax on worldwide income for the part of 2023 that he was resident. — requires a ‘‘fresh start’’ in Canada — would require facts suggesting that previous ties with Canada had been severed in 2019 and that new ties were established in 2023 — he did not leave a dwelling place in Canada available for his occupation [IT Folio S5-F1-C1, par. 1.12] — his parents’ home would not qualify since he was not living at home prior to leaving Canada in 2017 — he did not leave spouse and dependants in Canada — he did not leave any personal property or social ties — he sold nearly all of his belongings to finance the trip to Australia, and the remainder he must have taken with him — he did not keep a bank account in Canada while in Australia.

CHAPTER 2

— permanent resident status in Australia does not in and by itself mean that the individual is a non-resident of Canada [IT Folio S5-F1-C1 paragraph 1.21]

Introduction to Federal Income Taxation in Canada

D. Non-resident employed in Canada in 2023 — tax only on employment income in Canada — he was at least employed in Canada in 2023 from September of that year, while articling with a law firm in Halifax — he held permanent residence status in Australia since 2019. E. Conclusion — he was a part-year resident in 2023 — his previous ties to Canada had been severed in 2019 — the remaining ties indicated were not strong enough to conclude that he remained resident in Canada for tax purposes while in Australia — he established residence in September 2023 (at the latest) when he took the job in Halifax and had his belongings shipped — this would be enough to argue against being merely a non-resident employed in Canada during 2023.

Exercise 6 [See: Victoria Insurance v. MNR, 77 DTC 320.] — Resident by common law principle: taxed in Canada on worldwide income — central management and control in Canada — subsidiary of Canadian company — but — all directors Bahamian or resident in Bahamas — all meeting held in the Bahamas — books, minutes, and shareholders registry kept in Bahamas — all corporate housekeeping activities carried on in Bahamas — office, solicitor, auditor, and bank accounts in Bahamas — reports to governments and investment of funds carried on in the Bahamas — deemed full-time resident by ssec. 250(4): taxed in Canada on worldwide income — requires incorporation in Canada — incorporated in Bahamas — non-resident carrying on business in Canada: taxed on business income in Canada — not carrying on business in Canada — income came from new business not earned in Canada — conclusion — central management and control not exercised by Canadian parent which was the taxpayer’s only connection with Canada — corporation is not resident in Canada

Exercise 7 A. Resident in Canada (1) Must establish a continuing state of relationship with Canada — evidence — past history in Canada: born and educated in Canada, always lived there — expectation that he might return as president of the Canadian company at some time in the future

Ch. 2/Study Guide — Solutions to Exercises

— wife and minor children did not leave with him and had a car, furnished house, and bank account available to them — retained the cottage and rented it out — rented house in Mexico; did not buy — left some home furnishings — valuable paintings and sculptures — with married children — maintained investment portfolio in Canada — maintained pension in Canada — maintained Canadian driver’s licence — returned during August and December (2) Income tax consequences if resident in Canada throughout the year — would pay Canadian tax on worldwide income, which would consist of:

$ 23,333 $ 8,000 $ 70,833 $ 30,000 $ 25,500 $ 157,666

— the travel allowance would not be included by virtue of spar. 6(1)(b)(v), since he could be expected to negotiate contracts as president, as long as the allowance is reasonable when compared to his actual travel expenditures. — the moving costs paid by the Mexican company would not be a taxable benefit. B. Deemed resident in Canada by virtue of par. 250(1)(a) — in this case, must show that he was sojourning in Canada for 183 days or more resulting in the same tax consequences as full-time resident — until April 15, he was not sojourning (i.e., not visiting) — after that date, he was sojourning, but not for 183 days or more (about 30 days) — therefore, par. 250(1)(a) not applicable in this case C. Part-year resident in Canada (1) Must establish a clean break from Canada in the year — evidence — he took a position with a Mexican company this year — he left Canada in April for an indefinite period — his wife and minor children followed him to Mexico as soon as practical; their stay in Canada to June 30 was merely to complete the school year — Dundas home sold — had a permanent rented home in Mexico — most household effects moved to Mexico — personal property that remained in Canada effectively given to married children — cottage rented for most of the year and not available for his use — closed bank accounts and terminated insurance and club memberships

CHAPTER 2

Canadian salary to April 15 ($80,000 × 3.5/12) . . . . . . . . . . . . . . . . . . . . . Canadian bonus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mexico salary ($100,000 × 8.5/12) . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mexico bonus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Living allowance (8.5 × $3,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Introduction to Federal Income Taxation in Canada

34 (2) Income tax consequences

— Section 114 will apply because there was a period after April 15 in which he was not employed in Canada and not carrying on business in Canada — taxed in Canada on worldwide income while resident in Canada to April 15 of $31,333 (i.e., $23,333 + $8,000) — tax liability on sale of taxable Canadian property after April 15 — non-refundable tax credits pro-rated on a reasonable basis — deemed disposition of all property immediately before he became a non-resident on April 15 except: — pension rights — taxable Canadian property which would include: — home in Ottawa and cottage (i.e., real property) — therefore, investment portfolio and listed personal property (paintings and sculpture) would be subject to deemed disposition rules — can elect to be deemed to have disposed of taxable Canadian property, as well — the gain on the sale of the home on June 30 would be taxable in Canada, subject to principal residence exemption

Chapter 3 Employment Income

CHAPTER 3

Introduction to Federal Income Taxation in Canada

CHAPTER 3 — LEARNING CHART Problem Descriptions Textbook Example Problems 3-1 Employed vs. self-employed — case 32 Employee loan 3-3 Employee stock option 34 Employee stock option 3-5 Employee stock option 3-6 Standby charge and operating benefit — employer-owned — employment kilometres < 50% 3-7 Standby charge and operating benefit — employer-owned — employment kilometres > 50% 3-8 Standby charge and operating benefit — employer-leased — employment kilometres < 50% 3-9 Standby charge and operating benefit — employer-leased — employment kilometres > 50% 3-10 Deductible automobile expenses — employee-owned car 3-11 Deductible automobile lease expense — employee-leased car 3-12 Deductible automobile expenses — employee-leased car 3-13 Comprehensive example — employment income and expenses Exercises 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Employed vs. self-employed Employed vs. self-employed Taxable benefits Legal expenses — deductibility Employee discount Moving expense reimbursement Employee benefits — employer payments Employee stock option — CCPC Standby charge, operating benefit Home off ice expenses Personal meals while travelling Employment income — comprehensive calculation Employment income — implications of components of a compensation offer Employee vs. independent contractor Employment income — expenses of a salesperson

Ch. 3/Study Guide — Learning Chart

Problem Descriptions

CHAPTER 3

Assignment Problems 1 Auto benefits — company-owned vs. company-leased 2 Stock option — comparing CCPC to public company 3 Employee benefits — multi-part 4 Employee benefits — multi-part 5 Employee loans, car expenses 6 Commission expenses & limitation 7 Employee travel expenses 8 Employed vs. self-employed 9 Offer of employment — compensation options 10 Calculate employment income — benefits, stock option 11 Compensation alternatives — salar y, bonus, benefits or stock option 12 Compensation alternatives — forgivable loan, stock option 13 Auto benefits — company owned vs. leased 14 Car allowance vs. reimbursement 15 Payment on termination 16 Calculate employment income — benefits 17 Calculate employment income — expenses 18 Calculate employment income — benefits, expenses, stock option 19 Calculate employment income — travel expenses 20 Calculate employment income — comprehensive benefits 21 Calculate employment income — comprehensive expenses 22 Calculate employment income — comprehensive benefits, auto expenses 23 Calculate employment income — comprehensive benefits, auto expenses 24 Employed vs. self-employed 25 Employed vs. self-employed 26 Employed vs. self-employed, resident 27 Employed vs. self-employed, resident 28 Employment income comprehensive calculation 29 Employee vs. independent contractor 30 Employment income — comparison under t wo alternative employment offers

Introduction to Federal Income Taxation in Canada

Ch. 3/Study Guide — Review Questions

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REVIEW QUESTIONS

(1) The best way to calculate employment income is to follow the format used on the personal tax return. Comment on the accuracy of this statement. (2) It does not matter whether an individual is employed or self-employed since he or she can claim the same expenses under either category as long as the expense was incurred to earn income. Comment on the accuracy of this statement. (3) If an individual fails any one of the tests which are used to determine employed versus selfemployed status then the individual is employed. Comment. (4) When determining whether a person is employed or self-employed, one of the subtests used in the economic reality test is the ‘‘control test’’. What does this test involve? (5) If a bonus cheque is received by an employee, Ms. Davis, on December 15 of this year and she chooses not to cash her cheque until January 5 of next year, then she will be able to defer the tax on the bonus until the next year since individuals are taxed on the cash basis. Comment. (6) A bonus is payable to an employee, Mr. Lee, on December 15 of this year and he decides that he wants to be taxed on the income in the following year instead of this year. He can ask his employer to defer the payment of this bonus until next year to accomplish his goal. Comment. (7) Employees are taxed on income from their employer to the extent that it is a gross payment before withholding tax or a taxable benefit. The employer can deduct, as an expense, the full amount of the gross payments before withholding tax and taxable benefits that are reported on the employee’s T4. Comment. (8) To maximize the after-tax income from a disability insurance policy to a disabled employee, the employer should not pay any of the premium for the coverage. Comment. (9) On June 2 of this year, Opco loaned $10,000 to an employee and did not charge interest. The employee repaid the loan on June 30 of the same year. How many days are included for purposes of determining the deemed interest benefit?

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(10) EXplain the differences between a reimbursement and an allowance. (11) Opco bought a new car for its president that cost the company $40,000 plus $5,200 for HST. How much is the standby charge for this car for a full year assuming it is driven 40% for business purposes? (12) What are the five conditions that must be met before a sales/negotiating person can deduct expenses? (13) What are the four conditions that must be met by an employee, who is not a sales/negotiating person, in order to allow him or her to deduct travelling expenses other than car expenses? (14) Mr. Wang is a part-time lecturer at the University of Waterloo. He lives in a location in Toronto which is 105 kilometres away from the university. The rest of the time he has a tax consulting practice which he operates out of his home. The university pays him $0.40 per kilometre to travel to and from the university. He is issued a T4 at the end of the year for his teaching income on the basis that he is a parttime employee. How is the travel allowance of $0.40 per kilometre treated for tax purposes? (15) Guidelines for the deductibility of expenses related to work space in the home for employees are included in subsection 8(13). Under paragraph (a) of this provision the expenses are allowed if one of two conditions are met. In these conditions, the words ‘‘principally’’ and ‘‘exclusively’’ are used. What do these words mean for tax purposes? (16) Ms. Smith has come to you to ask your tax advice. She has just had a large bonus paid to her on December 31 and wants to defer some of it until next year. She is arguing that since the CRA’s portion was not sent to the Receiver General until January 15 she should be able to defer that portion until the next year on the basis that it was not received until January 15 when it was sent to the CRA. What do you think?

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Introduction to Federal Income Taxation in Canada

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EXERCISES

Exercise 1 The taxpayer is a qualified registered nurse, is entitled to use the traditional letters ‘‘R.N.’’ after her name and, in answering the questions contained in her income tax return, described herself as a ‘‘private duty’’ nurse both in the space provided for employed persons and in the space provided for persons in business or practising a profession. Thus, in trying to answer all the official questions on her return, the taxpayer indicated, on the one hand, that she was employed ‘‘as a private duty nurse’’ by the Canadian Forces Hospital at Halifax and, on the other hand, that she was in business of practising her profession ‘‘as a private duty nurse’’ in connection with the same hospital. The basic issue to be decided is, briefly, what was the taxpayer’s correct status vis-à-vis the Canadian Forces Hospital, Halifax in the taxation year in question. The taxpayer launched the present appeal by Notice of Appeal in which she alleged (in effect) as follows: that in the relevant taxation year she was employed by the Canadian Forces Hospital, Halifax, on a day-to-day basis terminable on 24 hours’ notice; that the usual so-called fringe benefits made available to and enjoyed by the regular full-time army nursing sisters such as holidays, sick pay, retirement plan, and so on, were not made available to her as a private duty nurse; that the regional surgeon’s office in Halifax classified her as a ‘‘self-employed R.N.’’; that in her previous return she claimed and was permitted to deduct from her income expenses of a similar type to those disallowed in the taxation year now under appeal; and that several of her fellow private duty nurses employed at the Canadian Forces Base, Halifax, were employed on the same basis as she was and had claimed expenses of a similar type to those disallowed in this appeal (i.e., the type of expenses one would associate with a private duty nurse). The CRA stated that, in making the assessment now in dispute, he had acted upon the following assumptions of fact — that the taxpayer is a registered nurse and was employed by the Department of National Defence at the Canadian Forces Hospital and Base, Halifax, during the taxation year, that in the course of carrying out her engagement as a general duty nurse the taxpayer was subject to supervision and discipline by the hospital authorities, and that of the expenses allegedly incurred by the taxpayer only the amount claimed as ‘‘R.N. fees’’ and the amount being her contribution to the Canada Pension Plan were permitted under the Act. The taxpayer testified, in effect, as follows: that she is a registered nurse; that in the relevant taxation year she was living in Halifax and was employed at the Canadian Forces Hospital (Stadacona Hospital), ‘‘not as a staff nurse but more or less as a private duty nurse, though my times were made up ahead of time’’ (the correct interpretation to be placed on the word ‘‘employed’’ in this appeal appears to be the key to the solution); that private duty nurses are allowed to claim as deductions from income certain expenses such as laundry, uniforms, travelling expenses, and so on; that the only difference between herself and a private duty nurse is that the hospital deducted her Canada Pension Plan contributions from the per diem amounts payable to her; that she acted as a private duty nurse at Stadacona Hospital for about five years, after which she moved from Halifax to Charlottetown and became associated with the Charlottetown Hospital as a relief nurse; that she is presently working under exactly the same conditions under which she carried on at the Canadian Forces Hospital, Halifax, i.e., ‘‘If I don’t work, I don’t get paid, I have no benefits or holidays. I get private duty wages (these amounted to $15 per day in Halifax and now amount to $20 per day). My time is made up. If they get full-time nurses they can let me go’’; that she and other private duty nurses were hired by Stadacona Hospital (on a dayto-day basis) to fill in while the hospital ‘‘didn’t have enough service nurses’’; and that in the year before she was replaced the said hospital ‘‘did get a large supply of military nurses in and we were all cut down’’ (i.e., a number of private duty nurses were simply laid off which was easy to do because they were working on a day-to-day basis). The Hospital supplied all equipment and supplies used by the taxpayer. The Hospital hired and fired all nursing assistants and other support staff who assisted the taxpayer in the performance of her duties. The taxpayer could request the Hospital to hire additional support staff but she personally did not hire them. The taxpayer also testified, in effect, as follows: that her time sheet in the Canadian Forces Hospital, Halifax, was made out a week in advance; that the said hospital’s authority to hire civilian nurses to meet its requirements was only valid while there was a shortage of military nurses; that, as they became available, the civilian nurses were replaced; that the hospital asserted its right to dismiss civilian nurses on 24 hours’ notice — ‘‘we were told that when we went there to work’’; that she, herself,

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Isaac v. M.N.R., 70 DTC 1285 (T.A.B.)

Ch. 3/Study Guide — Exercises

was not replaced by a military nurse in the taxation year, now under appeal, but later her shifts were cut down and she was eventually replaced; that she was, of course, obliged to follow hospital regulations with regard to the administration of drugs, medications, and so on, as she would be in any recognized hospital; that, when she was working at the Canadian Forces Hospital, Halifax, she was told which patients to look after; and that she did not sign any form of contract with the above hospital when she started to work there. — REQUIRED Is the taxpayer in this case employed or self-employed? In presenting your answer, discuss the tests that are applied by the courts in this type of situation and consider how the facts relate to these tests.

Exercise 2 Due to the poor economy, Davies Ltd., an architectural firm, has instituted a freeze in hiring. However, the company wants to engage the services of a specific architect, Anne Capwell, to manage the completion of a specific project over a two-year period. Following negotiations between the parties, a consulting contract was signed. Ms. Capwell will be paid $4,000 per month to work at least 14 days per month (i.e., between three and four days per week) for a two-year period. The agreement stipulates that Davies Ltd. will provide Ms. Capwell with an office and pay for underground parking at Davies Ltd. Ms. Capwell has other architectural work and she estimates that she derives appro Ximately 30% of her consulting income from other sources.

ITA: 248(1); Wiebe Door Services Ltd. v. M.N.R., 87 DTC 5025 (F.C.A.)

— REQUIRED EXpress your opinion as to whether Ms. Capwell is considered an employee or an independent contractor.

Exercise 3

ITA: 6(1)(a); Income Tax Folio S2-F3-C2

CHAPTER 3

William Winter works for an extremely generous employer, Benjamin’s Ltd., which paid the following amounts on behalf of William: (a) Registered pension plan contributions (defined benefit) .................................... $1,000 (b) Provincial employer health tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

600

250

(d) Drug plan premiums — Mutual of Omaha . . . . . . . . . . . . . . . . . . . . . . . . . . .

150

(e) Tuition fee for a basket weaving course offered by a local high school . . . . .

(f) Non-cash Christmas gift which the company did expense for tax purposes

(g) Subsidized lunches at company cafeteria: Fair market value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

640

Actual cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

420

Amount paid by William . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

200

(h) Membership fees in EXclusive Private Club for his personal use . . . . . . . . . .

800

(i) Financial counselling — ABC Investment Counselling Ltd. . . . . . . . . . . . . . .

1,000

— REQUIRED Comment on whether these amounts are taxable.

Exercise 4

ITA: 6, 8

Subdivision a — Income or loss from an office or employment, outlines the basic rules, inclusions and deductions when computing net income from employment.

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Introduction to Federal Income Taxation in Canada

42 — REQUIRED

EXplain when legal expenses are deductible in computing income from employment. Identify your references and outline any related sections, other resources and other relevant information.

Exercise 5

ITA: 6(1)(a); Income Tax Folio S2-F3-C2

Melanie Hughes, a division supervisor for Eli’s Ltd., a large department store chain, receives a 35% discount on all merchandise purchased through Eli’s Ltd. This discount is available to all executives above assistant department heads. Melanie calculated that the discount saved her $6,000 this year. — REQUIRED Discuss whether there is a benefit.

Exercise 6

ITA: 6(1)(a); Income Tax Folio S2-F3-C2

John Scott, an employee of Kelly Ltd., lives in Burlington and commutes by GO Train to Toronto where Kelly Ltd. is located. John, who is bored by reading, decides to move to Toronto, about 50 kilometres closer to his work, in order to cut down his travelling time. Kelly Ltd. reimburses him for the following amounts: Moving van costs ........................................................................................................... $2,500 Reimbursement of actual loss suffered in selling the house ........................................ 5,000 $7,500

— REQUIRED Discuss whether there is a benefit.

Exercise 7

ITA: 6(1)(a), 6(1)(f)

Tanya Sims, who is chairperson of her union’s negotiating team, has approached you concerning the management’s offer in connection with fringe benefits. The company proposes to pay one-half of the premiums of the following plans: (a) group term life insurance; (b) extended health care — a private plan; (c) dental care — a private plan; (d) an accident and sickness income protection plan — a private group plan covering up to 50% of the wages. All of these plans have premiums which are approXimately the same. The company at present does not contribute to any of these plans. — REQUIRED Discuss the tax implications of the company’s proposal.

Exercise 8 Katrina Knorr was granted, in year one, an option to purchase 50,000 common shares at $1 per share from her employer, Michael Ltd., a Canadian-controlled private corporation. The shares had an estimated fair market value at this date of $1.50. However, according to the agreement, Katrina could not exercise her option until her fourth employment year. Katrina did exercise her entire option in year five; the fair market value of the shares at that time was $3. Katrina sold all the shares in year siX, at $6 per share.

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ITA: 7; IT-113R4

Ch. 3/Study Guide — Exercises

— REQUIRED Discuss the tax implications of the above transactions.

Exercise 9

ITA: 6(1)(e), 6(1)(k), 6(2)

Ms. Singh has full use of an employer-owned Mustang GTS purchased for her use in mid-December of last year. It is now January. The original cost to the employer of this classic is $20,000, including HST. Other details of the car for the coming year are as follows: Capital cost allowance to be claimed by employer ..................................................... $4,792 Operating costs for the year paid by the employer, including HST and insurance ($600) .................................................................................................. $3,500 Personal-use kilometres ................................................................................................ 12,000 Number of months available . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Reimbursement to employer for personal use at 15 cents per kilometre ................. $1,800 — REQUIRED Compute the taxable standby charge and operating cost benefits, if the business-use kilometres are: (a) 10,000 (b) 20,000

Exercise 10

ITA: 8(1)(i), 8(13); IT-352R2

Calvin Cheng, who is employed and lives in Calgary, takes a considerable amount of office work home and, therefore, has built and furnished an office in his fully paid home. On this year’s tax return, he claimed the following expenses in respect of his office which represents appro Ximately 1/8 of the home. Estimated rental value for office space ............................... $1,000 Maintenance — 1/8 ......................................................................................................... 250 Taxes — 1/8 ............................................................................................................................ 200 Insurance — 1/8 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80 $1,530

Discuss whether Calvin’s course of action was correct.

Exercise 11

ITA: 8(4), 67.1(1)

The deduction for meals under paragraph 8(1)(f ) — (sales expenses), is restricted to those incurred while entertaining a client or a customer or a prospective client or customer. — REQUIRED Determine the condition(s) under which personal meals consumed by an employee while travelling on business are allowable. Are there any restrictions if a deduction is allowed?

Exercise 12 Susie Sellem is a top real estate salesperson employed by Sellem, Sellem and Fast Limited, a Canadian-controlled private corporation located in Burlington, Ontario. Susie has provided you with the following details of her remuneration for the year ended December 31, 2023. Gross commission before payroll deductions ............................................................ $126,000 Less payroll deductions: Income taxes withheld at source .............................................................. $44,617 Canada Pension Plan contribution (Enhanced portion is $631) . . . 3,754 Employment Insurance contribution . . . . . . . . . . . . . . . . . . . . . . . 1,002

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CHAPTER 3

— REQUIRED

Introduction to Federal Income Taxation in Canada

Registered pension plan contribution (money purchase; current service) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Group term life insurance premium . . . . . . . . . . . . . . . . . . . . . . . Group accident income protection plan premium . . . . . . . . . . . . . . United Way payroll deduction (registered charity) . . . . . . . . . . . . .

6,750 300 250 360

(57,033)

Net commission after payroll deductions . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 68,967

Susie indicated to you that her employer paid the following amounts on her behalf during 2023: Registered pension plan contribution (money-purchase) . . . . . . . . . . . . . . . . $ 6,750 Group term life insurance premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 700 Group accident income protection plan premium . . . . . . . . . . . . . . . . . . . . . . 250 Employer health tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,520 Dental plan premium paid to Manulife Financial . . . . . . . . . . . . . . . . . . . . . . 1,440 EXtended health care premium paid to Blue Cross . . . . . . . . . . . . . . . . . . . . 960 Membership in Cedar Springs Fitness & Racquet Club . . . . . . . . . . . . . . . . . . 1,800

The fitness club membership gives Susie access to a formal dining room, which she uses on a regular basis to entertain clients. She also takes clients out to special events at the club over the course of the year. Susie and her employer are in agreement that her membership at this club is primarily for the employer’s benefit as Susie would not otherwise have purchased this membership on her own. Susie has provided you with the following additional information related to her employment during 2023. (1) Susie received a sales incentive prize for being the top salesperson for the first quarter of the year. She received an all-expenses-paid trip for two to Nassau, Bahamas. She took her husband. The value of the prize was $4,000 which represented $1,000 related to airline tickets and $3,000 related to accommodation and expenses in the Bahamas. The value of the airline tickets was before HST @ 13%. There was no HST payable on the Bahamian accommodation charges. (2) Susie received a $40,000 interest-free loan from Sellem, Sellem and Fast Limited on January 4, 2023. The loan was to aid her in the purchase of an automobile required for employment purposes. Assume that the prescribed interest rate was 4% for all of 2023. The purchase of the automobile took place on January 4, 2023 as described in (4) below. (3) Susie received monthly allowances as follows: (a) $450 a month for her automobile expenses and (b) $300 a month to cover the costs she incurred in travelling out of town to meet clients and entertaining clients. (4) Susie incurred the following automobile related expenses during 2023 (including HST of 13% where applicable). She drove her automobile 95% for employment purposes during 2023. (a) Purchase price of a new vehicle acquired January 4, 2023 . . . . . . . . . . . . . . . . $41,400 (b) Maximum CCA for 2023 (Class 10.1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,289 (c) Gas and oil . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,500 (d) Maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,300 (e) Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,600 (f) Licence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90 (5) Susie incurred travel and entertainment related expenses during 2023 (including HST of 13% where applicable) as follows: (a) Meals for meetings with out-of-town clients (she was out of town for more than 12 hours on all occasions) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,400 (b) Accommodation for meetings with out-of-town clients ................................................. 4,200 (c) Hamilton Symphony Orchestra tickets for entertaining . . . . . . . . . . . . . . . . . . 900

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Ch. 3/Study Guide — Exercises

(6) Susie maintains an office in her home as required under her employment contract. This workspace is her only available office. Susie estimates that appro Ximately 10% of the total square footage of her home is occupied by her home office. She has provided the following TOTAL expense amounts (including HST where applicable) for expenditures made during 2023 related to her home. (a) Mortgage interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 8,000 (b) Property taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,300 (c) House insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600 (d) Repairs and maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 450 (e) Repainting office only . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300 (f) Office supplies consumed in the course of employment . . . . . . . . . . . . . . . . . . 200 — REQUIRED (A) Determine Susie Sellem’s employment income for tax purposes for 2023. Ignore the effects of a leap year in your answer. (B) Indicate briefly why you did not use any of the above information in your response.

Exercise 13 Rae Bob is currently the director of human resources for a relatively small region of Strikebusters Ltd. (SL), located in Windsor, Ontario. She is seriously considering accepting a promotion to the position of director of human resources for the company’s largest office, located in London, Ontario. SL has agreed to help her finance the purchase of a new home and relocate her family to London. She has a letter from SL outlining her new job responsibilities and her compensation package, should she choose to accept the promotion. The compensation package is attractive but she is uncertain of the tax consequences. She has asked you to advise her. In addition to an annual salary of $125,000, SL has offered the following to Rae if she accepts the promotion:

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(1) Rae is to receive a lump-sum payment of $20,000 on January 1 of this year coinciding with the effective date of her promotion. This payment is to compensate Rae and her family for the emotional upheaval and inconvenience associated with moving to a new city. (2) Rae will be a member of the company’s defined benefit registered pension plan. Membership in the plan is limited to the London office key executives. This year, Rae and SL will each be required to contribute $10,000 to the plan. (3) SL will pay 100% of the premiums for extended health coverage, a dental plan and group term life insurance coverage of $125,000. (4) SL will provide Rae with a monthly car allowance of $600. She expects her actual costs of operating the car (personal and employment combined) to be $600 per month. (5) SL will loan Rae $150,000 to help finance a new house in London. The loan will bear interest at 2% per annum payable no later than 30 days after the end of the year. (6) SL will loan Rae $20,000, interest-free, to help her finance the purchase of a new car. Rae expects to purchase a $40,000 car, including HST @ 13%. Her job responsibilities require her to provide her own car. Her responsibilities are such that she expects that 95% of the usage of the car will be in carrying out her duties of employment. (7) Rae is concerned about selling her Windsor home as house prices in Windsor have fallen significantly. SL has offered to reimburse Rae for any loss she incurs on the sale of her Windsor home, as well as for the cost of hiring a moving company to pack and move her furniture and personal effects from her Windsor home and unpack them in her London home. All other costs incurred by her, related to the move, will be reimbursed also. (8) Rae will be permitted to participate in the company’s stock option plan. She will be permitted to purchase 500 non-voting, fully participating common shares of SL over the next five years, with a stipulation that she cannot purchase more than 200 shares in any one calendar year. The option price will be $18 per share. The shares are currently valued at $21 per share and are expected to increase in value.

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Introduction to Federal Income Taxation in Canada

46 The following additional information has been provided:

(a) SL is a Canadian-controlled private corporation; (b) the distance between Windsor and London is greater than 40 kilometres; and (c) the prescribed rate of interest is 4% for the first two quarter of this year and will increase to 5% for each of the last two quarters. All loans were issued on January 1 of this year. — REQUIRED Comment on the tax implications of each item in the compensation package.

Exercise 14 Mr. Macher, a film director of repute, entered into a verbal agreement with Shlock Films Ltd., a production company, to provide his talent and energy in the direction of commercials. There was no specific term to the agreement, but Mr. Macher agreed not to direct commercials for other production houses. The director was responsible for finding clients to create business. He was reimbursed for certain expenses such as lunches with clients and promotion. Prior to production of a commercial, he would be involved in discussions with the clients on planning the commercials and these discussions would take place in various offices including those of the production company and the clients or in restaurants. During the production phase, the director was in charge of the talent and the crew. This phase could take place in a studio or on location anywhere. At the post-production stage, the director was responsible to put the commercial together by directing the work of editors and sound engineers. In general, the director had artistic control over the commercial, while the production company provided the finances and had an input on decisions such as overtime shooting. The director selected the talent and could hire his own assistants. The production company provided and paid for the equipment, such as cameras and lights, and the individuals who worked on the film, such as editors, camera crew, sound crew, lighting crew and assistant script writers. Mr. Macher was paid $905 every two weeks or $22,000 for a year as a retainer or guarantee for his services. He was also paid $850 per shooting day. He was not paid for re-shooting if he made an error. To be paid, he had to invoice the production company. He reimbursed the production company for its share of the premium for the medical plan in which he participated. He had no specified hours of work. He had no profit-sharing arrangement and no ownership rights in the commercials he made. The CRA disallowed Mr. Macher’s unreimbursed expenses incurred in the work he did on the basis that he was not self-employed. — REQUIRED As a judge of the Tax Court of Canada, discuss and evaluate the positions of Mr. Macher and of the CRA.

Exercise 15 June is a salesperson who earned a total of $40,000 in the current year, including $5,000 in commissions. She was required to travel in her job and was required to pay her own expenses, which consisted of the following annual amounts (including HST when applicable): (a) entertainment of clients (incurred in equal monthly amounts), including golf membership dues of $600 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,700 (b) home office expenses (including an allocated portion based on square footage of the home office of mortgage interest of $700 and municipal taxes of $250) . . . . . . . 3,500 (c) car operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,900 (d) interest paid on bank loan to purchase car (12 months of payments) . . . . . . . . . . . . 1,500 (e) convention dues (excluding meals and entertainment) . . . . . . . . . . . . . . . . . . . . . . 700 (f) meals expense (incurred in equal monthly amounts) while travelling (away from the metropolitan area of her employer for more than two days at a time) . . . . . . . . 1,000

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Ch. 3/Study Guide — Exercises

She owns her own car which she uses for employment purposes. The capital cost allowance available on the car for the year is $4,000 before reduction for employment use. The car was driven a total of 28,000 kilometres during the year, of which 18,000 kilometres were driven in the course of her employment. — REQUIRED Calculate June’s minimum employment income under the following independent assumptions: (1) She received no kilometre allowance for the use of her automobile in carrying out her duties of employment. (2) She received an allowance of $0.35 per kilometre plus a yearly allowance of $1,200. She received both allowances for the use of her car in carrying out her duties of employment. The allowances were in addition to her $40,000 income. Ignore the effects of a leap year and the HST rebate in your answer.

CHAPTER 3 ¶3,825

Introduction to Federal Income Taxation in Canada

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ASSIGNMENT PROBLEMS

Problem 1 You have come out of a meeting with Lisa, one of your personal tax clients. She is about to start a job with a public company and, as part of the compensation package, she is offered the use of a company car. She is given the choice between two options and she wants your opinion on which she should choose. The make, model, and year of the car are the same in both cases. She expects to drive about 24,000 km per year. However, she is not sure how many personal versus business kilometres she will be driving. She expects it will be either 60% business or 40% business. Assume that she is in the 42% combined (federal and provincial) marginal tax bracket. She has asked you to analyze the options below to determine which option minimizes her taxes payable on the automobile benefit. Option 1: The company will provide a company-owned automobile that costs $50,000 (before HST of 13%). The company will cover the insurance and operating costs which will cost $8,000 per year. Option 2: The company will provide a company-leased automobile that costs $1,100 per month (before HST of 13%). The company will cover the insurance and operating costs which will cost $8,000 per year.

Problem 2 You have been asked for advice on employee stock options by two different clients. (a) Omer is part of the management team of a Canadian public company and is eligible for the employee stock option plan. A few years ago he received an option on 1,000 shares. The current price of the shares is $35, and he is optimistic that it will go up. The option requires him to pay the option price of $30 (the fair market value at the time the option was granted) for the shares at the time he exercises his option. He plans to sell these shares when they reach $45. He has asked you to tell him the amount of income he will have to report and when he must report as a result of exercising the option and buying the shares for $30. (b) Hilda is part of the management team of a Canadian-controlled private company and is eligible for the employee stock option plan. A few years ago she received an option on 1,000 shares. The current price of the shares is $35, and she is optimistic that it will go up. The option requires her to pay the option price of $30 (the fair market value at the time the option was granted) for the shares at the time she exercises her option. She plans to sell these shares when they reach $45. She has asked you to tell her the amount of income she will have to report and when she must report as a result of exercising the option and buying the shares for $30.

Problem 3 Rishma, a good friend from your university days, has just left your office. She remembered that you have specialized in tax and has come to you for advice on an offer of employment that she has received. Motion Tech Inc., a public company, has offered her the position of VP of Human Resources. Motion Tech has a year end of November 30th. Her start date is one month from now. She has made the following list of items that are included in the package and would like your advice on the tax consequences of each: (1) A salary of $90,000 per year, payable by direct deposit on the last day of each month. (2) A bonus payable based on the year-end results of the company. The bonus would be up to $10,000. (3) Motion Tech has a defined contribution registered pension plan where Rishma and the company each contribute 6% of her salary. (4) Since she will have to move to Waterloo to take up this position, the company will pay her an allowance of $15,000 to cover her moving expenses.

¶3,850

ITA: 5(1); 6(1)(a), (b); 8(1)(m); 62; 118.2(2)(q); Income Tax Folio S2-F3-C2

Ch. 3/Study Guide — Assignment Problems

(5) Motion Tech will cover the annual dues for a fitness club up to a cost of $2,000 per year. (6) The company will pay for Rishma to have her personal tax return prepared at a cost of up to $1,000. (7) The company provides a group health plan administered by Manulife, including glasses. Rishma will pay about $200 per month and the company will pay about $800 per month. Comment on the tax implications of each item outlined in the offer of employment. Discuss both the current and future tax implications, if applicable.

Problem 4 You are working in the finance department at Auto Supply Inc. during your co-op work term. The CFO knows you have just taken a tax course and has asked you to do some research for him. The company is looking at possible employee benefit options and would like you to write a memo explaining whether each of the following would be considered taxable benefits of the employees. (1) Free parking. (2) Wedding or birthday gifts of up to $200. (3) All-expense paid holiday won as part of a sales contest. (4) The employee uses frequent flyer points for a personal trip. These points were earned as a result of business trips. (5) The company provides an employee discount of 24% on products sold by Auto Supply. (6) The company pays to provide financial counselling for all vice presidents, including the preparation of their personal tax returns.

Problem 5

ITA: 6(9), 8(1)(j), 80.4, 80.5

Leonard Lewis, an employee of BGE Ltd., received the following loans on January 1 of this year from his employer: $15,000 loan to purchase a car to be used primarily for employment purposes . . . .

$100,000 loan to purchase a home . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$10,000 loan to consolidate his other debts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Leonard does not receive a mileage allowance and is specifically required by his contract to pay his car expenses. According to Leonard’s travel log, he used the car for employment purposes, for 27,000 kilometres out of a total of 45,000 kilometres. Assume that the prescribed rates for this year were: 1st Quarter — 7%

3rd Quarter — 8%

2nd Quarter — 6%

4th Quarter — 7%

Leonard paid the interest on these loans on January 15 of the following year. Compute the interest benefit and any deduction for interest. Ignore the effects of any leap year.

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(7) The company will pay for annual professional dues for employees. For example, accountants and lawyers.

Introduction to Federal Income Taxation in Canada

Problem 6

ITA: 8(1)(f), 8(1)(i), 8(4)

Reille travels extensively with Biotech Corporation to market new pharmaceuticals throughout Canada. He is paid a base salary of $2,200 per month plus a 2% commission on gross sales. Reille was required to incur the following expenses to earn $24,000 in commission income: Hotel and airfare .............................................. $18,000 Out of town meals . . . . . . . . . . . . . . . . . . . . 4,000 Entertainment meals . . . . . . . . . . . . . . . . . . 2,500 Professional dues . . . . . . . . . . . . . . . . . . . . . 250 Notebook computer . . . . . . . . . . . . . . . . . . . 3,900 Total ............................................................... $28,650

Compute employment expenses deductible under section 8 of the Act.

Problem 7

ITA: 6(1)(b), 13(7)(g), 67.2; IT-522R

Ms. Irvine, who is employed by Susan’s Super Ltd., travels extensively across Canada in her role as an internal auditor. According to the terms of her contract, she receives an accommodation allowance of $10,000 per year. The contract states that she must use her own automobile and pay for all travelling expenses. Ms. Irvine acquired a new car, on January 5, 2023, for $42,000 plus HST at 13%. Her kilometres for business purposes were 16,000 out of a total of 21,000 kilometres. During the year, Ms. Irvine paid the following amounts, all of which are reasonable in the circumstances and which are supported by receipts: (a) accommodation, including meals of $4,500 (including HST) ............................ $12,000 (b) total car expenses: gas (including HST) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,500 maintenance (including HST) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500 insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,200 licences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90 interest on bank loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,000 Ms. Irvine calculated her capital cost allowance to be: (1.5 × 30% × $36,000 × 1.13) = $18,306 Ms. Irvine also filed the prescribed form (T2200) which her employer had signed. Assume that the employment use of the car is reasonable in the circumstances. Discuss the tax consequences of the allowance and related expenses plus the deductibility of the car expenses. Ignore the effects of any leap year or any potential HST rebate implications. ITA: 6(8); ETA: 253(1)

Problem 8 Harry Chow, the owner of Chow Installation and Repair Ltd. (‘‘Chow’’) has come to you for advice, but first he describes his business. Chow is in the business of installing and repairing overhead doors. Chow maintains a list of qualified installers and repair-persons and contacts them as work becomes available. Chow informed these workers that they would be considered to be running their own business, so no withholding of income tax, EI or CPP is made. Workers are paid by the job and work mostly on their own. If the person contacted refuses the assignment, Chow will call the next person on the list. The person who agrees to the job goes directly to the job site; he or she does not report to Chow’s work place, except to pick up a door or parts. Chow supplies the doors and the parts used in the repair or installation. Each worker maintains his or her own truck and tools. Chow, however, owns specialized racks made for transporting the doors and a special drill which can be used on cement. These items are available to any worker who requires them.

¶3,850

ITA: 248(1); Wiebe Door Services Ltd. v. M.N.R., 87 DTC 5025 (F.C.A.)

Ch. 3/Study Guide — Assignment Problems

Chow guarantees all work for one year. Under the terms of the agreement between Chow and the workers, if a guarantee has to be honoured, the worker will be responsible to fiX any defects. If any parts are required to correct the defect, the worker has to pay for them. Harry then asks you the question he wants advice on, ‘‘What is the risk that his installers will be considered employees for tax purposes?’’ He has heard that some other businesses are being reassessed and are facing significant liability for withholding taxes and he wants your advice on what his risk of reassessment is. You have agreed to meet with Harry again in one week and provide him with advice on this issue. As you think about how you will approach this assignment, you decide that you need to determine whether the workers should be considered employees of Chow or independent contractors. To do this you will need to consider the tests that are applied by the courts to this type of situation, and relate the facts of this case to those tests.

Problem 9 Miriam, the sole tax adviser of a financial planning firm, is contemplating an offer to become Director of Taxation of Neil Manufacturing Limited (NML) of Dundas, Ontario. The offered compensation package would include the following:

ITA: 5, 6(1)(a), 6(1)(b), 80.4; Income Tax Folio S2-F3-C2

● a salary of $142,000 per year, payable monthly; ● a one-time flat allowance of $25,000, payable on acceptance of the position, to help move her and

her family to Dundas; ● a company contribution of 6% of her salary to a defined benefit registered pension plan; ● company payment of the premiums for extended health coverage and a dental plan provided by

Star Insurance; ●

company payment, valued at $900, for the preparation of her tax return by the company’s accountants;

● company payment, valued at $2,500, for her membership in the Dundas Valley Golf and Curling

Club; ● a company loan of $180,000 to help finance the purchase of a new home in Dundas. The loan will

CHAPTER 3

bear interest at 2% per year payable monthly and will be made on May 1 of this year, the closing date on the purchase of the home. Miriam does not deal with many employment-related tax issues and recognizes the need for a corroborating opinion on the tax consequences of this compensation package. She has asked you to comment on the income tax consequences for employment income of each item in the compensation package. Assume that the prescribed rate of interest for employee loans was 4% on May 1 but decreased to 3% for the last two quarters. Ignore any effects of a leap year.

Problem 10 Erin is an employee of TD-ROM, Inc., a public company. In 2023, her compensation package was as follows:

ITA: 5, 6(1)(a), 6(1)(b), 80.4; Income Tax Folio S2-F3-C2

Gross salary .................................................................................................................. $79,000 Less: Payroll deductions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Employee contribution to a registered pension plan ............................................ (3,000) Charitable donations — United Way ................................................................................ (55) Canadian Pension Plan contributions .................................................................... (3,754) Employment Insurance contributions .................................................................... (1,002) Net pay received ..................................................................................................... $71,189

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Introduction to Federal Income Taxation in Canada

Non-cash perks: Employer contribution to a registered pension plan . . . . . . . . . . . . . . . . . . . $ 3,500 Private dental plan valued at . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 800 Mandatory employer-paid provincial health tax . . . . . . . . . . . . . . . . . . . . . . $ 450 Reimbursement of moving expenses for relocating from Edmonton . . . . . . . $ 900 Club membership (for company promotion) . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,800 Supplier’s prize for outstanding employee sales — Hawaii golf trip valued at $ 6,000 Bonus declared but not paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,000 Hard hat and safety glasses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 450 The company states that club memberships should be used for business promotion. TD-ROM also offered Erin a stock option to purchase 1,000 corporate shares at $12 a share. On June 4, 2023, she exercised the option. As of December 31, 2023, Erin had not disposed of the shares. February 1, 2023, Fair market value — Grant date ............. $11 June 4, 2023, Fair market value — EXercise date .............. $19 December 31, 2023, Fair market value ............................... $16 Erin has asked you to calculate her income from employment for income tax purposes.

Problem 11

ITA: 5, 6, 7

Three senior executives are renewing their employment contracts with Global Consulting Ltd., a public corporation. The corporation has provided each of them with the following alternative compensation plans for 2023 in addition to the $145,000 base salary each receives: (a) A cash raise of $5,000 in 2023. (b) A bonus of $5,500 payable in 2024. (c) Use of the company condominium in Hawaii for two weeks, valued at $9,000. (d) A stock option arrangement to purchase 1,000 shares of Global Consulting, a public company, in December 2023, when the fair market value of the shares is $5, and the option price would be $3.50 per share. Management anticipates the share price in December 2024 will be $6.50. The senior executives have asked you to analyze the various alternatives and provide a recommendation. You agreed to assume a marginal tax rate of 45%.

Problem 12 Craig Hunt is the general manager of the local professional hockey team, the Vancouver Golden Seals Ltd. (a Canadian public corporation). Assume that today’s date is November 15 in the current year. Craig has obtained approval from the owner of the hockey club to offer a contract to a 27-year-old free agent player who is available to the highest bidder. In addition to an offer of a $300,000 signing bonus and a $750,000 annual salary, Craig is authorized to offer the following two items as additional compensation: (a) an interest-free employee loan of $100,000 that will eventually be forgiven by the hockey club; and (b) a stock option to buy 100,000 common shares of Vancouver Golden Seals Ltd. Assume that on the grant date, the fair market value of the common shares is $10 per share, and that the exercise price will be $10 per share. Craig has asked for your advice on the following: (a) Assuming the player will exercise all shares when the FMV is $15.00 per share and then sell the shares immediately on the open market, outline the income tax consequences with respect to the stock option and explain how this will affect the player’s net income for tax purposes.

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ITA: 6, 110(1)(d)

Ch. 3/Study Guide — Assignment Problems

(b) From the player’s perspective, what, if any, are the consequences of the signing bonus and the proposed employee loan that will be forgiven in the final contract year? (c) Assuming instead that the loan will not be forgiven, calculate the deemed interest benefit of the loan for the current taxation year and the next taxation years. Assume the prescribed rate of interest on the loan is 4%. Ignore the effects of any leap year.

Problem 13 Your best friend, Mitch, was at a sales conference recently. During one of the breaks, he entered into a conversation with one of the other attendees, Darly, regarding the perks provided by their respective employers. In both cases, the employer provides a car. However, Darly commented on the significant tax advantage available to her since her employer leased the car instead of buying the car. Mitch was able to obtain all of the information from Darly regarding her car.

ITA: 6(1)(a), 6(1)(e), 6(1)(e.1), 6(1)(k), 6(2), 6(2.2)

Mitch has come to you for some ‘‘free’’ tax advice. He has asked you to compare the tax position he is in currently with the employer-owned car to the position that Darly is in with the leased car. Mitch Capital cost of the car including HST . . . . . . . . . . . . . . . . . . . . . . . . . . .

$38,772

Capital cost allowance claimed by the employer . . . . . . . . . . . . . . . . . . .

6,375

Operating costs paid by the employer (including HST) . . . . . . . . . . . . . .

4,250

Kilometres (as calculated from Mitch’s log): Employment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

8,000

Personal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

10,000

Amount reimbursed to the company for the personal use at 14 cents per kilometre . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 1,400

Darly Lease cost including $1,650 of insurance and HST . . . . . . . . . . . . . . . . .

$12,450

Operating costs paid by the employer (including HST) . . . . . . . . . . . . . .

2,975

Employment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

23,000

Personal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

9,000

Amount reimbursed to the company for the personal use at 9 cents per kilometre . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

CHAPTER 3

Kilometres (as calculated from Darly’s log):

810

Mitch wants you to calculate the minimum car benefit that would be included in employment income for the current year for both him and Darly.

Problem 14

ITA: 8(1)(h.1)

Crowchild Pipelines Corporation has offered Bing Lee a base salary of $65,000. Bing must choose one of the following compensation packages for the use of his personal automobile. (a) To receive a reasonable car allowance of $6,000 per year to compensate for the operating expenses and the depreciation of his Jeep, used to drive to remote work sites. The allowance is based on the kilometres to and from the remote location, multiplied by the number of workdays. (b) To submit receipts for all of his operating expenses for full reimbursement. Bing estimates that his total operating expenses are $4,000 annually. However, this amount does not cover the wear and tear on his car. Bing will use his car appro Ximately 65% of the time for employment and he will be able to claim capital cost allowance (tax depreciation) equal to $3,000. Bing has a marginal tax rate of 45%. He has asked you to determine, with explanation, whether he would be indifferent to the choice between these two compensation packages?

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Introduction to Federal Income Taxation in Canada

Problem 15

ITA: 5, 6(3)

Chrisa had been an employee of David Hardware, a hardware product distributor, for 15 years. Chrisa sold the David hardware products directly to hardware stores. She was a salesperson and she was paid 100% by commission. Chrisa was personally responsible for all of her business expenses. EXpenses, for example, for office supplies, stamps, telephone, parking, entertainment, promotion and samples, were supported by receipts and she deducted them. During the years that Chrisa was employed by David, she sold products and developed the hardware market in her geographic area. One of the ways in which she developed the market was by ‘‘renting’’ floor space in various stores to display the David products. However, no receipts were received from the various stores, because in many ways the money was considered a ‘‘tip’’ by the managers of the hardware stores. Chrisa did not deduct these expenses. Through this process, Chrisa had significantly increased David’s sales in her sales region and she had developed a loyal following in the hardware business. At the time of Chrisa’s departure from David, David paid $15,000 to Chrisa. The conditions of the agreement surrounding the $15,000 payment were as follows: ● ●

●

David was ‘‘buying back’’ Chrisa’s sales territory; Chrisa agreed not to enter a similar business to that of David’s business, in David’s distribution area, for a period of three years; and David and Chrisa agreed that the $15,000 would constitute a reimbursement of capital invested by Chrisa (i.e., the amounts she had paid to the stores for the rental of floor space for David products).

Chrisa has asked you to explain the income tax implications of the receipt of the $15,000.

Problem 16

ITA: 5, 6(1), 7, 8(1)

The following information relates to Leonard, a middle-management accountant, not engaged in negotiating contracts, of a public corporation, Peter Productions Ltd. which is located in Ontario. (A) Salary — gross . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 90,000 Payroll deductions: Income taxes ................................................................................... $26,100 Registered pension plan (money purchase; see (B) below) . . . . . 5,500 Canada Pension Plan contributions (incl. enhanced portion of $461) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,754 Employment Insurance contributions . . . . . . . . . . . . . . . . . . . . . 1,002 Charitable donations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 350 Employee’s portion of benefit plans (see (B), below) . . . . . . . . . . 800 (37,506) $ 52,494 (B) The company paid the following additional matching amounts on behalf of Leonard (an equal amount was withheld from salary as the employee’s contribution, as shown in (A) above): Registered pension plan ........................................................................................ $5,500 Dental plan — Sun Life Co. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175 Group income protection — Royal Insurance Co. . . . . . . . . . . . . . . . . . . . . 225 EXtended health care — Liberty Mutual . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150 Group term life insurance — General Insurance Co. . . . . . . . . . . . . . . . . . . 250 The group term life coverage for Leonard was $300,000.

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Ch. 3/Study Guide — Assignment Problems

(C) Selected additional information concerning Leonard’s receipts, disbursements, and other benefits: (i) Trip to Europe from one of Peter Productions Ltd.’s clients in appreciation of Leonard’s services (including HST) . . . . . . . . . . . . . . . . . . . . . . . . . . . (ii) Periodic payments received from Royal Insurance under the group income protection plan during a three-month illness. This plan had been in existence since 2010 and Leonard’s share of the premium since that date was $2,300 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (iii) Peter Productions Ltd. paid Leonard’s annual membership fee in a golf club . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (iv) Early in 2023, Leonard was granted an option to purchase 1,000 of the company’s shares for $2 per share. At that time the shares were trading on the market at $3 per share. Later in the year, Leonard exercised the option and acquired 1,000 shares when they were trading at $4.50 per share. In December 2023, he needed cash, so he sold the 1,000 shares for $5 each. (v) Leonard paid the following amounts during the year: Annual membership fee of a professional accounting body (including HST) Registered retirement savings plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 6,000

12,000 2,100

800 3,500

Leonard has asked you to calculate his employment income for 2023. For your files you also should document why you omitted any of the items mentioned above. Ignore the effects of any leap year or any potential HST rebate implications.

Problem 17 On September 1, Maria Battelio, a Calgary resident, commenced work as an investment dealer with Top Investments Corporation. Prior to September, Maria was a fourth-year commerce student at the University of Alberta. Maria’s contract of employment required that she use her own car and incur the necessary expenses to earn commission income. Maria purchased her car on September 1 for $21,000. Top Investments Corporation lent her the $21,000 for the car and she agreed to repay them $7,000 annually, without interest, on December 31 of each year. Assume that Maria’s deductible capital cost allowance (net of personal use) on her automobile is $3,000 (prorated for employment portion).

ITA: 5(1), 6(4), 8(1)(f), 8(1)(j); Income Tax Folio S2-F3-C2

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Total distance travelled from September 1 to December 31: Total kilometres driven ......................................................................................... 12,500 Personal kilometres driven ...................................................................................... 5,000 Maria received the following net pay in the year: Gross salary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6,000 Commissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,000 Bonus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000 Employment Insurance contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (352) Canadian Pension Plan contributions (incl. enhanced portion of $141) . . . . (1,238) Charitable donations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (396) Income tax withheld at source . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,600) Net pay ............................................................................................................... $17,414 To earn commission income, Maria incurred the following: Meals and entertainment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,300 Client promotion materials...................................................................................... 1,500 Gasoline and operating expenses ........................................................................... 1,600 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,400 Top Investment paid for the airfare and accommodation for Maria and her spouse to attend a conference in New York. The trip cost $800 for each person attending the conference. The company also pays premiums of $400 per employee for group life insurance with coverage of $100,000. Assume a 7% prescribed rate of interest on the employee loan. Maria would like you to calculate her income from employment. Ignore the effects of any leap year.

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Problem 18

ITA: 5(1), 6(1)(a), 7(1), 8(1)(f), 8(1)(i)

Susanna Sculley, a marketing representative with MBI Technology Inc. (a public company), provided the following information relating to her current year’s personal income tax return. Susanna’s cumulative pay at year end revealed the following: Gross pay Base salary ................................................................................................ $48,000 Gross commissions...................................................................................... 23,500 Daycare subsidy program ............................................................................. 1,200 Deductions from gross pay Employment Insurance contributions ....................................................... (1,002) Canadian Pension Plan contributions (includes the $631 enhanced portion of CPP) ...................................................................................... (3,754) Union dues ..................................................................................................... (280) Income tax paid ................................................................................... (19,800) Net pay ............................................................................................................... $47,864 EXpenses to earn commission income Meals and entertainment ............................................................................. 2,300 Hotel and travel incidentals ......................................................................... 1,780 Airfare ..................................................................................................... 1,800 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,880 MBI also granted Susanna a stock option, which she exercised in April of the current year. The following information relates to the stock option: Number of shares for options exercised.................................................................. 1,000 Fair market value — grant date ................................................................................... $1.50 Option price ........................................................................................................ $1.80 Fair market value — exercise date .......................................................................... $2.50 Susanna’s employer did not reimburse her, or provide her with an allowance for the expenses incurred to earn commission income. However, MBI did expect her to take clients out for lunch and travel when necessary. Susanna would like you to calculate her income from employment for the current year.

Problem 19 Sylvanna Chapelle, a national sales manager at Merche Tools Ltd. in Peterborough, Ontario, presented the following information for the current taxation year. (1) Gross salary ........................................................................................ $48,000 Bonus based on sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,000 Less payroll deductions: Employee contribution to a Registered Pension Plan . . . . . . . . . (4,000) Charitable donations — Heart Foundation . . . . . . . . . . . . . . . . . (150) Canada Pension Plan contributions (includes the $631 enhanced portion of CPP) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3,754) Employment Insurance contributions . . . . . . . . . . . . . . . . . . . . (1,002) Net salary .............................................................................................. $79,094 According to Sylvanna’s contract of employment, she must travel to Vancouver, Edmonton, Calgary, and Regina to oversee operations in western Canada. Sylvanna must pay for travelling and promotional expenses. The company does not provide her with a travelling allowance. Instead, Sylvanna receives a bonus based on a percentage of western Canada sales. Sylvanna’s travelling expenses were as follows:

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ITA: 5(1), 6(1)(a), 7(1), 8(1)(f), 8(1)(i)

Ch. 3/Study Guide — Assignment Problems

57 ITA: 5, 6, 7, 8

(2) Meals while travelling out of town (45 days) . . . . . . . . . . . . . . . $ 1,500 Accommodation.................................................................................... 5,200 Airfare .................................................................................................. 7,800 Taxi .........................................................................................................500 (3) Client promotion costs: Company logo shirts and golf balls . . . . . . . . . . . . . . . . . . . . . . $ 700 Client meals and entertainment .......................................................... 2,200 Holiday gifts for prospective clients ..................................................... 3,500 Annual golf membership ....................................................................... 1,800 (4) Sylvanna’s employment contract also required her to travel to the Oshawa manufacturing plant and four other warehouse outlets in Southern Ontario. The corporation provided her with a new fourdoor van last year. The cost of the van, including HST of 13%, was $36,000. The company also paid $2,400 for 100% of the operating cost. Sylvanna used the vehicle for the full calendar year for both employment and weekend pleasure. Personal kilometres driven totalled 9,900 and total kilometres driven is 18,000. (5) Merche Tools also paid out the following amounts: Tax return preparation for Sylvanna . . . . . . . . . . . . . . . . . . . . . $ 350 Life insurance premium .................................................................... 150 Sylvanna would like you to calculate her income from employment for income tax purposes for the current year.

Problem 20

ITA: 5, 6; Income Tax Folio S2-F3-C2

CHAPTER 3

Anita Lee, Vice-President of Gary Inc., has asked for your assistance concerning the tax implications of certain amounts and benefits she received from her employer during 2023. Salary, gross ................................................................................................................$ 90,000 Payroll deductions: Income taxes .................................................................................$26,100 Canada Pension Plan premiums (includes the $631 enhanced portion of CPP) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,754 Employment Insurance premiums . . . . . . . . . . . . . . . . . . . . . 1,002 Group accident disability insurance premiums . . . . . . . . . . . . 110 ( 30,966) Net pay ................................................................................................................. $ 59,034 Additional Information (1) In November 2023, Anita was in a skiing accident and was unable to work for four weeks. During this period she received disability payments totalling $1,600 from Paris Life Insurance Ltd. Half of the disability insurance premiums were paid by Gary Inc. and half by Anita (see payroll deduction above). Anita has paid a total of $350 in disability insurance premiums since she commenced employment at Gary Inc. in 2020. (2) In 2023, Gary Inc. paid $424 (including HST) for the preparation of Anita’s 2022 income tax return and $530 (including HST) for Anita to see a financial planning consultant regarding retirement planning. (3) Anita is taking courses towards her M.B.A. degree on a part-time basis during the evening. She is taking the courses on her initiative and for her own benefit. During 2023, Gary Inc. paid for the tuition for these M.B.A. courses which amounted to $1,000. Gary Inc. also paid $400 in tuition for Anita to attend a two-day computer workshop on company time to learn about the new software system that the company had just installed.

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(4) Director’s fees of $2,000 were received by Anita from Clint’s Hi-Tech Ltd., a company owned by Anita’s spouse. (5) Birthday gift of $200 cash was received and was expensed by Gary Inc. (6) Anita received an employee loan of $8,000 on January 15, 2023, at 1% interest to purchase a notebook computer for personal use. The interest was payable on each anniversary date of the loan, and Anita paid the interest owing on the loan on the due date in 2024. Assume that the prescribed interest rates applicable to employee loans for 2023 are: first quarter, 3%; second quarter, 2%; third quarter, 4%; fourth quarter, 2%. (7) For 12 months, Gary Inc. paid Anita a monthly gas allowance of $250 regardless of the number of kilometres she drove. In addition, she was provided with a company-owned automobile costing $38,500 (including HST) at the beginning of January. Anita’s kilometres for personal use were 16,000 out of a total of 25,000 kilometres. Operating costs paid (excluding gas) by Gary Inc. during 2023 amounted to $2,920, including insurance of $600 and HST. (8) Anita and her spouse Clint were provided with Gary Inc.’s condo in the Bahamas for a one-week holiday during the winter. E Xcluding HST considerations, such accommodation during this peak period would have cost them $500 as opposed to the $100 actually paid by Anita. (9) Anita used her frequent-flyer points accumulated as a result of her business trips (which had been paid by Gary Inc.) for her holiday in the Bahamas. She saved $800, plus $104 of HST, by using the frequent-flyer points. (10) Anita bought merchandise from Gary Inc. during the year and saved $180 (excluding HST of $23) using its 30% employee discount, which is available to all employees. Gary Inc.’s mark-up is 100%. Anita would like you to calculate her employment income for 2023. For your file you also should document the basis for your decision to include an item or not (i.e., whether it is based on the Act or on the CRA’s administrative position). You decide to ignore the impact of any leap year.

Problem 21

ITA: 5, 6, 7, 8, 67.1, 67.2, 67.3; IT-352R2

Robby Beamon has recently been appointed vice-president of sales and marketing for Lori’s Unpublished Books Limited, a public company. Robby has come to you for advice regarding the tax implications of his new position. During your meeting you were able to determine the following information: Remuneration for the year: Salary — gross . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: CPP contributions (incl. $631 enhanced portion) .................... $3,754 Income tax .............................................................................. 24,592 Employment Insurance contributions.......................................... 1,002 Disability insurance premiums . . . . . . . . . . . . . . . . . . . . . 600 Net pay . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Bonus based on company sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Allowances for the year (paid monthly): meals, accommodation, and air travel . . . . . . . . . . . . . . . . . . . . . . . . car . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . entertainment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Moving allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$84,800

29,948 54,852 13,000 34,000 6,300 2,000 15,000

Robby has summarized the following expenses related to his employment: Gas and oil — automobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Painting (office only) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Licences — automobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Meals (consumed while travelling away for more than 12 hours) . . . . . . . House insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accommodation (while travelling on company business) . . . . . . . . . . . . . Interest expense — car loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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$ 3,900 100 100 7,000 800 10,000 3,600

Ch. 3/Study Guide — Assignment Problems General maintenance (house) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Car insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Hydro . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Air travel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Car maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fuel (house) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Property taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mortgage interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Salary (to wife, including payroll taxes and employer contributions) . . . .

59 300 1,900 700 4,200 1,000 700 1,200 4,500 24,000 15,000

Lori’s Unpublished Books Limited requires Robby to provide an automobile in order to carry out his duties of employment. Robby is responsible for his travelling expenses. On March 17, 2023, he acquired a new car for $46,000, including HST at 15%, financing part of the acquisition through a bank loan arranged for the same date. The capital cost allowance rate in the first year is effectively 15%. He estimates that he will drive 38,000 kilometres in the course of his employment. He expects his total kilometres to the end of the year to be 45,000. The car and the employment use are reasonable for his position and his work requirements. Robby has receipts for at least $650 of moving expenses related to his move to work for Lori’s Unpublished Books Ltd. Robby’s contract also requires that he maintain an office in his home, since no other office is provided. He is responsible for all costs related to the operation of the office. He does not receive an allowance or reimbursement related to any of these costs. Robby has estimated that the office occupies approXimately 15% of his home. This estimate is based on square footage. Robby estimates that if he had to rent a comparable amount of space he would have to pay $850 per month plus utilities. (A) Robby would like you to calculate his employment income for 2023, assuming that all expenses are reasonable in the circumstances and will be documented. Ignore consideration of the HST rebate. (B) Robby would also like you to recalculate his deductible expenses assuming the following:

ITA: 8(1)

● the car was leased instead of purchased on March 17, 2023.

CHAPTER 3

● monthly lease payments are $1,100 including HST at 15%. ● manufacturer’s list price is $48,500 excluding HST.

Problem 22 Author’s note: Chapter 21, Problem 2 addresses the HST Rebate implications for this problem. The GST/HST solution may be used in conjunction with the solution for this problem or as a separate assignment question. Anita Flare is a skilled tool and die worker. She has been working for Car Parts Inc., a large manufacturer of parts for the automobile industry for over 10 years. Car Parts Inc. is a Canadiancontrolled private corporation. Anita has become their ‘‘Jane on the Spot’’ as far as diagnosing and quickly retooling machinery that breaks down or needs to be updated to run a short order. Anita is single and she rents a home in north Toronto. Because Anita is required to travel for 75% of the year, Car Parts Inc. actually pays the $1,200 monthly rent on Anita’s home in Toronto. Anita reimburses the company for 25% of this amount ($300 per month) through payroll deduction as set out below.

ITA: 5, 6, 7, 8, 67.2, 67.3; Income Tax Folio S2-F3-C2

The head office of Car Parts Inc. is located in north Toronto. The company, however, has plants that are located throughout Ontario and Quebec, wherever there are large automobile manufacturing operations to be supplied with parts. When a plant requires emergency retooling or repair Anita is sent out to that location to supervise and organize the work. As stated above, this involves about 75% of Anita’s total employment hours for any given year. She stays at a particular location for a period of days or weeks depending on the nature of the job involved. She is never at a site for less than 36 hours. For the balance of the year, Anita works at the head office in the research department.

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Anita’s final 2023 pay stub showed the following totals for the year. Gross salary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $115,000 Payroll deductions: Income tax withheld . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $44,200 CPP contributions (incl. enhanced portion of $631) . . . . . . . . . . 3,754 Employment Insurance premiums paid . . . . . . . . . . . . . . . . . . . 1,002 Contributions to company group RRSP . . . . . . . . . . . . . . . . . . . 1,750 RPP contributions on account of current service . . . . . . . . . . . . 5,000 Union dues to Canadian Union of Automobile Workers (HST 800 exempt) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Group accident income protection insurance premiums (matched by company) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240 Monthly rent reimbursement (as described above).............................. 3,600 In discussion with Anita you determined that the company also provides the following fringe benefits. Payment of board and lodging costs at special work sites as required — at cost to company.................................................................................................. $18,000 Bonus based on company profits for the year above budgeted targets .................... 12,500 Provision of safety boots and company uniform consisting of five shirts and five matching pairs of pants; the shirt is embroidered with her name on the front pocket and has the company name on the back . . . . . . . . . . . . 450 Registered pension plan contributions to defined benefit plan ................................... 6,750 Monthly allowance of $150 to cover personal phone calls, laundry costs and other incidentals while travelling. (She estimates that she spends $100 per month.) ..................................................................................................... 1,800 Fitness club membership dues to a club with locations across Ontario (including HST); Anita feels that it is important to her productivity to remain in top physical shape as her work can be physically demanding . . . . . . . 805 Anita was injured on the job early in the year and received total payments of $11,500 out of the company group income protection plan for 2 months while she was recuperating. She had not previously received any payments under this plan and has paid total premiums of $2,880 into the plan since she began employment 12 years ago (this includes all of the year 2023 premiums paid through December 2023). Due to her extensive travel, Anita’s employer requires her to have an automobile for employment purposes. Anita has provided you with the following details of her automobile expenses. Leasing costs(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gasoline and oil (including HST) . . . . . . . . . . . . . . . . . . . Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Maintenance (including HST) . . . . . . . . . . . . . . . . . . . . . Licence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CCA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Owned car(1)

Leased car

n/a $2,880 1,333 400 90 1,207

$3,680 1,440 667 240 30 n/a

NOTES: (1)

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During 2023, Anita drove the owned car a total of 40,000 kilometres, of which 35,000 kilometres were employment related. (2)

Anita leased the car as of September 1, 2023, at a cost of $1,243 a month (includes $143 in HST). The lease is for a three-year period that will expire August 31, 2026. At the time that she leased the car, the manufacturer’s list price on the vehicle was $55,000 excluding all taxes. During 2023, Anita drove the leased car a total of 20,000 kilometres, of which 18,000 kilometres were employment related. Anita would like you to calculate her income from employment for 2023. Ignore the effects of any leap year. Please indicate why you did not include any of the above amounts in your answer with the appropriate cross-reference.

Problem 23 Author’s note: Chapter 21, Problem 3 addresses the HST Rebate implications for this problem. The GST/HST solution may be used in conjunction with the solution for this problem or as a separate assignment.

ITA: Subdiv. a of Div. B, 67.1, 67.3; Income Tax Folio S2-F3-C2

Mr. Ned Newell is employed by Snoopy-Snacks Ltd. (a Canadian-controlled private corporation). As of February 15, 2023, Ned was promoted to vice-president sales due to his hard work negotiating puppy snack contracts on behalf of the company. This promotion required Ned to relocate from the Toronto office of Snoopy-Snacks Ltd. to its Victoria, British Columbia office. Ned has provided you with the following information regarding his 2023 income and expenses. He requests your assistance in determining his 2023 employment income for tax purposes. $125,000 $45,000 3,754 1,002 6,750 120 180

CHAPTER 3

Payroll details: Gross salary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CPP contributions (incl. enhanced portion of $461) . . . . . . . . . . . Employment Insurance contributions . . . . . . . . . . . . . . . . . . . . . . Registered pension plan contributions: defined benefit . . . . . . . . . Group income protection premiums paid . . . . . . . . . . . . . . . . . . . Group term life insurance premiums paid . . . . . . . . . . . . . . . . . .

56,806 $ 68,194

Employer-paid amounts and fringe benefits paid by Snoopy-Snacks Ltd.: Dental plan premiums — paid to Star Insurance Company . . . . . . Group term life insurance premiums . . . . . . . . . . . . . . . . . . . . . . B.C. provincial health care premiums . . . . . . . . . . . . . . . . . . . . . . Group income protection premiums . . . . . . . . . . . . . . . . . . . . . . . Monthly allowance to cover travel and automobile expenses (based on a flat monthly amount of $400 for travel and $400 for auto) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Travelling expenses for Ned and his wife to Bermuda for a sales conference. Ned’s time was spent attending the conference but his wife was on vacation the entire time. No HST was payable on the trip since it was outside of Canada. One-half of the expenses related to Ned and one-half to his wife. . . . . . . . . . . . A birthday gift (a watch) received while in Ontario (including HST). Snoopy-Snacks Ltd. deducted the cost of this gift as a business expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Outside financial counselling fees (including HST). The counselling firm indicated that 80% of its fees relate to counselling for future retirement while the remaining 20% of its fees relate to tax preparation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

245 90 640 400

9,600

2,800

150

2,568

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62 Other Information:

(1) Snoopy-Snacks Ltd. provided Ned with some assistance that relates to his move from Toronto to Victoria. The details of that assistance are set out below. (a) Ned purchased a new home in Victoria just prior to his move. However, he could not take possession of that home until April 30, 2023. Snoopy-Snacks Ltd. paid Ned’s rent for a Victoria apartment for the months of February through April 2023. The rent paid was $1,200 per month. (b) Ned and Snoopy-Snacks Ltd. agreed that he would receive reimbursement from Snoopy-Snacks Ltd. for one-half of the loss realized by him on the sale of his Toronto home. Ned received $16,500 as a result of this agreement. (c) Ned received an allowance of $15,000 to cover his moving expenses. In addition to the above, Ned’s employer agreed to reimburse him an amount equal to one-quarter of his annual mortgage interest payment for the first five years of his mortgage on his new Victoria home. This was intended to compensate for higher real estate prices in Victoria. For 2023, Ned received $2,000 under the terms of this agreement. (2) Ned had unlimited use of the company’s private swimming pool. All management level employees are permitted to utilize this pool. The local private swimming pool charges annual fees of $1,800 per year before HST. (3) Ned had the following expenditures during 2023. Automobile operating expenditures: Lease payments for 12 months ($850 a month including HST of 12%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $10,200 (lease commenced July 1, 2022 for a period of three years; deducted lease costs for 2022 were $4,585) Gasoline and oil . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,300 Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,050 Maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180 Licence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120 Travelling expenditures: Meals (consumed while out of metropolitan area for greater than 12 hours) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,200 Accommodation .................................................................................... 12,000 During 2023, Ned travelled a total of 36,000 kilometres, of which 22,500 kilometres were employment-related. The manufacturer’s list price on his automobile was $33,000 before HST. Ned would like you to calculate his employment income for tax purposes for 2023, cross-reference your answer to the appropriate sections of the Act and/or Income Tax Folios, and for your files you should indicate why you did not include any of the above amounts in your answer with the appropriate cross-reference.

Problem 24 Sandra Rae has worked in the investment business in Calgary for 12 years and is a salaried plus commissioned employee. Recently, however, Sandra has wished for more independence in her career. The alternative of starting her own mutual fund company is neither feasible nor cost effective. A recent offer from a new investment corporation has drawn her attention. Sandra decided to enter into a contract arrangement with Global Investments Inc. According to the agreement, a license costing $10,000 would give her the right to use the Global name on her letterheads, business cards, and any promotional materials. Sandra could also participate in selling any Global Investment product. The arrangement is peculiar. According to the agreement, Sandra is required to execute a minimum of $750,000 in sales each year before her contract can be renewed for another year. Although Global Investments has an office in Calgary, the agreement stipulates that Sandra use her own

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Ch. 3/Study Guide — Assignment Problems

office, supplies, computer, printer, fax, telephone, and automobile. The agreement also stipulates that Sandra not work for any other investment firm, nor act as her own agent. Although Sandra will execute transactions, closing a sale requires the signature of the client, herself and a vice-president of Global Investments. Upon the close of a sale, Sandra submits an invoice to Global Investments earning her a management fee equal to 4% of gross sales. Sandra converted her guest bedroom into a full-time and sole-purpose home office. She will not be reimbursed for any expenses incurred for setup, travelling or office expenses. She is also required to carry professional liability insurance. On the other hand, Global Investments will provide the expertise, research, promotion, and ordering materials. Last week, Global Investments placed an announcement in the newspaper introducing five new sales associates, including Sandra. How does this new venture affect her computation of net income?

Problem 25 Betina Harty, a well-known Vancouver artist, signed a contract with the University of Calgary to beautify the campus. Betina spent all of the year in completing the beautification. During that time, she enhanced the campus with her own artwork and pieces bought at local auctions. The University restricted Betina’s choice of art to Canadian artists. As well, the University controlled the colour schemes and the types of art selected (e.g., paintings, sculptures, or murals) for the various locations on campus. However, within these requirements, Betina was permitted to exercise artistic discretion over the actual pieces chosen. This gave her a great degree of latitude over the beautification of the campus. She could produce the art herself, purchase another artist’s work and focus on any theme she desired. Betina worked at her own studio and used her own tools for her own productions. If the University did not like the art she produced or bought, she was not reimbursed costs and had to sell the art on the open market. Over the year, Betina channelled all of her energy into the University’s beautification and did not produce art for any outside clients. How should Betina’s income from this contract be treated?

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Problem 26 The taxpayer, Sherry Cane, is an unmarried research analyst and senior executive for TSE Consultants in Toronto. In January 2021, TSE entered into a contract with the Iraq government, for $390,000, requiring that Ms. Cane be in Iraq from March 2021 to October 2022 to examine the long-term energy issues facing OPEC countries. TSE terminated Ms. Cane’s employment and engaged her as an independent subcontractor to perform this task. Sherry gave up her office downtown, terminated her condominium lease, moved out, and stored her furniture and personal effects at her mother’s house. Further, she shipped her clothing and books to Iraq. She retained her Canadian bank account so TSE could deposit the monthly contract income of $12,000 directly into her Canadian bank account. They did not withhold any income taxes. Similarly, in Iraq, no taxes were payable, and the government provided Ms. Cane with suitable living quarters, meals, and a part-time domestic for housekeeping. Since she intended to visit her boyfriend, Shawn, and family in Canada, she retained her Visa card and Ontario Health Care. Ms. Cane wanted to retain nonresidency status for obvious reasons. While in Iraq, Ms. Cane carried her business card with the TSE logo and promoted herself as a TSE representative. Shawn, an English professor from Queen’s University, spent one si X-month term on sabbatical at the University of Iraq. The letters mailed to the Canadian company from Iraq, however, indicated that she wanted to come home. She also noted that the cultural differences and political uncertainties were extreme. Ms. Cane returned home on October 17, 2022, married Shawn and purchased a lovely home in Waterloo, Ontario, with her savings. It is now October 29, 2023, and Sherry Cane is sitting in your office as you read the following Notice of Reassessment from the CRA:

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We have completed our review of your personal returns of income for the taxation years 2021 and 2022. Based on our findings, you are a resident of Canada for tax purposes. Thus, we have adjusted your computation of net income to include the receipts of income from TSE, plus a portion of the personal benefits received during your temporary stay in Iraq. Determine whether a Notice of Objection should be filed.

Problem 27 Claire Jordan, a registered dental hygienist, would like to file a Notice of Objection with the CRA for taxation years 2022 and 2023. The CRA has reassessed Claire as a resident in Canada for 2022 and as an employee for 2022 and 2023. Claire describes herself as an independent self-employed dental hygienist. For the past two years, Claire was employed by the Canadian Forces Dental Unit to work on a day-today basis. Generally, the Mobile Dental Unit contracts for her, in advance, depending on the regional demand for dental cleaning and examinations. In 2022, Claire contracted with the Canadian Forces Mobile Dental Unit to temporarily work at a Canadian Forces base in Saudi Arabia. The terms of the contract specified that she would work on a dayto-day basis depending on the demand for dental services over the next two years. Economically, the contract was very worthwhile because her room and board were provided by the government and her pay each day was $340. Despite the risk of no work, the pay she received was earned tax-free because she considered herself as a non-resident during her absence. Prior to leaving Canada, Claire sold her condominium and car and stored her furniture at her parents’ home. She also cancelled her membership at the YWCA in New Brunswick and put her engagement on hold for an indefinite period. Her plan was to stay away for the full two years, assuming that all went as planned. Unfortunately, after 12 months, the Mobile Dental Unit ceased operations and Claire was scheduled to return to Canada. The Department of Finance had severely reduced the budget for National Defence. Claire was happy to return home on January 1, 2023. She married three months after her return and resumed her work with the Mobile Dental Unit in Moncton, New Brunswick. Claire’s compensation package with the mobile dental unit differs from other employees of the Canadian Forces. Other employees are assistants and support staff who are paid on a monthly basis with fringe benefits. Claire does not receive any benefits or holidays. In Canada she is paid on a day-to-day basis ($280 per day with no deductions for EI, CPP, or tax). All dental clinics are headed by a dentist who is professionally responsible for overseeing the work of both contract and salaried dental hygienists and dental assistants. The Canadian Dental Association does not permit dental hygienists to administer anaesthetic or work without supervision. The clinic provides all of Claire’s tools, supplies, and support staff. If a workday is not more than 60% booked, patients are rescheduled to another day and Claire does not work. It is not unusual for the contract dental hygienists to be temporarily laid off. This does create problems because the contract specifies that Claire must be available to work at least four days per week (so she cannot work elsewhere). This has not bothered Claire because she has claimed all of her laundry, uniforms, shoes, and travelling expenses as a deduction against her self-employed business earnings. Travelling expenses are justifiable because the mobile unit moves to various remote locations outside of Moncton. Advise Claire on the filing of a Notice of Objection in respect of 2022 and 2023. How would you treat the various expenses incurred by Claire Jordan in each of the taxation years?

Problem 28 The following information for 2023 has been presented to you by Paula Promoter, the new vicepresident of marketing for a public Canadian oil company, Overpriced Petroleum Limited. Paula, who is 52 years old and now lives in Calgary, travels extensively across Canada. Paula, whose duties involve the negotiating of contracts, began her employment with Overpriced Petroleum on January 1, 2023.

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Ch. 3/Study Guide — Assignment Problems

Receipts and Fringe Benefits — 2023: Salary — net of payroll deductions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Director fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Receipt of an amount, not to compete, from former employer . . . . . . . . . . . Termination payment from former employer . . . . . . . . . . . . . . . . . . . . . . . . Travel allowance (Note (1) below): Accommodation and meals @ $200 per day for 150 days . . . . . . . . . . . . . . Car operating cost allowance @ 45¢ per kilometre plus $10 per day of travelling for business travel only (9,000 kilometres) for 150 days . . . . . Income protection receipts received from Regal Assurance (Note (2) below) Benefits paid by the corporation: Registered pension plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,000 EXtended health care — Liberty Mutual . . . . . . . . . . . . . . . . . 2,125 Group income protection premiums — Regal Assurance (Note (2) below) . . . . . . . . . . . . . . . . . 1,050 Membership fee in Petroleum Club (membership required by all employees) — initiation fee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000 — annual fee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,500 Moving costs (Note (3) below) . . . . . . . . . . . . . . . . . . . . . . . . 42,000 Group term life insurance (coverage is $300,000) . . . . . . . . . . 600 Loans by company (Note (4) below) . . . . . . . . . . . . . . . . . . . 160,000

$ 49,496 5,000 50,000 8,000 30,000 5,550 15,000

$213,275 $377,275

$ 41,000 4,000 3,754 1,002 1,050

Purchased 2,000 common shares on July 1, 2023 under a stock option plan at a price of $25 per share. Fair market value of shares at the date of purchase was $35. Fair market value of the shares was $25 per share on the date when the option was granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Legal fees paid in connection with the collection of the $50,000 noncompetition receipt from her previous employer . . . . . . . . . . . . .

$ 50,806

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Payroll deductions and selected disbursements — 2023: Payroll deductions: Income taxes withheld . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Registered pension plan (defined benefit) — current contribution . . . . . . . . . . . . . . . . . . . . . . . . . . . Canada Pension Plan contributions ($631 in Enhanced CPP) Employment insurance contributions . . . . . . . . . . . . . . . . . . . Group income protection premiums (Note (2)) . . . . . . . . . . . .

50,000 5,000

Notes and Additional Information: (1) Paula’s actual travelling and car expenses, which she is required to pay according to the terms of her employment contract, are as follows: Meals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $11,250 Accommodation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23,750 Travel costs (other than car see below) reimbursed by company . . . . . . . . . . 6,000 Car expenses (9,000 kilometres for business purposes out of total kilometres of 16,000): Gasoline . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,700 Maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800 Auto accident costs while on a business trip . . . . . . . . . . . . . . . 1,600 Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,800 Licence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90 Interest paid on car loan (see Note (4), below) . . . . . . . . . . . . 300 $6,290

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Introduction to Federal Income Taxation in Canada

(2) The company paid 50% of the premium to Regal Assurance re income protection payment. During 2023, Paula received $15,000 in periodic payments in respect of an eight-week illness. (3) Although Paula started to work for Overpriced Petroleum on January 1, 2023, her family did not move to Calgary from Toronto until February 28, 2023. The company paid for all the moving costs of $12,000, an actual loss on the sale of Paula’s Toronto home of $25,000 and a disruption allowance of $5,000. (4) Paula obtained two loans from the company as part of her employment contract: (a) Loan of $150,000, dated July 1, 2023, to acquire a new home in Calgary. The loan bears annual interest at 2% and is repayable over a 25-year period in equal annual instalments on the anniversary date of July 1. Interest is payable on the same date. (b) Loan of $10,000, dated January 1, 2023, to assist in the acquisition of a car acquired in early January 2023 for $35,000 (excluding GST; no PST in Alberta) to be used in connection with her duties of employment. The loan bears annual interest at 3%, and is repayable over the next three years in equal annual instalments. Interest is payable December 31 each year. Paula paid the interest for 2023 on time on December 31, 2023. (NOTE: For simplicity you may assume that the prescribed interest rate is a constant 4% for all quarters.) Determine Paula Promoter’s employment income for 2023 in accordance with Subdivision a of Division B. Ignore the effects of a leap year in your answer. Indicate why you have excluded any of the above amounts from your answer.

Problem 29 The taxpayer, Mr. Jayem Gee, a lawyer, had agreed to the following yearly contract in the three years at issue: ●

●

● ●

●

The contract is between the firm of Perry and Mason hereinafter called ‘‘the firm’’ and Mr. Jayem Gee hereinafter called ‘‘the lawyer’’. The firm retains the services of the lawyer for the year , from January 1 to December 31, and the lawyer agrees to provide his services exclusively to the firm for the aforementioned period. The lawyer will receive, for his services, fees representing 2.1% of the gross income of the firm, excluding work in progress, all as established by the firm’s accountants. The firm remitted CPP and EI for payments to Gee. This percentage has been set with reference to the number of lawyers practicing in the firm as of January 1, . Any change in the number of professionals practising in the firm will give rise to a revision in the fee percentage. The lawyer will receive, as an advance on fees, the sum of $1,450 in each two-week period and any adjustment will be made at the conclusion of the firm’s fiscal year. In consideration of the fact that the lawyer is receiving fees, no withholdings of income tax, or deductions in respect of pension plans, health insurance, or others will be made by the firm, and the lawyer will be personally responsible for making any payments required by the government authority in respect of these items.

There were seven or eight other lawyers in the same position with the firm as Mr. Gee, and there were about nine other lawyers who were senior. Mr. Gee had no capital investment in the firm and had no ownership claim to client accounts. All expenditures necessary for the proper operation of the firm such as support staff wages and office expenses were borne by the firm. The firm was responsible for billing clients for services that had been provided and for the collection of the billings for all lawyers including the senior lawyers.

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In Mr. Gee’s opinion, his relations with clients, his work habits and how he organized his work, whether with respect to keeping track of files or the place or method chosen for carrying out his responsibilities were similar to those of the senior lawyers. On the other hand, he indicated that there were differences in responsibilities in that, for example, the senior lawyers periodically examined his work. The senior lawyers, both individually and as a group, exercised greater control of the conduct of business in the firm. The lawyers in the firm were largely specialized in various areas of law, and as far as possible, every lawyer was free to follow his own direction, as long as he adhered to the general policy of the firm and his work appeared to be to the benefit of the firm. There was no evidence that the senior lawyers assigned legal files to the junior lawyers more than to themselves, or that the clientele or account books of the two groups were differently constituted. Mr. Gee did not pay personally for any insurance premium or expenses relating to his professional responsibility, being covered by liability insurance taken out by the firm. Mr. Gee further submitted that he did not receive orders or instructions from the firm on how to carry out his duties. He decided on his own the number of hours he would devote to his profession and no set timetable was imposed on him. He was in charge of the steps to be taken to carry out instructions from his clients. If for any reason Mr. Gee could not carry out a particular task, the firm selected someone to replace him according to which of the other lawyers in the firm were available and what their areas of expertise were. The selection also took into account the client’s preference. Mr. Gee considered himself to be a partner of the firm, earning income from the business of the firm, while the CRA considered him to be an employee of the firm. At issue was the deductibility of about $20,000 of expenses over the three years in question. Is Mr. Gee, in this situation, an employee or a partner (i.e., self-employed)? In presenting your answer, discuss the tests that are applied by the courts in this type of situation and consider how the facts relate to these tests by discussing both points of view on each issue. Be sure to state a conclusion based on your evaluation of the facts in this manner. (Do not reach a conclusion first and use only those facts or arguments which support your conclusion.)

Problem 30

Travel outside of Beamsville Meals (equal monthly amounts).................................................................... $3,200 Accommodation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000

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Graham Grepzer has come to you in connection with two offers of employment as a salesperson from two rival dry-goods manufacturing companies. Neither company has an office in Graham’s present location of Beamsville, Ontario, and he would be required to operate from the basement of his home. Graham indicates that his estimated cash expenses including HST @ 13% would be:

$8,200

Total car operating costs (Note (1)) Gas and Oil ..................................................................................................... $2,200 Maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800 3,000 1,300

$4,300

Office expenses — 20% of total space (Note (2)) Mortgage interest 20% × $19,000 .................................................................... $3,800 House insurance 20% × 800 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160 Municipal taxes 20% × 2,500 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500 Utilities 20% × 1,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200 Interest on bank loan (Note (3)) . . . . . . . . . . . . . . . . . . . . . . . . . . . 500

$5,160

Insurance (if car owned) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Entertainment expenses including golf club membership of $1,100 (equal monthly amounts) ..................................................................................................... $4,000 Telephone — long-distance calls .......................................................................................... $1,000 Office supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 500 Assume that all these expenses are reasonable in the circumstances.

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68 Notes:

(1) These amounts are the total car expenses. He estimates that his total kilometres will be 30,000 of which 24,000 will be for business purposes. (2) The home was purchased ten years ago for $150,000. (3) The interest on the bank loan is for the acquisition of $5,400 of office equipment. Offer 1 Employer Alpha’s remuneration package would consist of a salary of $58,000 plus estimated commissions of $12,000. Employer Alpha would also pay for a private dental and drug plan ($700/yr) and a contribution to a defined-benefit registered pension plan at 6% of gross salary and commissions but exclusive of other fringe benefits ($4,200/yr). Graham would be required to contribute an equal amount to the pension plan. Graham would be required to use his own car and pay for all of the expenses. However, the company would pay him a flat allowance of $450 per month for his 24,000 business kilometres. Graham has indicated that he would have to acquire a new car with an estimated cost of $19,000, including HST, which would be financed fully through a bank loan at 10%. Offer 2 Employer Beta’s remuneration package would consist of a straight salary of $70,000. Employer Beta would also pay for income protection premiums ($500/yr). A leased company car would be provided which would cost his employer $6,300 per annum including $1,100 for insurance, but excluding HST. Employer Beta would pay him a monthly travel allowance of $1,500 and the annual club dues ($1,100) at the local golf course for entertaining corporate clients. However, Graham would have to directly pay all of his expenses. In addition, the company would contribute to a money-purchase registered pension plan, 6% of Graham’s gross salary exclusive of other fringe benefits; Graham would contribute an identical amount. Compute Graham’s employment income for tax purposes for the current year under the two proposals given the assumption that these amounts are for a full calendar year. Ignore the effects of any leap year or any potential HST rebate implications. EXplain why you excluded any of the above information from your calculations.

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Ch. 3/Study Guide — Discussion Notes for Review Questions

CHAPTER 3 — DISCUSSION NOTES FOR REVIEW QUESTIONS (1) The personal tax return (T1 General) does not include RPP contributions, union and professional dues and other paragraph 8(1)(i ) deductions in the calculation of employment income. These are included under the heading ‘‘Net Income’’ in the personal tax return. It would be misleading to use the personal tax return format for this specific purpose, because certain deductions are limited to the amount of employment income in the year, such as the home office expense deduction. (2) An employee can only deduct those expenses that are specifically allowed under section 8 whereas a self-employed individual may deduct all expenses incurred to earn business and property income as permitted by Subdivision b. Both the employee and the selfemployed individual are subject to the reasonableness test.

ITA: 67

(3) No one test is conclusive in itself. All tests should be considered together before a conclusion is reached. (4) The control subtest in the economic reality test determines whether one person is in a position to order or require not only what is to be done but how it is to be done. Where such control, by the business over the individual, does exist, an employer–employee relationship is implied. (5) The Act uses the word ‘‘received’’ to determine the timing of the taxation of employment income. In this case, she will be considered to have received her bonus in the year she received the cheque. Just because she chose not to cash the cheque does not change the timing of when she received the payment.

ITA: 5

(6) The Act uses the word ‘‘received’’ to determine the timing of the taxation of employment income. The voluntary deferment of an unconditional right to receive the bonus is not an acceptable method of deferring income.

ITA: 5

(7) Employers cannot deduct all of the taxable benefits reported on the employee’s T4. Items such as deemed interest benefits and standby charges for automobiles are not deductible to the employer since they are not incurred expenses. The employer has not actually paid the interest benefit or standby charge. The employer may be able to deduct the cost of the automobile that created the standby charge through the capital cost allowance system.

ITA: 80.4

(8) If the employer makes any of the premium payments then the benefit payments received will likely be taxable.

ITA: 6(1)(f); IT-428

Blenkarn v. M.N.R., 63 DTC 581 (T.A.B.)

(10) A reimbursement is a payment by an employer to an employee for expenses of the employer which have been paid by the employee and which are substantiated by receipts. This is normally accomplished by submitting an expense report. An allowance is a fi Xed amount which is paid to an employee in excess of his or her salary without the requirement that the employee be accountable for the amount expended.

IT-522R, pars. 40, 50

(11) The standby charge is calculated as follows: 20,004 20,004

× 2% × 12 × ($40,000 + $5,200) = $10,848.

(12) The five conditions that a salesperson must meet in order to be able to deduct expenses are: (a) he or she must be employed in the year in connection with the selling of property or negotiating of contracts for his or her employer;

ITA: 8(1)(f)

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(9) The CRA follows normal commercial practice such that the first day of the contract is counted and the last day is excluded for purposes of determining the number of days of interest. In this case the number of days from June 2 to June 29 inclusive will be used to determine the benefit, that is, 28 days.

Introduction to Federal Income Taxation in Canada

(b) under the terms of his or her contract of employment he or she must be required to pay his or her own expenses; (c) he or she must be ordinarily required to carry on his or her duties away from his or her employer’s place of business; (d) he or she is remunerated in whole or in part by commissions or other similar amounts fiXed by reference to the volume of the sales made or the contracts negotiated; and (e) he or she was not in receipt of a reasonable allowance for travelling expenses in respect of the taxation year that was not included in computing his or her income. (13) The four conditions that must be met to allow an employee to deduct travelling expenses, other than car expenses, are:

ITA: 6(1)(b)(v)

ITA: 8(1)(h)

(a) he or she is ordinarily required to carry on his or her duties away from his or her employer’s place of business or in different places; (b) under his or her employment contract, he or she is required to pay the travelling expenses incurred by him or her in the performance of his or her duties; (c) he or she was not in receipt of a reasonable allowance for travelling expenses that was not included in computing his or her income; and

ITA: 6(1)(b)(v), 6(1)(b)(vi), 6(1)(b)(vii)

(d) he or she did not claim any deduction for railway company employees, salespersons, or transport company employees.

ITA: 8(1)(e), 8(1)(f), 8(1)(g)

(14) There is nothing in paragraph 6(1)(b) that would exclude this allowance from income. However, another rule would apply to cause this receipt to be exempt from tax. In order to be exempt under this provision, the allowance must meet the following tests:

ITA: 81(3.1)

(a) he must deal at arm’s length with his employer; (b) he must have other employment or business income (not necessary in this case, since he is employed as a professor or teacher at a designated educational institution); (c) the amount received must be reasonable and must relate only to travel to and from part-time employment; and (d) the part-time location must be at least 80 km away from both the employee’s ordinary place of residence and his principal place of employment or business. (15) Neither word is defined in the Act. However, an Interpretation Bulletin interprets the word ‘‘principally’’ as more than 50%. Therefore, as long as the employment-use of the workspace is its main or chief purpose, the test is met. ‘‘E Xclusively’’ is not defined in the tax law, so reference is made to other sources. Webster’s English Dictionary defines ‘‘exclusively’’ as ‘‘to the exclusion of all others’’ which is a much more onerous test.

IT-352R2, par. 2

(16) The Act deems that taxes withheld have been received at the time the bonus was paid. Therefore, even though the company still had the government’s portion of the bonus, tax cannot be deferred on it. In addition, if the amount withheld in respect of the tax was not deemed to have been received by Ms. Smith, then she would not have received credit for the payment of this tax on her personal tax return.

ITA: 153(3)

Ch. 3/Study Guide — Solutions to Exercises

CHAPTER 3 — SOLUTIONS TO EXERCISES Exercise 1 [See: Isaac v. M.N.R., 70 DTC 1285 (T.A.B.)] Although the test had not been articulated at the time of this case, the courts are now starting with a consideration of whether there is a mutual understanding or common intention between the parties regarding their relationship. That is best reflected in a contract between the parties, but in many cases, such as this one, no written contract is in evidence. In this situation, the courts have looked at how the parties treat each other. In the case, it appears that the hospital is treating the nurse as a non-military independent contractor by paying her a fi Xed rate with none of the usual employee benefits. The nurse has, at least, accepted that for about five years. However, the same facts might be used to suggest that the relationship between the parties was that of an employer/part-time employee. The following tests are applied to support the determination of the objective intention of the parties as to whether R.N. should be regarded as an employee or an independent contractor. Economic Reality In applying the control subtest, the question is whether Canadian Forces Hospital, Halifax controlled not only what was done by R.N. but how it was done. In this case the Hospital exercised control over R.N. in connection with dividing up the patients to be cared for among the available nurses and imposing routine rules and regulations with regard to the administration of drugs and other medications. On the other hand, the Hospital did not exercise any control over the method in which R.N. did her work, which requires special knowledge, skill, and judgement. Accordingly, it does not appear that the Hospital exercised sufficient control to conclude that R.N. was an employee on the basis of this test alone. However, the application of the other subtests (ownership of tools) is particularly revealing. R.N. does not run the risk of financing the equipment, supplying other assistants necessary to carry out her duties in the Hospital or seeking out clients. R.N. used the equipment and supplies furnished by the Hospital. She neither hired nor fired any of the nursing assistants who worked under her. She could only request that the Hospital hire additional staff to assist her.

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Application of the profit/loss test is also insightful. The clients were patients of the Hospital. R.N. was not in a position to substitute the services of another nurse if she was unable to perform her duties. Her work was done on a continuous day-to-day basis without there being any limited or specified amount of work that she had, by contract, to accomplish. Her time was made up on a weekly basis in advance. She could be laid off on 24 hours’ notice. On the other hand, R.N. was not a full-time nurse for any specified period of time. All this evidence tends to establish that from an economic reality point of view R.N. was an employee, but this test may not be definitive in this case. Conclusion As the intention is unclear as no contract exists to infer independent contractor or part-time employee, the economic reality tests become particularly important. The application of the economic reality tests as discussed in detail above, lead to the conclusion that R.N was an employee of the Hospital. Thus, there is evidence to support the determination of an employment relationship. (Your own conclusion after weighing all of these tests.)

Exercise 2 The courts generally rely on three tests to support a determination of the objective intention of the parties as to their relationship as either independent contractor or employment. In this case, a contract was negotiated that could be interpreted as establishing an independent contractor relationship. However, a contract can be written to be self-serving to both parties. Hence the need to apply the economic reality test to help determine the status of Ms. Capwell in relation to the architectural firm of Davies Ltd. Economic Reality Tests (a) Control Test The first subtest examines the day-to-day time commitment that is expected of an individual and the accountability of the individual to the corporation. In this instance, Ms. Capwell must work at least 14 days a month on the project (but the specific days appear flexible); however, she appears to be able

ITA: 248(1); Wiebe Door Services Ltd. v. M.N.R., 87 DTC 5025 (F.C.A.)

Introduction to Federal Income Taxation in Canada

to work under her own direction and on other projects on her days off. It does not seem to be conclusive as to whether or not Ms. Capwell is an employee given this test, but the evidence supports that she would be an independent contractor given the circumstances. (b) Ownership of Tools It is not clear, but Ms. Capwell appears to provide her own car, equipment, and technical expertise. We might also conclude that since she is working on the premises, many of her expenses, such as supplies and her place of work, will be covered by Davies Ltd. This test appears to support contractor status. (c) Chance of Profit, Risk of Loss This subtest assesses whether the individual incurs her own business risk, legal liability, and expenses. In this case, she is getting paid a flat fee of $4,000 per month, which we must assume is directly related to billable hours of work. She estimates that 30% of her contracting revenues will come from other sources, which is not entirely insignificant. Opportunity for profit or risk of loss is not obvious, suggestive of an employee relationship. Alternatively, in this case, there is no doubt that Ms. Capwell was taken on to complete a specific project, after which the contract will be fulfilled, suggestive of independent contractor status. This test is also not conclusive, and depending on the details, could go either way. Conclusion The tests would seem to support independent contractor status, principally because of the signed contract agreeing to a flat fee for one specific project suggesting a mutual understanding or common intention to enter an independent contractor relationship. The results of the tests do not always provide us with a definitive answer as to whether or not an individual should be viewed as an employee. However, they can help guide us to make that determination. In this case, the facts lead toward the independent contractor conclusion. Given that the contract was drafted for a specific project, and that Ms. Capwell seems to be working independently, the courts would probably allow the designation of independent contractor status.

Exercise 3 (A) Specifically exempted.

ITA: 6(1)(a)

(B) EXempted; provincial employer health tax.

ITA: 6(1)(a)

(E) Taxable. Income Tax Folio S2-F3-C2 only exempts tuition fees where the course is primarily for the benefit of the employer.

ITA: 6(1)(a), Income Tax Folio S2-F3-C2

(F) Normally, taxable, but since the payment meets the conditions, namely that the Christmas gift is under $500 and is not cash or near cash, the CRA’s position is that the gift is not a taxable benefit.

ITA: 6(1)(a)

(G) Partly taxable: The CRA takes the position that there will be no benefit if William had reimbursed the company the actual cost ($420). Since William did not completely reimburse the company for the actual costs, then the benefit would be calculated by taking the difference between the actual costs ($420) and the amount paid by William ($200) for a taxable benefit of $220.

ITA: 6(1)(a); Income Tax Folio S2-F3-C2

(H) Taxable, but the CRA takes the position that the amount would not be taxable if the membership was principally for the employer’s advantage rather than the employee’s.

ITA: 6(1)(a); Income Tax Folio S2-F3-C2

(I) Taxable unless the financial counselling was in respect of re-employment or retirement.

ITA: 6(1)(a), 6(1)(a)(iv)(B)

Exercise 4 Paragraph 8(1)(b) allows for the deduction of legal expenses against employment income in the year, on account of legal expenses incurred by the taxpayer to collect or establish a right to salary or wages owed to the taxpayer that, if received by the taxpayer, would be required by this subdivision to be included in computing the taxpayer’s employment income. Paragraph 6(1)(j ) requires any reimbursement to either be included in income or reduce the expense being claimed.

ITA: 6, 8

Ch. 3/Study Guide — Solutions to Exercises

Legal expenses may also be deductible for other purposes such as to earn income from business or property or as another deduction [ITA 60(o), (o.1)], but only those expenses specifically listed in section 8 can be deducted from employment income [ITA 8(2)]. Other resources — IT-99R5, Legal and Accounting Fees; CRA Guide T4044, Employment EXpenses

Exercise 5 The $6,000 merchandise discount is a taxable benefit. Administrative practice reflected in the Income Tax Folio does exempt discounts on merchandise, but they must be offered to all employees and not to just select groups. If there was an overall discount of 10% to all employees, it would seem reasonable in the circumstances to include only 25% in income; however, the Income Tax Folio is silent on this point.

Income Tax Folio S2-F3-C2

Exercise 6 None of the $7,500 is a taxable benefit. The exclusion for an eligible housing loss applies because the loss was incurred in an eligible relocation. This conclusion is supported by a 2012 Tax Court of Canada decision.

ITA: 6(1)(a), 6(19), 6(20), 248(1) ‘‘eligible relocation’’; Wunderlich v. The Queen, 2012 TCC 539; Income Tax Folio S2-F3-C2

Note that on the sale of the house, the loss cannot be greater than the actual loss to the employee, calculated as the amount by which the cost of the house exceeds the net selling price received. A reimbursement of actual moving costs is not a taxable benefit.

Income Tax Folio S2-F3-C2

Exercise 7 Premiums paid: (A) Group term life insurance premiums paid by an employer are a taxable benefit.

ITA: 6(1)(a), 6(4)

(B) and (C) The extended health care and dental care plans are private medical plans; hence, the premiums paid by the employer are not employment income.

ITA: 6(1)(a)

(D) Since the sickness or accident income protection plan is a group plan, premiums paid by the employer are exempt from employment income.

ITA: 6(1)(a)

Conclusion:

CHAPTER 3

The following rearrangement would result in a lower tax cost: (A) Company should pay for 100% of the extended health care and dental plan. (B) Employees should pay the provincial medical plan premiums since company payments would be taxable benefits. (C) Employees should consider paying the sickness or accident income protection premium themselves. When an employer pays any portion of the premium for this type of plan, amounts that are paid out of the plan are taxable as employment income, less the employee’s contribution to date. Conversely, if the employee pays all of the premiums, none of the amounts paid out of the plan are taxable. Since this particular plan has benefits of only 50% of the wages, the employee would be in a relatively poor cash position. The imposition of tax, even though at a lower rate, would certainly result in extreme hardship if the illness is prolonged.

ITA: 6(1)(f)

Exercise 8 Year 1 — No tax effect. Year 4 — No tax effect. Year 5 — No tax effect, since the employer is a Canadian-controlled private corporation. Year 6 — Must take into employment income under Division B the following: 50,000 shares × ($3 -- $1) = $100,000 — Will have a capital gain of

50,000 shares × ($6 -- $3) = $150,000

ITA: 7(1.1)

Introduction to Federal Income Taxation in Canada

— 50% of the above capital gain will be included in her income. — May be eligible for the capital gains deduction for qualifying small business corporation shares.

ITA: 110.6(1), 248(1)

— Since Katrina sold these shares within two years after the date of acquisition, she is not entitled to a deduction of one half of the subsection 7(1.1) inclusion. She is also not entitled to a general deduction since the exercise price of $1.00 was less than fair market value ($1.50) at the date the option was granted.

ITA: 110(1)(d), 110(1)(d.1)

Exercise 9 (a) Car benefit if business-use kilometres are 10,000 Standby charge 20,004 km(1) × [2% × ($20,000 × 12)] = . . . . . . . . . . . . . . . . . . . . . 20,004 km Operating costs(2) (12,000 km × $0.33) . . . . . . . . . . . . . . . . . . . . . .

ITA: 6(1)(e), 6(2)

$4,800 3,960 $8,760

Less: amount reimbursed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,800

Total car benefit if business-use kilometres are 10,000 . . . . . . . . . . .

$6,960

(b) Car benefit if business-use kilometres are 20,000 Standby charge 12,000 km(3) × [2% × ($20,000 × 12)] = . . . . . . . . . . . . . . . . . . . . . 20,004 km Operating costs(4) (50% × $2,879) = . . . . . . . . . . . . . . . . . . . . . . . .

ITA: 6(1)(k)(v)

ITA: 6(1)(e), 6(2)

$2,879 1,440 $4,319

Less: amount reimbursed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,800

Total car benefit if business-use kilometres are 20,000 . . . . . . . . . . .

$2,519

ITA: 6(1)(k)(v)

NOTES (1) The employee does not qualify for the standby charge reduction since the car is not used more than 50% in the performance of employment duties when the business use is only 15,000 km. Therefore, in this outcome, the value of A in the formula (i.e., 12,000 km) is deemed equal to the value of B in the formula (i.e., 1,667 × 12 rounded). (2) The election method is not available to the employee, since the car is not used more than 50% for business.

ITA: 6(1)(k)(iv)

(3)

When the business-use kilometres is 20,000, the employee qualifies for the standby charge reduction and the numerator becomes the lesser of (a) 12,000 km, and (b) 1,667 km × 12 months. (4) The operating benefit election at 50% of the standby charge is the same as $0.33 × 12,000 km = $3,960. The election method is available since employment kilometres comprise more than 50% of the total.

Exercise 10 The Act would appear to deny any deduction in respect of Calvin’s workspace in the home. In order for Calvin to avoid the restrictions, one of two tests must be met, neither of which appear to be adhered to. The first test is that the work place in the home must be where the individual principally performs the employment duties. The second test has two conditions that must be met and is even more stringent, namely, that the work place must be used exclusively for employment income purposes and that the work place must be used on a regular and continuous basis as a meeting place for employmentconnected persons.

ITA: 8(13)

If Calvin had met one of the tests, then he would be able to deduct some of the expenses indicated as long as he met the conditions of paragraph 8(1)(i ). First Calvin must have a contract with his employer indicating that he must pay for office rent and supplies and the employer completes and signs a T2200. However, of the expenses indicated, only the maintenance expense, including fuel, electricity, light bulbs, cleaning materials and minor repairs, on a prorated basis will be permitted. The imputed rent of $1,000 is not deductible; this position was confirmed in the Thompson case by the Federal Court–Trial Division.

ITA: 8(13)

IT-352R2, par. 2, 3 89 DTC 5439 (F.C.T.D.)

Ch. 3/Study Guide — Solutions to Exercises

Exercise 11 Since the question refers to meal expenses for employees, you need to refer to subsection 8(4). A deduction for personal meals consumed while travelling is only allowed where the employee is away from the municipality/metropolitan area for a minimum of 12 hours. All meal costs, regardless of their nature and purpose, are also restricted by subsection 67.1(1) to 50% of the actual cost. However, longhaul truck drivers can deduct 80%.

ITA: 8(4), 67.1(1)

Exercise 12 Part (A) Commission income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Group term life insurance premiums paid by employer . . . . . . . . . . . . . . . . . . . . . . . Sales incentive prize ($4,000 + $130 → HST on $1,000 only) . . . . . . . . . . . . . . . . . . Imputed interest benefit on automobile loan ($40,000 X 0.04 X 362/365) . . . . . . . . . . Monthly automobile allowance (not based on km driven for employment) . . . . . . . . . Monthly travel allowance (unreasonably low when compared to actual in Note 2, below) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Limited to commission of $126,000 (fully deductible) . . . . . . . . . . . . . . . .

$11,656

$18,306 1,587 19,893 X 95%

Employment use . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$18,898

(2) Gas and oil . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Licence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2,500 1,300 1,600 90

Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Employment use . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 5,490 X 95%

Deductible amount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 5,216

(3) Meals (50% X $2,400) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accommodation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 1,200 4,200

Deductible amount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 5,400

ssec. 6(4) par. 6(1)(a) ssec. 6(9)

1,587 5,400

ssec. 80.4(1)

3,600

spar. 6(1)(b)(v)

(6,750)

par. 8(1)(m)

(45) (300) (200) (18,898)

par. 8(1)(i )

(11,656)

Employment income .................................................................................................................$103,568 Notes to Solution (1) CCA on new vehicle given ($36,000 X 1.13 X 30% X 1.5) . . . . . . . . . . Interest benefit deemed to be interest paid (see below) . . . . . . . . . .

sec. 5

spar. 6(1)(b)(X)

par. 8(1)(i ) par. 8(1)(i ) par. 8(1)(j )

par. 8(1)(f )

CHAPTER 3

Less: Registered pension plan contributions made by Susie Sellem . . . . . . . . . . . . . . . . . . . Home office deductible under par. 8(1)(i ): Repairs and maintenance ($450 X 10%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Repainting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Office supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest and CCA on automobile deductible under par. 8(1)(j ) (Note 1) . . . . . . . . . . EXpenses limited to commission income under par. 8(1)(f ): Automobile operating expenses (Note 2) . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,216 Travel expenses (Note 3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,400 Entertainment (50% X $900) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 450 Home office property taxes ($5,300 X 10%) . . . . . . . . . . . . . . . . . . . . . . . 530 Home office house insurance ($600 X 10%) .................................................... 60

$126,000 700 4,130

Introduction to Federal Income Taxation in Canada

Note: The deductible interest on the automobile is the lesser of: (i) interest paid in the year (in this case deemed paid by 80.5) . . . . . . . . . .

$ 1,587

(ii) $10 X 362 days (or $300 X 362/30) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 3,620

Part (B) Omitted Items (1) Income taxes withheld at source are not deductible by virtue of ssec. 8(2). (2) Canada Pension Plan contributions and Employment Insurance contributions are not deductible by virtue of ssec. 8(2) but are eligible for deduction as tax credits in computing taxes payable. Enhanced CPP contribution is a deduction under subdivision e (paragraph at 60(e.1)), in the calculation of net income for tax purposes, not employment income. (3) Group term life insurance premiums and group accident income protection plan premiums paid by Susie Sellem are not deductible by her by virtue of ssec. 8(2). (4) United Way donation made via payroll deduction is not deductible in computing income from employment by virtue of ssec. 8(2) but will be eligible for a tax credit in computing taxes payable. (5) Registered pension plan contributions, dental plan premium and extended health care premium paid by employer are not a taxable benefit to Susie by virtue of subpar. 6(1)(a)(i) of the Act. (6) Employer contributions under the group accident insurance plan are not a taxable benefit to the employee [6(1)(a)]. (7) Employer health tax paid by employer is not a taxable benefit because it is a payroll tax required to be paid by the employer. This is confirmed in Income Tax Folio S2-F3-C2, Benefits and Allowances Received from Employment. (8) The membership in the fitness club is not considered a taxable benefit by virtue of Income Tax Folio S2-F3-C2, Benefits and Allowances Received from Employment based on the assertion by Susie and her employer that it is principally to the employer’s benefit for her to maintain membership in this club. (9) Mortgage interest on home office is a capital expenditure and is denied by virtue of subpar. 8(1)(f )(v), since par. 8(1)(j ) only allows interest expense for automobiles and aircraft.

Exercise 13 (a)

The $125,000 salary will be included in income for tax purposes in the year of receipt (ssec. 5(1)).

(b)

The $20,000 lump-sum payment will be included in employment income for this year (ssec. 6(3)).

(c)

The $10,000 contributed by SL to the RPP will not be included in income for tax purposes. It is specifically excepted (par. 6(1)(a)). Rae is entitled to deduct the $10,000 contribution she is required to make to the RPP in computing her employment income for tax purposes par. 8(1)(m) and 147.2(4)(a)). The benefit derived from SL’s contributions to extended health care and the dental plan is not included in income for tax purposes. The benefit derived from an employer’s contribution to private health plans is specifically excepted (par. 6(1)(a)).

(d)

(e)

The premium for group life insurance coverage paid by SL is included in employment income for tax purposes (ssec. 6(4)).

(f)

Since the car allowance is not based solely on the number of kilometres for which the motor vehicle is used in connection with employment, it is deemed not to be a reasonable amount (spar. 6(1)(b)(X)) and, therefore, is included in employment income for tax purposes (spar. 6(1)(b)(vii.1)). She will be entitled to claim a deduction for her actual car expenses (par. 8(1)(h), (h.1)).

(g)

Rae will have an annual benefit with respect to the housing loan and the car loan included in her employment income for tax purposes (ssec. 6(9)) computed as follows: par. 80.4(1)(a): housing loan $150,000 X .04 X 365/365 . . . . . . . . . $ 6,000 car loan $20,000 X (.04 X 181/365 + .05 X 184/365) 901 $ 6,901 par. 80.4(1)(c):

interest paid for the year, not later than 30 days after the end of the year, $150,000 @ 2% . . . . . . .

(3,000) $ 3,901

Ch. 3/Study Guide — Solutions to Exercises

(h)

Note: The prescribed rate of interest used to calculate the benefit on the housing loan in each quarter of this year is less than or equal to the prescribed rate in effect at the time the loan was made (ssec. 80.4(4)). Rae can claim as a travelling expense deduction, 95% of the aggregate of her automobile expenses (par. 8(1)(h.1)) and interest and CCA (par. 8(1)(j )). The imputed interest benefit on the car loan, $901, and any interest paid on any additional loan incurred by her to purchase the car, will be included, but the total interest is restricted to a maximum of $300 per month (sec. 67.2). The deduction for capital cost allowance on the car for this year would be computed as follows: $36,000 (1 + .13) X 30% X 1.5 X 95% = $17,391 The reimbursement of Rae’s loss on the sale of her Windsor home is a taxable benefit to the extent of one-half of the amount in excess of $15,000 [par. 6(1)(a), ssec. 6(20)]. The reimbursement by SL of any other expenses related to her move, as listed, is not a taxable benefit [Income Tax Folio S2-F3-C2, Benefits and Allowances Received from Employment]. As SL is a CCPC, Rae will have no income inclusion with respect to the stock option until the year in which she disposes of the shares. At that time, the difference between the fair market value (FMV) at the time she exercised the option and the option price of $18 will be included in her income as employment income (ssec. 7(1.1)). Half of the difference between the selling price of the shares and the shares’ FMV at the time of exercising the option will be included in her income as a taxable capital gain. Providing she holds the shares for two years from the date of exercising the option, she will be entitled to an employee stock option deduction in computing her taxable income equal to 1/2 of the benefit included in employment income (par. 110(1)(d.1)). If she does not hold the shares for two years after exercising the option, she will not be entitled to the par. 110(1)(d.1) deduction nor will she be entitled to the par. 110(1)(d ) deduction as the FMV of the shares at the time the option was granted exceeded the option price.

Exercise 14 1.

CHAPTER 3

Economic Reality Tests: the economic nature of the relationship (a) Control — whether someone is in a position to determine not only what is to be done but also how it is to be done — arguments supporting employment — as producer, the production company exerted financial control — arguments supporting self-employment — the director was not subject to detailed control over his work since he had the final artistic say;no one set out how he was to do his work — he had to find the work — he had no specific hours of work — in this situation, it would be difficult to exercise control over the manner of doing the work because of the professional or skilled nature of the work, whether it is performed by an employee or an independent contractor (b) Ownership of the Tools — arguments for employment — the production company provided the equipment and the personnel to work with — arguments for self-employment — the director provided the professional skills (c) Chance for Profit/Risk of Loss — arguments for employment — no profit-sharing arrangement — no ownership rights to the product — he was reimbursed for certain expenses — he did not pay for those who worked with him — he received a fiXed amount every two weeks — the agreement was for an indefinite period of service — no specific amount of work was to be completed; the verbal contract was not specific as to the work to be completed

Introduction to Federal Income Taxation in Canada

— arguments for self-employment — the payments for shooting days were dependent on the amount of work he obtained — he could have hired assistants — his fee for shooting days was dependent on how much work he got — he was not paid for re-shooting if he made the error — he could hire assistants; he did not have to do all of the work personally — he had complete control over the manner of doing the work to produce commercials

Exercise 15 1. Minimum employment income — June received no kilometre allowance: Applicable Provisions

Salary and commissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deductions: Entertainment [Note 1]

$40,000

par. 18(l)(l ) par. 8(1)(f ) ssec. 67.1(1)

(50% of ($3,700 - $600)) .........................................................

$1,550 Home office: municipal taxes [Note 2] ......................................... 250 Car operating expenses (18/28 km X $4,900) .................................................................. 3,150 Meal expenses (50% of $1,000) ....................................................................... 500

par. 8(1)(f ) par. 8(1)(f ) par. 8(1)(f ) ssec. 8(4)

$5,450 Deductions not in excess of commission [Note 3] . . . . . . . . . .

ssec. 67.1(1)

5,000 $35,000

Less: Deductions not limited to commission income: Home office [Note 2] ...................................................................$3,500 Less: interest & municipal taxes .................................................... 950 CCA on car [Note 4] (18/28 km X $4,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest on car [Note 5] (18/28 km X $1,500) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Employment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

sec. 5

par. 8(1)(f )

par. 8(1)(i )

2,550 2,571

par. 8(1)(j )

964

par. 8(1)(j )

$28,915

Notes: (1) The golf club membership dues are specifically denied as a deduction by par. 18(1)(l ) and spar. 8(1)(f )(vi). Paragraph 67.1(1) limits the deduction for entertainment expenses to 50% of that which would otherwise be deductible. (2) Outlays on account of capital are not deductible except for interest and CCA on a car used in the course of employment. Interest on account of the home mortgage is not deductible. Municipal taxes are deductible because June is claiming expenses under par. 8(1)(f ) of the Act. Municipal taxes are not deductible under par. 8(1)(i ). (3) Paragraph 8(1)(f ) limits the deduction for expenses claimed there under to the commission earned. (4) Paragraph 8(1)(f ) does not restrict the deductions under par. 8(1)(i ) or par. 8(1)(j ) (i.e., interest and CCA on the car, office-in-home expenses) to commission income. (5) Interest expense deducted is limited to $10 for each day that interest was payable ($300/30days). This is $10 X 365 days= $3,650 for the year. Using the formula in the act, the calculation would be $300 X 365/30 days = $3,650. This is greater than the actual interest paid so the actual interest paid is deducted. (6) By virtue of ssec. 8(2), convention expenses may not be deducted from employment income since they are not listed in ssec. 8(1).

Ch. 3/Study Guide — Solutions to Exercises 2.

Minimum employment income — June received an allowance of $0.35 per kilometre plus a yearly allowance of $1,200: Although the combined package of the two allowances may be reasonable in the circumstances, spar. 6(1)(b)(X) deems the allowances not to be a reasonable amount since the motor vehicle allowances received were not based solely on the kilometres. Hence, both allowances are taxable under spar. 6(1)(b)(v). June would have to include the allowances in income, but could deduct all of the automobile expenses. Her minimum employment income would be as follows: Employment income as calculated above: . . . . . . . Add: $0.35 X 18,000 km . . . . . . . . . . . . . . . . . . . . . yearly allowance . . . . . . . . . . . . . . . . . . . . . .

$28,915 $6,300 1,200

7,500 $36,415

CHAPTER 3

Chapter 4 Income from Business: General Concepts and Rules

CHAPTER 4

Introduction to Federal Income Taxation in Canada

CHAPTER 4 — LEARNING CHART Problem Descriptions Textbook Example Problems 4-1 Income vs. capital 4-2 Valuation of inventory 4-3 Amortization included in cost of inventory 4-4 Reserve for services not provided 4-5 Reserve for proceeds not yet due 4-6 Schedule 1 reconciliation 4-7 Sales person’s expenses Exercises 1 2 3 4 5 6 7 8 9 10 11 12 13

Employee benefits — employer/employee implications Income vs. capital Automobile options Contract termination payment Income vs. capital Inventory valuation Income Tax Act references Recreational facilities Home off ice expenses Deductibility of expenses Bond discount Schedule 1 reconciliation Income reserve

Assignment Problems 1 Independent issues — deductibility of expenses 2 Home off ice 3 Debt forgiveness 4 Income vs. capital 5 Four independent issues 6 Reasonable expectation of prof it 7 Schedule 1 reconciliation 8 Schedule 1 reconciliation 9 Schedule 1 reconciliation 10 Schedule 1 reconciliation 11 Income from business 12 Schedule 1 reconciliation 13 Income from business with home off ice 14 Schedule 1 reconciliation — comprehensive 15 Income from business with home off ice 16 Schedule 1 reconciliation 17 Income vs. capital, soft costs 18 Company automobile — impact on employer 19 Stock option — impact on employer 20 Employee benefits — impact on employer 21 Employee benefits — impact on employer 22 Employed vs. self-employed

Ch. 4/Study Guide — Learning Chart

Problem Descriptions 23 24 25 26 27 28

Sales expenses of employee or self-employed New job offer — employee and employer Reassessment, employee compensation Accounts receivable and warranty claims Business start-up costs Business income and expenses — implications to payor and recipient

CHAPTER 4

Introduction to Federal Income Taxation in Canada

Ch. 4/Study Guide — Review Questions

¶4,800

REVIEW QUESTIONS

(1) Mr. Fritz is a commissioned real estate client of yours. He has just bought and sold a piece of land in a ‘‘quick flip’’ transaction. What kind of income might this be to him: employment, business, property or capital gain? (2) Does the Act require that the ‘‘profit’’ from a business be calculated in accordance with generally accepted accounting principles? (3) Opco Ltd. is in the business of manufacturing equipment under contract for other manufacturers. One of its customers failed to live up to its contract and would not take delivery of or pay for its order. Opco took the customer to court and was awarded the amount of $100,000 as damages. Can this amount be treated as a non-taxable capital receipt by Opco? (4) Aco Ltd. and Xco Ltd. entered into an agreement to manufacture a new product for the next 20 years. This represented 80% of Aco’s business. After five years it was decided that the two parties could not work together so Xco paid Aco $500,000 to terminate the agreement. Is the receipt of this amount by Aco considered to be business income? (5) Donald Corleone owns an illegal gambling house. He has made significant ‘‘profits’’ on this activity, but has not reported the income since he believes it is not taxable. Is he correct? (6) Opco Ltd. took advantage of a program offered by the government and hired two employees whose wages were partially offset by a government subsidy. The owner felt that since he was really just getting some of his tax dollars back through this subsidy, the amount received would not be taxable. What do you think? (7) As long as an expenditure was made for the purpose of earning income from a business or property then it is deductible. Is this statement true? Comment.

ITA: 18

(8) One of your clients is having some short-term cash flow problems and cannot pay his year-end tax liability. He decides that he will defer his payment to the Receiver General instead of trying to get another short-term bank loan. He reasons that in either case the interest will be deductible. Comment. (9) Subsection 18(1) lists those items that are prohibited from being deducted because of the nature of the expenditure. If an expense passes those tests, will it be deductible? (10) A client had to replace the roof on its factory at a cost of $100,000. The client deducted the cost of the roof on the basis that it was simply replacing the previous roof with a new one of the same quality. Is the cost deductible? (11) Is the portion of the airline ticket that represents the meal subject to the 50% limitation on meal expenses? (12) Will a company that offers a warranty with its product be able to deduct a reserve?

ITA: 20(1)(m.1)

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Introduction to Federal Income Taxation in Canada

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EXERCISES

Exercise 1

ITA: 9, 11, 18, 20

Each of the following employee perks were provided to a senior executive of IPL Engineering Services: Value of university tuition fees for the employee’s child (age 21) $ 2,800 Out-of-town meals for a three-day management seminar ................... 150 Entertainment meals for clients (reimbursement) . . . . . . . . . . . . . 1,500 Professional dues to Civil Engineering Society . . . . . . . . . . . . . . . 250 Notebook computer provided for employment use . . . . . . . . . . . . . 3,500 Membership to Centre Health Club (client promotion) . . . . . . . . . 1,400 Interest-free loan for the purchase of company stock . . . . . . . . . . 40,000 Premiums paid for group term life insurance . . . . . . . . . . . . . . . . 150 Reimbursement for engineering systems software . . . . . . . . . . . . . 2,000 Assumptions: (a) Prescribed rate of interest throughout the year is 4%. (b) The senior executive takes the notebook computer home to complete IPL assignments and memos. Personal use is minimal. — REQUIRED For each of the above, discuss and quantify (where applicable) the income tax implications to the employer and to the employee.

Exercise 2

ITA: 9; IT-218R

The taxpayer corporation, Singh Enterprises Ltd., purchased a property consisting of some eight separate residential apartment buildings. When purchased, the property was ready for profit-producing operation and immediate arrangements were made for such operations. The principal shareholder of the corporation, Sam Singh, was an individual with a long history of trading in real estate in many different countries. He fully expected that the property would increase in value in the future. About 11 months after the purchase of the property, circumstances dictated a change in the investments of the corporation and the property was sold for a substantial profit. — REQUIRED Determine whether the profit realized by the sale of the property was income from a business or a capital gain.

Exercise 3 Samuel, an employee of the Fish Company, needs a vehicle to complete his employment duties. Samuel generally drives approXimately 10,000 kilometres for personal reasons. His manager estimates that Samuel will need to drive 7,000 kilometres to complete employment duties. Samuel estimates that his total operating expenses will be $2,500. The corporation offered Samuel three alternatives: (a) Twelve months use of a leased vehicle plus a reimbursement for 100% of the total operating expense. The leased vehicle costs the corporation $400 per month (including HST). (b) The same vehicle can be purchased for a total cost (including 13% HST) of $22,000 and Samuel would be reimbursed for the total operating expense. (c) Samuel provides his own vehicle and is reimbursed 68 cents for each of the first 5,000 kilometres and 62 cents for the balance of employment kilometres. — REQUIRED Assess the tax impacts for each alternative for both the employee and the employer for the current tax year.

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ITA: 9, 11, 18, 20

Ch. 4/Study Guide — Exercises

Exercise 4

ITA: 9

Cars Limited had a franchise for the distribution in Saskatchewan of Belchfire automobiles made in Argentina. The business had grown rapidly in its 10 years of existence. However, soon after the expansion of its facilities, Argentina Motor Industries terminated the distribution agreement and voluntarily agreed to pay Cars Limited $225,000. — REQUIRED What are the tax implications to Cars Limited?

Exercise 5 Alta Management Corporation (AMC) purchased three parcels of land in July of this year at an estate auction. Immediately after, the purchase plans were in place for the development of the properties into community shopping plazas. As a result of an unsolicited offer, two parcels of land were resold for an immediate and substantial gain. The third parcel of land sat vacant for three months while the corporation waited for the development and building permits from City Hall. The city would not approve the project because of several complaints from local residents. Consequently, the property was listed for sale with a realtor, Charles Roonie. Charles is also the major shareholder of Alta Management Corporation. The sale took place, with a substantial profit, siX months after the purchase of the land. Presently, the corporation holds two other pieces of undeveloped land, which it intends to develop if the economy improves. It also manages several apartment blocks and one shopping centre. The corporation often sells property when it becomes unfeasible to develop. For this reason, the company always ensures that any real estate purchased has good resale value. — REQUIRED What type of income was earned from the disposition of each real estate property? Provide reasons for your answer, and consider all factors that the courts may consider in substantiating the intent of the taxpayer.

Exercise 6

ITA: 10

Holey Mufflers Limited operates a fast-service repair shop. At the end of its fiscal year its inventory records showed the following: Item Mufflers . . . . . . . . . . . . . . . . Tailpipes . . . . . . . . . . . . . . . EXhaust systems . . . . . . . . . Shock absorbers . . . . . . . . . . Brackets . . . . . . . . . . . . . . . Clamps . . . . . . . . . . . . . . . .

Number 64 157 39 256 932 1,746

Actual cost

FIFO Replacement Net realization cost value cost

$17.50 $16.25 4.75 4.25 16.25 16.30 19.45 18.85 1.40 1.35 .65 .70

$18.40 5.00 17.00 20.50 1.50 .75

$15.50 4.50 15.50 19.75 1.30 .80

— REQUIRED ITA: 10(2.1)

Exercise 7

ITA: 18(1)(a), 18(1)(b), 18(1)(l), 18(1)(e), 18(1)(h), 67, 248(1)

The Act restricts the deduction of certain expenses incurred. In general, the following limitations determine the deductibility of expenses from a business: (a) Income earning purpose test (b) Capital test (c) EXempt income test (d) Reserve test (e) Personal expense test (f) Reasonableness test

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CHAPTER 4

What values could be used for the total inventory for tax purposes? (Assume that the method of valuing inventory could change with permission.)

Introduction to Federal Income Taxation in Canada

88 — REQUIRED

Cite the appropriate references for the above tests in specific provisions of the Act, including up to three related sections, ITs (primary) or Income Tax Folios, or ICs from the footnotes to those provisions in the Act.

Exercise 8

ITA: 18(1)(l)

Advice Limited, a consulting firm in Calgary, owns a small lodge in the Banff area. The lodge is used throughout the year for the purposes of entertaining clients. — REQUIRED (A) Comment on the deductibility of maintenance costs in respect of the lodge. (B) Reconsider the deductibility of these costs if the property is rented during the week to the public and used to entertain clients only on the weekends.

Exercise 9

ITA: 18(12)

Amina and Karim are married and work together as self-employed management consultants. They both work full-time on various projects in a 500-square-foot office located in their home. The total square footage of their home (bedrooms, kitchen, living room, and dining room) is 2,000 square feet. Amina teaches one evening course at the university each week. She earned $70,000 in consulting income and Karim earned $65,000. Other expenses, as listed below, were also incurred: EXpenses: Supplies and materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,800 Computer and software lease ....................................................... 2,300 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,100 Total home overhead costs incurred during the year: Mortgage interest ...................................................................... $16,000 Utilities, water, and electricity ..................................................... 2,400 Property taxes ............................................................................... 2,200 House cleaning .............................................................................. 2,400 Home insurance .......................................................................... 600 Total ..........................................................................................$23,600 — REQUIRED Advise Amina and Karim on the deductibility of their home office expenses.

Exercise 10 Mr. M. Black is the controller with responsibility for tax compliance of International Widget Manufacturing Limited based in Calgary. He has called to ask your advice, as the company’s accountant, on various matters pertaining to the company’s 2023 tax return. He has asked you the following questions. (A) On March 1, 2024, the company paid $234,000 for the benefit of 30 employees to a defined benefit registered pension plan. Of the $234,000 paid, $129,000 represents an adjustment required as a result of an actuarial valuation; the remainder was based on a current service contribution equal to 6% of each employee’s wages for 2023. What is the total amount that can be deducted for tax purposes in 2023? (B) The company paid $15,000 representation costs to obtain a special licence from the State of Montana to sell its widgets in the state. This amount was written off in the financial accounts but added back and amortized over a 20-year period in calculating income for tax purposes. How should this item be treated? (C) The amount of $1,500 spent to connect gas lines on conversion from oil to gas in the Toronto plant was added to the cost of the building for financial accounting purposes and depreciated with the building. How should the amount be treated for tax purposes? (D) The president’s wife is employed full-time as his secretary and paid $7,000 per month. Is this amount deductible and if not, how much is deductible? — REQUIRED Provide brief answers to the questions posed by the controller.

¶4,825

ITA: 17, 20(1)

Ch. 4/Study Guide — Exercises

Exercise 11

89 ITA: 20(1)(f)

In August 2019, Steel Blind Manufacturing Co. Ltd., a venetian blind manufacturer, issued a series of bonds at $956.71 per $1,000 par value. The issue matured in August 2023 and was redeemed at that time at par value. It bears a coupon rate of 4% to yield 5% to maturity. — REQUIRED How much of the bond discount can be deducted and in what year can it be deducted?

Exercise 12

ITA: 9–12, 18–20

The following information concerning the financial statements of Incredible Incubators Incorporated for its fiscal year ended September 30, 2023, has been presented to you in order to prepare tax returns. (a) Net income after tax per financial statements ..................................................$150,000 (b) Provision for income taxes — current ................................................................... 25,000 — future ................................................................... 130,000 (c) Amortization expense ............................................................................................. 40,000 (d) Reserve for doubtful debts — deducted in 2022 .................................................. 10,000 deducted in 2023 ............................................... 15,000 (e) Interest on income taxes paid after due date......................................................... 2,500 (f) Bond interest expense (including annual discount amortization of $7,500 regarding bonds issued this year) ............................................................................ 39,500 (g) Landscaping costs re factory premises — debited to land account ..................... 12,000 — REQUIRED Using the foregoing information, compute income for tax purposes for Incredible Incubators for their fiscal year ended September 30, 2023. [Ignore capital cost allowance in respect of depreciable capital property.]

Exercise 13 Quickturn Land Limited bought for cash 25 acres of land at a cost of $107,500 during the year. About two months later the land was sold to a developer for $250,000 consisting of a $110,000 down payment in cash and a note without interest due in one year for the balance. A real estate commission of $12,500 was paid. The company often engages in this type of transaction.

ITA: 9, 12(1)(e)(ii), 20(1)(n), 20(8)(b)

— REQUIRED Compute the minimum net income for the company in the year of sale and the next year in respect of this transaction.

CHAPTER 4 ¶4,825

Introduction to Federal Income Taxation in Canada

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ASSIGNMENT PROBLEMS

Problem 1 You are a co-op student working in the accounting department at Crystal Enterprises Inc. and have been asked to help with the year-end tax provision. You have gone through the detailed accounts that make up the company’s income statement and have made a list of items for which you have questions. When you took them to your boss, he asked you to determine whether the accounting treatment and the tax treatment are the same, and, if they are not, what they should do. (1) The company made charitable donations of $15,000 in the year. (2) While looking at the accounts receivable you noticed that they had set up an allowance for doubtful accounts for $120,000, calculated, based on their past history, as 60% of the accounts receivable that have been outstanding more than 60 days. (3) You also noticed that they wrote off bad debts of $15,000 during the year. (4) They included in revenue $10,000 received from a customer for goods to be delivered about two months after the year end. This is not a material amount so no adjustment was made at year end to account for this as deferred revenue. (5) You noticed that the professional fees showed legal and accounting fees of $25,000 related to the re-financing of the company’s long-term debt. (6) In miscellaneous expenses you saw that some application software of $12,000 was expensed, as was $30,000 for landscaping the grounds around their office building. (7) The company expensed a total of $55,000 on meals and entertainment, including $18,000 for a summer picnic for all employees. (8) They also expensed the cost of club dues for senior executives amounting to $8,000. This covered the dues for the Westmount Golf Club, the Board of Trade, and the Downtown Racquet Club. (9) The company expensed the costs of maintaining a small lodge located in the Muskoka area of Ontario north of Toronto and used throughout the year for the purposes of entertaining clients. (10) You know from experience that the company pays $0.70 per kilometre as the mileage rate for the use of employee-owned cars. You noticed that some of the employees are travelling a lot, with two employees driving 6,000 km in the year.

Problem 2 Victoria carries on a retail business as a sole proprietor in a commercial plaza. All the floor space is used for displays or storage so she set aside one room (estimated to be 15% of the floor space) in her house to look after the administration. She has asked you to explain what expenses she will be able to deduct related to this space.

Problem 3

ITA: 80(2)

Carson Manufacturing Inc. (Carson) is under financial stress. As a result of plummeting sales and increasing costs, it has been losing money and has now run out of cash. Last year, one of its biggest suppliers, Scott Distribution Inc. (Scott), loaned it $300,000, on commercial terms, to support them and guarantee a supply of product to them. They are expecting that they will have to sell their land and building next year to pay off some debts, including the bank. At the current time they have non-capital losses of $120,000 and net capital losses of $30,000. The land and building have the following values:

Fair market value . . . . . . . . . . . . . . . . . . . . Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . UCC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¶4,850

Land

Building

$1,900,000 1,500,000

$1,100,000 900,000 700,000

Ch. 4/Study Guide — Assignment Problems

At this point it appears unlikely that Carson will be able to repay the loan, since all of their assets have been pledged to the bank as security. As a result of recent discussions, Scott has agreed to forgive the loan. Now, Carson wants to know what the impact of this forgiveness will be on Carson.

Problem 4

ITA: 9; IT-218R

A piece of land was purchased by Yacov Corporation Ltd. for the purpose of constructing a high-rise residential building. Plans were made for the development of the property, surveys were made and the land was stripped and excavated in preparation for construction. Subsequent to this work on the land, it was determined that the location was not suitable for the intended purpose, due to heavy truck traffic in the area. As a result, the property was listed for sale with the realtor who acted in the original purchase. The sale at a substantial profit took place approXimately siX months from the purchase. The corporation had been newly formed when the above land was purchased. At about the same time, another piece of land was purchased and was developed into a commercial/industrial plaza which the corporation continues to own as a rental property. The principal shareholder of the corporation, Jake Yacov, owns and operates an electrical contracting business. The Articles of Incorporation of the corporation contain the following statement of objects: . . . to purchase, lease, acquire, hold, manage, develop, operate, pledge and mortgage, either absolutely as owner or by way of collateral security or otherwise, alone or jointly with others and either as principal or agent, property, real or personal, and assets generally of any and every kind of description. No mention is made of the purchase and sale of land as a business activity. Write a memo for the Yacov Corporation Ltd.’s file evaluating the issue of whether the sale of the land should be treated as a receipt of income or capital gain for tax purposes. Arrive at a conclusion consistent with your analysis of the facts, but indicate the basis for any areas of potential opposition to your conclusion.

Problem 5

ITA: 6(1)(a)

Comment on the income tax consequences for each of the following independent situations: (a) Dan, a construction contractor, entered into a verbal agreement with his friend, Mike, last year. Dan agreed to oversee a small renovation to Mike’s house in exchange for Mike’s painting services. (b) Yoko’s company won a $100,000 lawsuit against a competitor for patent infringement. (c) Isaac Corporation, a local observatory, hired Cornell for the summer. For each hour that Cornell worked, Isaac received $10 an hour from the government as part of a student employment grant. Cornell’s total compensation is $15 per hour. (d) Jessy works part-time as the residential manager in an apartment block. In exchange for the management and cleaning services she offers, she receives free rent in a two-bedroom apartment. Jessy uses her own supplies and equipment. One bedroom is used as an office for carrying out her duties and meeting existing and potential tenants.

Problem 6

CHAPTER 4

Cameron Chase purchased 200 acres of property about 30 years ago in the eastern Ontario area between Peterborough and Ottawa, as a holiday property for himself and his family. About two years later, it became their principal residence. He worked in Ottawa, both at that time and in the subsequent years; initially he commuted between the property and his Ottawa job on a daily basis. About 10 years later, he began living in Ottawa during the week and commuting home to the property only on weekends. When the property was first purchased, there was an old brick house on it which was not suitable as a residence for the family. A new house (referred to by Cameron as the D.V.A. house) was built; the family moved into it. It is clear that the family’s lifestyle was such as to enjoy the rural location.

ITA: 18(1)(a), 18(1)(h), 248(1)

About 14 years ago (i.e., 15 years after the purchase of the property), Cameron decided to turn part of the property into a campground; eight serviced campsites and appro Ximately twelve unserviced sites were created for this purpose. There was as well room for at least 10 other unserviced campsites more or less immediately available and potential for expansion to a much larger number (e.g., 100). Outhouses were built; a trout pond constructed; and the requisite service roads installed. The tax treatment of the expenses incurred with respect to this construction is not part of the dispute in this case.

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Introduction to Federal Income Taxation in Canada

After these initiatives had been taken, about a year or so later, Cameron sought the advice of a consultant with the Ontario Ministry of Tourism, a Mr. Bingham. The advice sought was with respect to the possibility of developing the campground and obtaining a business loan for this purpose. Cameron had applied around that time for a loan and was turned down in September of that year. Cameron’s consultations with Mr. Bingham at that time led to suggestions for the development of the campsite through the construction of additional facilities: additional serviced sites; proper toilets; laundry facilities; a store on the property; a swimming pool; an activities building which might be used by the campers in bad weather. Cameron’s accountant, Mr. McCoy, prepared projections as to the proposed profitability of the venture if the proposed development took place. These projections showed losses in the first year of operations (about 12 years ago) but a profit thereafter. The projections were based on information given to Mr. McCoy by Cameron and they envisaged the obtaining of a $500,000 loan. Cameron applied to the Eastern Ontario Development Corporation, in the third year of operations, for a loan ($80,000, not $500,000). Mr. Bingham was asked to evaluate the loan application from the Department of Tourism’s point of view. He was asked to consider: whether Cameron had the management capability to effect and operate the proposed development; whether there would be any negative effects on competitors in the area if the development took place; whether Cameron’s marketing plans looked reasonable. Mr. Bingham’s evaluation did not involve any financial analysis of the application. Mr. Bingham recommended that the loan application go forward for the next step, evaluation by the Eastern Ontario Development Corporation. Cameron was unable to obtain the loan, because the Eastern Ontario Development Corporation’s funds are new money for new projects. Cameron purchased a ‘‘pre-fab’’ house for $70,000 which was constructed across the road from the D.V.A. house. The family moved into that house eight years ago. Cameron indicated that he had decided to proceed with the plans for the development of the campsite by turning the D.V.A. house into the general activities building envisaged in the projected development. He planned to add laundry facilities, toilets, etc., thereto. The first year after moving in, Cameron rented the D.V.A. house to his daughter for $100 per month. This was not sufficient to cover the mortgage costs of the property. In May of that year, Cameron had a massive heart attack. He was incapacitated until at least September of that year. Cameron continued to charge the mortgage expenses of the property as a business expense. The profit and loss record of Cameron’s business never showed a profit from the first 10 years of its operation. Losses ranged from about $24,000 to $73,000, but have decreased somewhat in the last two years. The gross income for the campground itself for the siX years was minimal. In the last five years, the campground income was reported in a combined fashion with that received from the cottage and farmhouse property; therefore, it cannot be separately identified. The record is sketchy with respect to the renting of the cottage, the farmhouse, and the D.V.A. house. That which exists does not show a vigorous and concerted effort to run a business. The D.V.A. house, as well as being rented to the taxpayer’s daughter for $100 per month five years ago, was rented during a few of the winter months in the next year to some loggers and for appro Ximately siX months in that year to some miners who were prospecting in the area. Camp Chase was listed in a Government of Ontario camping brochure published for the second season and Cameron had had some calling cards made with Camp Chase, the address, a map and rates listed thereon. No expenses for advertising of the Camp were included in his tax returns for the period of operations to date. Determine whether expenses incurred by Cameron during the two peak loss taxation years (five and four years ago) are business expenses that are deductible for tax purposes.

Problem 7 TalkTech Inc. is a manufacturer and wholesaler of cellular communication products. TalkTech Inc’s customers are retailers who promote TalkTech Inc.’s products to the general public. TalkTech Inc. has an October 31 year end. You are conducting a review of TalkTech Inc’s year-end accounting records for its 2023 fiscal year and have been provided with the following information.

¶4,850

ITA: 12(1), 18(1), 20(1); IT-442R

Ch. 4/Study Guide — Assignment Problems

TalkTech Inc. has the following recorded reserves: Account

Opening

Additions

Subtractions

Closing

Warranty reserve

$35,000

$12,000

$19,500

$27,500

Allowance for doubtful accounts

32,000

7,500

5,000

34,500

TalkTech Inc. provides a one-year warranty on most of its products. The warranty is for defects in workmanship or component parts. This warranty is provided as part of the purchase price of TalkTech Inc.’s products. TalkTech Inc. honours its own warranties. The 2023 addition of $12,000 represents a standard percentage of sales made in the 2023 fiscal period. The 2023 subtraction of $19,500 represents an amount actually paid to honour warranties. The addition of $7,500 to the allowance for doubtful accounts is a result of the application of TalkTech Inc.’s annual year-end aging analysis. In conversation with the controller of TalkTech Inc. you determine that this $7,500 increase in the allowance for doubtful accounts was computed by applying the company’s historical collection percentages to the aged accounts receivable balances. Also, during its 2023 fiscal period, TalkTech Inc. wrote off $5,000 (the subtraction noted above) of amounts previously expensed and included in the opening allowance for doubtful accounts. TalkTech Inc. also ended up collecting $1,500 of previously written-off bad debts. In an attempt to attract a particular retail customer, TalkTech Inc. provided this new customer with an incentive to make a large initial purchase of its products. On April 1, 2023, TalkTech Inc. sold $300,000 worth of cellular phones to CellBlock Limited. TalkTech agreed to the following payment terms in an attempt to entice CellBlock Limited to make the purchase: ● $100,000 due and payable May 1, 2023; and ● $50,000 due and payable January 1 each year starting January 1, 2024, through January 1, 2027.

The cost of the goods sold under this contract was $180,000. The delivery date for the cellular phones sold under this contract was May 1, 2023. One of TalkTech’s customers, Phones’N’Things, was experiencing financial trouble. As a result, TalkTech Inc. had agreed to make shipments only if payments were received well in advance of the anticipated shipping dates. Under the terms of this agreement, TalkTech Inc. received $40,000 from Phones’N’Things on September 30, 2023. This payment was an advance payment for a shipment of new technology cellular phones which TalkTech Inc. expected to be shipping to customers commencing February 1, 2024. In the event that TalkTech Inc. was unable to honour its contract with Phones’N’Things, a full refund of the $40,000 was payable. You agree to prepare a schedule showing the effect of the above information on income for tax purposes of TalkTech Inc. for the year ended October 31, 2023. You will also determine any adjustments that would be necessary to reconcile accounting income and income for tax purposes for the year.

CHAPTER 4

In addition, you agree to analyze the tax consequences if the $5,000 subtraction in the allowance for doubtful accounts in 2023 included an account receivable of $800 which was written off only because it has been outstanding for more than 180 days. In fact, it has been outstanding for one year and is part of the opening allowance of $32,000. This $800 could still be collected and there has been no serious attempt to collect it. The remainder of that customer’s account is current and further sales have been made to that customer.

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Introduction to Federal Income Taxation in Canada

Problem 8

ITA: 9, 18, 20

Jordana is self-employed in the T-shirt distribution business. The following is Jordana’s income statement, for the calendar year ending December 31.

Statement of Income For the year ended December 31 Gross revenue . . . . . . . . . . . . . . . . . . . . . . . . . . .

$62,300

Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . .

(10,000)

Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

52,300

EXpenses: Accounting and legal . . . . . . . . . . . . . . . . . . . . .

$2,300

Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . .

800

Golf dues . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3,000

Reasonable estimated bad debt expense . . . . . .

2,000

Business, taxes, and licenses . . . . . . . . . . . . . . .

1,000

Amortization expense . . . . . . . . . . . . . . . . . . . .

8,000

Cycle Safety Program . . . . . . . . . . . . . . . . . . . .

1,200

Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

7,800

Meals and entertainment . . . . . . . . . . . . . . . . . .

4,000

Rent and lease . . . . . . . . . . . . . . . . . . . . . . . . .

2,200

Office rent . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,000

Salaries and wages — staff . . . . . . . . . . . . . . . .

6,000

Net income per financial statements . . . . . . . . . . .

(39,300) $13,000

Notes: (a) Legal fees include $500 of accrued fees for a pending lawsuit against Jordana for the sale of distasteful T-shirts. (b) Accounting fees include the purchase of a $1,200 computerized cash register. (c) Interest expense includes $3,000 paid to the CRA for late instalment interest. (d) The Cycle Safety Program cost was for Jordana, who is an active environmentalist and rides her bicycle to work every day. (e) Included in the cost of goods sold is $3,200 incurred for the purchase of shelving and lighting. Due to the nature of the transaction, the sale of Disney rights were not included in the financial statements. Jordana actively trades rights for T-shirt logos. Net proceeds from the sale of the Disney rights were $13,000, and the cost of the logo rights was $7,800. Jordana has asked you to calculate her income from a business for tax purposes, before CCA, for the calendar year ending December 31.

Problem 9 Source Renovations Ltd. specializes in home renovations and interior design in the Montreal area. Most of the construction and finish carpentry work is subcontracted to self-employed contractors. The following information relates to the corporation’s net income for the year ended July 31.

¶4,850

ITA: 12(1)(b), 18(1)(a), 18(1)(f), 18(1)(l), 67.1(1)

Ch. 4/Study Guide — Assignment Problems

Sales revenue ............................................................................ $4,100,000 Direct contracting expenses . . . . . . . . . . . . . . . . . . . . . .

3,750,000

Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

350,000

General and administrative expenses: Salary to Ginny (president) . . . . . . . . . . . . . . . . . . . . . .

100,000

Salary to spouse (accounting) (Note h) . . . . . . . . . . . . .

50,000

Meals and entertainment (Note a) . . . . . . . . . . . . . . . . .

12,200

Advertising expenses (Note b) . . . . . . . . . . . . . . . . . . . .

4,900

Travelling expense (Note c) . . . . . . . . . . . . . . . . . . . . . .

19,500

Interest and bank charges (Note d) . . . . . . . . . . . . . . . .

18,000

Amortization (Note e) . . . . . . . . . . . . . . . . . . . . . . . . . . .

8,000

Office expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6,000

Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

218,600

Net operating profit ...................................................................$ 131,400 Other: Gain on sale of real estate (Note f)....................................$

55,000

Sale of design contracts (Note g) . . . . . . . . . . . . . . . . . .

19,000

Net income .............................................................................$ 205,400

Ginny informed you that there was one unrecorded receivable of $16,500 for a renovation project completed on July 30. Notes: (a) Meals and entertainment includes:

Club dues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,000 Promotional meals and season hockey tickets

10,200

Total.................................................................... $12,200

(b) Advertising expenses include:

Charitable donations ............................................. $2,200

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Community promotion................................................ 650 Local advertising and mail outs ............................. 2,050 Total.................................................................... $4,900

(c) Travelling expense includes both air travel and travel reimbursement to employees for business travel. The company’s policy is to reimburse employees 60 cents per kilometre for the business use of their automobiles. The employees drove less than 5,000 kilometres.

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Introduction to Federal Income Taxation in Canada

96 (d) Interest and bank charges include:

Interest expense — operations . . . . . . . . . . . . . . . . . . . . . . . . . . $ 9,400 Penalty interest for late filing prior year’s corporate tax ................... 8,100 Bank charges ............................................................................................ 500 Total.............................................................................................. $18,000 (e) The company uses the straight-line method of amortization. The maximum capital cost allowance that may be claimed is $8,900. (f) During the year, the company purchased two homes. After Ginny redecorated, the corporation sold the homes for a profit. The corporation has sold si X homes in the last two years using the same strategy. (g) The sale of design contracts resulted from Ginny’s desire to downscale her involvement in commercial design. The gain on sale is net of all costs and expenses and is considered to be a capital gain. (h) The salary to Ginny’s spouse is considered reasonable because he spends most of his working day administering her business. The controller of Source Renovation Ltd. has asked you to calculate the company’s income from a business for tax purposes.

Problem 10 Duncan Ltd. is a Canadian-controlled private corporation owned by Mr. William Duncan. Mr. Duncan purchased all shares of Duncan Ltd. on July 1 of the prior year for $500,000 in an arm’s length transaction. Duncan Ltd. manufactures fabrics and will continue with its June 30 year end. The following is Duncan Ltd.’s income statement for the period of July 1 to June 30 of the current year. Duncan Ltd. Statement of Income For the period July 1 to June 30 Gross revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$6,000,000 (4,000,000)

Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2,000,000

EXpenses: Accounting and legal . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 60,000 Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150,000 Personal expense of Mr. Duncan . . . . . . . . . . . . . . . . . . . 30,000 Bad debts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000 Business taxes and licenses . . . . . . . . . . . . . . . . . . . . . . 10,000 Amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80,000 Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90,000 Meals and entertainment . . . . . . . . . . . . . . . . . . . . . . . . 40,000 Rent and lease . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 220,000 Office . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000 Salaries and wages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600,000

(1,310,000)

Net income per financial statements . . . . . . . . . . . . . . . . . .

690,000

Notes: (a) Legal fees include $15,000 of estimated fees for a threatened lawsuit against the company. (b) Advertising expenses include a $10,000 payment to a television station in the United States for commercials promoting the company’s products to the Vancouver market. (c) Interest expense includes $5,000 of interest paid to the CRA for late instalments. (d) Capital cost allowance deductible under paragraph 20(1)(a) is $165,270. (e) On July 31 in the current fiscal year, Duncan Ltd. paid $30,000 to an agent for services to raise financing. The amount is included in the advertising expense.

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ITA: 18, 19, 20, 67.1(1), 78(4)

Ch. 4/Study Guide — Assignment Problems

(f) An $80,000 bonus is included in salary and wages. The amount will be paid on January 15, next year. (g) Included in the cost of goods sold is $50,000 incurred for the purpose of earning exempt income. (h) On January 1 of the current year, Duncan Ltd. paid $100,000 to one of its tenants to cancel a rental lease agreement because Duncan Ltd. required the space for its own business operations. The amount has been included in the rent expense figure. The lease of property commenced on January 1 and had five years remaining at that time. Mr. Duncan has asked you to calculate the company’s income from a business for tax purposes for the year ended June 30.

Problem 11

ITA: 9, 12(1), 18(1)

A senior tax partner in your office has requested that you meet with Mr. Jehangir Dauwalla, a new client, to assist in preparing his personal income tax return. During your initial client meeting, you obtained the following information about Mr. Dauwalla’s new business, which he started on June 1. The proprietorship provides hot air balloon rides and weekend leisure trips. His accounting is prepared on the cash basis. Up and Away Cash Flow Statement from Proprietorship June 1 to December 31 Cash receipts (Note a) . . . . . . . . . . . . . . . . . . . . . $27,220 Cash disbursements: Advertising (Note b) . . . . . . . . . . . . . . . . . . . . . $ 2,200 Charitable donations . . . . . . . . . . . . . . . . . . . . . 380 Equipment rental . . . . . . . . . . . . . . . . . . . . . . . 3,450 Liability insurance . . . . . . . . . . . . . . . . . . . . . . . 2,860 Licences (Note c) . . . . . . . . . . . . . . . . . . . . . . . 680 Salary paid to Jehangir . . . . . . . . . . . . . . . . . . . 15,500 Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,870 Telephone — Long distance . . . . . . . . . . . . . . . . 610 (29,550) Cash outflow . . . . . . . . . . . . . . . . . . . . . . . . . . . .

($2,330)

Notes: (a) Payments received from customers in January for all December flights and outstanding accounts receivable total $6,650 and are not included above. (b) Advertising includes $462 of meals and entertainment expenses relating to promoting business with clients.

(d) In September, Jehangir won a new car through a minor hockey association ticket raffle. The prize had an estimated fair market value of $12,500. Jehangir has asked you to calculate his income from a business for tax purposes.

Problem 12 Marty started a self-employed bakery business in a North Bay warehouse on March 1, and he has selected a fiscal year end of December 31. His business includes the baking and delivery of muffins and bagels to various coffee shops throughout the city.

ITA: 18(1)(a), 18(1)(b), 18(1)(l), 18(1)(n), 67.1

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(c) Licences expense includes $460 for golf memberships for Jehangir and his spouse. He has met several potential new customers through the club and feels that this cost should be deductible. The remaining amount was for business licensing.

Introduction to Federal Income Taxation in Canada

Ma Bagels Statement of Income For the period March 1 to December 31 Gross revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . $340,000 Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . (190,000) Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $150,000 EXpenses: Accounting amortization (Note a) ..................... $4,000 Repairs and maintenance .................................... 2,800 Annual tennis club dues....................................... 2,500 Uncollectible bad debts (Note b) ....................... 4,200 Political donations ................................................ 1,000 Charitable donations ............................................ 8,000 Hotel and travel .................................................... 7,800 Meals and entertainment (Note c) ...................... 3,400 Building rent ....................................................... 12,000 Salary to spouse (Note d) . . . . . . . . . . . . . . . 40,000 (85,700) Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 64,300 Notes: (a) On March 1, Marty purchased a large gas oven, a computerized blender, and a used van for his business. Marty only used the van for deliveries. Assume the deductible CCA on this equipment is $22,400. (b) Uncollectible bad debts are from Jo Jo’s coffee shop. The owner has declared bankruptcy and the business closed on September 15. (c) Meals and entertainment expenses were incurred in the attempt to gain new business with several coffee shops. (d) Diane, Marty’s spouse, worked full-time for Marty overseeing hiring, orders and delivery of all goods. Marty has asked you to calculate his income from a business for tax purposes for the calendar year ending December 31.

Problem 13

ITA: 9, 18, 20(1)(l)

Traci works evenings and weekends as a computer consultant. Weekdays she is employed full-time as a network administrator with Jimac Distributors Ltd., a Canadian-controlled private corporation. Traci has an office organized for her consulting business in her four-room condominium where she takes care of paperwork as well as the assembly and repair of computers. This room is the smallest in the condominium taking up only 50 m2of the 400 m2 total space. The following information was provided by Traci. Receipts for condo fees .............................................. $1,800 Mortgage interest ............................................................ 5,250 Receipts for utilities (light, heat, water) . . . . . . . . 800 Telephone bills . . . . . . . . . . . . . . . . . . . . . . . . . . . 600 Deductible CCA on computer equipment used for diagnostic purposes ......................................................... 1,500 The telephone is used personally and for business. Long distance bills for business total $250. All consulting revenues are deposited into her personal account but she keeps a record in her consulting journal. All payments for supplies are paid out of her personal bank account. She provided you with the following information from her cheque book. Money received for consulting services ..................... $35,000 Cheques issued: CompWorld for parts . . . . . . . . . . . . . . . . . . . . . 18,000 Computer Association . . . . . . . . . . . . . . . . . . . . 50 Savoir Faire cocktail party for clients . . . . . . . . 300 Future Shop for a television and DVD player . . . 200 Straw Warehouse for living room furniture . . . . 5,500 Computer World magazine subscription . . . . . . . 80

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Ch. 4/Study Guide — Assignment Problems

Notes: (a) By looking at Traci’s last year’s tax return, you notice she claimed a reserve of $500 for amounts not collected. This year, $1,200 is outstanding on doubtful customers’ accounts. Traci’s records indicate that she was unable to collect $300 for two jobs completed last year. (b) At the beginning of the year, Traci had $1,500 worth of parts. At the end of the year, she held an inventory of SIMMS that had dropped drastically in price; while the original cost was $2,000, the replacement cost is only $1,200. (c) Traci often travels to a customer’s place of business to provide training, installation, and Home Page design services. Traci uses her own car and charges the customer an extra $50 (included in consulting services) for the on-site service. Assume that Traci’s capital cost allowance is $600. Traci kept track of her receipts and the kilometres she drove during the calendar year. Total kilometres driven ....................... 15,000 Kilometres for business ......................... 4,500 Gas and oil . . . . . . . . . . . . . . . . . . $ 1,500 Repairs (tires and muffler) . . . . . . . $ 350 Traci would like you to calculate her income from business for tax purposes.

Problem 14 You have been assigned to the audit team for B.B. JAMS Ltd., one of your significant clients. Below is the income statement prepared by the company’s accountant for the December 31, 2023, year end.

ITA: 18, 19, 20(1), 147.2(1)

B.B. JAMS LIMITED INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 2023 Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cost of sales (Note (1)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . General and administrative expenses (Notes (2)–(7)) . . . . . . . . . . . . . . . . . . Selling expenses (Note (8)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income from operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other income (Notes (9)–(10)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income before income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provision for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$147,840,000 (119,859,000) $ 27,981,000 (12,374,000) (9,311,000) $ 6,296,000 16,000 $ 6,312,000 (2,528,000)

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 3,784,000

Notes: Through various discussions with the accountant, you have been able to determine that the following information has been recorded in the financial statements: (1) JAMS had a number of items of inventory that did not sell well in the current year. For accounting purposes, the accountant has recorded a reserve for inventory obsolescence. The reserve was calculated based on the carrying value of any inventory item that had not had a sale in the last 180 days. The reserve at year end was $1,285,000.

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(2) JAMS provides insurance for employees and paid the following amounts to Nat Insurance Company during the year: $2,000,000 insurance policy on the life of the president included in insurance expense ($300 per month) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,600 $1,000,000 insurance policy on the life of the vice-president — marketing included in insurance expense ............................................................................... 2,000 Group term life insurance for employees included in salaries and benefits ($37,000 × 12 months) ....................................................................................... 444,000 Total..................................................................................................................... $449,600 JAMS is the beneficiary of the policies on the president and vice-president. On June 1, 2023, JAMS renegotiated its bank debt, and due to the ever-increasing responsibilities of the president, the bank

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Introduction to Federal Income Taxation in Canada

100

required the insurance policy on the life of the president as part of the collateral for the loan. The premiums on the policy are equal to the net cost of pure insurance for the policy. (3) An analysis of the professional fees for 2023 revealed the following expenses: Legal and accounting fees related to the issuance of shares . . . . . . . . . . . . . . . $29,300 Legal fees related to amending the articles of incorporation . . . . . . . . . . . . . . . 2,300 Costs incurred regarding the renegotiating of the bank loans . . . . . . . . . . . . . . 46,100 Costs incurred to defend the company against a wrongful dismissal charge . . . 59,600 Costs related to the structuring of an agreement for the purchase of equipment from a foreign company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38,700 Appraisal costs to determine value of the equipment for the bank . . . . . . . . . . 5,100 (4) During the year, there were substantial repairs completed to the outside of the building. After the repairs some of the landscaping had to be redone. The total costs were $139,000. Of this, $23,500 relates to the landscaping costs. The entire $139,000 was included in general and administrative expenses. (5) A review of the other expense accounts included in general and administrative expenses showed the following: Amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $4,560,000 Interest on late payment of municipal taxes . . . . . . . . . . . . . . . . . . . . . . . . 900 Severance payments to four managers* . . . . . . . . . . . . . . . . . . . . . . . . . . . . 245,000 Loss from theft by accounting clerk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,500 Donations to various registered charities . . . . . . . . . . . . . . . . . . . . . . . . . . . 57,000 * All of the amounts were paid in the year.

(6) The salaries and benefits account shows contributions for certain employees to the company’s registered pension plan. The contributions were not actually made until March 31, 2024. The pension plan is a defined contribution (money purchase) plan. The company matches the employees’ contributions on a dollar-for-dollar basis.

President . . . . . . . . . . . . . . . . . . . . . . . . Vice-president . . . . . . . . . . . . . . . . . . . . . Accountant . . . . . . . . . . . . . . . . . . . . . . .

Registered pension plan $17,025 10,250 5,400

Employment compensation $250,000 150,000 70,000

(7) In early November 2023, JAMS announced an early retirement package that was made available to employees over the age of 60. In order to provide employees with the time required to assess the offer, the deadline for accepting the package has been set at February 15, 2024. While no formal replies were received as of December 31, 2023, the personnel manager anticipates a high acceptance rate. She expects that the costs associated with the packages will be $672,000. This cost has been accrued in the 2023 financial statements. (8) The following information was taken from the various selling expense accounts: Cost of sponsoring presentations at a local theatre company . . . . . . . . . . . . . . $15,000 Hockey game tickets given to customers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000 Meals and entertainment costs of salespeople . . . . . . . . . . . . . . . . . . . . . . . . . 109,500 Staff holiday party and summer barbecue . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43,800 Cost of sponsoring local little league teams . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000 Memberships for salespeople at local golf courses . . . . . . . . . . . . . . . . . . . . . . 12,700 (9) The other income includes a loss on the sale of various fiXed assets of $35,900. (10) During the year, the company had cash on hand for a short period of time due to the timing of certain contract payments. The funds earned interest income of $10,400 while they were held. Other Information: (11) The accountant has calculated that JAMS is entitled to claim capital cost allowance of $5,835,000 in 2023. You have confirmed that this calculation is correct. (12) In reviewing the income tax assessments, you noted that JAMS had been charged interest of $4,900 on the late payment of instalments. You discussed this with the accountant and determined that the interest was recorded in the income tax expense account.

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Ch. 4/Study Guide — Assignment Problems

101

Based on the information that you have obtained, your manager has asked you to calculate the income from business for tax purposes for JAMS for December 31, 2023. He also wants you to show all calculations whether or not they seem relevant to the final answer and comment on all items omitted from the calculation.

Problem 15 On February 1, 2023, Wynn, a recent commerce graduate, began a self-employed, unincorporated coffee business, Chino’s & Beano’s Unlimited. Wynn would like assistance preparing his 2023 tax return. He has prepared a brief, unaudited statement of income. Chino’s & Beano’s Unlimited Statement of Income For the year ended December 31, 2023 Sales revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Provision for returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . EXpenses: Travel — meals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Travel — accommodation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Travel — total operating expenses — car . . . . . . . . . . . . . . . . . . Sales manager’s convention . . . . . . . . . . . . . . . . . . . . . . . . . . . . Salaries paid to staff . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Health club dues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Child care and housekeeping expenses (nanny — single parent) Home office expenses (Note e) . . . . . . . . . . . . . . . . . . . . . . . . . Telephone bills . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Office supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Entertainment — drinks and meals . . . . . . . . . . . . . . . . . . . . . . Private dental plan — for staff members . . . . . . . . . . . . . . . . . . Restaurant structural renovation costs . . . . . . . . . . . . . . . . . . . . Straight-line amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ITA: 12(1)(a)(ii), 18(1)(a), 18(1)(b), 18(1)(h), 18(1)(l), 20(1)(b)

$105,000 $1,200 22,000 (23,200) $81,800 $2,500 2,000 2,350 600 30,000 2,200 12,000 1,400 350 1,700 1,800 2,400 21,200 5,800

Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

86,300

Business loss before tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

($4,500)

Wynn also supplied the following additional information: (a) Wynn used his personal automobile for all his business travel. The $2,350 represents his total expenses for the 11-month period. His travel log included business mileage of 13,000 kilometres; the total number of kilometres driven during the 11-month period totalled 18,000 kilometres. (b) Wynn would like to deduct all of his nanny expenses against his income since the expenses were incurred to earn income.

CHAPTER 4

(c) There are no unrecorded revenues. However, Wynn feels that $380 of his accounts receivable balance is uncollectible because the customers recently declared bankruptcy. Wynn did not provide for this bad debt expense in his financial statements. (d) The structural renovation of the coffee shop included new walls, flooring, an office for Wynn, and a kitchen. (e) To ease the burden of being a single parent, Wynn set up a home office. Wynn uses the office to complete his administrative work in the evenings. The home office expenses relate to a proportion of heat, light and power. Wynn would like you to calculate her net income from a business for tax purposes, ignoring CCA.

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Introduction to Federal Income Taxation in Canada

102

Problem 16 The unaudited income statement for Lomas & Sons Limited, a Canadian-controlled private corporation, for its year ended December 31, 2023, shows the following: Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 995,000 Cost of sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $350,000 General and administrative expenses . . . . . . . . . . . . . . . . . . . . . . 225,000 Research and development expenditures . . . . . . . . . . . . . . . . . . . . 75,000 (650,000) Operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 345,000 20,000

Net income before taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 365,000 Provision for income taxes: — current . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 27,000 — future . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25,000 (52,000) Net income after income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 313,000

The information in the following notes has already been reflected in the above income statement. (1) Payment made by company on April 1, 2024, to a defined contribution (money purchase) registered pension plan for the president of the company in respect of current employment service, allocated to 2023 expenses by the company’s accountant; in addition, the president had $7,500 withheld from his compensation of $74,000 for the RPP . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,500 (2) Increase in warranty reserve on company’s product (net of expense 16,000 incurred; based on self-insurance warranty program) . . . . . . . . . . . . . . . . . (3) Amortization expense recorded in the financial statements . . . . . . . . . . . 40,000 (4) Landscaping costs re: factory premises . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,500 (5) Interest on bank loan obtained for the purpose of purchasing common shares in Advanco Ltd., a dividend-paying Canadian corporation . . . . . . . . . 6,300 (6) Legal costs of arranging an agreement among shareholders . . . . . . . . . . . 8,500 (7) Legal and accounting fees related to issue of shares . . . . . . . . . . . . . . . . . 12,700 (8) Interest on municipal real estate taxes paid late in error . . . . . . . . . . . . . 1,000 (9) Golf club membership fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,200 (10) Donation to United Way . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000 (11) Meals and entertainment for clients . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,000 (12) Appraisal fees to determine selling price of fiXed assets . . . . . . . . . . . . . 6,200 (13) Premium on term insurance on life of president with the corporation as beneficiary; policy was not required to be assigned as collateral for corporate borrowing from the bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,800 (14) Management bonuses ($20,000 of the bonuses expensed in 2023, and shown as ‘‘Bonus Payable’’ on the Balance Sheet as at December 31, 2023, has 40,000 not been paid at the time of filing the corporate tax return on June 30, 2024) (15) Amortization of bond discount on bonds issued in 2018 . . . . . . . . . . . . . 3,400 (16) Interest and penalties on income tax assessments, expensed for account1,250 ing purposes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (17) Items included in the financial accounting statements in arriving at the net profit: Amount paid by an insurance company on its business interruption insurance to compensate for loss of profits when company was closed down for a 26,800 month during the year because of a fire . . . . . . . . . . . . . . . . . . . . . . . Dividends received . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,700 Volume rebates and discounts on purchases . . . . . . . . . . . . . . . . . . . . . . . . 16,000 Your manager has asked you to compute the income from business or property for tax purposes, ignoring tax deductions in respect of depreciable capital or eligible capital property for Lomas and Sons Limited in respect of its 2023 fiscal year. In addition, she wants you to comment on all items not included in your derivation of income from business or property.

¶4,850

ITA: 9–12, 18–20, 37, 67.1, 78, 147

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Problem 17 Ryan Holeman, the president of Nine Iron Ltd., has come to your office seeking a second opinion. Nine Iron Ltd. carries on a mini golf and retail business in southern Manitoba. The CRA has reassessed Nine Iron Ltd. for the following transactions that occurred during last year: (a) Eighteen months earlier, the company purchased two acres of land just outside of Winnipeg with the intention of possibly developing a second retail outlet. Ryan did not have firm plans when he purchased the land. At the time, he thought he could either develop the property into a mini golf and retail outlet or build a gas station with an overnight park for recreation vehicles. Unfortunately, a significant lender backed down and the company was forced to sell the land. Luckily, as Ryan had speculated, the land was sold for a profit of $90,000. The new owner plans to develop an overnight park for recreation vehicles. (b) Nine Iron Ltd. immediately purchased a smaller plot of land within walking distance. The company is planning to build a second mini golf and retail outlet location next year. During the year, the company expensed interest and property taxes of $26,000 relating to the vacant land. The company also expensed $7,000 in architect’s fees, and legal and surveying costs for the development of the amusement park. The CRA reassessed Nine Iron Ltd. for $26,000 plus $3,500 in interest charges, claiming that Nine Iron Ltd. purchased the first plot of land with the intention of trading for profit. The CRA is also disallowing the expenses incurred on the second plot. Advise Ryan on the income tax issues that Nine Iron Ltd. must address with respect to the above transactions.

Problem 18 Lisa has come to see you again. She came to see you last week [Chapter 3 — Assignment Problem 1] about her decision to accept a company-owned or a company-leased car. Now she wants to make sure that she understands the company’s position before she makes her decision. She would like you to explain the impact on the company’s income for tax purposes of leasing or owning the car.

Problem 19 You have again been asked for advice on employee stock options by two different clients [Chapter 3 — Assignment Problem 2]. (a) Omer wants you to explain the impact of the stock option on his employer. (b) Hilda wants you to explain the impact of the stock option on her employer.

Problem 20

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Rishma has left your office again. She came to see you last week [Chapter 3 — Assignment Problem 3] about her offer of employment from Motion Tech. Based on your advice to her, she has again met with the company. Now she wants to make sure she understands the company’s position before she makes her decision. She would like you to explain the impact of the list of items in her offer on Motion Tech’s income for tax purposes.

Problem 21 The CFO for Auto Supply Inc. has asked you to explain to him the impact of the possible employee benefits you considered in Chapter 3 — Assignment Problem 4 on the company’s income for tax purposes.

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Problem 22

ITA: Subdivisions a and b

Coco Hardy is an apprentice with Sepp, a design house in Toronto. In her spare time, during some evenings and on weekends, she operates a sewing service for clothing manufacturers. She has set aside a spare room in her apartment where she keeps her equipment and materials and performs her services. This room occupies approXimately 20% of her apartment. She sews for many of the same companies that deal with her employer, Sepp. The demands of her employment with Sepp will continue to prohibit her from expanding her sewing services. Consequently, she has not advertised for additional sewing work. Her sewing billings average approXimately $600 per month. She and the manufacturers mutually agree upon what type of sewing is to be done in order to meet the manufacturers’ production deadlines. Her hourly rates are determined by the type of sewing required for a particular manufacturer. At the end of each month, she will issue a bill to the manufacturers bearing her name, home address, and home telephone number. Her clients pay her the gross amount on the invoice which does not include HST. Ms. Hardy has incurred some direct sewing expenses and has allocated some of her other costs to her sewing services in respect of the past year as follows: Direct expenses: Sewing supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Meals and entertainment for manufacturers . . . . . . . . . . . . . . . . . . . . . . . . . . Sewing machine repairs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Long distance telephone calls to manufacturers . . . . . . . . . . . . . . . . . . . . . . . Delivery of finished product . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 2,890 500 425 710 1,500

Total direct expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 6,025

Allocated costs: Rent ($1,000 per month) .......................................................................$12,000 Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,100 Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400 Allocation to sewing room . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital cost allowance: Sewing room furniture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sewing machine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Automobile for deliveries . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$14,500 × 20% $ 2,900 $

450 325 1,200

$ 1,975

Total allocated costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 4,875

Total .............................................................................................................................. $10,900 Coco has asked you to analyze the facts and determine whether she is earning employment income or business income from her sewing service. She also wants you to calculate her income as business income and again as employment income and comment on whether the listed expenses and allocated costs are deductible for income tax purposes under each alternative.

Problem 23 Mr. Peter Rajagopal, who is a salesman in Regina, Saskatchewan, has incurred the following expenses in connection with his employment in 2022. He was not reimbursed and did not receive an allowance in respect of any of these expenses. Peter has a Form T2200, signed by his employer, attesting to all of these expenses. (1) Peter uses one room in his home exclusively as a home office. He uses his home office most days and evenings to do paperwork and make phone calls and his home office computer is connected to his employer’s computer system. He visits his office at his employer’s premises appro Ximately once a week and spends the remainder of the time on the road, making sales calls throughout Western Canada.

¶4,850

ITA: 8(1)(f), 8(1)(h), 8(1)(h.1), 8(1)(i), 8(1)(j), 8(3), 8(4), 18–20

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(2) The following expenses relate to Peter’s home office which occupies 10% of the square footage of his house: Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,100 Mortgage interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,000 House insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,150 Municipal taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,050 Maintenance and repairs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,700 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $22,000 10% thereof . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,200 Capital cost allowance on computer equipment . . . . . . . . . . . . . . . . . . . . . . . . 1,035 Rental of photocopier . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,200 Office supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 750 Cellular phone charges (used for employment-related calls only) . . . . . . . . . . . 700 Long distance calls related to business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000 (3) Peter also has the following promotional expenses: Meals (with clients in Regina, Peter’s meals) ............................................................. $2,000 Client’s meals ......................................................................................................... $2,100 Theatre tickets ................................................................................................................ 1,200 Promotional gifts ............................................................................................................. 1,300 Country club membership .............................................................................................. 3,200 (4) Peter paid the following automobile expenses: Gas and oil . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Licence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Repairs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Parking (employment related) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$2,000 1,100 90 800 320

Peter purchased the car that he uses for employment purposes on August 1, 2022, for $50,000 plus $2,500 GST and $2,500 PST. Peter did not claim CCA on the car in 2022; therefore, the capital cost allowance rate for the car is 30% in 2023. The car was driven a total of 40,000 kilometres in 2023; 32,000 of the kilometres driven related to Peter’s employment use. (5) Peter also incurred the following travel expenses (while away at least 12 hours): Airfare . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,520 Meals and accommodation (including $2,400 for meals) . . . . . . . . . . . . . . . . . 4,960 Registration fees for convention in Vancouver to increase product knowledge 800 Out-of-town entertainment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,200 (6) Interest on bank loan: — to buy the computer equipment for the home office in (1) above . . . . . . . — to buy the car in (4) above . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

320 800

(7) Peter’s remuneration from employment is as follows: Salary .................................................................................................................... $40,000 Bonus based on company sales .................................................................................... 35,000 (8) Saskatchewan has GST of 5% and PST of 6%.

Problem 24 Valerie Borg is a vice-president of Program Management with an equipment leasing company in Calgary. Recently, Valerie was approached by a large public company, Key Equipment Finance Limited (‘‘Key’’), which is based in Toronto, about the possibility of joining their firm. Valerie has always been looking for opportunities for career advancement and Toronto is an ideal city for relocation.

ITA: 5(1), 6(1)(a), (b), (c), (e), (g), (k), 6(2), 6(9), 7(1), 7(8), 80.4(1), 110(1)(d); Income Tax Folio S2-F3-C2

Valerie is in the process of negotiating her compensation package. She has just received a letter outlining a proposed package from Key. The package looks very attractive, but she would like to know the tax impact on various items outlined in the letter. Valerie is also interested in knowing the tax

¶4,850

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Peter has asked you to calculate his income and expenses assuming he is an employee and assuming he is self-employed. You have agreed to do this and present him with the results with two columns; one for each option and one showing the differences, if any.

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implications of the compensation package to her future employer. She believes that if she knows the cost to the employer, she will be in a better position to negotiate. (1) An annual salary of $150,000 and bonus, tied to the company’s financial performance. Calculation of the bonus is based on the firm’s December year-end results, with payment to occur on June 30. (2) Key offers to loan Valerie $200,000, interest-free, to help finance a new house. In addition, Key will reimburse all of her moving costs. (3) Key will pay the premium for Valerie to join its group term life insurance plan. Key will pay the premiums for a private health plan, a dental plan, and a drug plan. The company’s insurance company is Green Shield. (4) Valerie is required to travel to Europe on a regular basis. Company policy permits a spouse to accompany its executives for these trips. Valerie’s husband, Matt, is a freelance writer working from home. He is very excited about going to Europe with Valerie. The main purpose of the trips will be for Valerie to oversee the company’s global operations. Her husband will spend his time visiting local museums. Key will pay a portion of the travelling expenses related to Matt. (5) Key will provide a BMW to Valerie. Valerie expects to drive the car 30% for business and 70% for her personal use. Valerie will receive a company credit card to be used to pay for gas and maintenance of the car. Key will pay a monthly lease of $950, including HST. Valerie will drive the car approXimately 20,000 kilometres per year. (6) Key recently installed a fitness club in its building. All employees are encouraged to use the club free of charge. The club also offers free personal training. The equivalent value for similar facilities at a private club would be $1,100 per year, including applicable taxes. (7) Key pays for counselling services related to the physical health of its employees. Valerie will be covered by this service. (8) Valerie will participate in Key’s defined contribution (i.e., money purchase) registered pension plan. The company will match Valerie’s contributions to the plan, which are not to exceed 50% of the maximum deductible amount. (9) Key owns a yacht and it is made available to all of its executives. This offer is extended to Valerie. She can have it free for one week each year. Valerie would like you to explain the tax implications of the compensation package to both herself and Key. She would also like you to describe the tax-related issues to be considered when designing an employee compensation package.

Problem 25 Samara, the president of Eden Prospects Ltd., has come to your office for a second opinion. Eden Prospects is a national marketing firm specializing in the development and implementation of marketing plans for partners in practices of law, accounting, medicine and dentistry. Samara is on the premises daily, carrying out her duties as president and a senior adviser to clients. The CRA recently reassessed Eden Prospect’s 2023 taxation year and is requesting that an additional $140,000 in taxes and $28,000 in interest and penalty charges be paid immediately for the following transactions. (a) In December 2023, the company declared a bonus of $280,000 to Samara and several senior vice-presidents. The amount was paid in September 2024. (b) In 2023, the corporation provided three senior executives with an interest-free loan of $240,000 for the purchase of shares of Eden Prospects Ltd. The company borrowed the funds from the bank and incurred $20,000 in interest charges. The executives began repayment in 2025. No amount was shown by Eden Prospects as a taxable benefit for these employees. (c) The corporation pays Samara a nominal salary to act as president. Samara provides her senior advisory services to Eden Prospects through a proprietorship, Sole Trust. Every month, Samara prepares an invoice on behalf of the proprietorship for services rendered to Eden Prospects. Prospects is Sole Trust’s only client. The CRA imposed a large penalty on Eden Prospects for not treating Samara as an employee and remitting Canada Pension Plan, Employment Insurance and withholding taxes.

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(d) In 2023, the corporation rented a fishing lodge to carry out group think sessions with three of their most senior clients. The purpose of the sessions was to provide a comfortable setting for the company’s largest clients to share marketing ideas. The sessions also helped Eden Prospects to become closer to their clients — especially while fishing and golfing. The corporation was denied a deduction for the rent of the lodge, although it was allowed 50% of the meals, entertainment and green fees. Advise Samara by preparing a memo on the various income tax issues that both Samara and Eden Prospects must address with respect to the above transactions.

Problem 26 London City Electronics Inc. has been a client of yours since it started in business five years ago. Isabelle Joy, the founder, has been very successful with her main product, which is a valve that measures and controls the flow of liquids. It is now the middle of March and you have just started your review engagement field work for the company’s December year end when Isabelle asks you to come into her office to talk to her. The first thing you do is congratulate her on the good year she had last year. Her sales, gross profit, and net income are all up substantially over the previous year. You are surprised when she starts to complain about the poor results so far this year. She indicates that her customers are just now starting to stretch their payments because they are facing increased competition from imports. In fact, one of her customers has given London City Electronics some of its products in exchange for the amount it owed. To compound this problem, Isabelle has had some quality control problems in her manufacturing process, and she has been receiving a large number of warranty claims. Sometimes she is able to repair the valve before there is significant cost to the customer, but in some cases the customer has had financial losses as a result of the faulty valve. Isabelle would like your advice on the tax implications of her situation.

Problem 27 Jordana Fluge and Noa Gold were finally able to hold the grand opening for their medical supply import business. It had been an expensive party, but both Jordana and Noa felt that their suppliers, customers, and new employees had appreciated it. It seemed like a long time ago that they got the idea and started to develop their plans. In fact, the idea had been introduced to them 12 months ago during a trip they took to California to look for business opportunities. Once they returned, they began to do their own research. They had one of the local universities do some market research for them to see whether their idea was viable. The research supported their idea of importing medical supplies from a large U.S. supplier to compete against other importers for the Canadian market. SiX months ago, the U.S. supplier put them in touch with their local importer, Beam Inc., whose owner wanted to retire. Since that time, they have been busy negotiating with Mr. Beam and the supplier, finding their own leased warehouse space (Beam Inc.’s space was too small), visiting customers, setting up the office and modern control systems and assessing the employees of Beam Inc. Even before the opening, they had spent $25,000 of their own money on expenses such as: ● their initial travel costs to California (July, last year); ● market research (September, last year); ● negotiating the operating line of credit (May, this year);

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● leasehold improvements, equipment (May, this year); ● travel and entertainment expenses (January to June, this year); and ● legal and accounting costs for the incorporation (June, this year).

But now it is all coming together. Jordana is going to provide the initial capital, including the personal guarantee to the supplier and the bank, and Noa is going to manage the business. They have bought the inventory, customer lists, accounts receivable, and equipment from Beam Inc. Their initial lease is for five years with two, five-year renewal options. Advise Jordana and Noa on the tax implications of the issues raised by this situation. Assume that they incorporated a company in June, but they have not used it in any way yet, and that it is now July when they are asking for your advice.

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Problem 28 The following analysis of certain expense accounts and related additional information was discovered during the December 31, 2023, year-end audit in the month of April 2024 for Meshigoneh Distributors Limited, a Canadian-controlled private company, owned 100% by I.M. Meshigoneh. Employee remuneration: Salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commissions accrued but not paid until Jan. 2024 . . . . . . . . . . . . . . . . Bonuses (Note (1)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Christmas presents to employees (Note (2)) . . . . . . . . . . . . . . . . . . . .

$ 125,000 10,000 50,000 2,000 $ 187,000

Fee for loan guarantee provided by Meshigoneh’s spouse (Note (3)) . . . . . .

8,000

Bond discount: (Note (4)) Amortization on new bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Paid on redemption of old bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 20,000 40,000 $ 60,000

Costs of issuing new bonds: (Note (4)) Legal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Printing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Depreciation and amortization: (Note (5)) Building (capital cost, $1,000,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . Automobile (capital cost, $42,500, excluding HST) . . . . . . . . . . . . . . . .

5,000 2,000 500

7,500

$ 33,333 8,500 $ 41,833

Advertising: (Note (6)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notes: (1) (2) (3) (4)

(5)

(6)

$ 50,000

The 2023 bonuses had not been paid by the date of the audit. The company gave each employee a $100 gift certificate. The 2023 fee had not been paid by the date of the audit. The 2022 fee of $10,000 and 2021 fee of $7,500 had not been paid either. During 2023, the company redeemed its outstanding 10% bonds, face value $100 each (10,000 units) for $970,000. In order to acquire a new building, the company had issued these bonds in 2013 for $930,000 to yield 12% to maturity. The company issued new 13% bonds at the request of its creditors under the threat of a bankruptcy action. The bond issue was for the same face value amount $1,000,000; however, the company only received $980,000. For book purposes, the company is depreciating and amortizing the aforementioned capital assets on a straight-line basis: Building ............................................................................................. 30 years Automobile........................................................................................... 5 years Organization expense ............................................................................. 10 years The automobile was purchased February 1, 2023, and was used by the president, I.M. Meshigoneh, for business use (8,000 kilometres) and for personal use (13,000 kilometres). The organization expense was incurred in 2013 when the company was formed. The $50,000 represents full payment for a series of advertisements in a local newspaper for the 2023-2024 Fall/Winter season of which only 60% have appeared by December 31, 2023.

Discuss, in point form, the tax implications for each of the above transactions with appropriate references to the Income Tax Act or Interpretation Bulletins/Income Tax Folios from the viewpoint of: (A) Meshigoneh Distributors Limited, and (B) the recipients of these payments and/or benefits, if applicable.

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CHAPTER 4 — DISCUSSION NOTES FOR REVIEW QUESTIONS (1) This type of transaction is commonly referred to as an ‘‘adventure in the nature of trade’’ and would result in business income, if the facts of the situation indicate that it has the ‘‘badges of trade’’. One of the indicators that a transaction is an adventure in the nature of trade is that the taxpayer has specialized knowledge in respect of the transaction. Mr. Fritz is a real estate salesperson and, hence, on the surface appears to meet this test. Since ‘‘business’’ is defined to include ‘‘an adventure in the nature of trade’’, this transaction would be classified as business income. The 2022 federal budget introduced new rules related to flipping transactions. Where property is owned less than 12 months, profits from the sale will be considered to be business income unless one of the exceptions apply. The question does not indicate how long Mr. Fritz held the property. The transaction would be business income in either situation.

ITA: 248(1)

(2) There is no requirement in the Act to use GAAP for tax purposes. The courts have, on occasion, rejected conformity between income for accounting and tax purposes, particularly in cases where GAAP is at variance with the court’s concept of ordinary commercial trading and business principles and practices or common law principles. However, GAAP profits are usually used as the starting point for the calculation of net income for tax purposes. (3) No. Since the performance of this contract would have been income to Opco if the customer had completed it, the damages received would also be treated as business income. (4) The agreement was of such importance to Aco Ltd. that it would constitute a large part of the company’s total business structure. As a result, the receipt may be treated as a capital transaction on the sale of class 14.1 property with no cost base. Thus, 50% of the receipt is included in business income. (See Chapter 5.) (5) No. Income from illegal activities is taxable. Subsection 9(1) does not impose conditions on how the profit is earned. See Income Tax Folio S3-F9-C1 for the CRA’s position. See, also, the cases listed in the text on this issue.

Income Tax Folio S3-F9-C1

(6) The subsidy is taxable and would be included in income. Opco would then be able to deduct the full salary of the two hired employees as an expense for earning business income. In essence, the subsidy would offset some expenses, leaving the net expense as a reduction of profits.

IT-273R2

(7) There are a number of limitations that restrict the deductibility of expenses even though they may have been incurred to earn income. E Xamples of expenditures that are not deductible include:

ITA: 18

ITA: 18(1)(b)

use of recreational facilities and club dues; specifically disallowed even if incurred to earn business income;

ITA: 18(1)(l)

●

political contributions;

ITA: 18(1)(n)

●

limitations on interest ($300/month); and

ITA: 18(2), 18(3.1)

●

property taxes on vacant land or buildings under construction.

●

(8) A provision specifically prohibits the deduction of any amount paid or payable under the Act. As a result, the interest paid to the Receiver General will not be deductible.

ITA: 18(1)(t)

(9) Not necessarily. The Act also places a limitation on the amount of several outlays or expenses. It can only be deducted to the extent that it is ‘‘reasonable in the circumstances’’. Meals and entertainment with a client would be an example of an expense that meets the tests in subsection 18(1) but section 67.1 limits their deduction to 50%.

ITA: 67

CHAPTER 4

capital outlay; these are deducted through CCA (see Chapter 5);

●

110

Introduction to Federal Income Taxation in Canada

(10) If the replacement of the roof served to restore it to its original condition then the cost should be fully deductible in the year incurred. If the replacement roof was superior to the old roof, the cost could be considered capital in nature. This would result in an addition to the undepreciated capital cost pool. Then, the cost would be deductible over a number of years. (11) No. Airplane, train, or bus fares are specifically excluded from the 50% limitation. (12) The reserve is only allowed if the company is the manufacturer of the product and pays an arm’s length party to take over the obligations of the warranty for the company.

Income Tax Folio S3-F4-C1 ITA: 67.1(4)(a), IT-518 ITA: 20(1)(m.1)

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111

CHAPTER 4 — SOLUTIONS TO EXERCISES Exercise 1 Employee Perk

Employee Taxable Benefit

Employer Impact

ITA: 9, 11, 18, 20

Tuition fees for the child of employee

$2,800 not a taxable benefit Deductible as compensaand jurisprudence supports an tion expense exempt scholarship for the child. Out-of-town meals Not taxable to employee 50% deductible for employment duties Entertainment for clients Not taxable to employee 50% deductible for employment duties Professional dues Not taxable to employee Fully deductible for employment duties Notebook computer Not taxable to employee Deductible CCA for for employment employment duties Membership for health club Not taxable if employmentNot deductible for related company Interest-free loan $40,000 is subject to an imputed No impact on employer interest taxable benefit of $1,600 (deductible by the executive as was used to invest in company shares) Life insurance premiums $150 taxable benefit Deductible as compensation expense Reimbursement for software Not taxable to employee Deductible CCA for employment duties

Exercise 2 [See Hiwako Investments Limited v. The Queen, 78 DTC 6281 (F.C.A.)] The intention of the taxpayer corporation in this case can only be inferred from the facts of the case. The nature of the asset involved in the transaction is of prime importance in this case. It was an income-producing asset that would have been regarded as a fi Xed capital asset had it been held longer. Normally, the increase in value on the sale of a capital asset is taxed as a capital gain. The gain represents an enhancement of value by realizing a security in the same sense that a growth stock may be sold for a gain that is regarded as a capital gain. Thus, the prospect of an increase in value does not, by itself, characterize the gain as income from business. The nature of the activity surrounding the transaction could characterize it as an adventure in the nature of trade. However, it could be argued that an income-producing property was purchased as an investment and circumstances changed such that the investment had to be sold. This would not necessarily be regarded as a gain made in an operation of business in carrying out a scheme for profitmaking.

The fact that the principal shareholder of the corporation had a long history of trading in real estate does not necessarily mean that his intention in the transaction at hand was to trade. That fact could be outweighed by the income-producing capital nature of the particular property in question. The Court held that the gain was not income from a business, based on the foregoing reasons. However, some believe that the arguments for business income are stronger in this case and that the decision in this case should be limited to its specific facts.

CHAPTER 4

The Court indicated that the concept of ‘‘secondary intention’’ does no more than refer to a practical approach for determining certain questions that arise in connection with ‘‘trading cases’’. If property is acquired where there is no business or the purchaser has not considered how he or she will use it, then the sale may be regarded as an adventure in the nature of trade, supporting a secondary intention to sell at a profit. However, where the property in question is an active, profit-producing property, it may be more difficult to conceive of its having been held as a speculation in the sense of an adventure in the nature of trade.

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112

Exercise 3 (a) If the company leased the vehicle and provided it for Samuel, the company would be able to deduct the cost of the lease as a business expense limited by the formula in section 67.3. Samuel would have a taxable benefit that would consist of: Standby charge Operating cost benefit Taxable benefit . . . . . .

ITA: 9, 11, 18, 20, 67.2, 67.3

($400 × 12 × 2/3) = $3,200 (10,000 × $0.33) = 3,300 $6,500

(b) If the company purchased the vehicle, it would claim capital cost allowance using the CCA rate of 30%, limited to a capital cost of $36,000. Interest on funds borrowed would be limited by section 67.2, thus receiving a tax reduction. This option requires the company to lay out cash and the company should do an analysis of which of the options is better for it for the period of time the automobile is needed. Samuel would have a taxable benefit that would consist of: Standby charge Operating cost benefit Taxable benefit . . . . . . . .

(2% × $22,000 × 12) = (10,000 × $0.33) =

$5,280 3,300 $8,580

(c) The allowance would cost the company $4,150, calculated as follows: $0.68 × 5,000 km = $3,400 $0.62 × 2,000 km = 1,240 Total ............................... $4,640 This amount would be deductible as an expense for the employer as it is tied to the CRA’s automobile expense deduction limits. Samuel’s operating costs incurred for business purposes = $1,029 ($2,500 × 7,000/17,000) plus depreciation. Samuel would be receiving $4,640 per year, which implies $3,611 ($4,640 -- $1,029) of the reimbursement is for depreciation of the vehicle.

Exercise 4 The $225,000 would be considered a capital receipt based on the Parsons-Steiner Limited v. M.N.R. case.

62 DTC 1148 (EX. Ct.)

The following paraphrased excerpt from that case will help explain the conclusion: On the whole therefore having regard to the importance of the franchise to Cars’ business, the length of time the relationship had subsisted, the extent to which the appellant’s business was affected by its loss both in decreased sales and by reason of its inability to replace it with anything equivalent, and the fact that from that time the appellant was in fact out of business, leads to a conclusion that this was a capital transaction. The payment in question was to replace ‘‘a capital asset of an enduring nature’’. It was one which Cars had built up over the years and which on the termination of the franchise they were obliged to relinquish. The payment received in respect of its loss was accordingly a capital receipt. The receipt would be treated as proceeds of disposition for a Class 14.1 asset with no adjusted cost bases and would be 50% taxable.

Exercise 5 Various factors must be examined in the determination of whether the dispositions should be considered income from a business or a capital gain. Primary intention The stated primary intention was to develop the properties into shopping plazas, thus, to earn income from these properties. However, this intention must be supported by objectively observable behavioural factors.

ITA: 248(1)

Ch. 4/Study Guide — Solutions to Exercises

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Behavioural factors Relationship of the transaction to the taxpayer’s business AMC’s main business appears to be the development and management of revenue properties. It also frequently engages in the sale of undeveloped properties. The fact that these transactions are closely related to AMC’s main business and the fact that its major shareholder is a realtor and, therefore, heavily involved in buying and selling land, points to treatment of the sales as income from a business. AMC often sells property when it is not feasible to develop and, as such, purchases land with good resale value. This focus on good resale value indicates an underlying intention of selling property for a gain. This indicates a treatment of the dispositions as business income. Number and frequency of transactions Transactions of buying and selling undeveloped land are frequently entered into as it is AMC’s business to develop land. This frequency indicates treatment as income from a business. Conclusion It could be argued that AMC’s primary intention was to hold the third parcel of land to develop it and earn income from it; therefore, its sale should be treated as a capital gain. But because of the likely secondary intention of earning a profit on its sale, the frequency of this type of transaction, and the closeness to AMC’s primary business, it is likely the court would consider all the dispositions as income from a business. The court could say that AMC held onto the third parcel for siX months only in order to get the best price and therefore to make a substantial profit.

Exercise 6 Since actual cost is known it must be used. Therefore, an assumption about cost is not appropriate. Market value is probably best reflected in net realization value for this inventory. The following calculation of inventory values could be used:

Item Mufflers (64 × $17.50/$15.50) . . . . . . Tailpipes (157 × $4.75/$4.50) . . . . . . . EXhaust system (39 × $16.25/$15.50) Shock absorbers (256 × $19.45/$19.75) Brackets (932 × $1.40/$1.30) . . . . . . . Clamps (1,746 × $0.65/$.80) . . . . . . . . Total . . . . . . . . . . . . . . . . . .

Actual cost

Reg. 1801 Market

Ssec. 10(1) Each item at lower of cost or market

$1,120.00 745.75 633.75 4,979.20 1,304.80 1,134.90

$ 992.00 706.50 604.50 5,056.00 1,211.60 1,396.80

$ 992.00 706.50 604.50 4,979.20 1,211.60 1,134.90

$9,967.40

$9,628.70

Either the $9,967.40 value can be used or the $9,628.70 value can be used. However, the ending valuation method used in a particular year must be the same as that used for the end of the preceding year.

ITR: 1801 ITA: 10(1), 10(2.1)

(a) The income-earning purpose test is found in paragraph 18(1)(a) — the ‘‘general limitation’’ re: an outlay or expense made or incurred for the purpose of gaining or producing income from the business or property. Students can list any of the following related sections, ITs or ICs in their answer: Related sections: subsections 20(1), 20(16); subsection 21(1); subsection 26(2); section 30 ITs: IT-99R5; Income Tax Folio: S3-F9-C1; IT-211R; IT-261R; IT-357R2; IT-364; IT-467R2; IT-475; IT-487; IT-521R ICs: IC 77-11; IC 88-2

ITA: 18(1)(a), 18(1)(b), 18(1)(c), 18(1)(e), 18(1)(h), 67, 248(1)

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Exercise 7

114

Introduction to Federal Income Taxation in Canada

(b) The capital test is found in paragraph 18(1)(b) — no deduction is allowed for an outlay, loss, or replacement of capital, a payment on account of capital or an allowance in respect of depreciation, obsolescence or depletion except as expressly permitted by this Part. Related sections: subsection 14(5); subsections 20(1), (10), (16); subsection 24(1); subsection 26(2); section 30 ITs: IT-187; IT-467R2; IT-475 ICs: none (c) The exempt income test is found in paragraph 18(1)(c) — limits an outlay or expense to the extent it may reasonable be regarded as having been made or incurred for the purpose of gaining or producing exempt income. Related sections: none ITs: IT-467R2 ICs: none (d) The reserve test is found in paragraph 18(1)(e) — no deduction for an amount as, or on account of, a reserve, a contingent liability or amount or a sinking fund except as expressly permitted by this Part. Related sections: none ITs: IT-321R (archived); IT-467R2 ICs: none (e) The personal expenses test is found in paragraph 18(1)(h) — no deduction for personal or living expenses of the taxpayer, other than travel expenses incurred by the taxpayer while away from home in the course of carrying on the taxpayer’s business. Related sections: subsections 20(1), (16); subsection 248(1) ‘‘personal or living expenses’’ ITs: no primary ITs ICs: none (f) The reasonableness test is found in section 67, which states no deduction is allowed for an outlay or expense in respect of which any amount is otherwise deductible under this Act, except to the extent that it was reasonable in the circumstances. Related sections: subsection 8(9); subsection 248(1) ‘‘amount’’ ITs: no primary ITs ICs: none

Exercise 8 (A) The deduction of these costs are prohibited, notwithstanding the argument that the lodge was used to produce income from client business.

ITA: 18(1)(l)

(B) The deduction of costs are allowed if they were incurred in the ordinary course of the company’s business of providing the property for rent. The facts of this case may fit this exception.

ITA: 18(1)(l)

Exercise 9 First, it must be determined whether any expense incurred may be deducted in respect of the home office. To make this determination, the specific conditions outlined in subsection 18(12) are that: (i) the office is the principal place of business; or (ii) it is used exclusively for the purpose of earning business income and is used on a regular and continuous basis for meeting clients, customers, or patients in respect to the business. Since Karim performs only consulting work, the home office qualifies under condition (i). Although Amina teaches in addition to consulting, it is only part-time and her principal business is consulting. Therefore, she also qualifies under condition (i). Amina and Karim are carrying on separate selfemployed businesses. Since they also live together, the home office expenses would be split on an agreed basis. Assuming that the split was agreed at 50%, both taxpayers would be permitted to deduct 50% of the eligible home office expenses. Eligible home office expense is equal to 500/2,000 (25%) square feet times the total home office costs. Supplies, materials, and software would be considered business expenses, not home office expenses and therefore the full amount would be deductible.

ITA: 18(12)

Ch. 4/Study Guide — Solutions to Exercises

115

Assuming they agree to a split of 50% for the eligible expenses, Amina and Karim may each deduct the following as their share: Home office expense (subsection 18(12)) . . . . . Supplies and materials . . . . . . . . . . . . . . . . . . . . Computer and software lease . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$23,600 × 25% × 50% = $1,800 × 50% = $2,300 × 50% =

$2,950 900 1,150 $5,000

Exercise 10 (A) — contribution may be made within 120 days of the end of 2023, — an employer contribution to a defined benefit RPP is deductible where it is made on the recommendation of an actuary in whose opinion the contribution is required so that the plan will have sufficient assets to provide benefits in accordance with its terms as registered, — in this case, both the current service contribution and the lump-sum amount based on an actuarial valuation would be deductible in 2023 if they are in accordance with the plan. (B) A full deduction of an amount paid in the year is permitted — or a taxpayer may elect to write it off in equal amounts over the 10-year period beginning in the current year.

ITA: 20(1)(cc)

(C) The deduction of the full amount of utilities connection costs is permitted. Since the taxpayer does not own the gas lines but the utilities company does, the amount is not eligible for capital cost allowance.

ITA: 20(1)(ee)

ITA: 20(9)

(D) Salary of an owner-employee’s spouse is an allowable deduction to a corporation as long as it is reasonable in the circumstances. While $7,000 per month for full-time secretarial work is probably not reasonable, some lesser, reasonable amount would be deductible in this case. The amount in excess of a reasonable amount will not be deductible to the corporation, but will be included in the recipient’s income from employment.

Exercise 11 Only 1/2 of the discount of $43.29 may be deducted because the bond was issued at less than 97% even though within the 4/3 × 4% or 5.33% yield range.

ITA: 20(1)(f)

Given that the discount is paid effectively on maturity when the principal amount is repaid, then 1/2 of the $43.29 or $21.65 is deductible in 2023.

Exercise 12

Net Income for tax purposes before CCA . . . . . . . . . . . . . . . .

$338,000

ITA: 18(1)(e) ITA: 18(1)(b) ITA: 18(1)(t ) ITA: 18(1)(b), (e) ITA: 12(1)(d )

ITA: 20(1)(aa) ITA: 12(1)(l )

CHAPTER 4

Net income per financial statements ................................................................. $150,000 Add: Items deducted in financial statements but not deductible for tax purposes: Provision for income taxes — current . . . . . . . . . . . . . . . . . . . . . 25,000 — future . . . . . . . . . . . . . . . . . . . . . . 130,000 Amortization expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,000 Non-deductible interest — re. interest on late taxes . . . . . . . . . . . 2,500 Bond discount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,500 Reserve for doubtful debts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000 $365,000 Deduct: Items not deducted in financial statements but deductible for tax purposes: Landscaping costs ............................................................ $12,000 (27,000) Reserve for doubtful debts................................................. 15,000

Introduction to Federal Income Taxation in Canada

116

Exercise 13 This transaction would likely involve a receipt of income because the intention is likely to make a profit on the purchase and sale of land. This would be substantiated by the frequency of transactions in land or, at least, the indication of an adventure in the nature of trade. During the year of sale the following income would be computed: Revenue from the sale of land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: cost of land...................................................................................... $107,500 real estate commission ............................................................................ 12,500 Income from the sale of land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: reserve for amount not due until later year* $130,000 × ($250,000 -- $110,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $250,000 Income after reserve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$250,000 120,000 $130,000

ITA: 9 ITA: 20(1)(n)

72,800 $ 57,200

* The reserve is not available, unless the sale occurred within 36 months of the end of the year in which a reserve is to be taken.

Note that the minimum two-year repayment period does not apply on the sale of land which qualifies for the reserve. In the next year, the reserve of $72,800 would be taken into income.

ITA: 20(8)(b)

The Capital Cost Allowance System for Depreciable Property, Including Intangibles

117

CHAPTER 5

Chapter 5

Introduction to Federal Income Taxation in Canada

118

CHAPTER 5 — LEARNING CHART Problem Descriptions 5-1

Textbook Example Problems Tax shield 5-2 A – Accelerated investment incentive B – Immediate expensing 5-3 Half-year rule 5-4 Disposal of depreciable assets 5-5 Short f iscal year – sole-proprietor 56 Short f iscal year – public company 5-7 Replacement property Exercises 1 2 3 4 5 6 7 8 9 10 11 12

Immediate expensing Luxury automobile CCA Sale of luxury automobile Maximum CCA calculation Sale of a rental property CCA calculations and the effects of a short f iscal year CCA schedule CCA on automobile Sale of intangible capital property Public company – Purchase and sale of intangible capital property CCPC – Purchase and sale of goodwill CCA calculations

Assignment Problems 1 Purchase and sale of assets 2 Leasehold improvements 3 Luxury automobile 4 Goodwill 5 Short f iscal year 6 Available for use 7 Asset disposition 8 CCA schedule 9 CCA on change of use 10 Intangible asset transactions 11 Intangible asset transactions 12 Five independent issues 13 CCA schedule

Ch. 5/Study Guide — Learning Chart

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Problem Descriptions Class 12 assets and half-year rule Schedule 1 reconciliation and CCA schedule Insurance and damages receipts Purchase and sale of assets Schedule 1 reconciliation and CCA schedule

CHAPTER 5

14 15 16 17 18

120

Introduction to Federal Income Taxation in Canada

Ch. 5/Study Guide — Review Questions

¶5,800

121

REVIEW QUESTIONS CHAPTER 5

(1) In the year of acquisition, how is a new addition to a CCA class treated? (2) If an asset is sold for less than the UCC balance in the class then there will be a terminal loss that can be used to reduce income. Comment. (3) The ‘‘cost amount’’ of depreciable property is the original cost of the asset. Comment. (4) The ‘‘capital cost’’ of depreciable property is the original cost of the asset before any CCA is claimed. Comment. (5) The accelerated investment incentive applies to all property acquired in all CCA classes. Comment. (6) The half-year rule is designed to take into account the period of ownership during the year and the fact that not all assets are purchased at the beginning of the year. Comment. (7) CCA can be claimed in the year that title and the incidence of ownership are acquired by the taxpayer. Comment. (8) Once a CCA claim has been made a taxpayer cannot go back and change the amount of the prior year’s claim. Comment. (9) When the fiscal period of a business is less than 365 days then the CCA must be prorated for the number of days in the fiscal year. Comment. (10) Once an asset has been disposed of, then no CCA can be claimed on that asset. Comment. (11) A client bought a new piece of equipment that cost her $50,000. Because of the nature of the asset she has received a government grant of $15,000 to help pay for it. She thinks she can only depreciate $35,000. Comment. (12) It has cost a client $20,000 in legal fees to obtain a patent on some new equipment. Given his profitability, he is unhappy that he can only depreciate these costs as a Class 14 asset over the 20-year life of the patent but his controller says that he does not have any choice. Comment. (13) Mrs. Smith has incorporated her company to carry on a retail business. As part of the start-up costs she has paid $800 to have the company incorporated and $10,000 to obtain the indefinite-life franchise that she wanted. Each of these expenditures is a Class 14.1 intangible depreciable property and since they are different they each go into a separate Class 14.1 pool. Comment. (14) Mr. Fin has come to tell you that he has decided to wind up his business and retire. He is in the process of selling all of his assets but he cannot find one buyer who will continue the business and pay him something for goodwill. He is disappointed since he has a balance of $15,000 in his Class 14.1 that cannot be used. Comment.

¶5,800

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¶5,825

EXERCISES

Exercise 1 Review the following independent scenarios from the current year: A CCPC purchased a new bobcat for $45,000 on July 1. A CCPC purchased a new warehouse for $1 million on August 15. A Public corporation purchased new furniture for its head office for $10,000 on September 20. A CCPC renovated their leased retail space for a cost of $200,000. A sole proprietorship purchased a delivery van for $80,000. — REQUIRED Identify the amount eligible for immediate expensing. If the amount is not eligible for immediate expensing explain why.

Exercise 2

ITA: 13(7); ITR: 7307(1)

Harrison Chen, an insurance salesperson, acquired a luXury antique sports car in 2023 for a capital cost of $42,000. The car will be used 40% of the time in performing his duties of employment. — REQUIRED Compute Harrison’s estimated CCA in his first and second year of owning the car (ignore HST).

Exercise 3 Scott is a commission salesman who has been claiming capital cost allowance on his automobile under paragraph 8(1)(j ). The automobile was purchased for $48,000 (including 13% HST) in October 2021. The undepreciated capital cost of his automobile at January 1, 2023, was $14,792. In 2023, he sold the automobile for $12,000. Scott does 75% of his driving for employment purposes out of 16,000 kilometres of total driving.

ITA: 20(16.1), 21(1); ITR: 1100(2.5), 1100(6)

— REQUIRED (A) What are the tax consequences in 2023 to Scott on the sale of the old car? (B) What are the tax consequences in 2023 if Scott buys a new car in October 2023 for $56,000 including HST (13%)? His net commission income after deducting cash expenses for 2023 is $3,000.

Exercise 4 The following balances were found in the various classes of depreciable assets on the tax return for Wasting Assets Ltd., a public company, as at January 1, 2023. Class 1 (see (1) below) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $620,000 Class 8 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75,000 Class 10 (truck for transportation of goods) . . . . . . . . . . . . . . . . . . . . . . . . . . 140,000 Class 13 (see (2) below) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42,000 Class 14 (see (3) below) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54,400

Additional information and transactions during 2023: (1) The Class 1 undepreciated capital cost represents two buildings costing $400,000 each. One building was sold for $450,000 during 2023.

¶5,825

ITA: 20(1)(a); ITR: 1100; Sched. II, III

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(2) The Class 13 balance relates to a long-term lease on a warehouse for 30 years with an option to renew for a further 20 years. The original cost of the leasehold improvements in 2007, when the lease was entered into, was $50,000.

CHAPTER 5

(3) Class 14 consists of a patent for 20 years costing $68,000 on January 1, 2019. (Ignore the effects of the leap years in the period.) (4) Purchases during the year: Manufacturing equipment ........................................................................$250,000 Office equipment ..................................................................................... 10,000 — REQUIRED A) Prepare a schedule showing the maximum capital cost allowance deductions for tax purposes in 2023. B) Calculate CCA on the individual classes using the direct formulas.

Exercise 5

ITA: 13

Liam O’Neille acquired an apartment building a few years ago for $940,000. The cost of the entire property was allocated as follows: Land................................ $380,000 Building .......................... $560,000 The UCC of the building as of the beginning of this year was $456,609, and the net rental income for last year was $54,800. Liam turned 65 years old this year and decided to begin his retirement by selling his apartment building. He received $1,180,000, $400,000 of which was allocated to the land and the remaining balance to the building. — REQUIRED Calculate the maximum capital cost allowance that may be claimed in the current year, and compute the undepreciated capital cost, recapture, or terminal loss.

Exercise 6

ITA: 20(1)

The following are independent situations: (a) Jim Craig, a sole proprietor, purchases his sole asset, costing $100,000, on November 15 of the current year. The company has a December 31 year end. The asset purchased is a Class 14.1 asset. — REQUIRED Calculate the capital cost allowance that may be claimed in the taxation year under the following independent scenarios: (i) The business started on January 1 (fiscal period is 365 days). (ii) The business started on November 2 (fiscal period is 90 days). (b) Jim Craig Inc, a CCPC, purchased the asset with a cost of $100,000, on November 15 of the current year. The company has a December 31 year end. The asset purchased is a Class 8 asset. — REQUIRED Calculate the capital cost allowance that may be claimed in the taxation year under the following independent scenarios: (i) The business started on January 1 (fiscal period is 365 days). (ii) The business started on November 2 (fiscal period is 90 days). (c) RSI Ltd., a public corporation, sells computers and has a December 31 year end. RSI Ltd. leased a warehouse this year for ten years with a renewal option of two years and a second renewal option of three years. Leasehold improvements of $25,000 were made to the warehouse during the year. RSI has no other leasehold improvement assets.

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Introduction to Federal Income Taxation in Canada

124 — REQUIRED Calculate the CCA that may be claimed in the taxation year.

(d) Constabulary Ltd., a public corporation, acquired franchise rights for the amount of $25,000 to operate a doughnut and coffee shop. The franchise is valid for a period of 15 years commencing March 1 of the current year. Constabulary Ltd.’s year end is July 31. — REQUIRED What CCA or other deduction is Constabulary Ltd. allowed this year?

Exercise 7

ITA: 20(1)

Mr. E. Presley has been operating an automobile repair business as a sole proprietorship since 2009. The business owns the following assets: (a) A frame building used as a garage was acquired in 2013. The capital cost of the building in 2013 was $250,000. The UCC of this Class 1 asset was $208,985 as of the last year end. During the current year, renovations were made to the garage in the amount of $20,000. (b) A warehouse adjacent to the frame building was leased this year. The lease has a term of five years with five options for renewal of five years each. The lease period commences April 15. The cost of leasehold improvements was $70,000. (c) Computer equipment was acquired on April 15, 2020. The UCC at October 1, 2022 is $40,000. The equipment was used to perform analysis for repairs. (d) Two trucks were acquired in a previous fiscal period. The UCC as of the last year end for these Class 10 assets was $25,000. One of the trucks was sold this year for gross proceeds of $10,000. The capital cost of the truck was $15,000. Selling costs incurred to sell the truck were $1,000. (e) The rights to a licence to sell special racing car parts was purchased for $30,000. The licence is valid for a period of 15 years commencing June 1 this year. — REQUIRED Compute CCA for Mr. Presley’s automobile repair business for the taxation year ended September 30, 2023. Where immediate expensing is allowed, state the maximum deduction allowed as well as calculate the CCA should Mr. Presley choose not to apply immediate expensing. Ignore the leap year effects.

Exercise 8

ITA: 13(7)(d)

Steven purchased a car in 2021 for $29,600 (before GST). His business is a GST registrant. His business use of the car during each year is a total of 16,000 kilometres with the business use shown below: Business use 2021 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2022 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

95% 85% 90%

— REQUIRED Assuming Steven has not elected to immediately expense his car, compute the maximum capital cost allowance that can be claimed in each year.

Exercise 9 Ms. Glutton sold her unincorporated grocery business in 2023 and received $245,000 for goodwill. The business had a December 31 year end. The grocery store had been purchased on January 2, 2020 with a payment of $190,800 for goodwill at that time.

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ITA: 13(1), 20(1)(a)

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125

— REQUIRED ITA: 20(1)(a)

Exercise 10

ITA: 13(1), 20(1)(a)

Buylo Ltd. is a public corporation, which has been in the same business, except as noted below, since 2018, made the following purchases and sales throughout the period 2023 to 2029. Jan. 1, 2023 June 1, 2025 Mar. 1, 2026 Nov. 1, 2027 Sept. 7, 2028 Aug. 3, 2029

Purchased goodwill at $140,000. Purchased a government licence with an indefinite life for $250,000. Purchased a trademark for $40,000. Purchased customer list for $90,000. Sold customer list for $100,000. Sold all of the remaining assets of the business to a competitor for $700,000 of which $300,000 could be attributed to the licence, $225,000 to the trademark and $175,000 to goodwill.

— REQUIRED Calculate the effect of these transactions on income for the 2023 to 2029 taxation years, assuming the company always took the maximum CCA deductions each year for its fiscal years ending December 31. For simplification, ignore the accelerated investment incentive phase out – assume the accelerated investment incentive ends on January 1, 2024 and the half-year rule does not apply. Calculate the amount of UCC balance as at January 1, 2030.

ITA: 13(1), 20(1)(a)

Exercise 11

ITA: 13(1), 20(1)(a)

Chalupshka Inc. is a CCPC and has carried on business from the beginning of its 2023 taxation year. In that year, it purchased a store and paid $5,000 for goodwill. In 2025, the store was sold and $6,500 was received for the goodwill. Also, in January, 2025, Chalupshka Inc. purchased another store and paid $4,450 for goodwill. Then, in 2026, Chalupshka Inc. ceased to carry on business and sold the business with no part of the proceeds attributed to goodwill which was considered to have no value. — REQUIRED Calculate the income effects of these transactions for each of the years in question, assuming that Chalupshka Inc. claimed the maximum CCA each year.

Exercise 12 Golden Horseshoe Manufacturing Ltd., incorporated in Ontario in 2007, manufactures widgets in a small community just north of Toronto. In 2010, Golden Horseshoe Manufacturing Ltd. listed its shares on the Toronto Stock EXchange. The following balances are reflected in the company’s trial balance and corporate tax return as at January 1, 2023. The controller has asked us to prepare a schedule for tax purposes to reflect the corporation’s capital asset transactions and to calculate the maximum capital cost allowance for 2023 and the UCC balances on January 1, 2024. (Note: Ignore the effect of the ssec. 13(4) election on the sale of the building). Book records Rate of write-off 20 yr.

Type of asset Brick building (used by prior owner before March 19, 2007)) . . . . . . . . . . . . Equipment 10 yr. — office . . . . . . . . . . . . . . . . . . . . . . — manufacturing . . . . . . . . . . . . . . . 5 yr. Trucks (for transportation of goods) . . . 5 yr. Leasehold improvements (Note (1)) . . . 13 yr. Patent (Note (2)) . . . . . . . . . . . . . . . . . 17.5 yr. Intangibles . . . . . . . . . . . . . . . . . . . . . . Indefinite

Tax records Balance Class Jan. 1, 2023

Cost

Book Value

$160,000

$24,000

$70,000

10,000 65,000 30,000 24,000 29,000 0

4,000 28,000 12,000 21,176 26,500 0

8 43 10 13 44 14.1

6,000 27,000 13,000 19,500 25,375 0

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CHAPTER 5

Compute the effect of the 2023 sale on Ms. Glutton’s income. Assume that maximum deductions for CCA have been made in previous years.

Introduction to Federal Income Taxation in Canada

126 NOTES:

(1) The leasehold improvement represents an improvement to a leased warehouse in downtown Toronto on January 1, 2021, costing $24,000. The lease is for three years with two successive options to renew of five years each. (2) The patent was purchased on June 30, 2021 at a cost of $29,000. The originator of the patent had registered the patent on January 1, 2019. (3) During 2022 the company made the following expenditures: (a) Purchased a newly built brick building in Hamilton, Ontario for total cost of $350,000, including land costing $100,000. The building is used 95% for the manufacturing operations. (b) Additional expenditures concerning the building: Paved parking lot ....................................................................................... $ 5,000 Landscaping ................................................................................................... 4,000 Utilities service connection ........................................................................... 1,000 (c) Further leasehold improvements were made to the leased warehouse (see Note (1), above) of $9,000 on January 1, 2023. (d) Equipment purchased in 2023: Computer hardware and systems software ............................................. $10,000 Manufacturing ............................................................................................. 25,000 Office ........................................................................................................ 2,000 Small tools (costing less than $500 each) ................................................ 6,000 (e) Purchased a 5-year licence to manufacture a related product line from a foreign manufacturer on April 1, 2023 at a cost of $12,000. (f) Legal fees, paid on October 1, 2023 in reorganizing the capital structure of the company, cost $14,000. (4) During 2023 the company disposed of the following assets: Building (brick) . . . . . . . . . . . . . . . . . . . . . . . . Office equipment . . . . . . . . . . . . . . . . . . . . . . . . Manufacturing equipment (Class 43) . . . . . . . . .

¶5,825

Proceeds (net) $300,000 1,000 5,000

Capital cost $160,000 1,500 8,000

Ch. 5/Study Guide — Assignment Problems

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127

ASSIGNMENT PROBLEMS

Problem 1

To: From: Date: Subject:

CHAPTER 5

Memorandum Acme Inc. Staff Accountant Controller Month xX, Year xX CCA Calculations and Adjustments

We are in the process of completing the corporate tax return and we have come to the fi Xed asset section, where we have identified three things that I would like you to do. (1) Calculate the maximum CCA that can be claimed, as well as any other income inclusions or deductions. (2) Calculate the ending UCC balance in each class. (3) Identify adjustments you will need to make to reconcile accounting income and income for tax purposes. The following is the information in our files: Acme Inc. has been in business for a number of years and has its shares listed on the Canadian Securities EXchange (‘‘CSE’’). The following are the balances in its CCA classes at the end of its last fiscal year: Class 1 8 10 10.1

Single building (NRB) . . . . . . . . . . . . . . . . . . . . . . . Multiple assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . Multiple assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . Passenger vehicle . . . . . . . . . . . . . . . . . . . . . . . . . .

Note (1) (2) (3) (4)

Rate 6% 20% 30% 30%

Balance $ 825,000 30,000 20,000 13,000

During the year Acme had the following transactions: (1) It sold its building and moved into rented space. It received proceeds of $1,500,000 for the building which had an original cost of $1,275,000 and a net book value of $900,000. (2) It sold a Class 8 asset for $3,000 which had an original cost of $6,500 and a net book value of $3,600. (3) It bought a Class 10 asset for $6,000. It also sold a Class 10 asset for $8,000 which had an original cost of $7,000 and a net book value of $5,500. (4) It sold the Class 10.1 asset for $15,000 which had an original cost of $45,000 and a net book value of $35,000.

Problem 2 Memorandum Acme Inc. To: From: Date: Subject:

Staff Accountant Controller Month xX, Year xX Leasing Issues

When we moved out of our building we rented a building. To make it work for us we had to make leasehold improvements costing $250,000. Our lease has a term of five years with a five-year renewal period. I would like you to determine what is included in leasehold improvements, how much we can deduct for the leasehold improvements, and what lease terms would have been ideal to maximize the tax deduction. Acme Inc. has been in business for a number of years and has its shares listed on the Canadian Securities EXchange (‘‘CSE’’).

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Introduction to Federal Income Taxation in Canada

128

Problem 3 Memorandum To: From: Date: Subject:

Accounting Associate Tax Manager Month xX, Year xX Seaforth Consulting Inc.

The Controller at Seaforth Consulting Inc., our client, has reached out to us with some questions about the tax treatment of some capital transactions. She has asked us to provide her with detailed notes on how to treat them on the company’s tax return for its year ended December 31, 2023 and how to report it on the 2023 T4 for Judy Wall, the corporation’s president. Seaforth, a public corporation, provides a car for its president. On July 1, 2019 it purchased a new car for her use costing $45,000 plus HST, when the prescribed limit was $30,000. On January 2, 2023 they replaced this car; they sold the old one for $25,000 and bought a new one for $60,000 plus 13% HST. In 2023, Judy drove the vehicle 19,000 kms of which 17,100 were for employment purposes. The NBV of the car purchased in 2019 was $27,000 at the time of sale. The corporation has claimed maximum CCA each year. Seaforth is a public company and is registered to collect HST. Please report to me the impact of these transactions on the company and on Judy.

Problem 4 Memorandum To: From: Date: Subject:

Accounting Associate Tax Manager Month xX, Year xX Green Proprietorship

Our client, Ms. Green, has asked us to determine the impact of some transactions involving the purchase and sale of goodwill projected over the next few years. Effective January 1, 2023, she purchased a health food store. As part of the purchase price she paid $80,000 for goodwill. She plans to build up the customer base, and in 2028 she expects to sell the store. As part of the selling price, she expects to receive $100,000 for goodwill. Ms. Green operates the store as an unincorporated proprietorship, with a December 31 year end and intends to claim the maximum CCA deduction. In addition to considering the impact on income of the projected sale of goodwill in 2028 for $100,000, consider the impact if Ms. Green sold the goodwill in 2028 for: (a) $80,000; and (b) $40,000. Assume that the legislation in this area remains unchanged in the period under consideration.

Problem 5 Memorandum To: From: Date: Subject:

Accounting Associate Tax Manager Month xX, Year xX Farthing Proprietorship

Our client, Vicky Farthing, has decided to purchase, personally, a used building in 2023 to be used in her new proprietorship business, which is considered to have started with preliminary work on May 1, 2023 and will have a December 31 year end. As part of her planning, she would like to know what CCA deduction she can take on the purchase of the building if it becomes available for use on September 30th. The cost of the building is $350,000. Would there be a difference if she incorporated her business on May 1, 2023 and had the corporation buy the building to be available for use on September 30th? The corporation’s year end would be December 31.

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129

Problem 6 Memorandum Accounting Associate Tax Manager Month xX, Year xX Huang Manufacturing Inc.

CHAPTER 5

To: From: Date: Subject:

Huang Manufacturing Inc., a CCPC, has been in business for many years with a December 31 year end. Our audit staff has become aware that, in 2023, the company bought a new manufacturing machine at a cost of $500,000 plus HST. They received the machine on November 30, but it took some time for them to install it, so it wasn’t ready to be used until January 15, 2024. We need to determine the maximum CCA that can be claimed in 2023 and 2024 related to this machine.

Problem 7

ITA: 13, 20(16)

Memorandum To: From: Date: Subject:

Accounting Associate Tax Manager Month xX, Year xX Silvia Fields

Our client, Silvia Fields, is the self-employed operator of a VIP delivery service. Three years ago, Silvia purchased her only asset, a van, for a cost of $65,000. The van has been used 100% for business deliveries since it was purchased. The UCC balance in Class 10 at the beginning of this year is $10,814. On March 1, Silvia sold the van for $8,300 and leased a new van for $1,200 a month. Please draft the contents of a letter to Sylvia explaining the income tax implications of the disposition of the van.

Problem 8 On May 1, 2023, Jennifer Lobo incorporated Lobo Enterprises Inc. (LEI)) as a CCPC with a December 31 year end. The corporation purchased the licence to manufacture the boardgame and app version of the latest gameshow, ‘‘Tax is a Microcosm of Life’’. LEI acquired the following assets:

ITA: 13(1), 13(2), 20(1)(a), 20(16.1); ITR: 1100(1), 1100(2.5), 1100 (3), 1101(5p), 1103(2h), 7307(1)(b); Sch. II, III

Manufacturing building .................................................................................................. $500,000 Manufacturing equipment ...................................................................................................20,000 Tools (each costing under $500) ............................................................................. 16,000 Dies and moulds .............................................................................................................. 8,000 Computer equipment and systems software ............................................................... 12,000 Office furnishings .......................................................................................................... 15,000 Customer lists (expected to be used indefinitely)..................................................... 4,000 Delivery van .................................................................................................................. 28,000 Design software ............................................................................................................. 22,000 Chairs and tables (for the employee eating area) ........................................................ 2,500 Automobile (for use by sales manager — 90% for employment purposes) ............... 38,000 Licence to manufacture, based on patented information, ‘‘Tax is a Microcosm of Life’’ for three years — acquired May 1, 2023 ................................................. 30,000 Made improvements to the office building that LEI leased on March 1, 2023; the lease was for three years with two successive options to renew of three years and four years ...................................................................................... 9,000

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Introduction to Federal Income Taxation in Canada

130 During 2024, LEI made the following disposals:

Sold the automobile ..................................................................................................... (25,000) Sold the design software ............................................................................................. (18,000) Sold some of the tools (costing less than $500 each) . . . . . . . . . . . . . . . . . . (5,000) You have been asked to prepare a schedule to show the maximum capital cost allowance for the fiscal years ended December 31, 2023 and December 31, 2024, ignoring HST considerations. For file documentation, where choices are available, state the reasons for your decision. Ignore the effects, if any, of a leap year.

Problem 9

ITA: 13(7)

Memorandum To: From: Date: Subject:

Accounting Associate Tax Manager Month xX, Year xX Sale of Residence

On June 1, 2023, a residential building owned by an individual was sold for fair market value of $605,000. The building originally cost $580,000. On January 20, 2021, it was converted into a rental property. At that time the property had a fair market value of $620,000. I would like you to research the following question. If the building was the only asset in Class 1, which has a 4% capital cost allowance rate, how much capital cost allowance may be deducted for the years 2021 through 2023, inclusive? In addition, please research the tax implications of the sale of the building in the 2023 taxation year. [Note that where an individual has income from property, the taxation year for that income is the full calendar year, i.e., there cannot be a short taxation year for that income.]

Problem 10

ITA: 13, 20(1)(a)

Sharp is a musician. In 2023, he purchased the name of a popular local band that stopped performing earlier that year. The cost of the name was $56,000. Also in 2023, he purchased for $25,000 an indefinite-life licence from the city which allowed him to perform on a street corner on Saturday afternoons. In 2024, Sharp found that he wanted to spend more time in the studio, so he sold the street corner licence for $26,000. In 2026, Sharp decided to break up his band and pursue a career as an accountant. He sold the band name for $60,000. Sharp has not yet filed his tax return for 2026. The year end of the business is December 31. You have been asked to prepare a schedule calculating the balance of the CCA account on January 1, 2026 and calculating the impact on income for 2026. Assume that the legislation remained unchanged throughout the period described.

Problem 11 Con-Glo Corporation, a CCPC, has been involved in various food services businesses since its incorporation in 2020. Con-Glo has a December 31 year end. You have been asked by the controller to examine the transactions involving various intangible assets due to an impending sale of the business. The controller wants to ensure that he understands the implications on the sale in 2028. You have been provided with the following information. Shortly after the business was incorporated, Con-Glo developed, on its own, a property that it owned into its first family restaurant. In 2023, after operating this business for a period of time and ensuring that it was profitable, another restaurant was purchased. The purchase included goodwill in the amount of $68,000. The second restaurant had more of a roadhouse atmosphere. The business had obtained an unlimited life liquor licence. The value of the licence at the time of the purchase was $35,850, and this amount was allocated to the licence in the purchase agreement. Con-Glo operated the two restaurants until 2025 when it purchased a fast food franchise. The franchise was for an undefined number of years and cost $103,000. Also in 2025, it was determined that the original family restaurant would be more successful if it obtained a liquor licence. In order to obtain the licence a presentation had to be made to the liquor licensing board. Con-Glo paid $29,000 in legal fees related to the presentation to the board.

¶5,850

ITA: 13, 20(1)(a), 20(1)(cc); IT-206R

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131

The fast food restaurant, while successful, was too much of a drain on the time of the owners of Con-Glo and was sold in 2027. The value of the franchise agreement was determined to be $110,000.

CHAPTER 5

In 2028, the second restaurant was sold. Con-Glo received $80,000 for the goodwill and $60,000 for the liquor licence. Due to health problems of the owner’s wife, Con-Glo is also considering a sale of the balance of their restaurants in 2029. The selling price will include $250,000 for goodwill, which was internally generated (i.e. not purchased). The controller has asked you to prepare a schedule calculating the UCC balance for the intangible asset transactions as of January 1, 2030, and determine the impact of the above transactions on income for 2023 through 2029. Assume that the company took the maximum tax write-offs that it was entitled to each year. (Hint: consider paragraph 20(1)(cc).) Assume also that Con-Glo was deemed to be in the same business in respect of its restaurant and fast food business as per IT-206R and that the legislation remained unchanged from 2023 to 2030.

Problem 12

ITA: 20(1), 20(16)

For each of the following independent situations identify the deduction for CCA, amortization, or other amount. (a) Janice Martin was an employee of Bayshore Ltd. She was required to use her car in her employment duties and at the end of last year the UCC of her car (Class 10) was $13,500. She left Bayshore during this year and began working for E Xecutive Search Service, where she was not required to use her car. Janice sold her car this year for $10,200. (b) Ramesh acquired a residential rental building on September 1 this year at a cost of $575,000. His net rental income for the four months is $32,000. He wants to claim the maximum CCA. (c) In a prior year, William acquired two residential rental buildings at a cost of $460,000 each. He has sold one for $490,000. The opening UCC of each building was $345,000. Ignore any capital gain. (d) Colin bought a piece of land that he is renting to a farmer for pasturing his cows. The land cost $435,000 and Colin received $81,500 in rent. Is Colin restricted on the CCA he is allowed? (e) Randi sold her residential rental property last year for $1,000,000. The allocation was $750,000 for the building and $250,000 for the land. Her legal fees for selling the property were $15,000. What are her net proceeds of disposition for the building?

Problem 13 Jon’s Auto Parts Ltd. is a CCPC which manufactures small equipment, was incorporated in 2007, and had the following balances in its records concerning its capital assets as at January 1, 2023. Amortization Type of asset Land . . . . . . . . . . . . . . . . . . . . . Building (purchased before 2007) . . . . . . . . . . . . . . . . . . . Equipment . . . . . . . . . . . . . . . . Rolling stock — trucks, etc. (for transportation of goods) . . . . . Leasehold improvements (see Note (1), below) . . . . . . . . . . Licences . . . . . . . . . . . . . . . . . . Intangibles . . . . . . . . . . . . . . . .

Straight-line

Book value

$102,000

40 years 5 years

ITA: 13, 20(1)(a); ITR: 1100; Sched. II, III

CCA Class

UCC

900,000 163,000

1 8

$568,000 39,000

3 years

306,000

170,000

life of lease 5 years indefinite

113,000 70,000 0

13 14 14.1

165,000 87,393 0

Additional Information (1) The Class 13 assets consist of: — Improvements to a leased warehouse costing $100,000 in 2022. The remaining length of the lease in 2022 was siX years with two successive options of four years. — Improvements to a leased office space for head office downtown, costing $81,600 in 2021. The remaining length of the lease was five years with an option to renew for an additional one year.

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132

(2) The licences were purchased to start on April 22, 2021, at a cost of $110,500 and had a life of five years. (3) During 2023, the company had the following capital transactions:

Additions: — Purchased, in June, a new concrete manufacturing building costing $1,625,000, including $325,000 for land. — Additional expenditures regarding the building: Paved parking lot for employees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 97,000 Erected a steel fence around an outside storage area .......................................... 65,000 — Further renovations to leased office space, costing .............................................. 51,000 — Purchased equipment: Office equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 47,000 Manufacturing equipment ............................................................................................255,000 Radio communication equipment ........................................................................... 60,000 — Purchased a distributing licence on March 1, 2023, for five years from a foreign manufacturing company of a related product line, cost: $240,000. — Paid $34,500 in legal fees in reorganizing the capital structure. Disposals:

Cost

Equipment — office . . . . . . . . . . . . . . . . . . . $ 16,250 Brick building in Class 1 (excluding land)

Book value Proceeds

1,400,000

4,225

$ 1,950

900,000

568,000

You have been asked to prepare a schedule for tax purposes to reflect the above transactions and calculate the maximum write-off for tax purposes. (Ignore the effects of the replacement property rules in subsection 13(4) and the effects of leap years.) Assume that Jon’s Auto Parts has business income for tax purposes before CCA of $1,000,000.

Problem 14 For the following properties all purchased on May 15, 2023 and put into service on June 10, 2023, identify the amount eligible for immediate expensing and if immediate expensing does not apply explain why not. (a) A CCPC purchasing a construction crane for $500,000. (b) A CCPC purchasing an indefinite term franchise for $2 million. (c) A public corporation purchasing a construction crane for $500,000. (d) A CCPC renovating the retail location they lease which cost $100,000. (e) A CCPC purchasing a new warehouse for $1.5 million. (f) A sole proprietorship purchasing a dump truck for its construction business for $50,000. (g) A CCPC purchasing new Class 53 manufacturing equipment for $2.5 million.

¶5,850

ITR: 1100(2)

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133

Problem 15

CHAPTER 5

The controller of Choleva Products Limited, a public corporation, has provided you with the following draft income statement as well as some notes that she made during the preparation of this statement.

ITA: 13, 14, 18–20; ITR: 1100; Sched. II, III

Choleva Products Limited STATEMENT OF INCOME For the year ended December 31, 2023 Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cost of goods sold (Note (1)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commission income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 8,300,000 ( 6,800,000) $ 1,500,000 70,000 $ 1,570,000

Administrative and marketing expenses (Note (2)) ................................ $500,000 Amortization (Note (3)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80,000 Interest on long-term debt (Note (4)) . . . . . . . . . . . . . . . . . . . . . . 70,000 Interest on bank indebtedness .................................................................... 120,000

Gain on disposal of property, plant and equipment (Note (3)) . . . . . . . . . . . . . Net income before income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provision for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income after income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

( 770,000) $ 800,000 40,000 $ 840,000 ( 400,000) $ 440,000

Notes Prepared by Controller: (1) The cost of goods sold expense includes the following amounts: (a) A $9,000 loss from a theft by a warehouse employee; (b) A $15,000 reserve for future decline in the value of inventory because of new products expected to be introduced by the competitor. There was no such reserve in 2022. (2) Administration and marketing expenses include: (a) An $11,000 increase in the reserve for warranty expenses; (b) $4,000 of donations to registered charities; (c) $1,500 for golf club membership dues for the Vice-President of Sales and $2,000 for meals and entertainment expenses at the golf club. The Vice-President of Sales uses the club to generate sales; (d) $85,000 in accrued bonuses, including $62,000 paid to employees on May 31, 2024, and $23,000 paid to employees on June 30, 2024; (e) A $15,000 year-end party for all employees; (f) $8,000 of financing fees incurred in connection with the mortgage of the corporation’s new plant, including legal fees of $6,000 and an appraisal fee of $2,000; (g) $5,000 of legal fees in connection with the purchase of shares of another company; and (h) $300 for an upgrade of word processing software. (3) The fiXed asset section of the controller’s working papers indicate the following: (a) The undepreciated capital cost balances at January 1, 2023 were as follows: Class 1 . . . . . . . . . . . . . . . . . . . Class 8 . . . . . . . . . . . . . . . . . . . Class 10 . . . . . . . . . . . . . . . . . . Class 13 . . . . . . . . . . . . . . . . . . Class 14.1 . . . . . . . . . . . . . . . . .

$200,000 60,000 80,000 37,500 0

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(b) Gain on disposal of property of plant and equipment consists of the profit on the sale of the corporation’s only Class 1 asset (proceeds: $180,000; original cost in 2006: $300,000). The land on which the building was situated was also sold for its fair market value which was equal to its cost in 2006. (c) During 2023, the corporation made the following purchases: ● A new office building was purchased in October for $700,000. The cost of the related land

was $400,000. It cost $20,000 to pave part of the land for use as a parking lot;

● New office furniture was purchased for $25,000. This purchase replaced office furniture

which was sold for its $4,000 net book value (original cost: $10,000);

● An unlimited life franchise was purchased for $100,000; ● A 10-year licence to use patented information (expiring June 30, 2033) was purchased on

July 1 for $20,000; and

● Improvements on its leased head office premises which were rented in 2021 for four years

with two successive options to renew for five years and five years. Improvements had originally been made in 2021 in the amount of $45,000. Additional improvements were made in 2023 at a cost of $28,000.

(d) During the year, the corporation sold some small tools (each costing less than $500) for their net book value of $500. (4) Interest on long-term debt includes: (a) Bond discount amortization in the amount of $2,000; (b) $18,000 of interest on bonds issued to buy shares in another company; and (c) $50,000 of interest on the mortgage on the new plant. You have been asked to calculate the corporation’s minimum income from business or property for the year ended December 31, 2023. Assume that all expenses are reasonable in the circumstances. For file documentation purposes, you have been asked to support your treatment of each item listed above with a reason or a section reference. Ignore the effects of leap years.

Problem 16 RBL Proprietorship was heavily damaged during a recent street riot. The mobs broke in, set fire to the store, and physically assaulted the owner, Larry. Fortunately the business was insured, and the owner received the following amounts without delay: Personal injury damage award . . . . . . . . . . . . . . . . . . $ 50,000 Insurance receipts — business interruption .........................80,000 Insurance receipts for delivery truck destroyed ..................30,000 Insurance receipts for leaseholds destroyed by fire ........ 15,000 Total............................................................................... $175,000 The undepreciated capital cost in Class 10 is $15,000 and in Class 13, $10,000. The original cost of the truck was $35,000 and the original cost of the leaseholds was $20,000. Larry does not understand why the damages are not treated as an expense for tax purposes. RBL plans to replace the truck immediately. The damage to the leaseholds, however, presents a challenge because the cost to repair the damage far exceeds the insurance compensation. RBL is considering relocating its business to a safer location. The company will then be able to change its image to suit a new clientele. The architect estimates that the leasehold improvements could be completed in 12 months. The total cost for the move would be as follows: Moving costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 12,000 Estimated lost profits due to business interruption ............48,000 Leasehold improvements .......................................................60,000 Lease cancellation penalty ..................................................... 4,400 Total............................................................................... $124,400 Larry would like your advice on the tax implications of his plans.

¶5,850

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Problem 17

CHAPTER 5

Dundas Printing, a proprietorship, has been in business for the past 20 years. It has only been in the past three years that Bill Peach has taken over the operations from his father (who founded the business and is now retired). As a result of his new-found management freedom and changes in the marketplace, Bill has decided to expand his operations. One of the printing presses he needed to buy would have been too expensive if he had bought it new, so he found a used press at half the price. The drawback is that it will take some time to get the press into production, since it needs some repairs to put it into workable condition. However, Bill feels that this is still a good buy since it will meet his needs for the next five years, by which time new technology will probably make it obsolete and he will be forced to buy a new machine. Before his retirement, Bill’s father drove a car that the company had purchased for his use at a cost of $45,000. The car was given to Bill for his use on his father’s retirement. Bill has now decided that he is going to trade in this car for a car that he always wanted — a sports car that is going to cost $65,000 less the trade-in value of $25,000 for the old car. He is considering an electric vehicle but the cost is $10,000 higher. Bill promises to take you for a ride when it is delivered. In order to increase his market share, Bill is considering purchasing all of the assets of one of his competitors. This will not only give him access to some important customers, it will also allow him to acquire some specialized equipment and skilled operators. The vendor had wanted to sell Bill the shares of his company, but Bill has convinced the vendor to sell him the assets, instead, including goodwill of $40,000. He is considering incorporating before the asset purchase. Bill would like your advice on the tax implications of his plans.

Problem 18 The controller of Martinez Power Tool Corporation Ltd., a public corporation, has reached out to us, requesting that we calculate the minimum income from business or property of the company for the year ended December 31, 2023 under the provisions of the Income Tax Act. She would like us to indicate, briefly, the reasons for making any necessary adjustments to financial accounting profits. She would, also, like us to indicate reasons for not considering an item in our computation, so that all items are accounted for in our work. The corporation has carried on business in Canada since its incorporation in 2004. Its net income for the year ended December 31, 2023, as determined under generally accepted accounting principles, is as follows: Martinez Power Tool Corporation Limited INCOME STATEMENT For the Year ended December 31, 2023 Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cost of goods sold: Inventory, January 1, 2023 . . . . . . . . . . . . . . . . . . . . Purchases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 800,000 7,000,000 $7,800,000 Inventory, December 31, 2023 . . . . . . . . . . . . . . . . . . 600,000 Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Selling expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 500,000 General and administrative expenses . . . . . . . . . . . . . 100,000 Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provision for income taxes . . . . . . . . . . . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$8,500,000

(7,200,000) $1,300,000 (600,000) $ 700,000 60,000 $ 760,000 (300,000) $ 460,000

Included in this summary of the financial results of Martinez Power Tool Corporation Ltd. are the following details: (1) Closing inventory was written down, for a possible future impairment of fair market value below cost, by $40,000 in 2023 and $25,000 in 2022. (2) Selling expenses include: Meals and entertainment ....................................................................................... $11,500

¶5,850

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Golf club memberships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

10,000

Utilities service connection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,000

Charitable donations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5,000

Bonus declared but unpaid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

20,000

(3) General and administrative expenses include: Provincial payroll taxes .......................................................................................... $ 1,000 Depreciation ....................................................................................................... 29,000 (4) Other income includes: Gain on disposal of truck (proceeds of $10,000; net book value of $7,500)

2,500

Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3,000

Dividends from taxable Canadian corporations . . . . . . . . . . . . . . . . . . . . .

1,500

Volume rebates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2,000

(5) The truck sold during the year had an original cost of $15,000. A replacement truck was purchased in the year at a cost of $20,000. (6) The corporation has operated from leased premises since 2021 when it spent $30,000 on infrastructure during the first year of a five-year lease with two three-year renewal options. During 2023, improvements were made to the premises at a cost of $6,000. (7) In 2023, the corporation purchased goodwill for $36,000 and an indefinite-term licence for $20,000. The corporation had not purchased any intangible assets prior to 2023. The 2022 T2 Schedule 8 prepared by the corporation indicates that at December 31, 2022, the corporation had the following undepreciated capital cost balances: Office equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$43,000

Trucks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

64,000

Leasehold improvements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

24,375

The bonus remained unpaid on May 15, 2024 when the 2023 corporate tax return was being prepared.

¶5,850

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CHAPTER 5 — DISCUSSION NOTES FOR REVIEW QUESTIONS ITR: 1100(2)

(2) A terminal loss is allowed only when the asset sold is the last asset in the class. The lower of cost and proceeds are removed from the UCC of the class. If the asset is not the last asset in the class, and a balance still remains in the pool, the balance is assumed to belong to the remaining assets and CCA is claimed on the remaining balance.

ITA: 13(21), 20(16)

(3) ‘‘Cost amount’’ reflects the tax value of an asset at a particular moment in time. With respect to depreciable property, cost amount is that proportion of the UCC that the capital cost of the asset is of the capital cost of all the assets in the class. Capital cost is not defined, but as used here, it means the laid-down cost which includes the actual cost plus all costs of preparing the asset for use.

ITA: 248(1) ‘‘cost amount’’; 13(21)

(4) The ‘‘capital cost’’ is the amount that is added to the CCA class when the asset is first acquired [item A in the definition of ‘‘undepreciated capital cost’’]. See (3) above for a broadly worded definition.

ITA: 13(21)

(5) Accelerated investment incentive (AI) applies to both property where CCA is calculated on the declining balance method and property where CCA is calculated using straightline depreciation. Classes 43.1, 43.2, 53, 54, or 55 benefit from full expensing measures for 2022 and 2023. Property eligible for AI also excludes property purchased from a non-arm’s length person and has been used, or has been previously acquired for use, for any purpose before it is acquired by the taxpayer (i.e., used property). The accelerated investment incentive applies to eligible property available for use between November 20, 2018 and before 2028. Full expensing and the accelerated investment incentive begin to phase out for eligible property available for use between 2024–2027.

ITR: 1100(2); 1100(1)(b), (t) , (ta)

(6) The half-year rule is a simple, arbitrary adjustment that is made to reflect a period of ownership during the year. It is a simpler alternative to prorating CCA for the number of days the asset is owned during the year. The accelerated investment incentive suspends the halfyear rule for eligible depreciable property until 2028. (7) Normally, the statement is true. However, the ‘‘available-for-use’’ rules do not allow CCA to be claimed until the asset is available for use by the taxpayer.

ITA: 13(26)–(32)

(8) An Information Circular provides the CRA’s position on when the CCA claim for prior years can be changed. If the change results in a lower taxable income for the year, it must be requested within the normal time limits for adjustments (see Chapter 14). If the change does not result in a lower taxable income, as, for example, the case of a loss year, the change will be allowed.

IC 84-1, par. 9, 10

(9) A regulation provides for this daily proration in the case of the short taxation year. This may occur for an incorporated or unincorporated business that started up or ceased to exist in the year. For a corporation, prorated CCA may be required where the corporation has a short taxation year due to an amalgamation or acquisition of control.

ITR: 1100(3)

(10) Normally, this statement is true. However, a regulation allows a CCA claim equal to one-half the normal CCA in the year of disposition, as compensation for the inability to claim a terminal loss on the disposal of a Class 10.1 automobile. To qualify, the taxpayer must have sold an auto that was in Class 10.1 and that was owned by him or her at the end of the preceding year.

ITR: 1100(2.5)

(11) Your client is correct. The Act reduces the capital cost of depreciable property for grants, subsidies, forgivable loans, deductions from tax, investment allowances or other

ITA: 13(7.1)

CHAPTER 5

(1) In the year of acquisition, the entire value of the asset is added to a CCA class. If the acquisition is eligible for full or immediate expensing, the entire value is deducted from the CCA class and from income. If the addition is eligible for the accelerated investment incentive an adjustment of an additional 50% of the value of net additions is temporarily added to the UCC base before calculating CCA for the year.

Introduction to Federal Income Taxation in Canada

138

assistance received on the acquisition of the property. CCA should only be claimed on actual or net cost. (12) There are four choices available for the legal costs of obtaining the patent: (a) deduct them as expenses of representation;

ITA: 20(1)(cc)

(b) deduct the costs equally over 10 years;

ITA: 20(9)

(c) capitalize them in Class 14 by an election not to include them in Class 44 and depreciate them over the life of the patent; or

ITR: 1103(2h)

(d) capitalize the costs in Class 44 and depreciate them at a 25% declining-balance rate. Any deduction under paragraph 20(1)(cc) or subsection 20(9) is subject to recapture. (13) There is only one Class 14.1 for all intangible depreciable property for each business. Since Mrs. Smith is only carrying on one business within her corporation, the additions to the company’s Class 14.1 in the year will be $10,000. The $800 of incorporation expenses are deductible, since they are not in excess of $3,000. (14) He is able to deduct the full Class 14.1 balance as a terminal loss from business in the year that he ceased to carry on business. Since he is ceasing his business and he is unable to find a buyer to purchase the goodwill, he will be deemed to have disposed of his goodwill for proceeds of zero.

ITA: 13(12); IT-99R5

ITA: 20(1)(b)

ITA: 20(16)

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CHAPTER 5 — SOLUTIONS TO EXERCISES Immediate expensing is available to a CCPC acquiring capital property on or after April 19, 2021 other than property in Classes 1 to 6, 14.1, 17, 47, 49, and 51 that becomes available for use before 2024. Immediate expensing was expanded to include unincorporated businesses (i.e. sole-proprietors) and certain eligible partnerships made on or after January 1, 2022 for property that becomes available for use before 2025 for individuals or partnerships where all the partners are individuals (or 2024 for eligible partnerships where all the partners are not individuals).

58 DTC 491 (T.A.B.)

(a) The $45,000 is Class 10 equipment and eligible for immediate expensing. (b) Class 1 assets are not eligible for immediate expensing. (c) Immediate expensing is not applicable to public corporations. (d) The $200,000 is Class 13 and is eligible for immediate expensing. (e) The $80,000 delivery van is Class 10 and eligible for immediate expensing up to the amount of income from the source of income that is business.

Exercise 2 Harrison’s automobile is defined as a passenger vehicle for CCA purposes. Passenger vehicles with a cost in excess of $36,000 (2023 amount) must be placed into a separate CCA class, Class 10.1. The depreciation rate for Class 10.1 assets is 30%. However, CCA may only be taken on the deemed capital cost of the vehicle up to a maximum of $36,000 (paragraph 13(7)(a) and ITR 7307(1)). Harrison’s maximum CCA claim for the first and second year of owning the car would be calculated as follows:

ITA: 13(7); ITR: 7307(1)

Year 1 Capital cost of additions ...................................................................................................... $36,000 Less CCA (36,000 × 30% × 1.5*) ......................................................................................... 16,200 UCC, end of year 1 ......................................................................................................... $19,800

* Accelerated Investment Incentive applied.

Business use CCA (CCA × usage %) = $16,200 × 40% = $6,480 Year 2 UCC, Beginning of Year 2 .................................................................................................... $19,800 Less CCA @ 30% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,940 UCC, end of Year 2 ......................................................................................................... $13,860

Business use CCA (CCA × usage %) = $5,940 × 40% = $2,376

Exercise 3 Scott can deduct the employment portion of the CCA against his employment income on his personal tax return. He will also be eligible for a GST/HST rebate in respect of the CCA and other vehicle expenses related to his employment use of the vehicle.

ITA: 20(16.1); ITR: 1100(2.5)

CHAPTER 5

Exercise 1

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No terminal loss can be deducted for an automobile in Class 10.1. The special ‘‘half-year rule’’ to compute capital cost allowance in the year of disposition applies to Class 10.1. (A) Sale of the old car Class 10.1 Jan. 1/23 UCC (Class 10.1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2023 CCA (1/2 × .30 × $14,792) . . . . . . . . . . . . . . . . . . . . . . Proceeds of disposition . . . . . . . . . . . . . . . . . . . . . . . . . Balance in the Pool . . . . . . . . . . . . . . . . . . . . . . . . . . . .

573

Terminal loss denied(2) . . . . . . . . . . . . . . . . . . . . . . . . .

(B) New vehicle purchased in 2023 Class 10.1 2023 Purchase ($56,000) max. . . . . . . . . . . . . . . . . . . . . . . . . Dec. 31/23 UCC before adjustment . . . . . . . . . . . . . . . . . . . . . . . . . Add 50% of net amount (1/2 × $40,680) . . . . . . . . . . . . UCC before CCA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CCA @ 30% of $61,020 . . . . . . . . . . . . . . . . . . . . . . . . . Deduct: 1/2 net amount . . . . . . . . . . . . . . . . . . . . . . . . . Jan. 1/24

$ 14,792 (2,219)(1) (12,000)

UCC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 40,680(3) $ 40,680 20,340 $ 61,020 (18,306)(4) (20,340) $ 22,374

— NOTES TO SOLUTION (1)

Note that 75% of $2,219 or $1,664 is the deduction based on business use.

(2)

Employees cannot claim a terminal loss.

(3)

Limited to $36,000 plus HST (13%) or $40,680, since it was acquired on or after January 1, 2023.

(4)

Note that 75% of $18,306 or $13,730 is deductible, since CCA claimed is not subject to the limitation on sales/negotiating person’s expenses.

Exercise 4 (A) Prepare a schedule showing the maximum capital cost allowance deductions for tax purposes in 2023. Wasting Assets Ltd. is a public company. As a result, immediate expensing is not available. Cl. 1: 4% Jan. 1/23 UCC . . . . . . . . . . . . . . . . 2023 Purchases: — mfg. equip. . . . . . . . — off. equip. . . . . . . . . Disposals: — building (LOCP) . . . Dec. 31/23 UCC before adjustment 1/2 net (Accel Inv.) . . . . . UCC before CCA . . . . . . . CCA . . . . . . . . . . . . . . . . 1/2 net amount . . . . . . . . Jan. 1/24 UCC . . . . . . . . . . . . . . . .

Cl. 8: 20%

Cl. 10: 30%

Cl. 13: S.L.

Cl. 14: S.L.

Cl. 53: 50%

$620,000 $75,000

$140,000

$42,000

$54,400

$250,000

10,000 (400,000)(1) $220,000 0

$85,000 5,000

$140,000 0

$42,000 0

$54,400 N/A

$250,000

$220,000 $90,000 $140,000 $42,000 (2)$54,400 (3) $250,000 (4) (8,800) (18,000) (42,000) (1,250) (3,400) (250,000) 0 5,000 0 0 N/A

$211,200

$67,000

$ 98,000

$40,750

$51,000

ITA: 8(1)(f), 8(1)(j)

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(B) Calculate CCA on the individual classes using the direct formulas. ($620,000 -- $400,000) × 0.04 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ($75,000 × 20%) + ($10,000 × 1.5 × 20%) . . . . . . . . . . . . . . . . . . . . . $140,000 × 0.3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . see Note (2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . see Note (3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $250,000 × 100% (Note (4)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 8,800 18,000 42,000 1,250 3,400 250,000 $323,450

CHAPTER 5

Class 1 Class 8 Class 10 Class 13 Class 14 Class 53

— NOTES TO SOLUTION (1) (2)

Capital gain on disposition of building of $50,000. Lesser of: (a) 1/5 of $50,000 .........................................................$10,000

}

(b) $50,000/40 (max.) . . . . . . . . . . . . . . . . . . . . . $ 1,250 — no accelerated CCA because not first year of ownership $68,000 (3) × 365 = $3,400 (20 × 365) (4) Full expensing allowance is allowed for Class 53 allowing 100% write-off.

$1,250

Exercise 5 The proceeds from the sale of Liam’s building are greater than the UCC of the building. This would indicate that, although Liam claimed CCA in previous years, the market value of the building did not decline. Accordingly, CCA claimed in previous years must be recaptured and added to income for tax purposes in the current year. Liam must report recaptured CCA of $103,391, calculated as follows: Class 1 — 4% UCC, beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less disposition at lesser of: Capital cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net proceeds ($1,180,000 -- $400,000) . . . . . . . . . . . . . . . . . . UCC Balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Recaptured CCA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . UCC Balance after accounting for recapture . . . . . . . . . . . . . . .

ITA: 13

$456,609 $560,000 $780,000

560,000 (103,391) (103,391) 0

Note that no CCA may be claimed in the year of the disposition since the UCC balance in the class after recapture is 0.

Exercise 6 (a)(i) $100,000 × 5% × 1.5 = $7,500 (ii) $100,000 × 5% × 1.5 × (90/365) = $1,849 In (ii), CCA is prorated because the fiscal year is less than 365 days. Class 14.1 properties are not eligible for immediate expensing. (b)(i) $100,000 can be immediately expensed if designated. Otherwise accelerated CCA applies. (ii) $100,000 can be immediately expensed if designated as the property acquired is less than $369,863 prorated limit ($1.5 million × 90/365). Otherwise accelerated CCA applies. (c) RSI is a public company therefore not eligible for immediate expensing. Leasehold improvements — CCA are calculated for Class 13 as the lesser of (1) $25,000 × 1/5 × 1.5 = $7,500 (2) $25,000 × 1/12 × 1.5 = $3,125 (Twelve years is the denominator; this includes the initial lease term and the first renewal period.) (d) Constabulary Ltd. is a public company therefore not eligible for immediate expensing. The franchise is for a limited term, hence it is a Class 14 asset. The CCA on Class 14 assets is computed on a straight-line basis over the remaining life of the asset. CCA allowed to July 31 (153 days) is: $25,000 × 1/15 × 1.5 × (153/365) = $1,048

ITA: 20(1)

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Exercise 7

ITA: 20(1)

Mr. Presley can deduct the CCA computed below when calculating business income on his personal tax return for the year. (a)

Class 1 — Building ($208,895 + 1.5 × ($20,000)) × 4%

(b)

Class 13 — Leasehold Improvements Eligible for immediate expensing if designated

$ 70,000

Otherwise, the CCA would be: Lesser of: (i) 1/10 × 1.5 × 70,000

(c)

(d)

(e)

9,556

$10,500

(ii) 1/5 × 1.5 × 70,000 CCA for the year if no immediate expensing Class 50 - Computer Equipment Eligible for immediate expensing if designated Otherwise, the CCA would be: UCC, beginning of year CCA 40,000 × 55%

$21,000 $10,500

UCC, end of year

$18,000

$ 40,000 $40,000 (22,000)

Class 10 — Trucks UCC, beginning of year Less dispositions ($10,000 -- $1,000) CCA 30%

$ 25,000 (9,000) $ 16,000 4,800

UCC, end of year

$ 11,200

Class 14 Licence Eligible for immediate expensing if designated

$ 30,000

Otherwise the CCA would be: $30,000 × 1/15 × (122*/365) × 1.5

$ 1,003

* Number of days from June 1 to September 30.

Note that for an individual, the amount eligible for immediate expensing is limited to income from the source of income that is business for the year.

Exercise 8 Steven can deduct the business use portion of CCA against business income on his personal tax return for the year. The deductible amounts are calculated as follows: 2021 Dec. 31, 2021 Dec. 31, 2022 Dec. 31, 2023 Jan. 1, 2024

Purchase . . . . . . . . . . . . . . UCC . . . . . . . . . . . . . . . . . CCA @ 30% × 1.5 × $29,600 . . . . . . . . . . . . . UCC . . . . . . . . . . . . . . . . . CCA @ 30% . . . . . . . . . . . UCC . . . . . . . . . . . . . . . . . CCA @ 30% . . . . . . . . . . . UCC . . . . . . . . . . . . . . . . .

Cl. 10: 30% $29,600

Business deduction of CCA

$29,600 (13,320) $16,280 (4,884) $11,396 (3,419)

95% of $13,320 = $12,654 85% of $4,884 = $4,151 90% of $3,419 = $3,077

$ 7,977

Exercise 9 Ms. Glutton’s business is unincorporated. As her LOCP from the sale of goodwill is in excess of the UCC balance in Class 14.1, she will have recaptured CCA which is treated as business income from the sale. As the proceeds exceed the purchase price of the goodwill, she will also have a taxable capital gain to report.

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The Class 14.1 balance would be affected as follows: Additions (Dispositions) $190,800 — — ( 190,800)

Par. 20(1)(a) CCA Deduction(1) $14,310(2) 8,825 8,383 — $ 31,518

Ssec. 13(1) Business Income Inclusion — — — $ 31,518

2023 Opening balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sale (LOCP) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Negative UCC balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Recapture to business income Closing UCC balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Closing UCC Balance $176,490 167,665 159,282 —

CHAPTER 5

Year 2020 . . . . . . . 2021 . . . . . . . 2022 . . . . . . . 2023 . . . . . . . Total . . . . . .

Opening UCC Balance — 176,490 167,665 159,282

$159,282 (190,800) (31,518) 31,518 $ 0

Proceeds ($245,000) in excess of capital cost ($190,800) is a capital gain of $54,200. — NOTES TO SOLUTION (1)

Accelerated CCA applied in 2020.

(2)

$190,800 × 5% × 1.5.

Exercise 10 Buylo Ltd. will need to report recapture as business income and taxable capital gains on the disposition of goodwill, the licence, customer list, and trademark. Class 14.1: 5% Jan. 1/23 Dec. 31/23 Jan. 1/24 Dec. 31/24 Jan. 1/25 June 1/25 Dec. 31/25 Jan. 1/26 Mar. 1/26 Dec. 31/26 Jan. 1/27 Nov. 1/27 Dec. 31/27 Jan. 1/28 Sept. 7/28 Dec. 31/28 Jan. 1/29 Aug. 3/29 Dec. 31/29 Jan. 1/30

Purchase of goodwill ............................................................................. $ 140,000 CCA @ 5% × 1.5 × $140,000 .................................................................. (10,500) UCC ................................................................................................. $ 129,500 CCA @ 5% × $129,500 ............................................................................... (6,475) UCC ................................................................................................. $ 123,025 Purchase of licence .............................................................................. 250,000 UCC ..................................................................................................... 373,025 CCA @ 5% of $373,025 ........................................................................ (18,651) UCC ................................................................................................. $ 354,374 Purchase of trademark .............................................................................. 40,000 UCC ................................................................................................. $ 394,374 CCA @ 5% of $394,374 ........................................................................ (19,719) UCC ................................................................................................. $ 374,655 Purchase of customer list .......................................................................... 90,000 UCC ................................................................................................. $ 464,655 CCA @ 5% of $464,655 ........................................................................ (23,233) UCC ................................................................................................. $ 441,422 Sale of customer list (LOCP: $90,000 < $100,000(1)) .......................... (90,000) UCC ................................................................................................. $ 351,422 CCA @ 5% × $351,422 ............................................................................. (17,571) UCC ................................................................................................. $ 333,851 Sale of licence (LOCP: $250,000 < $300,000)(1)) ............................... (250,000) Sale of trademark (LOCP: $40,000 < $225,000(1)) ................................. (40,000) Sale of goodwill (LOCP: $140,000 < $175,000) ..................................... (140,000) UCC ..................................................................................................... (96,149) Recapture to business income................................................................... 96,149 UCC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0

ITA: 20(1)(a)

Introduction to Federal Income Taxation in Canada

144 — NOTES TO SOLUTION (1)

Proceeds -- Cost = Capital gain, half taxable Licence ................... $300,000 -- $250,000 = $50,000 Trademark . . . . .

$225,000 -- $40,000 = $185,000

Goodwill . . . . . . .

$175,000 -- $140,000 = $35,000

(2) Immediate expensing is not available to a public company. Accelerated investment incentive ends for assets purchased after December 31, 2023. Half-year rule is suspended until January 1, 2028.

Exercise 11 The following CCA and terminal loss amounts were deductible on the corporate tax returns. Class 14.1 (5%) 2023

UCC at the beginning of the year ................................................................. $

5,000

UCC before adjustment .................................................................................. $

5,000

2024

2025

2026

Add: purchase during the year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Add: Adjustment amount of 1 2 of excess purchases-disposals . . . . . . . . .

2,500

UCC before CCA ............................................................................................. $

7,500

Deduct: CCA @ 5% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(375)

Deduct: Adjustment amount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(2,500)

UCC at the beginning of the year ................................................................. $

4,625

Deduct: CCA @ 5% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(231)

UCC at the beginning of the year ................................................................. $

4,394

Add: purchase during the year

4,450

Deduct: disposition (LOCP)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(5,000)

UCC before CCA ............................................................................................. $

3,844

Deduct: CCA @ 5% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(192)

UCC at the beginning of the year ................................................................. $

3,652

Deduct: disposition (LOCP) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(0)

UCC at the end of the year ........................................................................$ 3,652 Terminal loss (positive balance but no assets) . . . . . . . . . . . . . . . . . . . . (3,652) UCC balance after terminal loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

— NOTES TO SOLUTION (1)

Taxable capital gain = 1/2($6,500 -- $5,000) must also be included in income.

(2)

Immediate expensing does not apply to Class 14.1.

Ch. 5/Study Guide — Solutions to Exercises

145

Exercise 12

Schedule to Reflect 2023 Capital Write-Offs and Balance in Tax Accounts

UCC Jan. 1, 2023 . . . . . . .

Cl. 1 (separate)

Cl. 1

Cl. 8

Cl. 10

Cl. 12

10%

20%

30%

100%

$70,000

$6,000

$13,000

Cl. 13

Cl. 14

$19,500

—

Additions Bldg. . . . . . .

$250,000

—

Leaseholds

—

$9,000

—

Office equip.

—

$2,000

—

Jigs etc. . . . .

—

$6,000

—

Licence . . . .

—

$12,000

Bldg. . . . . . .

—

(160,000)

—

Office equip.

—

(1,000)

—

Net . . . . . . . .

$250,000

$(90,000)

$7,000

$13,000

$6,000

$28,500

$12,000

Adjustment 1/2 of net additions . . . .

125,000

—

500

n/a

—

UCC after net adj. . . . . . . . .

$375,000

$(90,000)

$7,500

$13,000

$6,000

$28,500

$12,000

Recapture . . . .

—

90,000

—

(2)

Disposals

(5,250)

(2,712)

CCA — 2023

(37,500)

(1,500)

(3,900)

(6,000)

Adjustment of net additions

(125,000)

—

(500)

n/a

UCC Jan. 1, 2024 . . . . . . .

$212,500 (B)

$0 (B)

$5,500 (B)

$9,100

$23,250

$9,288

CHAPTER 5

Golden Horseshoe Manufacturing Ltd. is a public company and is not eligible for immediate expensing. The maximum available CCA deductible in 2023 on the company’s Schedule 1 is calculated as follows.

Introduction to Federal Income Taxation in Canada

146

UCC Jan. 1, 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . Additions Parking lot . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Legal fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Disposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Manufacturing equip. . . . . . . . . . . . . . . . . . . . . . Net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Adjustment: 1/2 of net additions . . . . . . . . . . . . . . . . . UCC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CCA — 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deduct Adjustment . . . . . . . . . . . . . . . . . . . . . . . . . .

Class 14.1 5% $0

Class 17 8% $0

Class 43 30% $27,000

Class 44 25% $25,375

— 11,000(3) — — $11,000 5,500 $16,500 (825) (5,500)

5,000 — 0 — $5,000 2,500 $7,500 (600) (2,500)

— — — (5,000) $22,000 n/a $22,000 (6,600) n/a

— — — — $25,375 0 $25,375 (6,344) 0

$10,175

$4,400

$15,400

$19,031

Class 50 55% $0

Class 53 100% $0

10,000 — 0 $10,000 5,000 $15,000 — (8,250) (5,000) $1,750

— 25,000 0 — — $25,000 — (25,000) — —

UCC Jan. 1, 2024 . . . . . . . . . . . . . . . . . . . . . . . . . . .

UCC Jan. 1, 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . Additions Computer hardware/software . . . . . . . . . . . . . . . . Manufacturing equipment . . . . . . . . . . . . . . . . . . Disposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Adjustment: 1/2 of net additions . . . . . . . . . . . . . . . . . UCC after net adj. . . . . . . . . . . . . . . . . . . . . . . . . . . . Recapture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CCA — 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deduct Adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . UCC Jan. 1, 2024 . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Other Transactions: — landscaping fully deductible [par. 20(1)(aa)] — utility service connection fully deductible [par. 20(1)(ee)]. — NOTES TO SOLUTION (1)

Class 13: Leaseholds (a) $24,000 2021: Lesser of 5 (b) $24,000 3+5 plus 2023: Lesser of

(a) (b)

(2)

Class 14:

$9,000 5 $9,000 1+5

= $4,800 = $3,000

= $1,800 = $1,500

$12,000 1.5 × 275 1,825 days days

} }

$3,000

$1,500 × 1.5 →

$2,250 = $5,250

= $2,712

(3) Costs associated with reorganizing the capital structure of the company are considered reorganization costs which are included in Class 14.1. The first $3,000 of the expense is eligible for immediate expensing therefore only $11,000 was included in Class 14.1.

Chapter 6 Income from Property

CHAPTER 6

147

Introduction to Federal Income Taxation in Canada

148

CHAPTER 6 — LEARNING CHART Problem Descriptions Textbook Example Problems 6-1 Reporting interest income — individual 62

Reporting interest income — individual 6-

Reporting interest income — corporation

6-4

Dividends — public company

6-5

Carrying charges on land

6-6

Rental property CCA

Exercises 1

Interest income

Carrying charges on land

Rental property CCA

Rental property disposal

Interest expense

Rental property

Rental property during construction

Assignment Problems 1

Dividends — eligible, other, foreign

Sale with earn out

Interest vs. dividend

Expenses of vacant land

Income from rental properties

Construction costs

Property income and employee loan

Property income

Interest expense

Interest, dividend, business income with tax planning

Interest, dividend and rental income

Ch. 6/Study Guide — Learning Chart

149

CHAPTER 6

Introduction to Federal Income Taxation in Canada

150

¶6,800

REVIEW QUESTIONS

(1) Billy has come to you to tell you that he has found a great way of generating income of which only one-half is taxable as a capital gain. He buys a bond that pays interest annually and he holds it until just before the payment date and then he sells it, including the accrued interest, at a gain. Comment. (2) Opco Inc. recently borrowed $300,000 to buy 30 acres of industrial land. The corporation has constructed a building, shipping and receiving area and parking for employees on this property using up 20 acres. The remaining 10 acres is available for future needs. Is all of the interest on the $300,000 loan deductible? (3) Rent Co. Ltd. is a corporation in the residential rental business. Because of some recent purchases, its financing costs are high and it is operating at a break-even before CCA this year. However, in the prior three years it made a profit. Can the corporation claim CCA to create a loss this year to carry back to the prior years, using the carryover rules in Division C, to offset income in those years? (4) Ms. Campbell has bought some gold as a protection against inflation. However, she did not have the cash to make the purchase so she borrowed from the bank to buy the gold. This is the first time that she has done this and she plans to hold the gold for some time. She is repaying the loan over three years. Will she be able to deduct all or some of her interest expense? EXplain. (5) You have been told of a court case where a taxpayer borrowed money initially to purchase a home, because some of the funds that he was to receive from Iran had not arrived when expected. When the funds at last arrived, interest rates had risen above the rate he was paying on his house mortgage. He then chose to invest his money at these higher interest rates instead of paying off the mortgage. He deducted the interest portion of his mortgage payments on his tax return. Comment. (6) A client is in the process of selling his house and buying a bigger one. In order to sell his existing house he is going to have to take back a mortgage owing from the purchaser for $100,000 at 5% for a five-year term. The client will then have to borrow $100,000 in order to buy his new house. Is the interest on this loan going to be deductible? If not, how might he restructure the transaction to make the loan interest deductible? (7) You have just interviewed a new client and have discovered that she borrowed to buy shares in a private corporation five years ago. The loan is still outstanding but the corporation has since gone bankrupt. Is the interest she is paying on the loan still deductible?

¶6,800

Ch. 6/Study Guide — Exercises

¶6,825

151

EXERCISES

Exercise 1 What would be the first year in which the taxpayer would have to include interest in income in each of the following cases and to which years would that interest relate?

ITA: 12(1)(c), 12(4), 12(11)

(A) A corporation with a June 30 year end buys a bond that pays interest semi-annually on March 31 and September 30 from its previous owner on January 1, 2023. (B) An individual buys a compounding GIC on November 1, 2023. (C) On June 1, 2023, an individual buys a $1,000 bond paying $40 interest each of May 31 and November 30. The bond was issued on December 1, 2022.

Exercise 2

ITA: 18(2)

A downtown hotel bought a vacant lot adjacent to the hotel building. Comment on the deductibility of property taxes and interest paid on funds borrowed to buy the property if: (i) the property is used as a parking lot for hotel guests;

CHAPTER 6

(ii) the property was bought for potential gains on future sale but in the meantime it is being used as a public parking lot generating net revenues before the taxes and interest of 75% of the expenditures for taxes and interest; (iii) the property was bought for future expansion of the hotel and in the meantime is being used under the same condition as in (ii) above.

Exercise 3

ITR: 1100

Mr. Provident is a salaried employee who invests in small residential rental properties. He bought Property 1 last year and at the beginning of this year the undepreciated capital cost balances for that property were as follows: Class 1 — brick building................................................................................................. $948,000 Class 8 — furniture and fiXtures ......................................................................................125,000 This year he bought Property 2 for $850,000 including land valued at $292,500. The net income before capital cost allowance for each property this year was: Property 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 45,270 Property 2 ................................................................................................................ 28,750 — REQUIRED Compute the maximum capital cost allowance on these rental properties for the current year.

Exercise 4 Ms. Alimeag owns two residential rental properties, located in St John’s Newfoundland. One produced rental revenue of $42,500 and had allowable expenses (excluding capital cost allowance) of $31,250. The other had rental revenue of $62,500 and expenses of $48,750. Data on the two Class 1 buildings are as follows: Property A

Property B

Capital cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$860,000

$1,600,000

UCC, January 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$830,000

$1,280,000

ITA: 20(1)(a); ITR: 1100, 1101(1ac)

During the year, Property A was sold for net proceeds of $836,000. — REQUIRED (A) What is the effect of the above information on the income of Ms. Alimeag for the year?

¶6,825

Introduction to Federal Income Taxation in Canada

152

Exercise 5

ITA: 20(1)(c)

Nadi borrowed $140,000 at a 5.5% annual interest rate from a local financial institution to finance the following investments. Cost Common shares of a public corporation paying no dividends . . . . . $20,000 Gold bullion (treated as capital) . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000 Cryptocurrency (treated as capital) . . . . . . . . . . . . . . . . . . . . . . . . 15,000 Corporate bond (yield is 6% per annum) . . . . . . . . . . . . . . . . . . . 20,000 Preferred shares (4% annual dividend) purchased in RRSP . . . . . . 10,000 Common shares (2% annual dividend) . . . . . . . . . . . . . . . . . . . . . . 30,000 Paintings from well-known galleries . . . . . . . . . . . . . . . . . . . . . . . . 15,000 Guaranteed Investment Certificate paying interest at 6% per annum . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000 Total cost ............................................................................................$140,000

— REQUIRED Assuming that the investments were held for the full calendar year, determine the deductibility of interest expense for each investment.

Exercise 6 Capital cost allowance, recapture, and terminal loss all form part of the net income calculation for rental properties. There are two special rules that apply only to rental properties that serve to limit the treatment of capital cost allowance. One of the special rules stipulates that each rental property having a cost of $50,000 or more must be held in a separate capital cost allowance class. — REQUIRED Discuss the second special rule.

Exercise 7 You have just been to your physician, Dr. Do Noharm, for your annual physical. During your visit, she told you about her latest investment. On April 1, 2023, she purchased an old Victorian home, located in Red Deer, Alberta, at what she was assured was the bottom of the real estate market. She paid $500,000 for the home and figures 50% is attributable to the value of the land and the other 50% to the building. After putting a first mortgage of $200,000 on the property at 4% and paying cash for the remainder, she hired the best architect in the city to renovate the house as a triplex. The renovations began April 1 and were completed by October 31. The first tenant moved in on November 1. The renovations were expensive and as she could not persuade the bank to take a second mortgage on the property, she placed a 5%, $150,000 mortgage [representing the full cost of the renovations] on her principal residence on May 1, 2023 in order to finance the renovations. Dr. Do Noharm is delighted with her investment: the renovations are beautiful, all three units are rented and she will be able to write off a large loss on the property against her income from her medical practice. Her brother-in-law, the real estate agent who sold her the house, has prepared a draft of her 2023 taxable income calculation (EXhibit I) and Dr. Do Noharm would like you to have a look at it. — REQUIRED Review Dr. Do Noharm’s 2023 draft taxable income calculation and make any corrections that are necessary. EXplain any changes you make to the return. Ignore the effects of a leap year in your answer.

¶6,825

ITR: 1100(11), 1101(1ac)

Ch. 6/Study Guide — Exercises

153

EXHIBIT I Draft of Dr. Do Noharm’s 2023 Personal Tax Return Practice income .....................................................................................................................$400,000 Rental income: Rental revenue (2 months)............................................................................... $16,000 EXpenses: Mortgage interest

200,000 × 4% × 275/365 . . . . .

$ 6,027

Mortgage interest — principal residence

150,000 × 5% × 245/365 . . . . .

5,034

Property taxes — 9 months . . . . . . . . . . . . . . . . . . . . . . . . . . .

7,000

Insurance — 9 months . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,500

Utilities (April to October 31, paid by tenant since November 1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2,100

Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,500

CHAPTER 6

Repairs and maintenance (part of the total $150,000 renovations costs): Replace carpet (to restore to its original condition) . . . . . . .

5,000

Repair roof (to extend the life of the property) . . . . . . . . . . .

10,000

Painting (to restore to its original condition) . . . . . . . . . . . .

4,000

Capital cost allowance, Note 1 . . . . . . . . . . . . . . . . . . . . . . . . .

15,240

Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

57,401

Net rental income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(57,401) (41,401)

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(41,401) $358,599

Note 1 Capital cost allowance: Cost of building purchased . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$250,000

Renovations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$150,000

Less: repairs and maintenance included in renovations . . . . . . . . . . . . . . . . . . . . . . .

$(19,000) 381,000

CCA rate (Class 1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

× 4%

CCA claimed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$15,240

¶6,825

Introduction to Federal Income Taxation in Canada

154

¶6,850

ASSIGNMENT PROBLEMS

Problem 1 Victor is confused, so he has come to you for advice. He has heard that not all dividends are treated the same, so he would like you to explain how the following are taxed to decide where he should invest his money. Victor has income that will result in the income below being taxed in the highest tax bracket, which has a combined federal and provincial marginal tax rate of 53% for the province he lives in. Assume the following: (1) $1,000 of dividends from Canadian public companies. (2) $1,000 of dividends from Canadian private companies earning active business income taxed at a low rate. (3) $900 of dividends from foreign public companies. $100 was deducted at source and remitted to the foreign government. (4) The provincial dividend tax credit is 4/13 for Canadian private company dividends earning active business income taxed at the low rate and 5/11 for public company dividends.

Problem 2

ITA: 12(1)(g); IT-462

The Country Pie is a highly recognized baker of quality pies in Beamsville, Ontario. The current proprietor, Rudolph Strudel, started the business about 20 years ago with an initial purchase of equipment of $150,000 and built up the name of the company by closely supervising the pie production process. Many have said that it is this attention and his recipes that have made the business a success. Rudolph has decided to sell his business and move to the coast to get away from the pressures of running a business. An offer has been made for the assets of The Country Pie by Big Food Corporation Ltd. (‘‘BFC’’). There was a meeting of the minds as to the value of the fi Xed assets of The Country Pie. However, there was considerable dispute as to the value of The Country Pie name in generating pie sales after a purchase by BFC. Consequently, it is proposed that the full proceeds be determined in part by future sales. The BFC offer is for $50,000 cash; $60,000 to be paid on the basis of sales over the next three years with any balance of the $60,000 remaining at the end of the third year payable at that time; and 25% of gross sales in the next five years. As part of the agreement, Rudolph would provide consulting services to BFC as needed during the next three years. Rudolph would like you to explain the income tax implications of the proposal from BFC.

Problem 3 Mr. Wiser is contemplating investing in two different mutual funds. His investment options are set out below.

Amount

Mutual Fund

Distribution

$200,000 $200,000

International Income Fund Canadian Dividend Fund

Annual interest of 4% Annual dividend of 3%

Mr. Wiser contemplates holding both mutual funds for the same period of time — from purchase to December 31, 2025. Mr. Wiser is in the top federal income tax bracket (33%). Mr. Wiser’s provincial tax on income rate is 20%. Assume that the combined federal and provincial dividend tax credit is equal to the dividend gross-up. Assume that the Canadian Dividend Fund receives and distributes dividends from Canadian-resident public corporations. Based on the above information, Mr. Wiser would like you to advise him on which mutual fund he should prefer.

¶6,850

ITA: 12(1)(c), 12(1)(j), 74.1, 74.5, 82(1); IT-510, IT-511R

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Problem 4 Furniture Focus Limited provides competitive prices to consumers by using a no-frills approach to displaying its product in large stores surrounded by ample parking. Furniture Focus Limited has excess land that is not currently used in its business. This vacant land is rented to the adjacent automobile dealer who stores new cars on it. For the year ended December 31, 2023, Furniture Focus Limited had the following operating income/expenses: Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Selling expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . General and administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$35,000,000 (20,000,000) $15,000,000 (5,000,000) (2,000,000) $ 8,000,000 50,000

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 8,050,000

Determine the income tax consequences of the various payments related to the vacant land.

Problem 5 Sara Shimizu is the owner of two residential rental properties located in Saskatchewan, 509 Brunswick Avenue and 356 Spadina Road. These properties were purchased siX years ago for $525,000 and $600,000, respectively. In the current year, 509 Brunswick Avenue was sold for $550,000. A reasonable allocation of this amount is considered to be 75% to the building and 25% to the land. The following income and expenses were incurred in renting out the two properties in the current year:

ITA: 20(1)(a); ITR: 1100(11), 1101(1ac); Sched. II

Rental ................................................................................................................... $ 60,000 Interest on mortgage ................................................................................................... (40,000) Operating costs ............................................................................................................ (15,000) Promotion costs for sale of property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,000) Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 There are no meal or entertainment expenses included in the $5,000 of legal fees. The opening undepreciated capital cost of 509 Brunswick Avenue was $383,500 and that of 356 Spadina Road was $400,000. Sara has asked you to determine her income from the property, assuming she wishes to report the least amount possible for tax purposes in the current year.

Problem 6

ITA: 18, 20

Author’s note: Chapter 21, Problem 4 addresses the GST/HST implications for this problem. The GST/HST solution may be used in conjunction with the solution for this problem or as a separate assignment question. It is early January 2023 and the president of BDC Distributing Limited, a client of your firm, called recently to discuss the tax implications regarding the construction of a new building. BDC has been growing rapidly and needs new warehouse space. They have been unable to locate any suitable space in the existing buildings in town and, therefore, have decided that their only option is to build their own building. They have identified the site and have estimated the costs of the project. These projected costs (and dates of completion) are as follows: The land that has been identified will be purchased on February 15, 2023, for $405,000. There is no significant site preparation required so construction of the building can commence immediately. The cost of the building is estimated to be $1,348,000 plus the costs noted below. It is anticipated that BDC will be able to occupy the building on October 31, 2023. BDC currently has an architect finalizing the drawings for the building. The architect fees, which will all be paid in 2023, will amount to $7,200. There will also be fees of $2,100 for an engineer to examine the drawings.

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The general and administrative expenses include $30,000 of interest and $5,000 of property taxes on the vacant land rented to the automobile dealer. There are no other expenses connected with this land. Other income includes $10,000 of rental income paid by the automobile dealer.

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156

BDC has arranged for the financing required for the project. The project will be financed with a mortgage of $875,000 and $1,000,000 of preferred shares issued on January 15, 2023. Interest on the mortgage is payable semi-annually on July 15 and January 15 at a rate of 8% per annum. The preferred shares pay dividends of 5% per annum, payable semi-annually on July 15 and January 15. There will be a number of costs incurred in order to issue the debt and shares. These costs are legal and accounting fees of $18,450, commissions of $58,300 and registration fees of $1,800 for amending the articles of incorporation to allow the issuance of the preferred shares. BDC had previously deducted $3,000 for its original incorporation costs. The balance of the costs related to the building are summarized below: Building insurance from April 15, 2023 @ $450 per month . . . . . . . . . . . . . . . Property taxes from February 15, 2023 @ $770 per month . . . . . . . . . . . . . . . Soil testing to determine location of footings for building . . . . . . . . . . . . . . . Relocation expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Utilities service connections estimated to be completed on May 20, 2023 . . . . Mortgage insurance premium from March 1, 2023 of $325 per month . . . . . . . Maintenance from October 31, 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Utilities from October 31, 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Landscaping . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 3,825 8,085 1,825 34,100 3,800 3,250 2,500 6,300 15,500

The president would like you to advise him of the impact of the proposed transactions on their December 31, 2023 income tax return. Ignore the effects of a leap year.

Problem 7 Tim Markus, Vice President of Phone Lines, earned $95,000 in salary last year. In addition to his salary, he also received low-interest loans from his employer. Tim’s interest rate on these loans is 0% and he owed $150,000 throughout last year. Tim used the loan to purchase a rental property (see Schedule 1). Assume a prescribed interest rate of 2% for the entire year. Five years ago, Tim invested in some common shares of a foreign corporation. He receives $18,000 in dividends (net of $2,000 withholding tax) annually from this corporation. Last year, he also received taxable eligible dividends of $30,000 from his investment in a Canadian public company that is resident in Canada. Tim also owns $100,000 worth of 5% bonds.

ETA: 123(1), Sch. V, Parts VI, VII

Schedule 1: Rental revenue ......................... $16,400 Maintenance expenses ................ 5,500 Utilities on rental units ............... 8,200 CCA............................................ 9,600 Tim has asked you to calculate his income for tax purposes for last year.

Problem 8 John Ingles has provided you with the following information related to his various investment holdings as of December 31, 2023. Interest earned on joint bank account with his spouse (spouse contributes equally) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,000 Interest earned on his investment account (not joint) with his investment broker . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800 Interest earned on 2022 personal income tax assessment, received May 15, 2023 450 Interest on short-term investments: $20,000 term deposit taken out November 30, 2023 (interest at maturity in siX months) Accrued interest from December 1 to December 31, 2023 . . . . . . . . . . . . 85 $200,000 GIC purchased November 1, 2023 (interest payable at maturity on October 31, 2025) Accrued interest from November 1, 2022 to October 31, 2023 .......................... 16,000 Accrued interest from January 1, 2023 to December 31, 2023 .......................... 16,214 Government of Canada Treasury Bills purchased for $9,009 on January 3, 2023 Amount received on maturity on December 31, 2023 ......................................... 10,000 Cash dividends received from investment in common shares of Canadian resident public corporations ........................................................................................... 24,000 Cash dividends received from common shares in US corporations (net of $3,000 of foreign withholding taxes; all in Canadian dollars) ............................................ 17,000

¶6,850

ITA: Subdivision b

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Rental details from operation of two separate rental properties:

Gross rental revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Property taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Repairs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mortgage interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Opening UCC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Property 1

Property 2

$ 30,000 5,000 2,400 1,500 20,000 $368,209

$ 46,000 8,000 3,500 4,800 32,000 $520,225

Interest expenses paid during 2023: Interest on bank line of credit used for investing in shares described above $50,000 Interest on loan to acquire an automobile for his daughter for her 18th birthday . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,200 Interest on a parcel of vacant land (purchased in 2017, the land does not generate any income) ....................................................................................... 10,000

Problem 9

ITA: 18(2), 20(1)(c), 74.1

Your client, Ashley, has come to you for some advice on computing her net income from property. (a) In February, Ashley sold all her investments and paid off her personal residence mortgage. On March 1, she borrowed $90,000 to reacquire many of the same investments she previously held. Many of the common shares purchased do not carry dividend rights. (b) On April 15, Ashley purchased a government bond that pays annual interest of 2.5%. When the bond was purchased, Ashley paid accrued interest of $262.50 to the previous owner of the bonds. (c) On June 1, Ashley borrowed $450,000 to purchase the vacant land next to her apartment block. The land is used as a parking lot and she collected monthly revenues of $2,500 per month. She plans improvements that will double her income from the lot. Ashley’s only expenses were $45,500 for interest and property taxes. Ashley has asked you to explain the income tax implications of each item above.

Problem 10 Funds are borrowed by an individual from a financial institution at a 4% per annum interest rate to purchase the following unrelated investments:

ITA: 18(1), 20(1)(c); IT-533

(a) cryptocurrency on which gains or losses will be treated as capital gains or losses; (b) an RRSP portfolio of investments yielding 3% in interest; (c) a five-year GIC paying interest at 2% per annum; (d) common shares of a Canadian-resident public corporation paying no dividends; (e) preferred shares of a Canadian-resident public corporation paying 3.5% dividends; (f) preferred shares of a U.S. corporation paying 5% dividends; (g) Mindy owns 1,000 shares of International Inc., a corporation listed on the TSX, for which she paid cash. Mindy also owns the condominium she lives in that is financed with borrowed money. Mindy is planning to sell the 1,000 shares of International Inc. and use the proceeds from the sale to pay off the mortgage on the condominium. She will then borrow money to buy another 1,000 shares of International Inc.; (h) lottery tickets which yielded $75,000 in winnings which were reinvested in short-term securities yielding 2%; and (i) common shares of a Canadian-resident public corporation paying dividends of 4%; later in the year the shares were sold at a small gain to repay a 5% second mortgage on a principal residence. Determine the deductibility of the interest expense in each of these unrelated cases.

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CHAPTER 6

Based on the above, John has asked you to calculate his income for the year. He would also like you to comment on the income tax implications of items not included in your calculations.

158

Introduction to Federal Income Taxation in Canada

Problem 11

ITA: Division B

Trent Zalinski recently retired as a football player with the Saskatchewan Roughriders. In the current year, he received his salary of $150,000 from the team and is eligible for a CFL pension in 15 years. He and his wife Mary have settled in Weyburn, Saskatchewan, where he runs a small sporting goods store as a proprietorship. He has provided you with the following additional information related to the current taxation year: (a) His net income from the store for the fiscal year ended December 31 was $35,000. Next year he is hoping to double that. Mary works in the store about 35 hours a week and is paid $6 per hour. This is already included as an expense in determining the $35,000. (b) Trent’s other current-year receipts are: fees received from endorsement of a brand of football equipment, $30,000; eligible dividends from Canadian public corporations, $7,200; dividends from foreign public corporations, (net of $750 withholding tax) $6,750; interest from Canadian bank, $3,000. (c) Trent also had the following expenses: cycling trip to Cypress Hills Provincial Park with family, $2,200; interest on bank loan to acquire public company shares, $4,050. (d) In May of the previous year, Trent purchased a five-year GIC. The interest rate was 2%, and it was for $10,000. None of the interest is receivable until maturity in five years. Trent has asked you to calculate his income for tax purposes for the current year. In addition, he wants you to provide any basic tax planning advice that might be appropriate.

Problem 12 Keara Rogers has come to you for some help in computing her income from her investments. She is trying to plan for the payment of her 2023 taxes and wants an idea as to how much that tax bill will be. She has provided you with the following details regarding her investments for 2023. Banking She has a chequing and savings account that are both joint with her common-law spouse, Rose (funds equally contributed and used by both). Total service charges are $140; total interest earned is $75. GIC She has a 2.5% three-year semi-annual compound-interest GIC purchased April 1, 2022 for $15,000. Interest accruing on the GIC has been as follows: April 1, 2022 to September 30, 2022 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . October 1, 2022 to December 31, 2022 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . January 1, 2023 to March 31, 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . April 1, 2023 to September 30, 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . October 1, 2023 to December 31, 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$188 95 92 188 95

Shares She has owned 2,500 shares of APenner Corporation, a private Canadian Corporation. She purchased the shares through a stock option plan and still holds these shares at the end of 2023. The shares paid total dividends of $0.25 per share in 2023. The dividends were classified as non-eligible dividends. Keara also owns shares of Oban Chocolate Corporation, a Scottish corporation. During the year she received dividends of $2,340 (translated into Canadian dollars, net of Cdn$260 taxes withheld). Rental Properties At the beginning of 2023, Keara and Rose held two rental properties. Each contributed to the purchase price equally and there is no longer a mortgage on these two properties. These properties had the following cash flows: Gross rents received . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . EXpenses related to earning rental income: Advertising (for tenants) . . . . . . . . . . . . . . . . . . . . . . . . . . Property taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Utilities (landlord provided) . . . . . . . . . . . . . . . . . . . . . . . . Opening UCC — at January 1, 2023 . . . . . . . . . . . . . . . . . .

¶6,850

Property 1 $ 25,800

Property 2 $ 18,500

150 2,750 3,180 $281,788

175 2,125 2,580 $323,758

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On June 15, 2023, Keara and Rose purchased a third rental property for $750,000, $175,000 related to the cost of the land. They spent the last two weeks of June cleaning and painting the property, getting it ready for the new tenant who took possession of the property on July 1, 2023. The cash flows related to the new rental property are: Gross rents received . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . EXpenses related to earning rental income: Advertising (for tenants) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Property taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Utilities (paid by tenants) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mortgage interest paid on the rental property in 2023 . . . . . . . . . . . . . . . . . . . .

$9,900 25 3,700 0 9,625

— REQUIRED Calculate the effect on income for tax purposes for 2023 of the above investments. Keara Rogers always likes to report the minimum possible income each year. Support your treatment of each item listed above with a reason or a complete calculation.

CHAPTER 6 ¶6,850

160

Introduction to Federal Income Taxation in Canada

CHAPTER 6 — DISCUSSION NOTES FOR REVIEW QUESTIONS (1) The principal would be separated from the accrued interest at the time of sale. The accrued interest would be included in Billy’s income as interest income. The purchaser would be paying for both the value of the bond and the accrued interest. To ensure the interest is not taxed in both the seller’s and purchaser’s hands, the purchaser can deduct the same amount that the seller included in income. The appreciation in the value of the bond is property income (interest on the bond) which is 100% taxable. It is not a capital gain.

ITA: 20(14)(a);

(2) The interest on the 10 acres not currently being used to earn business revenue would not be deductible as there is no indication that revenue is being earned on the vacant land. The interest would be capitalized and added to the cost base of the land.

ITA: 18(2)

(3) CCA cannot be claimed to create or increase a loss on rental property. However, those loss limitation rules do not apply to a corporation whose principal business was the leasing, rental, development or sale, or any combination thereof, of real property owned by it. In this case, Rent Co. will be able to claim CCA to create or increase a loss.

ITR: 1100(11)–(14)

(4) No interest is deductible if Ms. Campbell is considered to realize a capital gain on the sale of the gold. Since capital gains are not income from business or property, she does not meet the requirements and cannot deduct the interest. Also, there is no provision that would allow her to capitalize the interest to the cost of the gold. On the other hand, if the gain on the sale of the gold is considered to be income from business or property, the interest would be deductible. Note that the CRA would allow her to choose income treatment for these transactions. (5) In the Attaie case, the Federal Court–Trial Division agreed that the interest expense was deductible. However, the Federal Court of Appeal reversed this decision and decided that the interest was not deductible, since there was not a direct link between the borrowed funds and the income from property. A direct link between the borrowed funds to the income earning property is a critical factor in determining the deductibility of interest paid on borrowed funds.

20(14)(b)

ITA: 9(3); 20(1)(c); 53 IT-346R, par. 8

87 DTC 5411 (F.C.T.D.); 90 DTC 6413 (F.C.A.)

(6) Under the proposed plan, the interest on the loan received by the client would not be deductible since the money is not being used to earn income. He has borrowed the $100,000 to purchase a new home for personal use. However, if your client were to instead borrow from the bank the $100,000 needed to loan to the purchaser in order to complete the sale of his existing house, then the interest would be deductible. The purchaser would then be in a position to pay the full purchase price for the existing house and your client could purchase his new house without borrowing additional funds. Your client would include in their income interest of 5% on the loan made to the purchaser and would be able to deduct the interest he pays on the bank loan taken out and loaned to the purchaser. (7) Since the corporation that your client invested in has gone out of business, there is no longer a possibility of earning income from business or property. However, the amount of the lost capital would be deemed to continue to be borrowed for the purpose of earning income and, hence, would allow the interest in this case to continue to be deductible.

ITA: 20.1(1) Income Tax Folio S3-F6-C1 — Interest Deductibility

Ch. 6/Study Guide — Solutions to Exercises

161

CHAPTER 6 — SOLUTIONS TO EXERCISES Exercise 1 (A) In its June 30, 2023 taxation year, the corporation would be required to include in income the interest received March 31, 2023 for the period October 1, 2022 to March 31, 2023 plus interest accrued from April 1 to June 30, 2023. Accrued interest from October 1, 2022 to January 1, 2023 (the period prior to acquisition), which was purchased with the bond, would give rise to a deduction.

ITA: 12(3), 20(14)

(B) The Act would require accrued interest from November 1, 2023 to October 31, 2024 to be included in income in 2024.

ITA: 12(4)

(C) The $80 received each year would be included in income. On November 30, 2023, there will be an anniversary day, but all of the interest accrued to that day will have been included in income as interest received in the year.

ITA: 12(1)(c)

Exercise 2 ITA: 18(2)

(ii) The Act will limit the deductibility of carrying charges to 75% of their total (i.e., to the amount of the net revenues) so as not to create a loss by their deduction, unless the land is owned by a corporation whose principal purpose is the rental of real property (i.e., land and building) owned by it. This is not the principal purpose of a hotel corporation. The non-deductible interest will be added to the ACB of the land.

ITA: 18(2)(e)

(iii) The deductibility of carrying charges may be limited in the same manner as in (ii), above, until the property is used in the business. The non-deductible interest will be added to the ACB of the land.

ITA: 18(2)

ITA: 18(2)(f)

Exercise 3

UCC, January 1 . . . . . . . Purchases . . . . . . . . . . . UCC, December 31 (A) Max eligible CCA for each class(2) . . . . . . . . . . . .

Class 1: 4%

Class 8: 20%

Building 1 $948,000 —

Building 2(1) — $557,500

$125,000 —

$948,000

$557,500

$125,000

37,920

33,450(2)

25,000

Actual CCA(3) — considering the restriction on rental income (B) . . . .

37,920

33,450

2,650

UCC, January 1 (A - B)

$910,080

$524,050

$122,350

Total

$96,370

— NOTES TO SOLUTION (1)

Separate class for rental building costing $50,000 or more.

(2)

This is the maximum CCA for each class before the rental income restriction. 4% × $557,500 × 1.5 for accelerated CCA initiative.

(3)

Net rental income before CCA ($45,270 + 28,750)........................................ $74,020 CCA on rental building and leasing properties (i.e., furniture and fiXtures) limited to $74,020 [$74,020 -- ($37,920 + $33,450) = $2,650] .......................... (44,020) Net income from rental properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0

Note that where less than maximum capital cost allowance is taken, the less than maximum amount should be taken in classes with relatively higher CCA rates, so that the UCC carried forward to the following year is eligible for CCA at the higher rate in that subsequent year.

ITR: 1101(1ac)

CHAPTER 6

(i) The deductibility of carrying charges is not limited because the land is being used in the course of the hotel business.

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Exercise 4 (A) UCC, January 1 . . . . . . . . . . . . . . . . . . . . . . . . Disposal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . UCC, December 31 . . . . . . . . . . . . . . . . . . . . . Recapture . . . . . . . . . . . . . . . . . . . . . . . . . . . . CCA @ 4% (Class 1) — see below . . . . . . . . . .

Property A $830,000 (836,000) $ (6,000) 6,000 —

UCC forward . . . . . . . . . . . . . . . . . . . . . . . . . .

Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Recapture . . . . . . . . . . . . . . . . . . . . . . . . . . . . EXpenses before CCA . . . . . . . . . . . . . . . . . . .

$ 42,500 6,000 (31,250)

62,500 — (48,750)

$105,000 6,000 (80,000)

Net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 17,250

13,750

$ 31,000

Property B Total $1,280,000 — $1,280,000 — (31,000)(1) $1,249,000

CCA (4% of $1,280,000 = $51,200; limited to net above) . . . . . . . . . . . . . . . . . .

(31,000)

Net income from property . . . . . . . . . . . . . . . .

— NOTES TO SOLUTION (1)

The maximum allowed CCA would be $31,000 rather than the calculated CCA $51,200 (4% X $1,280,000) because the amount allowed is restricted to the rental income before CCA. A rental loss cannot be created using CCA, therefore in this case the max amount of CCA that can be claimed is $31,000.

Exercise 5 Interest expense is deductible if there is a reasonable expectation of earning income from property. Investment Common shares . . . . . . . . . Gold bullion . . . . . . . . . . . . Cryptocurrency . . . . . . . . . Corporate bond . . . . . . . . . Preferred shares (RRSP) Common shares . . . . . . . . . Paintings . . . . . . . . . . . . . . GICs . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . .

Not deductible $10,000(2) $15,000(2) 10,000(4) 15,000(6) $50,000

Deductible $20,000(1) 20,000(3) 30,000(5) 20,000(5) $90,000

Deductible interest = $90,000 × 5.5% = $4,950 — NOTES TO SOLUTION (1)

As there is an expectation of dividend income on common shares, the interest is deductible.

(2)

As capital treatment has been chosen for gains/losses, the interest is not deductible.

(3)

The corporate bond is income-producing and the associated interest would be deductible.

(4)

The preferred shares were purchased in an RRSP; deduction of interest is disallowed.

(5)

The associated interest on the common shares and GICs would be deductible, as there is the expectation of earning property income.

(6)

The paintings from well-known galleries would be considered an investment for earning future capital gains and, therefore, the associated interest would not be deductible.

ITA: 20(1)(c)

Ch. 6/Study Guide — Solutions to Exercises

163

Exercise 6 Since the rule relates to capital cost allowance, Regulations Part XI, Capital Cost Allowances, would be a starting point. More specifically, ITR 1101(1ac) deals with the separate classes rule related to rental properties having a cost of at least $50,000.

ITR: 1100(11), 1101(1ac)

The other special rule is ITR 1100(11), which states that capital cost allowance on rental properties can only be deducted to the extent that it does not create or increase a net loss from all rental properties combined. Note that Interpretation Bulletin IT-195R4, Rental Property–Capital Cost Allowance Restrictions, provides further details.

Exercise 7 $400,000 $16,000 1,337 1,253 1,553 333 — 1,500 9,000 1,024 16,000

CHAPTER 6

Practice income . . . . . . . . . . . . . . . . . . . . . . . . Rental income: Rental revenue . . . . . . . . . . . . . . . . . . . . . Mortgage interest(1) . . . . . . . . . . . . . . . . . . Mortgage interest - principal residence(2) Property taxes(1) . . . . . . . . . . . . . . . . . . . . Insurance(1) . . . . . . . . . . . . . . . . . . . . . . . Utilities(3) . . . . . . . . . . . . . . . . . . . . . . . . . Advertising(4) . . . . . . . . . . . . . . . . . . . . . . Repairs and maintenance(5) . . . . . . . . . . . . CCA(6) . . . . . . . . . . . . . . . . . . . . . . . . . . . Total expenses for rental property . . . . . . . Net rental income . . . . . . . . . . . . . . . . . . .

—

Taxable income . . . . . . . . . . . . . . . . . . . . . . . .

$400,000

Notes: (1) Costs which are attributable to the period of renovation and relate to the renovation or the ownership of the land must be capitalized to the building [ssec. 18(3.1)]. Rounded to nearest dollar.

Mortgage interest (rounded) . . . . Property taxes (rounded) . . . . . . Insurance (rounded) . . . . . . . . . .

Total 275 days $6,027 7,000 1,500

Renovation Period 214 days $4,690 5,447 1,167

Rental Period 61 days $1,337 1,553 333

(2) In general, the interest on the mortgage on Dr. Do Noharm’s principal residence will be deductible against the rental income since the mortgage was used to earn rental income and not for personal purposes. Applying ssec. 18(3.1) as outlined above:

Mortgage interest (rounded) . . . .

Total 245 days $5,034

Renovation Period 184 days $3,781

Rental Period 61 days $1,253

(3) Applying ssec. 18(3.1), the full amount of utilities will be capitalized since it relates to the renovation during the renovation period. (4) The advertising expense does not relate to the renovation of the building or the ownership of the land during that period of time, and, therefore, is fully deductible. (5) The repairs and maintenance are required to be capitalized as they extend the life of the property. When an expense restores the property back to its original condition, these items can likely be expensed in the year they are incurred. The information provided indicates that the roof repair extends the life of the property, therefore ssec. 18(3.1) will require the roof

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repair cost to be capitalized to the building since it relates to the renovation. The new carpet and painting would be fully deductible. (6) Capital cost allowance: The property is available for use since construction was complete on October 31. Cost of building purchased . . . . . . . . . . . . . . . . . . . . . . . . . . .

$250,000

Renovations [includes repairs and maintenance — see Note 1 in problem] . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

150,000

Less: repairs and maintenance (carpet and painting) . . . . . . .

(9,000)

Add items capitalized 18(3.1): Mortgage interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4,690

Mortgage interest — principal residence . . . . . . . . . . . . . .

3,781

Property taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5,447

Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,167

Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2,100 $408,185

CCA rate (Class 1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

CCA before accelerated incentive . . . . . . . . . . . . . . . . . . . . . .

16,327

Accelerated incentive . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.5

Maximum available CCA for the class (rounded) . . . . . . . . . . .

$ 24,491

The CCA claim is restricted to the net rental income before CCA, i.e., CCA cannot be used to create or increase a loss. There is no proration of CCA for short fiscal periods since it is property income calculated on a calendar year. The maximum CCA that can be claimed is $1,024, which is equal to the rental income before CCA. Alternatively, $1,024 of soft costs could be deducted in accordance with ssec. 20(29) instead of the CCA. The soft costs deducted under ssec. 20(29) would not increase the capital cost of the building. If CCA of $1,024 is claimed, the opening UCC for the building would be as follows: UCC as calculated above .......................................................................................$408,185 Less CCA claimed .................................................................................................... (1,024) Opening UCC for the next year ............................................................................$407,161

Chapter 7 Capital Gains: Personal

CHAPTER 7

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CHAPTER 7 — LEARNING CHART Problem Descriptions Textbook Example Problems 7-1 Personal-use and listed personal property 7-2 Principal residence 7-3 Change in use of principal residence 7-4 Share transactions — averaging of ACB 7-5 Share transactions — open market and stock option76 Stock dividends 7-7 Mutual funds reinvestment 7-8 Capital gains reserve 7-9 Superficial loss 7-10 Capital gains deferral 7-11 Allowable business investment loss 7-12 Replacement property 7-13 ACB replacement property 7-14 Disposal of building with terminal loss 7-15 Election on change in use 7-16 Foreign exchange gains and losses Principal residence Principal residence Change in use of principal residence Personal-use and listed personal property Share transactions Share transactions Listed personal property Stock dividends Replacement property Sale of accounts receivable Sale of building with terminal loss Replacement property Income vs. capital Sale of business; replacement property Income vs. capital Superficial loss

Assignment Problems 1 Stock transactions 2 Stock option — capital gain 3 Sale of mutual fund 4 Allowable business investment loss 5 Personal-use and listed personal property 6 Principal residence 7 LPP loss and ABIL 8 Allowable business investment loss 9 Principal residence with change in use 10 Stock transactions

CHAPTER 7

Exercises 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

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Problem Descriptions 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

Stock transactions Comprehensive Asset sale Sale of land and building, reserve Dividend in kind Foreign exchange Reserves if income or capital Replacement property Sale of building with terminal loss Sale of building with terminal loss Replacement property Schedule 1 with capital transactions Replacement property Sale of land with apple trees Sale of a business; replacement property

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REVIEW QUESTIONS

(1) A client invested in a rental property some years ago and paid $10,000 as a down payment and $150,000 was in the form of a mortgage. Recently, the vacancy rate has climbed and the value of the property has fallen. She thinks that she will just walk away from the property and let the mortgage company take over the property. What will her proceeds of disposition be? (2) As a result of a reorganization in a company in which Mr. Smith is a shareholder, he has just had a return of some of the corporation’s capital. As a result, the adjusted cost base of his shares has become negative. This does not bother him since he has been told that as long as he continues to own the shares he will not have to recognize this built-in capital gain. Comment. (3) Mr. Chan has come to you with a problem. He owns the family cottage and his wife owns the house in town. Both housing units were purchased within the last 30 years. They are thinking of selling both of these properties and moving to another province. He thought they could each claim the principal residence exemption to avoid any tax but someone has told him that they can only claim one of the residences. In general terms can you explain the rules to him? (4) Ms. Starra bought a cottage property on a lake that has since become polluted. As a result, the value of the property has declined since no one wants to go there anymore. She sold the property and realized a loss on the sale. She wants to claim the loss on her personal return. Can she do it? (5) What is the ‘‘$1,000 rule’’ as it relates to personal-use property? Does the same rule apply to listed personal property? (6) Mr. Davids has come to you to have his personal tax return done. He sold some shares of a public corporation that he has owned for some years and wants help in minimizing his tax on the transaction. One point that is confusing him is the stock dividend that he received this year. He does not know how to treat the dividend for tax purposes. Please help him. (7) Under Divisions B and C, what happens when the capital losses exceed the capital gains in any one year? (8) If you were to win a Jeep Compass in a lottery, what would the cost base be to you given that you might want to sell it to buy a car more fitting for an accountant? (9) On July 1 nine years ago, Ms. Marr was transferred with her family to Victoria from Toronto by her employer, a large public company. She was sure that the value of her Toronto house would go up significantly so she kept it and rented a house in Victoria. It was this year that the same employer moved Ms. Marr and her family back to Toronto, at which time they moved back into their house. However, they found that the neighbourhood had changed significantly so they decided to sell the house and buy in another location. Discuss how much of the principal residence exemption she can claim on the sale of the Toronto home. (10) Ms. Green has been told that a good way to create a capital gain is to buy shares on the stock market and then sell someone an option to buy the shares at a price slightly higher than the current market price. Her understanding is that the proceeds on the sale of the option is a capital gain. What advice can you give her? (11) Mrs. Garland has been going south for many years and usually keeps some U.S. currency handy in case she needs it. This year, because of some unusual fluctuations in the Canadian dollar, she realized an exchange loss on her U.S. dollar transactions of $2,500. How will this be treated for tax purposes? (12) Mr. Rollins bought a convertible debenture two years ago for $10,000 and is now in the process of converting it into common shares of the company. The debenture is convertible into 1,000 common shares. At the time of the conversion the common shares are worth $20 each. What are the tax effects of the disposition of the debenture and the acquisition of the shares? (13) Rachel is a real estate salesperson who invests her spare cash in ‘‘good land buys’’ which she occasionally finds. This year Rachel sold one of these properties and realized a large profit. Is this an income or a capital receipt? (14) Winston White, an accountant, uses his spare time and cash to trade in low-cost mining shares listed on a Canadian stock exchange. Winston made a large profit this year on his stock market transactions. Is this profit income or capital gain?

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(15) Diana purchased some land to erect a shopping centre which she intended to sell. However, zoning bylaws could not be changed and Diana sold the property at a large profit. Is this profit income or a capital gain? (16) Doug spends his Saturday afternoons at the race track. This year Doug was extremely fortunate and his net winnings were $15,000. How will these winnings be taxed? (17) Mr. Cole bought siX acres of lake-front property 15 years ago for $24,000. This year, he sold the three acres that are not on the lake to a neighbour who wanted the woodlot. His proceeds on the three acres sold are $30,000. Discuss what the cost base of the three acres sold would be. (18) Two years ago, Mr. Bosma had 20 acres of his farm expropriated by the city for industrial land. Because he disputed their value, the proceeds were not finally decided until this year. How soon does he have to replace the land in order to defer the tax on the capital gain realized on the sale of the land? (19) Opco Ltd. had a large piece of equipment destroyed by fire with the insurance proceeds being paid and the machine replaced in the same year. Can the replacement property rules be applied? (20) Last year Ms. Chung sold some land that was capital property and realized a capital gain of $150,000. As part of the proceeds she took back a note for $100,000 at 5% which, unfortunately, was unsecured. This year she realized that the note will become a bad debt, but since she has not disposed of the note she does not think that it can be used for tax purposes. What is your advice to her? What would be the result if the land that was sold was personal-use property?

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EXERCISES

Exercise 1

ITA: 40(2)(b), 54

Ms. Amin has come to you for advice on the tax consequences of the disposition of the following two residences in 2023: Date of purchase

Residence Regina home . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cottage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2012 2017

Cost

Selling price

$400,000 $517,500 250,000 375,000

— REQUIRED Compute the minimum amount of taxable capital gains.

Exercise 2

ITA: 40(2)(b)

Peter Patel has only two residences which he wishes to dispose of in 2023. The following facts relate to those residences:

City home . . . . . . . . . . . . . . . . . . . . . Cottage . . . . . . . . . . . . . . . . . . . . . . .

Date purchased 2008 2013

Cost

Real estate commission

Estimated selling price

$180,000 90,000

$12,000 6,000

$247,000 164,000

— REQUIRED Determine how Peter must designate residences in order to achieve the minimum capital gain.

Exercise 3

ITA: 40(2)(b), 45, 54, 54.1

Howard Bauer, who presently lives in Vancouver, is considering moving to Montreal. Although Howard intends to purchase a home in Montreal, he does not want to sell his fully-paid Vancouver home in case he decides to return some time in the future. Howard would rent his Vancouver home which cost him $50,000 in 2008 and now has a fair market value of $350,000. — REQUIRED Discuss the tax implications concerning Howard’s Vancouver home if: (A) Howard is self-employed; or (B) Howard is employed.

Exercise 4

ITA: 41, 54

Karl Kim disposed of the following assets in 2023, all of which were bought within the last nine years:

Painting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Antique clock . . . . . . . . . . . . . . . . . . . . . . . . . . . Outboard motor . . . . . . . . . . . . . . . . . . . . . . . . . Gold coin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

— REQUIRED Determine Karl’s net taxable capital gain for the year.

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Sale price

Cost

Selling cost

$2,000 1,200 750 600

$ 300 250 500 1,000

$100 20 15 10

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Exercise 5

ITA: 53(1)(f), 54

Ivan Bedard purchased the following shares of Solid Investments Ltd.:

March 1, 2022 .......................................... 100 shares @ $30 including brokerage June 1, 2023 .......................................... 150 shares @ $35 including brokerage January 10, 2024 ..................................... 200 shares @ $26 including brokerage

On December 15, 2023, Ivan sold 200 shares @ $25 less brokerage of $75.

— REQUIRED (A) Determine Ivan’s taxable capital gain or allowable capital loss on his December 15, 2023 disposition. (B)

Compute the adjusted cost base of the shares on hand on January 10, 2024.

Exercise 6

ITA: 47(1)

Regan San Juan participated in the following stock transactions to December 31, 2023:

Description

Share price

Number of shares

Broker fees

Jan. 1/18 Jun. 5/19 Aug. 5/20 Dec. 3/20 May 1/21 Nov. 8/22 Jan. 9/23 Jan. 10/18 Jan. 14/19 May 20/23

Hi Growth Co. — purchased Hi Growth Co. — purchased Hi Growth Co. — purchased Hi Growth Co. — purchased Hi Growth Co. — sold Hi Growth Co. — purchased Hi Growth Co. — sold Hi Risk Co. — purchased Hi Risk Co. — purchased Hi Risk Co. — sold

$3.00 2.80 3.80 5.10 7.50 5.75 8.40 0.25 0.80 0.30

1,000 3,000 1,500 1,000 3,000 1,000 1,500 20,000 4,000 24,000

$70 90 70 120 420 130 240 200 75 150

CHAPTER 7

Date

— REQUIRED (A) Compute Regan’s adjusted cost base for the shares of Hi Growth Co. that he still holds at the end of 2023. (B) Compute Regan’s 2023 taxable capital gain or allowable capital loss on the disposal of the Hi Risk Co. shares.

Exercise 7

ITA: 3, 5, 6, 7, 8, 9

Fong currently earns $23,000 income from employment and $10,000 from operating a part-time coffee bar business. 10 years ago, Fong inherited an antique painting. At that time the heirloom was worth $9,000. Today, the painting is apparently worth $29,000.

— REQUIRED What would Fong’s income for tax purposes be if he sold the painting and realized a capital gain?

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Exercise 8

ITA: 53(2)

Miriam Franklin decided to purchase shares in Strippit Limited, a public company, listed on the Canadian Venture EXchange. Miriam purchased 1,000 shares at $35 per share plus brokerage of $500 on December 10, 2015. Miriam received the following dividends during the intervening years: February 1, 2019................ A stock dividend of 5% with a paid-up capital of $10 per share. April 10, 2020 .................... A stock dividend of 10% with a paid-up capital of $10 per share. August 1, 2023 ................... A stock dividend of 20% with a paid-up capital of $10 per share.

— REQUIRED Determine the adjusted cost base of Miriam’s shares as at December 31, 2023.

Exercise 9

ITA: 13(4), 44

Tax Processing Ltd.’s computer was completely destroyed in a fire in 2021. The insurance company has been disputing the claim. In the meantime, the company is renting computer time until the claim is settled. The following facts relate to the destroyed computer: Capital cost ................................................................................................................ $50,000 UCC immediately before the fire — Class 10 ................................................................ 17,150

During 2023, the insurance company paid $60,000 in respect of the claim. The company continued to rent computer time for another 24 months, and in 2025 it purchased a new-generation computer for $70,000. — REQUIRED Indicate the tax consequences for Tax Processing Ltd. for the above years.

Exercise 10 Mr. Flint has arranged to sell substantially all of the assets of his proprietorship business, including accounts receivable valued at $36,000, to Mr. Small, who will continue the proprietorship business. At the end of last year, Mr. Flint had deducted a reserve for doubtful debts of $6,500. The face value of the accounts being sold is $45,000.

ITA: 20(1)(l), 20(1)(p), 22, 38, 39, 50

— REQUIRED What are the tax implications to both Mr. Flint and Mr. Small of not using section 22 on the sale of accounts receivable?

Exercise 11

ITA: 13(21.1)

Sienna Research Inc. has one last building to dispose of in its liquidation process. Higher Peaks Ltd. has agreed to purchase the building for $1.28 million. The president of Sienna would like to maximize the after-tax profits of the disposition by creating a terminal loss on the building. He bragged about how the terminal loss on the building would nicely reduce the capital gain on the land. He drafted a sales contract allocating the total proceeds as follows: Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Building . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 895,000 385,000

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$1,280,000

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The capital cost of the land and building was as follows: Land ................................................................. $345,000 Building ............................................................. 520,000 Total ................................................................. $865,000 The UCC of the building (last asset in Class 1) is $438,700. — REQUIRED The president would like you to confirm the tax implications of this disposition.

Exercise 12

ITA: 13(4)

Windswept Storage Ltd. had a brick warehouse that was completely destroyed by a tornado early in its 2022 fiscal year ended December 31. The building had cost $300,000 and its Class 4 undepreciated capital cost at the time of its destruction was $221,000. Agreement was reached on the insurance claim later in 2022 when the company received only $295,000. A new brick building was fully constructed by August 2023 for $400,000. — REQUIRED Trace the effects of these events on the balance of the undepreciated capital cost from 2021 through to the beginning balance for 2024, assuming that the proper election is made.

ITA: 13(4)

Exercise 13 The appellant company was incorporated in 1952 with broad charter powers to engage in the real estate business. The objects of the company included the power to buy, sell, subdivide and dispose of properties. Over a period covering about fifteen years, the company purchased various properties in the Toronto area, holding some as investments and reselling others. To the date of the case, the company had sold 12 properties. Two were sold at large profits because good offers were received. The appellant’s two principal shareholders had a history of extensive dealing in real estate.

CHAPTER 7

In three purchases during a four-year period, the appellant assembled a parcel of land in a Toronto suburb with the intention of erecting buildings on the property for rental purposes. This would be done if the surrounding area developed to the extent that rental of the planned buildings was viable. The property was resold at a substantial profit nine years later. It had been listed for sale with a real estate corporation, wholly owned by the president of the appellant, and had remained undeveloped from the time of purchase to the time of sale. When the Minister taxed the profit as income, the appellant contended that its profit was a capital accretion from the realization of an investment. — REQUIRED Analyze the facts of this case thoroughly by considering all of the factors that have been developed by the courts to determine whether the receipt involved in the sale of the property was one of income or capital. Draw a reasoned conclusion from your analysis.

Exercise 14 On March 1, 2023, Mr. Sole Proprietor sold for cash his printing shop, located in downtown Oakville, to a competitor, as indicated below:

Accounts receivable net (see Note (1), below) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Building — Class 1 . . . . . . . . . . . . . . . . . . . . Equipment — Class 8 . . . . . . . . . . . . . . . . . . Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Cost

UCC Jan. 1, 2023

Cash proceeds

$ 12,000 20,000 20,000 60,000 30,000 —

— — — $47,000 8,850 —

$ 8,000 17,000 75,000 200,000 10,000 50,000

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176 Additional information concerning the sale of business:

(1) The accounts receivable cost is net of a $2,000 allowance for doubtful accounts which was claimed at the end of the preceding year. (2) Mr. Proprietor has been in the same business since 1995 and has a fiscal year ending December 31. During February 2024, Mr. Proprietor purchased the following capital property and other assets in order to start a new printing business in Northern Ontario: Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 90,000 Building (new)..................................................................................................... 135,000 Equipment — Class 53 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,000 Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25,000 — REQUIRED (A) Compute the minimum amount of income Mr. Proprietor must include in his 2023 tax return from the sale of the printing business, assuming he does not elect under sec. 44, par. 13(4)(d ), and sec. 22. (B) Compute the minimum amounts of income Mr. Sole Proprietor must include in his 2023 return if he elects under sec. 44 par. 13(4)(d ), and sec. 22. Also, compute the undepreciated capital cost on January 1, 2025 of the new building. (C) Give a brief explanation to Mr. Sole Proprietor as to why the use of these elections is advantageous.

Exercise 15 In 2018 Hi-Tech Limited’s computer research facility was substantially destroyed by fire. They were fortunate in obtaining rental space from which to operate while searching for a suitable building to purchase. They located a building on 10 acres of land in a suburban area for sale, but were reluctant to acquire so much excess land. The vendor indicated that he would only consider offers for the entire property. However, after several additional months of searching they acquired this property for $1,750,000. (The appraisal indicated that the building had a value of $1,250,000 and the land had a value of $500,000.) After obtaining the property, Hi-Tech decided that they would move their head office to a new building to be constructed adjacent to the research facility when the lease in their downtown office tower expired in 2023. Hi-Tech’s financial position deteriorated substantially and management concluded in 2023 that the commencement of construction of the new head office would be too great a financial drain. Shortly thereafter, a developer approached Hi-Tech and suggested a joint venture to construct an exclusive community of homes on the excess acreage. The joint venture agreement provided that Hi-Tech would receive 20% of the proceeds from the sale of the 20 homes, to a maximum of $500,000. All homes were constructed and sold by the end of 2023 and Hi-Tech received $500,000. — REQUIRED Discuss the alternative methods of treating the gain on the sale of the five acres of land and recommend the position that Hi-Tech should take when filing their 2023 income tax return.

Exercise 16 Your client, Mr. Y, has unused capital losses forward of $30,000. In January 2023, he sold his mutual fund investments and immediately repurchased them in order to trigger a $50,000 capital gain. Since that time, the mutual funds have declined in value so that he has an accrued loss of $10,000. Mr. Y plans to sell his mutual fund holdings in August 2023 and immediately repurchase them in order to trigger a $10,000 capital loss. — REQUIRED Comment on Mr. Y’s plan.

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ASSIGNMENT PROBLEMS

Problem 1 During the year Rachael had the following transactions in common shares of Carnegie Inc., a Canadian public company. She would like you, as her tax adviser, to explain the tax consequences to her of each of the following transactions:

Date

Transaction

Jan 15/23 Feb 20/23 April 5/23 Sept 16/23 Nov 30/23 Dec 12/23

Purchase Purchase Stock dividend — 10% Stock split Sold Purchase

Price/Share

Number of Shares

Broker Fees

1,200 200 120 1,520 200 200

$700 150

$34 37

17 13

Notes

1 2 75 125

Notes: (1) The April 5, 2023 stock dividend resulted in an increase in paid-up capital of $40 per share. (2) The stock split gave Rachael one share for every share she held at the time. (3) On December 15th she received a cash dividend of $10 per share.

Problem 2 This is a continuation of Assignment Problem 2 in Chapter 3. The following two situations are not related. Once again, you have been asked for advice on employee stock options by two different clients.

CHAPTER 7

(1) Omer is part of the management team of a Canadian public company and is eligible for the employee stock option plan. A few years ago he received an option on 1,000 shares. The option required him to pay the option price of $30 (the value at the time the option was granted) for the shares at the time he exercises his option. Omer exercised the option three years ago when the shares were worth $35 and is now selling the shares for $45. He has asked you to tell him the amount and type of income he will have to report in his net income for tax purposes. (2) Hilda is part of the management team of a Canadian-controlled private company and is eligible for the employee stock option plan. Several years ago she received an option on 1,000 shares. The option required her to pay the option price of $30 (the value at the time the option was granted) for the shares at the time she exercises her option. Hilda exercised the option three years ago when the shares were worth $35 and is now selling the shares for $45. She has asked you to tell her the amount and type of income she will have to report in her net income for tax purposes.

Problem 3

ITA: 53

Ivy Jackson invested $2,000 on April 1, 2022, in Growth Mutual Fund sold by a major financial institution. Her investment purchased 72.788 units of the fund. On December 31, 2022, the fund allocated $96.37 of capital gains to her account. As a result, the $96.37 was reinvested in the fund to purchase 3.774 units at the market value of $25.535 per unit. On June 30, 2023, she sold 25 of her units for a total of $1,000. Ivy has asked you to calculate the effects of these events on her income for tax purposes in 2022 and 2023.

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Problem 4 Ten years ago, Mr. Chu invested in Able Inc., a Canadian private company which meets the definition of a ‘‘small business corporation’’. He invested $100,000 in common shares and made an unsecured loan of $60,000 with an interest rate of 5%. He has been receiving interest on this loan until recently. He has just found out that due to the bankruptcy of a significant customer and the loss of the related accounts receivable, Able Inc. is also in significant financial difficulty. Mr. Chu has come to you for tax advice. (1) At this point, can Mr. Chu claim a loss on either the loan or the shares without disposing of the shares or debt? (2) He has someone who is interested in buying the shares for $10,000 and the debt for $6,000. What are the tax consequences if he does this?

Problem 5

ITA: 41, 46

Mr. Adam Lamb sold the following assets this year, all of which were purchased within the last 10 years: Cost Oil painting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,500 Canoe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 700 Rare coin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,400 Bible produced in 1635 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800 Antique car . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,000 Antique chair . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300 Antique table . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,500

Proceeds $1,500 500 500 4,000 10,000 1,200 2,000

Mr. Adam Lamb has an unclaimed capital loss on listed personal property of $1,200 arising three years ago. Mr. Lamb would like you to calculate his net taxable capital gain for this year.

Problem 6

ITA: 40(2)(b), 54

Mr. Doug Hart, who lives in Ontario, is contemplating moving to Switzerland. He came to you to discuss the tax consequences of disposing of his residences, as indicated below, in April 2023. He is single and ordinarily inhabits each of the residences for several months each year. He has never used his principal residence exemption since purchasing these properties. The following information relates to the proposed 2023 dispositions. Residence Toronto home . . . . . . . . . . . . . . . . . Farm in Quebec . . . . . . . . . . . . . . . . Condominium in Florida . . . . . . . . . .

Date of purchase 2016 2018 2021

Cost $170,000 100,000 150,000

Selling price $250,000 148,000 186,000

— REQUIRED Mr. Hart has asked you to calculate the minimum amount of taxable capital gains that he will have to report in 2023.

Problem 7

ITA: 3, 41

Dave Stieb reported the following information for tax purposes: Business income . . . . . . . . . . . . . . . . . . . . . . . Property income . . . . . . . . . . . . . . . . . . . . . . . Capital gains:* Listed personal property . . . . . . . . . . . . . Personal-use property . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . * Brackets indicate capital loss. ** Includes a $3,000 business investment loss.

¶7,850

2021 $ 60,000 2,000 5,000 (2,000) (8,000)**

2022 $ 65,000 3,000

2023 $70,000 (1,000)

(7,000) 5,000 6,000

3,000 4,000 (16,000)

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Your manager has asked you to calculate the income under Division B for each year after making the necessary amendments to the returns of other years. (Deal with each item line-by-line across the years, rather than computing income one year at a time.) Assume that no capital gains deduction was ever claimed.

Problem 8

ITA: 3, 39, 41

Simon has the following sources of income and losses for tax purposes:

2022

2023

Employment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $25,000

$30,000

Property income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

10,000

(4,000)

Business income — other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

8,000

(9,000)

4,000

(1,500)

— Personal-use property . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

8,000

(1,000)

— Shares — Canadian-controlled private corporation (Note 2)

(6,000)

(2,000)

— Public corporation . . . . . . . . . . . . . . . . . . . . . . . . (12,000)

9,000

Capital gains (capital losses): — Listed personal property (Note 1) . . . . . . . . . . . . . . . . . . . .

Additional Information (1) Simon has a capital loss from listed personal property of $1,000 carried forward from 2019. (2) These losses qualify as business investment losses. No capital gains deduction has ever been claimed.

Problem 9

ITA: 40(2)(b), 45(2), 54

Ms. Andrews purchased a home in Waterloo in 2013 at a cost of $86,000. She lived in the home until January 29, 2016, at which time she moved to Vancouver and rented a home in Vancouver. At the time of the move, Ms. Andrew’s Waterloo residence had risen in value to $230,000. EXpecting that real estate prices would continue to rise, Ms. Andrews chose to retain ownership of her Waterloo home and rented it to a third party. In June 2022, Ms. Andrews decided she missed living in Waterloo and chose to return. She returned to Waterloo where she took up residence in her Waterloo home. At the time, the Waterloo residence had a fair market value of $294,000. In March 2023, Ms. Andrews decided she was tired of living in the city. She sold her Waterloo home for $284,000 and moved to the countryside. Prior to filing her 2023 personal tax return, Ms. Andrews has requested your advice in minimizing the capital gains she must report on the sale of her home. Ms. Andrews has asked you to calculate the minimum capital gain that she will have to report on the sale of her home under the following circumstances:

(A) assuming that she elects to be deemed not to have changed the use, and

ITA: 45(2)

(B) assuming that the election is not made.

¶7,850

CHAPTER 7

Simon has asked you to calculate his Division B income for 2022 and 2023. (Deal with each item line-by-line across the years, rather than computing income one year at a time.)

Introduction to Federal Income Taxation in Canada

180

Problem 10

ITA: 47, 53

Sherman Schleuter likes to invest in the stock market for the long term. While some of his investments have been failures, some have been very successful. Generally, he has been very fortunate in buying certain stocks at a relatively low price and selling them at their peak. One such stock is Headed For the Sky Corporation, a public corporation. Sherman has provided the following trade information related to this investment: Nov. 8, 2016 Apr. 15, 2017 June 6, 2018 July 2, 2018 Aug. 30, 2019 June 20, 2020 Nov. 8, 2021 Jan. 12, 2022 Nov. 5, 2023

— Purchased 1,000 shares at initial offering price of $5. — Purchased 2,000 shares at price of $3.50. — Sold 500 shares at $3.75, incurred brokerage commission of $50. — Purchased 2,000 shares at $4. — Received a stock dividend of 10% of shares held; stock dividend increased corporation’s paid-up capital by $.50/share. — Two-for-one stock split. — Purchased 2,000 shares at $6. — Received a stock dividend of 10% of shares held; stock dividend increased corporation’s paid-up capital by $1/share. — Sold 10,000 shares for $8.50/share, incurred brokerage commission of $650.

Sherman has asked you to calculate the taxable capital gain or allowable capital loss on the above transactions.

Problem 11

ITA: 52; 53

Ms. Plant decided to purchase shares in Schvantz Ltd., a public company. She purchased 800 shares at $25 per share plus brokerage of $690 on May 24, 2009. The following additional transactions took place: Schvantz Ltd. Shares: Aug. 20, 2010 Aug. 27, 2012 Sept. 20, 2012 June 9, 2014 Aug. 20, 2020 Dec. 28, 2023

— Purchased 1,100 additional shares of Schvantz Ltd. at $30 plus brokerage of $940. — Sold 900 shares of Schvantz Ltd. at $24.50 per share plus brokerage fee of $860. — Purchased 600 additional shares of Schvantz Ltd. at $19.50 plus brokerage of $400. — Sold 250 shares of Schvantz Ltd. at $32 per share plus brokerage fee of $275. — Received 20% stock dividend from Schvantz Ltd. of which $25 per share issued was credited to paid-up capital. — Sold 350 shares of Schvantz Ltd. at $39 per share plus brokerage fee of $355, settlement date January 4, 2023.

Shtupp Metal Ltd. Shares: June 30, 2010

— Purchased 500 shares of Shtupp Metals Ltd., a public company, at $35 plus brokerage of $600. Oct. 31, 2012 — Sold 200 shares of Shtupp Metals Ltd. at $32 per share plus brokerage fee of $220. May 24, 2016 — Received a 10% stock dividend from Shtupp Metals Ltd. (i.e., 30 shares) of which $20 per share issued was credited to paid-up capital. June 30, 2018 — Sold 150 shares of Shtupp Metals Ltd. at $36.50 per share plus brokerage fee of $165. Ms. Plant has asked you to calculate the taxable capital gain or allowable capital loss for each of the above sales.

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Problem 12 Mr. Richmond, a new client, has invested in rental properties, principal residences and other capital property with inheritance monies and other liquid cash. He provides you with the following information with respect to his 2023 taxation year.

ITA: Division B, Subdivisions a, b, c

Mr. Richmond is employed by Wealth Inc., a Canadian-controlled private corporation, and received the following income and benefits: (1) Salary (net) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Payroll deduction: Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $23,624 CPP (includes enhanced CPP of $631) . . . . . . . . . . . . . . 3,754 EI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,002 Registered pension plan (defined benefit: current service) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,700

$ 52,920

32,080 $ 85,000

(2) Mr. Richmond paid professional fees of $500 to the Professional Engineers of Ontario. (3) Mr. Richmond sold two lots of his Wealth Inc. employee stock option shares. He provides you with the following: 1st lot — 450 shares sold on March 15, 2023, for $26.50 per share. These shares were exercised on February 2016 for $8. The fair market value of each share on the date exercised was $10.50. The fair market value at the date of grant was $8. 2nd lot — 600 shares sold on December 5, 2023, for $25 per share. These shares were exercised on April 12, 2022, for $15. The fair market value of each share on the date exercised was $21. The fair market value at the date of grant was $17.

CHAPTER 7

(4) Mr. Richmond received an interest-free loan of $9,000 on March 12, 2023, to enable him to purchase the 2nd lot of shares of Wealth Inc. The loan was outstanding until the shares were sold on December 5, at which time the loan was repaid. Assume that the prescribed rate throughout the year was 3%. In addition, during 2023, Mr. Richmond received the following income from various sources including certain capital dispositions. (A) Mr. Richmond sold the following assets:

Antique foot stool . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Painting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Stamp collection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Cost

Proceeds

$1,100 950 250

$ 900 1,500 850

(B) During 2023, Mr. Richmond sold his two residences, in order to purchase a larger home in an expensive suburb. The following facts relate to these two residences:

City home . . . . . . . . Cottage . . . . . . . . . .

Date purchased

Cost

Commission

Proceeds

2014 2009

$95,000 15,500

$21,000 12,000

$350,000 200,000

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Introduction to Federal Income Taxation in Canada

182

(C) In addition to his residences, Mr. Richmond owns two rental properties. The following information pertains to these two properties: Cost of land . . . . . . . . . . . . . . . . . . . . . Cost of building . . . . . . . . . . . . . . . . . . UCC — January 1, 2023, Class 1 . . . . . . Rental revenue in 2023 . . . . . . . . . . . . . EXpenses: Taxes (property) . . . . . . . . . . . . . . Other expenses . . . . . . . . . . . . . . . Mortgage interest . . . . . . . . . . . . . .

Wealthier St. $70,000 55,000 39,000 18,000

Richmount St. $100,000 80,000 65,000 7,600

2,100 4,300 3,600

1,800 6,100 0

$10,000

$ 7,900

The Richmount St. rental property was sold in November for proceeds of $250,000 less $9,000 of selling costs. Of the proceeds, $140,000 was for the land. Mr. Richmond purchased the Wealthier St. rental property by placing a mortgage on his home. His monthly payments are $450 per month, of which $300 per month represents interest. (D) Mr. Richmond received dividends from the following investment: Wealth Inc. — a Canadian-controlled private corporation (from income taxed at the low corporate rate) ......................................................................... $800 (E) Mr. Richmond owns units in Dumark Mutual Fund. He received a T3 slip from Dumark Mutual Fund indicating the following income amounts allocated to his account and reinvested in 2023: Capital gains .................................................................................................................$1,200 Actual amount of dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 362 Taxable amount of dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500 Mr. Richmond had invested $20,000 in the Dumark Fund in 2022. This resulted in the purchase of 1,640.824 units of the fund. In 2022, income of $46.31 was allocated to his account and reinvested. The reinvestment resulted in the purchase of 3.845 units at the market value of $12.044 per unit. The 2023 income allocation resulted, on reinvestment of the $1,544.97, in the purchase of 119.358 units at the market value of $12.944 per unit. Late in 2023, after the income allocation, Mr. Richmond sold 1,000 units for a total of $12,881. (F) Mr. Richmond sold a $100,000 Government of Canada bond for $115,327. This bond paid interest semi-annually at an interest rate which was much higher than current interest rates. The proceeds received of $115,327 included accrued interest of $5,327. Mr. Richmond had purchased the bonds on the open market for $98,000. (G) Mr. Richmond has a listed personal property loss, carried forward from 2017, of $700. Mr. Richmond has asked you to calculate his Division B income for 2023. Assume that he claimed $60,000 of his capital gains exemption in prior years. Ignore the effects of any leap year.

Problem 13 Tony is 59 years of age. Tony established and, for 34 years, successfully maintained Tony’s Future Hardware, a proprietorship in a small city. The business has a December 31 year end. Tony has come to you for tax advice on how to best structure the sale of all the assets, what after-tax cash from the sale would be retained by him, and when he would pay the tax on the sale. Tony, a hard-working man, is looking forward to retirement. Fortunately for Tony, a large hardware store chain, Nailem Inc. (which was looking to expand), offered on August 31, 2023, to purchase all of the business assets from Tony. Nailem has stated that it is only interested in the purchase of the assets of an existing hardware store business, not the shares of an incorporated hardware store business. Nailem Inc. is willing to pay the following fair market values for all the listed assets.

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Accounts receivable (net of allowance for doubtful accounts of $2,000) . . . . . . . . . . . . . . . . . . . . . . . . . . Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Furniture & equipment (Class 8 UCC – $10,000; cost – $15,000) . . . . . . . . . . . Computer equipment (Class 50 UCC – $8,000; cost – $18,000) . . . . . . . . . . . Land (cost -- $20,000) . . . . . . . . . . . . . . . . . . . . . . . . . . Building (Class 1 UCC -- $6,000; cost -- $30,000) . . . . . . . . . . . . Trade payables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Net Book Value

Fair Market Value

$ 18,000 35,000

$ 17,000 48,000

11,000

10,000 20,000

7,000 140,000

6,000 (10,000)

260,000 (10,000)

Nailem proposes to buy Tony’s business for $663,000 cash, net of the trade payables of $10,000. This price includes $190,000 for the internally generated goodwill produced by Tony. The closing date is scheduled for September 30, 2023, if Tony accepts Nailem’s offer. Tony is taxed at a combined federal and provincial marginal rate of 46% (ignore any possible effects of the alternative minimum tax). He estimates that the taxable income from the business from January 1, 2023, to September 30, 2023, will be appro Ximately $40,000. He has never previously had any capital gains or losses and has had no investment losses. He is willing to accept the offer if the after-tax cash from the sale is at least $500,000.

Problem 14 Lev has owned his commercial property for many years, but he has now decided to sell it. The potential purchaser does not have enough cash to pay the full price of $2,325,000, so he is asking Lev to accept cash of $1,425,000 and a note payable of $900,000 with interest at 3% for the balance. The note would be repayable in equal annual amounts of $450,000 on the anniversary of the original closing. Lev has come to you for your advice on the tax consequences of this proposal.

UCC $465,000

Proceeds $1,650,000 675,000 $2,325,000

$1,425,000

CHAPTER 7

Land . . . . . . . . . . . . . . Building . . . . . . . . . . . .

Cost $300,000 600,000 $900,000

Proposed Consideration Cash Note

$900,000

Problem 15 Adele owns 100% of Active Inc. The company owns a small piece of land that she would like to now own personally. It has been proposed that she declare a ‘‘dividend in kind’’ where instead of paying cash as a dividend the company will transfer the land to her name. The land is currently worth $100,000 and has an adjusted cost base of $45,000. Adele would like to understand the tax implications of this proposal.

Problem 16 When he was vacationing in Florida this year, Joe Raymer sold, for US$10,000, an asset used in his proprietorship business in Ottawa, which he purchased four years ago for C$4,000. Joe was paid in U.S. dollars. At the time of the sale, US$1 bought C$1.34. When Joe returned, he converted the U.S. currency to Canadian dollars and received C$14,500.

ITA: 39(2)

Joe has asked you to calculate the taxable capital gain or allowable capital loss, if any, arising on the above transactions.

Problem 17 Len Jamal bought a parcel of land in 2011. It was his intention that he would relocate his proprietorship business to the land some day. However, the city continued to delay issuing permits to landowners in the area and eventually Len purchased another property to relocate his proprietorship business to. He held onto the land for a number of years but has now decided that he needs the cash and will sell the property. The details related to his purchase of the land are set out below.

ITA: 20(1)(n), 20(8), 40; IT-152R3

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184 Purchase Price: $4,000; Purchase Date: May 21, 2011

Len has received an offer from an acquaintance to purchase the land. The payment terms are set out below and are considered to represent fair market value. Purchase Price: $160,000; Purchase Date: October 1, 2023 Payment terms: $40,000 down payment on purchase date; $20,000 payable on January 1 each year for the period January 1, 2024, through January 1, 2029, inclusive. Interest: Interest is payable at 6% annually on the unpaid balance. Len is uncertain as to whether the disposition is on account of capital or income. You have been asked to compare the income tax consequences to Len of this sale if the sale is on account of capital and, alternatively, if it is on account of income. Do not calculate the interest income. Ignore the consequences and calculation of the interest income.

Problem 18

ITA: 13(4)

Elaine Barblaik owns an apartment building which she holds for rental income. In March 2022, Elaine settled with municipal authorities on expropriation proceeds for the property including the building. The agreed expropriation proceeds for the building and the separate sale proceeds for the appliances and fiXtures are indicated in the following data: Expropriated building Cl. 1

Sold appliances & fixtures

$406,000 188,500 362,500

$26,000 7,250 2,600

Cost . . . . . . . . . . . . . . . . . . . . . . . . . . UCC January 1, 2022 . . . . . . . . . . . . . Proceeds . . . . . . . . . . . . . . . . . . . . . .

Since negotiations had been prolonged, Elaine was able to anticipate the approXimate date of settlement and, as a result, she was able to replace in February 2023 the assets expropriated. Replacement cost for the building and the cost of new appliances and fiXtures were as follows: Building................................... $1,276,000 Appliances and fiXtures . . . . . 46,400 Elaine would like you to calculate the undepreciated capital cost for both assets through to the opening balance on January 1, 2024, assuming no further additions are made to either class of assets.

Problem 19

ITA: 13(21.1)

Pidgeon Dock Ltd. (PD) sold a property in its year ended January 31, 2022. The details are as follows: Proceeds Building ............................ $600,000 Land................................... 350,000

Cost

UCC

$800,000 200,000

$650,000 N/A

The building was the last remaining asset in Class 1. PD prepared its corporate tax return based on the proceeds of disposition shown above. The CRA is now auditing PD. PD has asked you to identify and calculate any adjustment the CRA will make to their 2022 income tax return.

Problem 20 Johnny Wong had purchased a dilapidated apartment block, The Empress, 20 years ago for $220,000. At the time, the purchase price had been allocated $80,000 to the land and $140,000 to the building. The Empress is the only building Johnny owns and is considered a Class 1 asset for CCA purposes. To date, Johnny has claimed CCA of $37,000. High Towers has acquired all the lots in the same block as Johnny’s building, except for The Empress. Johnny realized that as the last hold-out he was in an enviable negotiating position with High Towers. High Towers was desperate to gain ownership of The Empress and tear it down. After receiving ever-escalating offers, Johnny agreed to accept High Towers’ offer of $1,000,000.

¶7,850

ITA: 13(21.1)

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Johnny has been asked for your advice regarding the allocation of the purchase price between the land and building.

Problem 21

ITA: 13(4), 44

On March 1, 2023, Raymond Fan, a sole proprietor, sold his garden supply store in downtown Toronto to a competitor because of declining sales caused by competition from large suburban hardware and grocery stores. The following information relates to the sale of the business:

Accounts receivable . . . . . . . . . . . . . . . . . . . Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Building — Class 1 . . . . . . . . . . . . . . . . . . . . Equipment — Class 8 . . . . . . . . . . . . . . . . . . — Class 10 . . . . . . . . . . . . . . . . . Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Proceeds

Cost

UCC Jan. 1, 2023

$ 6,000 120,000 170,000 3,000 4,000 5,200 52,000

$10,000 65,000 62,000 1,200 12,000 7,000 —

— — $28,000 300 800 — —

Raymond’s business year end coincided with the calendar year. Raymond has been in the same business since 2013. As of December 31, 2022, there was a balance in the allowance for doubtful accounts for tax purposes of $1,300. Subsequent to the sale of the business, Raymond worked for his brother, Kevin, who owned a shoe store. However, Raymond became bored and when a garden supply store on a busy highway north of Toronto came on the market in late November 2023, he immediately bought it. The following information relates to his purchase of assets of the new business: Land .................................................................................................................. $105,000 Building (built and used before 2007)..................................................................... 220,000 Equipment — Class 8 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,000 — Class 10 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,000 Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 Raymond has asked for your help and you have decided to do the following: ITA: 13(4), 44

(B) Show the effect on Raymond’s 2023 (amended) and 2024 tax returns if he elects to defer capital gains and recapture after purchasing the new business, but does not elect for additional deferral.

ITA: 13(4), 44

CHAPTER 7

(A) Compute the minimum amount Raymond must include on his 2023 tax return in respect of the sale of the business, before any election is made to defer capital gains and recapture.

ITA: 44(6)

Discuss whether Raymond should have elected for additional deferral. (C) If the above situation had been an involuntary disposition instead of a voluntary disposition, how would your answer under part (B) differ?

Problem 22 Author’s Note: Problem 5 in Chapter 21 addresses the GST/HST implications for this problem. The GST/HST solution may be used in conjunction with the solution in Chapter 21 or as a separate assignment.

ITA: Subdivisions b and c; ETA: 123(1), 169(1), 170(1)(a), 174, 231, 236

PITA Co. Ltd. is a nutritional consulting firm that advises manufacturers and distributors on consumers’ dietary needs and preferences. For its year ended December 31, 2023, it reported net income before taxes of $900,000 for financial statement purposes. This amount included an accounting gain on the disposition of land held as capital property of $50,000 and of a building (not the only one in the class) of $95,000. The corporation also realized an accounting loss of $20,000 on securities and of $10,000 on a trademark. These assets were acquired for the following amounts: Land . . . . . . . . . . . . . . . $120,000 in 2012 Building . . . . . . . . . . . . . 100,000 in 2012 (UCC of the class is $125,000) Securities . . . . . . . . . . . . 50,000 in 2021 Trademark . . . . . . . . . . . 80,000 in 2021

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186 The proceeds of disposition of these assets were as follows: Land .................. $150,000 Building............... 120,000 Securities .............. 30,000 Trademark ............. 75,000

The corporation has reported accounting amortization of $80,000 and wishes to claim the maximum available capital cost allowance of $100,000. During 2023, the corporation also made payments in respect of interest on unpaid income taxes ($1,500), charitable donations ($10,000), and an annual employee dinner-dance in December 2022 ($14,000). During 2023, the corporation established that an unsecured $5,000 note receivable in respect of the sale (as capital property) of a parcel of land in the prior year had become a bad debt. This was not reflected in the financial statements. PITA has asked you to do the following: (A) Prepare a reconciliation between net income for financial statement purposes and net income for income tax purposes for the year ended December 31, 2023. Support your reconciliation with references to the Income Tax Act.

Problem 23 Sudbury Processing Inc. has had some tough times. In December 2022, just before its December 31st year end, there was a fire in its processing plant which destroyed the building and most of the contents. Tom Haskett, the owner, had to move fast to get back in operation before he lost customers to the competition. Tom owns all the shares of Sud Holdings Inc. (‘‘Holdings’’). Holdings owns all the shares of Sudbury Processing Inc. (‘‘Processing’’), which is the operating company. Holdings also owns the land, building, and equipment used by Processing (the ones destroyed by fire). In order to get back into business, Tom had Processing lease a new building until he could make arrangements for a new permanent home. He had some delay in making any new arrangements, because he and the insurance company had a difference of opinion on the replacement value of the building and equipment that were destroyed. They eventually agreed in March 2023, and Holdings received the cheque shortly thereafter for the building, equipment, and some repairs. However, the delay meant Tom had to make alternate arrangements for acquiring new equipment, so Processing entered into an equipment lease with an option to buy it at the end of the five-year term. Luckily, Processing had business interruption insurance, which paid it $10,000 per month for four months until it was up and running again. In July 2023, Tom made the final decision on a new factory. He decided not to build at the old location. Instead, that land is being sold and new property is being bought with the intention of constructing a new building in the next couple of years. On the sale of the existing land, the purchaser wants a warranty that there are no environmental problems as a result of the fire. Holdings and the purchaser agreed that if there were any problems, then Holdings would pay $20,000 of the purchase price back. Rather than purchase the new parcel of land at this time, Tom has had Holdings buy an option to acquire the land at any time in the next two years for an agreed-upon price. Advise Tom on the tax implications of Sudbury’s situation.

Problem 24 Mac Tosh is 66 years old and was a self-employed apple farmer in Kelowna. Since his children did not want to take over his farming business, he sold the farm (which qualifies for the lifetime capital gains deduction) to a real estate developer for $450,000. The developer sold the crop in late August, cleared the land and began the development of a 50-unit condominium complex. Mac Tosh paid $10,000 for the land in 1996 and planted 500 apple trees with a cost base of $2,000. He was saddened by the attitude of the developer, as the farm had been his pride and joy. Since Mac never used insecticides or fertilizers, he could earn a premium on the sale of the ‘‘organic’’ apples. Mac had the land appraised at $400,000 by two independent appraisers. The appraisal values were supported by the price of a piece of raw land which had recently sold in a nearby community. To compensate Mac Tosh for all his hard work over the years as well as for the current crop, the developer agreed to pay an additional $50,000 over the appraised land value. Mac Tosh’s annual revenues from his apple harvest were approXimately $15,000. Mac was pleased with this additional offer because it was very similar to the offer he received the previous year for his entire farm and crop from a neighbouring farmer. Mac has not had any other dispositions of capital property, and has no other sources of earned income.

¶7,850

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Just last week, Mac received a letter from the CRA requesting further details on the sale of his farm. He was requested to submit appraisals and a statement regarding the reason behind his tax treatment of the disposition. Mac reported the entire disposition as a capital gain and offset the gain by utilizing the necessary capital gains deduction. Mac did not have any cumulative net investment losses. Mac can’t understand why the CRA wants this information. He thought that he had considered all income tax implications of the disposition of the farm. He even read a professional tax planning book. How should Mac have reported the transaction?

Problem 25 Joe Shmaltz had come to you for some tax advice concerning the potential sale and relocation of his computer service business, a sole proprietorship under the name of Joe’s Computer Service. Joe had inherited the present site of his business from his father in 2012. He has received an offer to sell the present land and building for an excellent price. Joe has investigated other properties in the area and believes he can acquire a suitable site which is now being rented until October 2024. Joe cannot resume his business operations until this date and intends to sell all his present business assets. He will then acquire the necessary assets to resume business under the present name. The following list of assets will be sold in September 2023:

Estimated Proceeds Accounts receivable . . . . . . . . . . . . . . . .

ACB

UCC Jan. 1, 2023

9,600

$ 12,000

n/a

Land . . . . . . . . . . . . . . . . . . . . . . . . . . . .

720,000

180,000

n/a

Building — Class 1 . . . . . . . . . . . . . . . . .

420,000

120,000

$54,000

Equipment — Class 8 . . . . . . . . . . . . . . .

12,000

60,000

24,000

Inventory . . . . . . . . . . . . . . . . . . . . . . . .

14,400

15,600

n/a

CHAPTER 7

Additional Information: (1) The accounts receivable will be sold to a factoring agent. (2) There is a balance in the allowance for doubtful accounts of $960. (3) The cost of land and building reflects the fair market value at the date of his father’s death. (4) The equipment will be sold to another computer service business. (5) The present business, Joe’s Computer Service, has a December 31 year end. Joe will retain this year end when he resumes business in November 2024. (6) Joe will acquire the new land and building for $575,000 and $360,000, respectively. Indicate the tax consequences of the sale of the present business assets and acquisition of the new real property supported by your computations.

¶7,850

188

Introduction to Federal Income Taxation in Canada

CHAPTER 7 — DISCUSSION NOTES FOR REVIEW QUESTIONS (1) ‘‘Proceeds of disposition’’ is defined to include the principal amount of the mortgage that is owed to the mortgage company. This transaction may trigger recaptured CCA or a terminal loss.

ITA: 13(1), 13(21.1), 20(16), 54 ‘‘proceeds of disposition’’ (h)

(2) Whenever the adjusted cost base becomes negative there will be an immediate capital gain. The only exception to this rule is for a partnership interest in a general partnership (but not a limited partnership).

ITA: 40(3)

(3) The principal residence exemption is restricted to one residence per family unit. The rules provide the framework for deciding which residence should be claimed for which years in order to maximize the exemption. Mr. Chan and his wife must choose one residence or the other for the exemption.

ITA: 54 ‘‘principal residence’’ (c)

(4) The cottage is considered to be ‘‘personal-use property’’ (PUP). Any loss on the disposal of PUP is denied and cannot be deducted. The losses are considered to arise as a result of normal personal use over time.

ITA: 40(2)(g)(iii), 54

(5) For the purpose of calculating the capital gain or loss on any disposal of PUP the taxpayer’s cost is deemed to be the greater of the adjusted cost base of the property and $1,000. Similarly, the taxpayer’s proceeds of disposition are deemed to be the greater of actual proceeds and $1,000. Listed personal property (LPP) is defined to be a subset of PUP; therefore, the $1,000 rule also applies to LPP.

ITA: 46(1)

(6) The stock dividend should be grossed up and the grossed-up amount included in income. The amount of the dividend before the gross-up will increase the cost base of the shares and effectively reduces the capital gain or increase the capital loss when the shares are sold.

ITA: 53(2)

(7) The result of the taxable capital gains minus the allowable capital losses cannot be negative. Any negative amount is a ‘‘net capital loss’’ that can be carried back three years or forward indefinitely.

ITA: 3(b) of Div. B; 111(1)(b), 111(8) of Div. C

(8) You would be deemed to have acquired the prize at a cost equal to its fair market value at the time you received it.

ITA: 52(4)

(9) Since she was moved by her employer nine years ago and was still employed by that employer when she moved back this year, the Act modifies paragraph (d ) of the definition of ‘‘principal residence’’ to allow her to continue to claim her house as her principal residence for more than the 4 years generally allowed on a normal change in use under the definition. All years qualify since she was still resident in Canada, as required. She still has to make the election not to have a change in use in the year they moved. As a result, on the sale of the house, she will be able to claim the full principal residence exemption.

ITA: 45(2), 54, 54.1

(10) The Act generally treats the sale of this option as a disposition with the cost base being zero. Therefore, the capital gain will be equal to the proceeds and will be taxed in the year the option is sold.

ITA: 49(1)

(11) The loss on foreign currency is a capital loss. However, as an individual, she must deduct $200 from the loss in arriving at her capital loss. In this case her capital loss is $2,300.

ITA: 39(2)(b)

(12) A rollover on the exchange of the common shares for the debentures is provided as long as the debenture had the conversion feature built into its terms and no consideration other than shares (i.e., cash) was received. The shares will have a cost base of $10 each, so the accrued gain of $10 per share will be deferred until the common shares are sold.

ITA: 51

(13) The transaction will probably be an income receipt. Rachel has used her specialized knowledge, derived from her normal occupation, to make the large profit. This factor, combined with her trading history, would weigh heavily in favour of income treatment. (14) Normally, stock market transactions are treated as capital gains or losses. However, his intention seems to be to make a profit in trading shares, thereby indicating an income

ITA: 40(2)(b)

ITA: 54

ITA: 40(2)(b)

Ch. 7/Study Guide — Discussion Notes for Review Questions

189

receipt. He may elect to have these transactions treated as capital gains. However, Winston should be careful that the CRA does not subsequently deem him to be a ‘‘trader’’ and thereby revoke his election. (15) The transaction would probably be an income receipt. Her primary intention is to develop the shopping centre for sale which would be an income transaction. Therefore, the sale of the land prior to development would also be an income transaction. (16) Capital receipt (not taxable). Doug’s $15,000 net winnings should not be treated as income because his actions are more in the nature of a hobby, not making a profit. If this was his business, the profits would be taxable and any losses would be deductible. (17) One way to approach this question is to assume that the cost was allocated equally to each acre. Therefore, the cost of the three acres sold would be 1/2 of the original cost of the siX acres or $12,000. However, the CRA, in applying the law, may consider that $12,000 is too high an amount to be ‘‘reasonably regarded as attributable to that part,’’ since the lakefront portion would usually be more valuable than the non-lakefront property assuming that access is still available to both parcels. This, then, becomes a valuation issue. (18) He has to replace the land before the end of the second taxation year after the initial year. If they finally agreed to the price in 2023 then he has until December 31, 2023 to replace the property. The initial year is the year that the ‘‘amount has become receivable as proceeds of disposition’’, i.e., 2023 in this case. (19) Yes. In order for these rules to apply the destroyed equipment must be either property that was stolen, destroyed or expropriated or a ‘‘former business property’’. The definition of ‘‘former business property’’ only refers to real property which has a common law definition of ‘‘land and building’’. Equipment is not included in that definition. However, if the property is stolen, destroyed or expropriated, it only has to meet the definition of ‘‘property’’. In this case the equipment meets this definition and the replacement property rules can apply. Of course, any potential recapture would be offset, by the normal rules, because the purchase of the new machine was made in the year of loss.

CHAPTER 7

(20) Ms. Chung can elect to have disposed of her note when it is established to have become uncollectible. This will result in a capital loss equal to $100,000 and the note will then have a cost equal to zero. All or some of this loss can then be carried back under Division C to be applied against the previous capital gain. If the original property disposed of was personaluse property then the debt would have been ‘‘personal-use property’’. Then the Act allows a capital loss only to the extent of the capital gain on the original disposition.

Introduction to Federal Income Taxation in Canada

190

CHAPTER 7 — SOLUTIONS TO EXERCISES Exercise 1 Step 1: Determine gain per year of ownership Regina home Par. 40(2)(b) gain P of D . . . . . . . . . . . . . . . . . . . ACB . . . . . . . . . . . . . . . . . . . . Gain . . . . . . . . . . . . . . . . . . . . Gain per year . . . . . . . . . . . . .

Cottage

$ 517,500 (400,000) $ 117,500 $117,500 12 years

9,792

$ 375,000 (250,000) $ 125,000 $125,000 7 years

= $ 17,857

Step 2: Assignment of no-option years In the five taxation years 2012 to 2016, Ms. Amin owned only the Regina home. Therefore, there is no option in those years but to designate the city home as her principal residence. Step 3: Gain determined under paragraph 40(2)(b) The gain per year of ownership for the cottage ($17,857) exceeds that for the city home ($9,792). If all seven years are assigned to the cottage, however, one year will be wasted. Hence, the city home should be designated for one of the years 2017 to 2023.

Gain . . . . . . . . . . . . . . . EXemption . . . . . . . . . . Capital gain . . . . . . . . .

Regina home Cottage $ 117,500 $ 125,000 (68,542)(1) (125,000)(2) $ 48,958 $ 0

Taxable capital gain . . .

24,479

— NOTES TO SOLUTION (1) 1 + 5 + 1

(2)

12 1+6 7

$117,500 = $68,542; years designated — 2012–2016 and one of 2017–2023 (Say 2017)

$125,000 = $125,000; years designated — all but one of 2017–2023 (Say 2018–2023)

Exercise 2 Step 1: Determine gain per year of ownership City home P of D . . . . . . . . . . . . . . . . . . . ACB . . . . . . . . . . . . . . . . . . . . SC . . . . . . . . . . . . . . . . . . . . .

$ 180,000 12,000

$ 164,000

$ 90,000 (192,000) 6,000

Gain . . . . . . . . . . . . . . . . . . . . Gain per year . . . . . . . . . . . . .

Cottage

$ 247,000

(96,000)

$ 55,000 $55,000 16 years

3,438

ITA: 40(2)(b)

$ 68,000 $68,000 11 years

6,182

Step 2: Assignment of no-option years In the five taxation years 2008 to 2012, Peter owned only the city home. Therefore, there is no option in those years but to designate the city home as his principal residence. Step 3: Gain determined The gain per year of ownership for the cottage ($6,182) exceeds that for the city home ($3,438). If all 11 years are assigned to the cottage, however, one year will be wasted. Hence, the city home should be designated for one of the years 2013 to 2023.

ITA: 40(2)(b)

Ch. 7/Study Guide — Solutions to Exercises

191 City home

Cottage

Gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . EXemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 55,000 (24,063)(1)

$ 68,000 (68,000)(2)

Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 30,937

— NOTES TO SOLUTION (1) 1 + 5 + 1

(2)

16 1 + 10 11

× $55,000 = $24,063; years designated — 2008–2012 and one of 2013–2023 × $68,000 = $68,000; years designated — all but one of 2013–2023

Exercise 3 When Howard rents his home, he is deemed to have changed the use of the home and a capital gain may be triggered. However, Howard can designate the home with the appropriate number of years and should not be taxed on the gain. Under this course of action, Howard would now have a rental property from which he must declare the income less all his expenses. However, a rental loss could not be generated with capital cost allowance on the home and equipment therein.

ITA: 45(1)

Alternatively, Howard could elect to defer the gain until he either sells the home or rescinds his election. Note that the CRA normally permits a retroactive election at the time of sale. In this situation, Howard would not be allowed to claim any capital cost allowance on the home or the election to be deemed not to have changed the use would be invalid.

ITA: 45(2)

The election would permit Howard to designate his Vancouver home as his principal residence for at least four extra years depending upon whether he is self-employed or employed.

ITA: 45(2)

ITR: 1100(15))

Income Tax Folio S1-F3-C2 — Principal Residence ITA: 45(2)

Paragraph (d ) in the definition of a ‘‘principal residence’’ permits Howard to designate his Vancouver home as his principal residence for four years, while it is being rented, if he elects to be deemed not to have changed the use according to paragraphs (b) and (d ) of the definition.

ITA: 54 ITA: 45(2)

Howard might consider rescinding his election after the fourth year. This course of action would enable Howard to claim capital cost allowance after the fourth year subject to the loss restrictions discussed above. (B) Employed The Act waives the four-year restriction discussed above if Howard (or his wife) has moved at least 40 km closer to his new work location. Howard then can designate his Vancouver home as his principal residence during all the rental years if:

ITA: 54.1

(i) Howard subsequently resumes ordinary habitation of his home while employed with the same employer; or (ii) Howard subsequently resumes ordinary habitation of his home within one year from the end of the year in which he terminates employment with that employer; or (iii) Howard dies. Note that ‘‘ordinarily inhabited’’ means any time during the year according to the CRA, but Howard cannot temporarily move back in order to qualify for this exemption.

Income Tax Folio S1-F3-C2 — Principal Residence

CHAPTER 7

(A) Self-employed

Introduction to Federal Income Taxation in Canada

192

Exercise 4 Painting

Antique clock

Outboard motor

P of D . . . . . . . . . . . $2,000 $1,200 ACB . . . . . . . . . . . . . $1,000 $1,000 $1,000 SC . . . . . . . . . . . . . . 100 (1,100) 20 (1,020) 15

$1,000

CG (CL) . . . . . . . . . .

$ (15)

$ 900

$ 180

Gold coin

$1,000 $1,000 (1,015) 10 (1,010) $ (10)

Net taxable capital gain: LPP — Painting . . . . . . . . . . . . . . . . . . . . . $ 900 — Gold coin . . . . . . . . . . . . . . . . . . . . (10)(1) $ 890 — 50% . . . . . . . . . . . . . . . . . . . . . . . . PUP — Antique clock (50% × $180) . . . . .

$ 445 90 $ 535

— NOTE TO SOLUTION (1)

Listed personal property losses, whether current or carried-over, are applied at the full capital gain (capital loss) amount.

Exercise 5 (A) P of D 200 shares @ $25 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ACB 200 shares @ $33(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . SC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CL(2) (Superficial loss of $1,675)

$5,000 6,600 75

..................................

(6,675) $

(B) Adjusted cost base of shares 50 shares @ $33 = $1,650 200 shares @ $26 = 5,200 superficial loss 1,675 $8,525 ÷ 250 shares = $34.10

— NOTES TO SOLUTION (1)

(2)

100 shares @ $30 150 shares @ $35

= $3,000 = 5,250 $8,250 ÷ 250 shares = $33

Since Ivan acquired additional shares of Solid Investments within the 30-day period the capital loss is considered a superficial loss. He will not have a capital loss in the year of sale. The superficial loss will be added to the adjusted cost base of the new shares.

Ch. 7/Study Guide — Solutions to Exercises

193

Exercise 6 (A) For identical properties, the weighted ‘‘moving average’’ basis is to be used to calculate the ACB of each individual property (subsection 47(1)).

ITA: 47(1)

High Growth Co. Shares Share Adjusted Date Purchased Price Cost Base ACB/Share Jan. 1/18 1,000 $3.00 $ 3,070 $3.07 Jun. 5/19 3,000 2.80 8,490 4,000 11,560 2.89 Aug. 5/20 1,500 3.80 5,770 5,500 17,330 3.15 Dec. 3/20 1,000 5.10 5,220 6,500 22,550 3.47 May 1/21 (3,000) 3.47 (10,410) Nov. 8/22 1,000 5.75 5,880 4,500 18,020 4.00 Jan. 9/23 (1,500) 4.00 (6,000) 3,000 $12,020 4.00 Note: The disposition of shares has no effect on the moving average cost. (B) Jan. 10/18 Jan. 14/19 Totals May 20/23

High Risk Co. ACB: (20,000 × $0.25) + $200 = (4,000 × $0.80) + $75 = 24,000 shares

$5,200 $3,275 $8,475 $7,200 (8,475) (150) $(1,425)

Allowable capital loss

$(712.50) ITA: 3, 5, 6, 7, 8, 9

Exercise 7 With Sale Paragraph 3(a) Sections 5–8 Section 9 Paragraph 3(b)

Section 3

Sources of income Employment income Business income Taxable capital gains Sale of antique painting (.50 × (29,000 -- 9,000)) Net income for tax purposes

$23,000 10,000 10,000 $43,000

Exercise 8 Adjusted cost base: 1,000 shares @ $35 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . brokerage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2019 — stock dividend — 50 shares (5% × 1,000) × $10 . . . . . . . . . . . . 2020 — stock dividend — 105 shares (10% × 1,050) × $10 . . . . . . . . . . . 2023 — stock dividend — 231 shares (20% × 1,155) × $10 . . . . . . . . . . . Shares (1000 + 50 + 105 + 231) = 1,386 ACB per share: $39,360 ÷ 1,386 = $28.40

$35,000 500 500 1,050 2,310 $39,360

CHAPTER 7

Proceeds ACB Broker fees Capital loss

Introduction to Federal Income Taxation in Canada

194

Exercise 9 (A) During the years prior to the settling of the claim, Tax Processing Ltd. is deemed to own the destroyed asset. Hence the company can continue to take capital cost allowance.

ITA: 44(2)

Class 10: 30% UCC before the fire.................................................................................................. $17,150 CCA — 2021 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,145 CCA — 2022 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3,602

(8,747)

UCC before proceeds received . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 8,403

Note that the available-for-use rules do not apply when the asset has been used by the taxpayer.

ITA: 13(27)(a)

(B) In the second year after the fire (2023) when the company received the proceeds, the company would be deemed to have sold the computer for $60,000 with the following tax consequences: Taxable capital gain: P of D ................................................................................................................ $60,000 ACB .................................................................................................................. (50,000) CG ..................................................................................................................... $10,000 TCG (50% × $10,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 5,000

Recapture: UCC before proceeds received . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 8,403

Less the lesser of: (i) Capital cost ....................................................................... $50,000

}

(50,000)

(ii) P of D................................................................................ $60,000

Recapture ......................................................................................................... $41,597

(C) In the year of purchase of the new computer (2025), which is within the 24-month time limit for an involuntary disposition, Tax Processing Ltd. would file an amended return for the 2023 year in which the taxable capital gain and recapture were recognized. Taxable capital gain: 50% of the lesser of:

}

(i) capital gain (see above) ................................................... $10,000 (ii) P of D . . . . . . . . . . . . . . . . . . . . . . . . . . . . $60,000 less replacement cost . . . . . . . . . . . . . . . . . 70,000 $

ACB of new computer in 2025: ($70,000 -- $10,000) = $60,000

ITA: 44(1)(f)

Ch. 7/Study Guide — Solutions to Exercises

195

Recapture:

ITA: 13(4)

Class 10: 30% UCC before proceeds received (see above calculation) . . . . . . . . . . . . . . $ 8,403 Less deemed disposal: lesser of (i) cost ($50,000)

ITA: 13(4)(c)

(ii) P of D ($60,000) ................................................

$50,000

Less the lesser of: (i) the recapture ($8,403 -- $50,000) . . . . . . . . . . . . . $41,597 (ii) replacement cost . . . . . . . . . . . . . .

70,000

41,597

UCC after proceeds received, Dec. 31, 2023 . . . . . . . . . . . . . . . . . . . . .

8,403 $

Class 50: 55% 2025 addition: Capital cost of replacement property . . . . . . . . . . . . . . . . . . . . . . .

$70,000

Less reduction for deferred gain . . . . . . . . . . . . . . . . . . . . . . . . . .

10,000

Deemed capital cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$60,000

Less reduction for deferred recapture . . . . . . . . . . . . . . . . . . . . . .

41,597

UCC before CCA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$18,403

CCA (55% × 1.5 × $18,403) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(15,182)

UCC after CCA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 3,221

ITA: 44(1)(f )

ITA: 13(4)(d )

If section 22 is not used, Mr. Flint must still include in income last year’s reserve of $6,500. However, the loss of $9,000 will be regarded as a capital loss which is only fractionally deductible and can be offset only against taxable capital gains. Since Mr. Small has not included any amount as income in respect of these accounts receivable, he will not be allowed a deduction for a reserve or for bad debts because the conditions of the reserve for doubtful debts or the bad debt expense rules will not be met. If Mr. Small collects more than the $36,000 fair market value, the excess will be a capital gain and, if he collects less than $36,000, the difference will be a capital loss.

ITA: 20(1)(l), 20(1)(p)

Exercise 11 Sienna Research Inc. has what, at first, appears to be a terminal loss on the building and a capital gain on the land. When this occurs, subsection 13(21.1) reallocates the proceeds so that the terminal loss is reduced by the capital gain on the land.

Without adjustment

Land

Proceeds per contract . . . . . . . . . . . . . . . . . .

$ 895,000

ACB, UCC . . . . . . . . . . . . . . . . . . . . . . . . . .

345,000

Capital gain, terminal loss . . . . . . . . . . . . . . .

$ 550,000

Building $

385,000 438,700

53,700)

Total $ 1,280,000

ITA: 13(21.1)

CHAPTER 7

Exercise 10

Introduction to Federal Income Taxation in Canada

196 With subsection 13(21.1) adjustment Adjusted proceeds . . . . . . . . . . . . . . . . . . . . ACB, UCC . . . . . . . . . . . . . . . . . . . . . . . . . .

Land $ 841,300 345,000

Building $ 438,700 438,700

Capital gain, terminal loss or recapture . . . . .

$ 496,300

Total $ 1,280,000

There are no tax implications on the disposition of the building. Even though the deemed proceeds are less than the capital cost of the building, a capital loss can never arise on the disposition of depreciable property.

Exercise 12

Jan. 1, 2022

UCC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Disposal(1) lesser of: (a) capital cost ............ $300,000 (b) proceeds . . . . . .

$295,000

Cl. 1: 4% (6% or 10%) $ 221,000

(295,000)

$ 295,000

Dec. 31, 2022

UCC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Recapture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ (74,000) 74,000

Jan. 1, 2023 Aug. 2023

UCC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . File an amended return for 2021 as follows:

Jan. 1, 2022

UCC . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deemed proceeds lesser of: (a) capital cost ............. $300,000

$ 221,000

(b) proceeds . . . . . .

$295,000 → $295,000

reduced by lesser of: (a) recapture ($295K -- $221K)

$ 74,000 → $ 74,000

(b) replacement cost

$400,000

0 ITA: 13(4)

ITA: 13(4)(c)

$(221,000)

Dec. 31, 2022

UCC . . . . . . . . . . . . . . . . . . . . . . . . . . . . Recapture . . . . . . . . . . . . . . . . . . . . . . . .

0 0

Jan. 1, 2022

UCC . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Cl. 1-NRB: 6%

Dec. 31, 2023 Jan. 1, 2024

Purchase of new building ................................... $400,000 Less: reduction above . . . . . . . . . . . . . . . 74,000 UCC . . . . . . . . . . . . . . . . . . . . . . . . . . . . CCA @ 6% of [$326,000 + (1/2 × $326,000)] UCC . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 326,000 $ 326,000 (29,280) $ 296,720

ITA: 13(4)(c)

— NOTES TO SOLUTION (1)

The CRA appears to require that even if a replacement property is purchased before the tax return for the year of disposition must be filed (i.e., within si X months of the taxation year end), the recapture must be reported in the year of disposition. The taxpayer can request a reassessment if and when the replacement is purchased within the specified time limits. In lieu of paying tax initially on the recapture, the CRA will take acceptable security until the final determination of tax is made.

IT-259R3, par. 3

Ch. 7/Study Guide — Solutions to Exercises

197

Exercise 13 Manru Realty Limited v. M.N.R., 72 DTC 6415 — Intention: must be established by reference to facts classified by behavioural factors below (a) primary: to erect buildings on the property for rental purposes, thereby using the land as a capital asset (b) secondary: to purchase and sell land at a profit — if the area developed, the land would be built on; if not developed, then it would have been sold, providing a suitable profit opportunity presented itself — Behavioural factors used to classify facts on intention (a) Relationship to the taxpayer’s business — the appellant’s two principal shareholders had a history of extensive dealing in real estate (b) Nature of the activity surrounding the transaction — the sale of the land did not result from an unsolicited offer, reflecting an intention to trade — the land was listed for sale by a real estate corporation — but there was no evidence that the appellant took any concrete steps to develop or build on the land at any time (c) Nature of the asset — circulating or working capital since it was handled like inventory — the land was bought as raw land and it was sold as such — no income was generated by the use of the land as a productive asset (d) Number and frequency of transactions — to the date of the case this company had sold 12 properties (e) Corporate objects

Exercise 14 (A) Assuming no elections under ITA 44 and ITA 22: Division B Income Arising from Sale of Business Assets Accounts receivable — opening reserve [par. 12(1)(d )] . . . . . . . . . . . . . $ 2,000 — capital loss (($8,000 -- $14,000) × 50%) . . . . . . (3,000) Inventory [sec. 23] ($17,000 -- $20,000) . . . . . . . . . . . . . . . . . . . . . . . . . (3,000) Land (($75,000 -- $20,000) × 50%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27,500 Building — taxable capital gain (($200,000 -- $60,000) × 50%) . . . . . . . 70,000 — recapture ($47,000 -- $60,000) 13,000 Equipment — Class 8 recapture ($8,850 -- $10,000) . . . . . . . . . . . . . . . . 1,150 Goodwill (50% × $50,000) ................................................................................. 25,000 $132,650 (B) Assuming an election under ITA 44 and ITA 22: Division B Income Arising from Sale of Business Assets Accounts receivable — opening reserve [par. 12(1)(d )] . . . . . . . . . . . . . — business loss ($8,000 -- $14,000) [sec. 22] Inventory [sec. 23] ($17,000 -- $20,000) . . . . . . . . . . . . . . . . . . . . . . . . . Land(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Building — taxable capital gain(2) (50% × $50,000) . . . . . . . . . . . . . . . — recapture(3) Equipment — Class 8 recapture ($8,850 -- $10,000) . . . . . . . . . . . . . . . . Goodwill — taxable capital gain (50% × $50,000) . . . . . . . . . . . . . . . . .

$ 2,000 (6,000) (3,000) $ 0 25,000 $ 0 1,150 25,000 $ 44,150

CHAPTER 7

— included the power to buy, sell, subdivide and dispose of properties thereby encompassing the transaction at hand

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198

(C) The ssec. 44(1) election combined with the ssec. 44(6) election permits a deferral of capital gain in respect of the land and the building. However, with the building, the potential future capital cost allowance claim is accordingly reduced by the $75,000 capital gain deferral and the $13,000 recapture deferral. The sec. 22 election has advantages to both Mr. Sole Proprietor and the purchaser. First, the otherwise allowable capital loss of $3,000 is converted to a full $6,000 business loss for Mr. Proprietor. Without the sec. 22 election, the purchaser is denied a reserve or future bad debt write-offs under ssec. 20(1) since he has not included in income an amount in respect of these receivables. Section 22 permits these deductions if the $6,000 loss is included in the purchaser’s income. — NOTES TO SOLUTION No ssec. 44(6) (1) Land — lesser of

(a) P. of D. — actual . . . . . . . . . . . . . . . . . Plus ssec. 44(6) election . . . . . . . . . . . Deemed P. of D. . . . . . . . . . . . . . . . . . ACB . . . . . . . . . . . . . . . . . . . . . . . . . . C.G. . . . . . . . . . . . . . . . . . . . . . . . . . . (b) Deemed P. of D. . . . . . . . . . . . . . . . . . Replacement cost . . . . . . . . . . . . . . . . EXcess, if any . . . . . . . . . . . . . . . . . . .

Ssec. 44(6)

$ 75,000 $ 75,000 0 15,000 $ 75,000 $ 90,000 (20,000) (20,000) $ 55,000

$ 70,000

$ 75,000 $ 90,000 (90,000) (90,000) 0 0

Reported gain . . . . . . . . . . . . . . . . . . .

Deferred gain . . . . . . . . . . . . . . . . . . .

$ 55,000

$ 70,000

ACB of replacement . . . . . . . . . . . . . .

$ 35,000

$ 20,000

(2) Building — lesser of (a) P. of D. — actual . . . . . . . . . . . . . . . . . Less ssec. 44(6) election . . . . . . . . . . . Deemed P. of D. . . . . . . . . . . . . . . . . . ACB . . . . . . . . . . . . . . . . . . . . . . . . . . C.G. [cls.44(1)(e)(i)(B)] . . . . . . . . . . . (b) P. of D. — deemed . . . . . . . . . . . . . . . Replacement cost . . . . . . . . . . . . . . . .

$200,000 $200,000 0 (15,000) $200,000 $185,000 (60,000) (60,000) $140,000

$125,000

$200,000 $185,000 (135,000) (135,000)

EXcess, if any [cls. 44(1)(e)(i)(B)] . . .

$ 65,000

$ 50,000

Reported gain . . . . . . . . . . . . . . . . . . .

$ 65,000

$ 50,000

Deferred gain . . . . . . . . . . . . . . . . . . .

$ 75,000

ACB of replacement . . . . . . . . . . . . . .

$ 60,000

$ 60,000 Building Cl. 1: 4%

(3) UCC prior to disposal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less par. 13(4)(c) deemed disposal — lesser of: (a) cost — $60,000 . . . . . . . . . . . . . . . . . . $ 60,000 (b) P. of D. — $200,000* . . . . . . . . . . . . . . Less — the lesser of (a) Recapture ($60,000 credit to class — $47,000 UCC) . . . . . . . . . . . . . . . . . . . 13,000 (b) Replacement — $135,000 . . . . . . . . . . . UCC December 31, 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 47,000

47,000 $ 0

Reported recapture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Deferred recapture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 13,000

Ch. 7/Study Guide — Solutions to Exercises

199 Building Cl. 1: 6%**

Replacement cost ................................................................................... $135,000 Less: par. 44(1)(f ) ($125,000 -- $50,000) with ssec. 44(6) (deferred gain) ........................................................................... (75,000) par. 13(4)(d ) reduction (deferred recapture)

(13,000) $ 47,000

Add: 1/2 of net amount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

23,500

UCC, December 31, 2024 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 70,500

CCA (i.e., 6% of $70,500) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(4,230)

/2 of net amount .....................................................................................................(23,500)

UCC, January 1, 2025 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 42,770

* Note that the deemed proceeds arising from ssec. 44(6) are not applicable for the purposes of section 13. ** The new building can be put into Class 1 and is eligible for the 6% CCA rate available to non-residential buildings in this class.

Exercise 15 — The courts have attempted to assess the intention of the taxpayer at the time of the purchase in this type of case: (a) primary: did the taxpayer enter the transaction to make a business profit? (b) secondary: did the taxpayer know at the time of the purchase that there was a profitable ‘‘escape hatch’’ if the primary intention to hold the property as a capital asset did not work out?

(a) relationship of the transaction to the taxpayer’s business — if a taxpayer’s regular business is associated with land (i.e., a builder or a real estate agent), it will be considered a business transaction (in the absence of evidence to the contrary): — Hi-Tech is not in the real estate business — they have no known expertise in real estate — however, they entered a joint venture with a developer (b) organization or activity associated with trade — if a sale of property is the result of an active campaign to sell it rather than the result of something unanticipated at the time of purchase, (e.g., expropriation, sudden need of money, frustration of original intention), the profits will be considered business income from an adventure in the nature of trade: — unsolicited offer by developer — sold because financial position deteriorated — however, in the joint venture with the developer, an organized effort was put into the sale of the excess land

CHAPTER 7

— Since intention is a state of mind, the courts must be presented with evidence of intention from the taxpayer’s whole course of conduct, i.e., actual behaviour, before, during, and after the particular transaction in question (See IT-218R):

Introduction to Federal Income Taxation in Canada

200 (c) nature of the asset

— the nature of some assets is such that they can only be considered as either inventory or fiXed assets — land can fall into either category, but when an organized effort is made to put a property into a more marketable condition (e.g., laying sewers, building roads, preparing a plan of subdivision), it indicates inventory for a business of selling properties: — Hi-Tech was forced to buy the new property, including the excess land, as a result of the fire: — another suitable property could not be located — the vendor would not sell the building without also selling all 10 acres of land — Hi-Tech planned to construct an office building on the land, i.e., fiXed asset — however, no evidence of plans for the building was offered (d) number and frequency of transactions — a history of extensive buying and selling of similar properties or of quick turnover of properties may be taken as evidence indicating that a taxpayer is carrying on a business of dealing in real estate — Hi-Tech had no prior land transactions (e) corporate objects or articles — if the transaction belonged to a class of profit-making operations contemplated by the objects, then in the absence of any evidence to the contrary, the profit would be one arising from the business of the taxpayer — not definitive and no evidence in this case — Recommendation: — recommend that they file their 2021 return on the basis that the gain is a capital gain — company should be warned of the possibility of reassessment

Exercise 16 — The $10,000 loss will be denied as a superficial loss since he will have repurchased the mutual funds within 30 days of the disposition that triggered the loss, assuming that he owns the mutual funds at the end of the 30-day period. — The $50,000 gain will not be denied since there are no superficial gain rules.

Chapter 8 Non-Arm’s Length Transfers and Other Special Circumstances

CHAPTER 8

201

202

Introduction to Federal Income Taxation in Canada

Ch. 8/Study Guide — Learning Chart

203

CHAPTER 8 — LEARNING CHART Problem Descriptions Textbook Example Problems 8-1 Transfer to non-arm’s length (NAL) — adult child 8-2 Transfer to NAL — spouse 8-3 Transfer to spouse — attribution 8-4 Transfer to spouse — attribution 8-5 Transfer to minor child — attribution Exercises 1 2 3 4 5 6 7 8 9

Attribution — spouse Non-arm’s length transactions — attribution Arm’s length Non-arm’s length transaction Transactions with spouse Sale of shares Non-arm’s length transactions Non-arm’s length transactions Becoming a resident

Assignment Problems 1 Attribution — spouse, children 2 Attribution 3 Business and property income, attribution 4 Interest vs. dividend and attribution 5 Non-arm’s length transactions, attribution 6 Non-arm’s length transactions, attribution 7 Transfer of property on divorce 8 Related, aff iliated, arm’s length 9 Non-arm’s length purchase of rental property 10 CCPC stock option with attribution 11 Death of a taxpayer 12 Becoming resident and non-resident 13 Death of a taxpayer 14 Going non-resident 15 Going non-resident

CHAPTER 8

204

Introduction to Federal Income Taxation in Canada

Ch. 8/Study Guide — Review Questions

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205

REVIEW QUESTIONS

(1) Mr. Simpson owns an unincorporated business. In recognition of his wife’s considerable contribution of her time and skills to the business he gives her a one-half share of the business income. Comment. (2) Mr. Smith has guaranteed a bank loan that his wife has taken out to buy shares in a corporation carrying on a business that she is starting. He is concerned about the attribution rules. Comment. (3) Last year Ms. Milne inherited $5 million from her uncle’s estate and is now appalled by the amount of tax that she has to pay on her interest income. She has always liked the Cayman Islands and has decided to move there permanently in order to avoid Canadian tax. Her only assets are $5 million of term deposits but she has heard that there is a lot of tax to pay on leaving the country. What do you think? (4) Mrs. Gleba owns 20 acres of land that have an appraised value of $100,000. She is considering selling the land to a friend for $50,000 in order to have the friend live closer to her. The two individuals are not related. What tax issues would you discuss with her? (5) Scott was 25 years old when his father, Bill, gave him shares in Bell Canada as a gift. Bill paid $1,000 for them 10 years ago and they were worth $5,000 at the time of the gift. Scott has come to you to find out how much tax he will have to pay. Discuss the tax implications of the gift to Scott and Bill. (6) Mr. Shiloh was transferred to Canada by his employer four years ago and is now being transferred back to the United States. At the time he entered Canada he held shares in his US employer which are listed on the TSX Stock EXchange. He still owns all these shares and is unhappy about all the tax he is going to have to pay on the deemed disposition. Advise him.

CHAPTER 8 ¶8,800

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206

¶8,825

EXERCISES

Exercise 1

ITA: 74.1, 74.5

(A) A husband wants his wife to have a $1,000 bond that he owns paying interest at 7%. What are the consequences to the couple during the year if: (i) he gives the bond to her without receiving any financial consideration from her in return? (ii) he sells the bond to her for $1,000 plus accrued interest to the date of sale in return for cash? (iii) he sells the bond to her for $1,000 plus accrued interest to the date of sale in return for a demand note which she signs payable to him without interest? (iv) he cashes the bond, lending the proceeds to her in return for a promissory note, which she signs payable to him without interest but with a definite repayment period and she uses the funds from the loan to buy a similar bond? (B) Would any of the above answers change for the current year if he undertook the same transactions with a trust set up in favour of a child aged 15 instead of his wife? (C) Would any of the above answers change if he undertook the same transactions with a child aged 20?

Exercise 2 Robin is an extremely wealthy lawyer who wants to lower his taxes without losing control over his wealth. On January 1, 2020, he decided to make an interest-free loan of $75,000 to his 25-year-old daughter, Faith. Immediately, Faith used the money to purchase 750 shares of Hiflier Public Co., which paid dividends of $7,500 in 2023. Faith had no other income in 2023. — REQUIRED What are the tax consequences to Robin and Faith for 2023?

Exercise 3

ITA: 251

Which of the following individuals are not at arm’s length with Ms. Gamma: (A) her brother’s wife? (B) her niece? (C) her husband from whom she is legally separated? (D) an unrelated person?

Exercise 4 James Meadows is not at arm’s length with his son, Hayden. James wants Hayden to have a painting that cost him $1,200 and now has a fair market value of $1,500. What are the consequences under the non-arm’s length transfer rules to James and Hayden if:

ITA: 69(1)

(A) he sells the painting to him for $2,000? (B) he sells the painting to him for $1,200? (C) he gives the painting to him without any financial consideration?

Exercise 5 Alice Verwey is considering the following courses of action in transferring assets to her spouse this year:

ITA: 73, 74.1, 74.2, 74.5; IT-511R

(A) gifting to her husband shares with a fair market value of $15,000 and an adjusted cost base of $12,000, no election was made; (B) selling to her husband shares with a fair market value of $15,000 and an adjusted cost base of $12,000 for cash of $15,000. An election out of the interspousal rollover was made; (C) selling to her husband shares with a fair market value of $15,000 and an adjusted cost base of $12,000 for a $15,000 non-interest-bearing promissory note with a definite repayment period, no election was made;

¶8,825

ITA: 73(1)

Ch. 8/Study Guide — Exercises

207

(D) gifting to her husband $15,000 such that he purchases the shares on the open market; and (E) lending her husband $15,000 evidenced by a non-interest-bearing promissory note with a definite repayment period such that he purchases the shares on the open market. — REQUIRED Discuss the tax implications arising from the above transactions and any subsequent disposition by the spouse.

Exercise 6 Mr. I.M. Smart has come to you for some tax advice concerning the sale of his shares of XYZ Ltd., a public corporation, to his wife, a friend, and to his 10-year-old son by means of a trust. As consideration for the shares, he accepted a non-interest-bearing demand note.

Wife . . . . . . . . . . . . . . . . . . . . Friend . . . . . . . . . . . . . . . . . . . Son . . . . . . . . . . . . . . . . . . . . .

Date of sale Jan. 1, 2023 Mar. 1, 2023 Apr. 1, 2023

No. of shares 500 500 500

Selling price $35 55 40

FMV at date of sale $60 55 70

Mr. Smart’s records show the following information concerning the shares: Purchases 2015 .................................... 500 shares @ $10 2016 .................................... 300 shares @ $15 2017 .................................... 100 shares @ $20 2019 .................................... 500 shares @ $30 Dividends Received 2015–2023

—

2020

—

June 30th each year; a cash dividend of approXimately 10% of fair market value. 10% stock dividend which resulted in an increase in the paid-up capital of $5 per share.

Additional Information: (1) Mr. Smart does not wish to elect to use subsection 73(1). (2) Mr. Smart’s spouse and child (by means of a trust) plan to invest the dividend income on these shares in five-year compounding 4% Guaranteed Investment Certificates. — REQUIRED (A) EXplain the tax implications of the above transactions, supported by all your computations. (B) If Mr. Smart had consulted you prior to these transactions, what advice would you give him to avoid the adverse tax consequence in part (A), if any?

Exercise 7

CHAPTER 8

Sandi Senseless completed the following transactions during 2023: (1) She gifted her husband 1,000 Bell Canada shares. The fair market value at the time of the transfer was $65 per share, and her adjusted cost base was $40 per share. (2) She sold to her fifteen-year-old child a valuable painting that had a fair market value of $125,000 for $1,000. Sandi had inherited the painting from her father, at which time the painting had an appraised value of $40,000. Her son intends to sell this painting five years hence to finance his university education. (3) She loaned her husband $190,000 through a non-interest-bearing note. Her husband acquired a farm with these funds and operated the farm successfully in 2022, making a substantial profit. However, in 2023 he sold the farm for $310,000.

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— REQUIRED Discuss the income tax implications. For Part (1), discuss the tax implications of the gift, assuming no election is made and if she elects out of section 73.

Exercise 8 Mr. S has non-capital losses that are about to expire. Therefore, he gifted his investment portfolio to his wife. He will elect in his 2023 tax return not to have subsection 73(1) (transfer to spouse at adjusted cost base) apply to the transfer so that the transfer is at fair market value and the capital gain will be realized. He also feels that this will help him income split since he plans to have his wife claim all future income and capital gains from investments.

— REQUIRED Comment on Mr. S’s income splitting plan and provide any suggestions that might be necessary to make the plan successful.

Exercise 9 Mr. Emerson, a United States citizen, entered Canada on June 1, 2018, and became resident in Canada for tax purposes. Mr. Emerson had a capital asset, A, which he brought with him upon his entry to Canada. The cost of the asset was $2,000 and the fair market value was $5,000 at the time of entry. In 2019, Mr. Emerson purchased another capital property, B, for $10,000. Mr. Emerson is considering returning to the United States on a permanent basis in 2023. He estimates that the two properties will have fair market values of $12,000 for A and $20,000 for B.

— REQUIRED Discuss the tax consequences of Mr. Emerson’s pending departure from Canada.

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209

ASSIGNMENT PROBLEMS

Problem 1 Donna is married to Don and they have two children, Danielle, age 25, and Susan, age 15. Donna earns $250,000 annually while Don earns $100,000. Danielle works full time and earns $30,000 annually while Susan is still in high school and doesn’t have any income. Donna has been looking for ways to pay less tax and a friend of hers has suggested that she take advantage of the lower tax brackets of her husband and children. With $100,000 of extra cash in her bank account she is considering the following options and would like your advice as her accountant. Assume the following combined tax rates: Donna ............................ 53% Don ................................ 41% Danielle ......................... 25% Susan . . . . . . . . . . . . . — Transaction with Don (husband): (1) Loan the $100,000 to her husband at 0% interest. He would invest it in a bond earning 3%. (2) Give the $100,000 to her husband. He would invest it in a bond earning 3%. Transaction with Susan (minor child): (3) Loan the $100,000 to her 15-year-old daughter at 0% interest. She would invest it in a bond earning 3%. (4) Give the $100,000 to her 15-year-old daughter. She would invest it in a bond earning 3%. Transaction with Danielle (adult child): (5) Loan the $100,000 to her 25-year-old daughter at 0% interest. She would invest it in a bond earning 3%. (6) Give the $100,000 to her 25-year-old daughter. She would invest it in a bond earning 3%.

Problem 2

ITA: 12(1)(j), 74.1

The following are independent situations: (a) Tony Lee gave $50,000 to his wife, Shannon, for the acquisition of shares of a Canadian company on the Toronto Stock EXchange. During the year, an eligible dividend of $5,000 cash was paid on the shares owned by Mrs. Lee. (b) At the beginning of the year in which her daughter, Carey, turned 18 in December, Ellen gifted $25,000 directly to Carey. Carey invested the $25,000 in an income-bearing investment that paid her interest of $2,500 during the year. In addition to the $2,500, Carey also earned another $7,500 in interest income from monies received from her mother previously. What are the tax consequences for the above situations?

Problem 3

ITA: Division B

John Tanner recently retired as a football player with the Saskatchewan Roughriders. In the current year, he received his salary of $190,000 from the team and is eligible for a CFL pension in 15 years. He and his wife, Kate, have settled in Weyburn, Saskatchewan, where he runs a small sporting goods store as a proprietorship. He has provided you with the following additional information.

CHAPTER 8

(a) His net income from the store for the fiscal year ended December 31 was $45,000. Next year he is hoping to double that. Kate works in the store about 30 hours a week and is paid $6 per hour. This is already included as an expense in determining the net income of $45,000. (b) John’s other current-year receipts are: fees received from endorsement of a brand of football equipment, $31,000; eligible dividends from Canadian public corporations, $7,250; dividends from foreign public corporations, (net of $750 withholding tax) $6,950; interest from Canadian bank, $3,000. (c) John also had the following expenses: cycling trip to Cypress Hills Provincial Park with family, $2,200; interest on bank loan to acquire public company shares, $4,500. (d) In May of the previous year, John purchased a five-year GIC in Kate’s name. The interest rate was 6%, and it was for $10,000. None of the interest is receivable until maturity in five years.

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John has asked you to calculate his income for tax purposes. In addition, he wants you to provide any basic tax planning advice that might be appropriate.

Problem 4 Mr. Wiser is contemplating investing in two different mutual funds. His investment options are set out below. Amount $200,000 $200,000

Mutual Fund International Income Fund Canadian Dividend Fund

Distribution Annual interest of 4.0% Annual dividend of 3.0%

Mr. Wiser contemplates holding both mutual funds for the same period of time — from purchase to December 31, 2024. Mr. Wiser is in the top federal income tax bracket (33%). Mr. Wiser’s provincial tax on income rate is 20%. Assume that the combined federal and provincial dividend tax credit is equal to the dividend gross-up. Assume that the Canadian Dividend Fund receives and distributes dividends from Canadian-resident public corporations. Mr. Wiser would like you to advise him on the following: (A) Based on the above information, which mutual fund should he prefer? (B) Can he achieve any advantage by purchasing the above mutual fund in the name of his 8-yearold daughter who has no other source of income? (C) His spouse has no source of income. Can he achieve any advantage by lending $200,000 to his spouse and having her purchase a rental property earning $16,000 per year? The $200,000 loan would be evidenced by a promissory note repayable in four equal annual instalments on each of December 31, 2021 to 2024 and bearing interest at the prescribed rate of 1%.

Problem 5 Donna has 1,000 shares in a Canadian public company that are worth $100,000 and pay a dividend of $5,000 each year. Her adjusted cost base on these shares is $70,000. She is already in the top tax bracket. For estate planning purposes she is proposing the following options, but she would like your advice, as her personal tax planner, before she makes a decision. Options considered: (1) Give the shares to her husband. (2) Give the shares to her 15-year-old son. (3) Give the shares to her 25-year-old daughter.

Problem 6 Katie has Canadian public company shares that are worth $50,000 and pay a dividend of $2,500 each year. Her adjusted cost base on these shares is $35,000. She is already in the top tax bracket. She would like your advice on the following proposed transactions: Sell the shares to her husband (1) Sell the shares to him for cash of $50,000. (2) Sell the shares to him for a non-interest-bearing note of $50,000. (3) Sell the shares to him for cash of $40,000. Sell the shares to her 25-year-old daughter (1) Sell the shares to her for cash of $50,000. (2) Sell the shares to her for a non-interest-bearing note of $50,000. (3) Sell the shares to her for cash of $40,000.

Problem 7 Sally and Harry have ended their 15-year marriage and are now living apart. They have sold their house and divided the proceeds, but they don’t necessarily want to sell some shares that Sally owns.

¶8,850

ITA: 12(1)(c), 12(1)(j), 74.1, 74.5, 82(1); IT-510, IT-511R

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However, they have agreed that Sally needs to transfer 50% of her shares to Harry as part of the equalization payment. Sally’s shares have a fair market value of $40,000 and an adjusted cost base of $25,000. They would like you to explain the tax consequences of this transfer.

Problem 8 Mr. and Mrs. Grand are married with one child, Noah, who is 16 years old. Mr. Grand owns his own business, which he operates out of a company called Father Inc. He owns all the shares. Mrs. Grand owns her own business, which she operates out of a company called Mother Inc. She owns all the shares of this company. Identify, with reference to the Act, who is: — Related — Affiliated — Arm’s length

Problem 9

ITA: 13(7)(e)

On October 1, RoXanne acquired her brother’s West Vancouver condominium rental property for $600,000 (ignore any land portion). Her brother has owned it for five years and had a capital gain of $250,000 on selling it to RoXanne. He will include 50% of that in his income. RoXanne believes she can earn net rental income of $9,000 annually, and 1/4 of that amount for the final quarter of this year. RoXanne has asked you to calculate the maximum CCA that she may claim in this first taxation year.

Problem 10 During 2022, Madame Martel exercised a stock option that she held in her employer (a public company). It is now November 2023. She is currently contemplating a number of scenarios in terms of the shares she received under the 2022 stock option exercise. She has asked you to explain the tax consequences of her actual and contemplated transactions.

ITA: 7, 69, 73, 74.1, 74.2, 74.5, 56(4.1), 110(1)(d)

The details of the stock option exercised during 2022 are as follows. Number of shares Fair market value of purchased Exercise price shares at exercise date 6,000

$20

$35

Fair market value of shares at grant date $20

The current fair market value of a share is $42. Madame Martel is married and has two children (ages 21 and 15). She is expecting large dividends to be paid on the above shares in December 2023 and each December on an ongoing basis. She also expects that the shares will increase in value quite considerably over the near future. As a result, she is looking for a means of splitting income with her immediate family. She is proposing the following scenarios in terms of distributing these shares amongst her immediate family: (1) gift the shares to her spouse and children (1/3 to her spouse and 1/3 to each child);

CHAPTER 8

(2) sell the shares to her spouse and children (1/3 to her spouse and 1/3 to each child) for cash proceeds of $20 per share; or (3) sell the shares to her spouse and children ( 1/3 to her spouse and 1/3 to each child) in exchange for a note payable of $42 per share. The note payable described in (3), above, will be payable over five years with no interest. Since the note pays no interest and is repayable over future years, the estimated present value of the note is $25 per share. Madame Martel has asked you to prepare a memorandum explaining the income tax consequences of her completed and proposed transactions.

¶8,850

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Problem 11 Brandon died on March 15, 2023. His estate is not complicated, as most of his assets were bank deposits. However, he did have 1,000 shares in a public company at the time of his death. Of these, he left 500 to his surviving spouse and 500 to his daughter. The executor would like your advice on the tax consequences to the estate and the beneficiaries of these bequests. The shares have a fair market value at the time of death of $50 per share. Brandon’s adjusted cost base at the time of his death was $20 per share.

Problem 12 The following two situations are not related: (1) Stella moved to Canada from Greece early this year to work for a financial institution in Toronto. Her family moved with her and they bought a house in Oakville. At the time of her move, she owned shares of a public company listed on the New York Stock E Xchange. These shares had a fair market value of $40,000 at the time she became a resident. She originally paid $25,000 for the shares. They are now worth $50,000. Stella is now considering selling these shares and has asked you to advise her on the Canadian tax consequences. (2) Harry moved to England from Canada early this year to work for a financial institution in OXford. His family moved with him and they bought a house near O Xford. At the time of his move, he owned shares of a public company listed on the New York Stock E Xchange. These shares had a fair market value of $40,000 at the time he ceased to be a resident. He originally paid $25,000 for the shares. They are now worth $50,000. Harry is now considering selling these shares and has asked you to advise him on the Canadian tax consequences.

Problem 13 On July 31 of the current year, Mary McArthur passed away after a lengthy illness. Mary was survived by her husband and one adult child, Margaret. Both her husband and daughter are residents of Canada. Information related to Mary’s assets, as at her date of death, is set out below.

Description Rental property — Toronto, Ontario Land . . . . . . . . . . . . . . . . Building (Class 3) . . . . . . Rental property — Stratford, Ontario Land . . . . . . . . . . . . . . . . Building (Class 1) . . . . . . CBV shares (see Note below) View Canada shares (see Note below) . . . . . . . . . . . . . . . .

Capital Cost/ACB

UCC

Fair market value

Beneficiary

$40,000 55,000

n/a $15,000

$ 100,000 145,000

Spouse Spouse

25,000 65,000

n/a 42,000 n/a

45,000 93,000 1,000,000

Daughter Daughter Spouse

n/a

150,000

Daughter

Note: Mary inherited these shares from her father upon his death a few years ago. Her father had an adjusted cost base of $250,000 in the CBV shares. The fair market value of the CBV shares on the date of his death was $500,000. Her father had an adjusted cost base of $150,000 in the View Canada shares. The fair market value of the View Canada shares on the date of his death was $180,000. The executor for the estate has asked you to calculate the minimum income and/or taxable capital gains to be reported by Mary McArthur in her final return in respect of the above-noted assets. Ignore any available elections.

¶8,850

ITA: 13(7)(e), 70(5)(a), 70(5)(b), 70(5)(c), 70(6)(d), 70(6)(e); ITR: 1100(2)(h), 1102(14)(d)

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The executor has also asked you to determine the cost amounts of the above assets to the respective beneficiaries.

Problem 14

ITA: 3, 41

In Billy’s attempt to sever all business and personal ties with Canada before beginning long-term and permanent employment in Beijing, he sold all his personal assets and most of his investments.

Description

Sale proceeds

Personal residence . . . . . . . . . . . . . . . . . . . . $475,000 Household furniture . . . . . . . . . . . . . . . . . . . 20,000 Skis, bicycle, and skates . . . . . . . . . . . . . . . . 750 Rights to season tickets . . . . . . . . . . . . . . . . 4,000 Paintings . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,400 Chevrolet . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,600 Fishing lodge . . . . . . . . . . . . . . . . . . . . . . . . 45,000 Business loan — private . . . . . . . . . . . . . . . . 0 ABC shares (public co.) . . . . . . . . . . . . . . . . 46,000

Cost

Disposition costs

$125,000 35,000 1,200 3,500 1,900 12,000 31,000 8,000 20,000

$3,600 800 0 0 120 350 4,500 0 200

Additional Information: ●

●

All years available for a principal residence designation were used to exempt the gain on the personal residence, leaving no years available to designate the fishing lodge. The business loan was made to a Canadian-controlled private company, which is now in receivership. Billy has never claimed a capital gains exemption.

Billy has told you that his employment income is $48,000 and asked you to calculate his income for tax purposes.

Problem 15 Theresa Vert is considering emigration to the United States. She has approached you to estimate the income tax consequences on her holdings of taxable capital property. Her plan is to dispose of all the real estate holdings and retain her investments in stocks and bonds. Theresa and her husband currently live in a downtown townhouse which was purchased in 2011 for a cost of $130,000. The estimated value is now $320,000. Theresa also inherited a cottage in 2012 (estimated fair market value was $55,000). The value of the cottage is now approXimately $270,000. In 2008, Theresa purchased a rental property for $105,000, of which $25,000 was allocated to the land. There is no mortgage on the property. The land and the building have a fair market value of $150,000 and $100,000, respectively. Legal costs at the time of purchase totalled $3,000 and the estimated cost of disposal is $20,000. The UCC on the building is $30,000.

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Theresa also has the following investments: ● Common shares of Canadian publicly traded companies. These shares were purchased on October 19, 2012, at a cost of $140,000 and have current value of $190,000. ● A $100,000 10-year Province of Alberta 12% bond, due in five years, with interest payable annually on June 30. The bond has a current value equal to $110,000. ● A Steinway grand piano purchased at an auction for $8,000. Theresa can sell this to her piano teacher for $10,000.

Assuming Theresa emigrates in 2023, advise Theresa on the various income tax consequences of emigrating and the tax treatment of her holdings.

¶8,850

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CHAPTER 8 — DISCUSSION NOTES FOR REVIEW QUESTIONS (1) Attribution would not appear to apply to cause any income allocated to Mrs. Simpson to be reallocated to her husband since there is no attribution of business income. (It should be noted that, if she is not actively involved in the business, then she will not be a specified member of the partnership and the income from the partnership will be deemed to be income from property.)

ITA: 74.1(1) ITA: 248(1), 96(1.8)

(2) Although the corporation is carrying on a business, Mrs. Smith is not. She will be earning property income (i.e., dividends on the shares), so the exception to the attribution rules for business ITA: 74.5(7) income does not apply. Attribution as a result of guarantees would only cause the attribution rules to ITA: 74.5(1) apply if the loan was not at commercial rates. If the bank is charging commercial interest rates, then the attribution rules will not apply. (3) The Act causes a deemed disposition on all her property other than certain property and certain items that are subject to withholding tax. In this case, the term deposits will be deemed to be disposed of, but since there is no capital gain, there would not be any tax.

ITA: 128.1(4)

(4) If a person sells something to someone with whom he or she does not deal at arm’s length, then the proceeds will be deemed to be the fair market value. Related parties do not deal at arm’s length, but in this case the two are not related. However, it is a question of fact whether persons not related to each other are dealing at arm’s length. In this case, there is no evidence of hard bargaining and the transaction is obviously not at fair market value. Therefore, it would be unlikely that they would be considered to be dealing at arm’s length and the proceeds would likely be deemed to be $100,000. Her friend will have a cost base equal to what she paid for the land of $50,000. As a result, there will be double taxation.

ITA: 69, 251, 251(1)(c)

(5) At the time of the gift, Bill will be deemed to have sold the shares at their fair market value. Scott will be deemed to have received the shares at a cost to him equal to the fair market value at the time of the gift. Since the shares were a gift, the attribution rules applicable to an income-splitting loan will not apply.

ITA: 69(1)(b), 69(1)(c)

(6) Mr. Shiloh will be excepted from the deemed disposition rules on the shares of his U.S. employer since he was in Canada less than 60 months in the past 10 years.

ITA: 128.1(4)

ITA: 56(4.1)

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CHAPTER 8 — SOLUTIONS TO EXERCISES Exercise 1 (A) (i) The Act would attribute the income on the bond to him even though she is legally entitled to receive it, since a gift is considered to be a transfer and is not a fair market value exchange which would be exempt. (ii) Since a sale is also considered to be a transfer, attribution would apply except that, in this case, the transfer would be exempt because the transfer happened for fair market value consideration, as long as they elect out of the rollover provisions. (iii) This situation still involves a sale directly between husband and wife and is, therefore, a transfer subject to the attribution of income. A non-interest-bearing demand note would not qualify for the exception because a commercial rate of interest was not charged. Therefore, the income would attribute back to the transferor. (iv) The loan of funds would result in attribution because the exception would not apply since a commercial rate of interest was not charged on the loan.

ITA: 74.1(1), 74.5(1)

ITA: 74.1(1), 74.5(1)(a), 73(1) ITA: 74.1(1), 74.5(1)(b)

ITA: 74.1(1), 74.5(2)

(B) If the loan was to a non-arm’s length minor or a niece or nephew who is also a minor, then attribution would apply to transfers or loans by means of a trust to or for the benefit of a minor in the ITA: 74.1(2) same way as spousal attribution applied in part (A), above. However, there are special rules pertaining ITA: 74.1(1) to transfers or loans to a trust. These rules will be discussed in Chapter 19. (C) Attribution of income does not apply to a transfer involving an individual who is 18 or older. However, another provision might apply to transactions (iii) and (iv) involving loans. The key condition for this rule to apply is that one of the main reasons for the loan was to reduce or avoid tax on income from property or substituted property. A loan bearing a commercial rate of interest would be exempt from attribution.

ITA: 74.1(2) ITA: 56(4.1)

Exercise 2 Subsection 56(4.1) will apply to deem the dividend income of $7,500 received by Faith to be Robin’s income and not Faith’s income for tax purposes. Robin loaned money directly to his daughter, a nonarm’s length party, with one of the main reasons being to reduce tax.

Exercise 3 (A) Since they are related by marriage, they are not at arm’s length.

ITA: 251(2)(a), 251(6)(b)

(B) Since they are not considered to be related by blood, they are at arm’s length.

ITA: 251(6)(a)

(C) Since they are still legally married, they are not at arm’s length. (D) The facts of a situation can determine that two unrelated persons are not at arm’s length.

ITA: 251(1)(b)

Exercise 4 (A) sale at $2,000 . . . . .

(B) sale at $1,200 . . . . .

deemed [par. 69(1)(b)] to have proceeds of $1,500 and, hence, a capital gain of $300 deemed [par. 69(1)(b)] to have proceeds of $1,500

Hayden (purchaser or transferee) deemed [par. 69(1)(a)] to have acquired at $1,500 resulting in potential double-counting of $500 gain acquired at $1,200 resulting in potential double-counting of $300 gain deemed [par. 69(1)(c)] to have acquired at $1,500

Exercise 5 (A) (i) Since a gift is a transfer, the interspousal rollover would automatically deem that Alice’s proceeds of disposition are equal to her adjusted cost base ($12,000), resulting in no capital gain.

ITA: 73

(ii) Alice would be subject to the income attribution rules on any dividends from the shares because a gift would not meet the exception, since the fair market value of the property transferred exceeded the fair market value of the consideration received and an election out of the interspousal rollover was not made.

ITA: 74.1, 74.5(1)(a) ITA: 73(1)

CHAPTER 8

James (seller or transferor) has proceeds of $2,000 and, hence, a capital gain of $800 (i.e., $2,000 -- $1,200)

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216

(iii) Alice would also be subject to capital gains attribution for the same reason as discussed in part (A)(ii), above. There would be full capital gains attribution on all substituted property.

ITA: 74.2; IT-511R, par. 27

(B) (i) Since Alice does elect out of the interspousal rollover, the non-arm’s length transfer rule, with which the transaction conforms, will apply, since the cash consideration ($15,000) was equal to the fair market value of the property transferred. A capital gain of $3,000 would be triggered.

ITA: 73(1)

(ii) There would be no income or capital gains attribution because Alice has conformed with the attribution rule exception. The fair market value of the property transferred did not exceed the fair market value of the consideration received and an election out of the interspousal rollover was made.

ITA: 74.5(1)(a)

(C) (i) Unless Alice elects not to have the provisions of the interspousal rollover apply, there will be no capital gain triggered on the transfer to her husband.

ITA: 73

(ii) Although Alice has received consideration (debt) with a face value ($15,000) equal to the fair market value of the property transferred, the interest rate must be at least equal to the prescribed rate at the time or a commercial rate. In addition, the Act requires that Alice elect out of the interspousal rollover. Therefore, Alice will be subject to both income and capital gains attribution.

ITA: 74.5(1)(b)(i)

(D) The result would be the same as in (A), above, since the shares would be considered substituted property for a transfer of cash for no consideration. (E) The result would be the same as in (C), above, since the shares would be considered substituted property.

Exercise 6 (A)(i) Transfer to wife Capital gains Since Mr. Smart does not wish to elect out of subsection 73(1), his proceeds of disposition are deemed to be equal to his adjusted cost base (i.e., $17.66 per share as calculated below) and hence there is no capital gain or loss. Mr. Smart’s adjusted cost base becomes his wife’s adjusted cost base. P. of D. — deemed (500 shares @ $17.66) . . . . . . . . . . ACB (500 shares @ $17.66(1)) . . . . . . . . . . . . . . . . . . .

$ 8,830 $ 8,830 Nil

Mr. Smart has transferred property (shares) to his wife and, therefore, ssec. 74.1(1) will require him to include in his income any dividend income received on the shares. Also, ssec. 74.2(1) will require him to include in computing his income any subsequent capital gain or loss on the shares. Income realized on previously attributed income from property is exempt from the attribution rules. The entire gain on substituted property acquired will be attributed. The above attribution will not apply if the transfer is at fair market value and if Mr. Smart receives consideration equal to the fair market value of the property received [par. 74.5(1)(a)]. However, in this case, the transaction is at less than fair market value ($35 < $60). In addition, par. 74.5(1)(b) exempts the transfer where consideration received includes indebtedness with an interest rate equal to the lesser of the prescribed rate or a commercial rate. Finally, in order for a capital transaction between spouses to be exempt from the attribution rules, par. 74.5(1)(c) requires the transferor spouse to elect not to have ssec. 73(1) apply. Dividend income The proposed five-year GIC acquired with the dividend income is an investment contract and will require an annual accrual income inclusion [ssec. 12(4)]. Since this income is in respect of previously attributed income, the amounts will not be attributed back to Mr. Smart.

ITA: 69(1)(b)(ii)

ITA: 73(1)

74.5(1)(c)

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(ii) Transfer to friend Capital gains The taxable capital gain to Mr. Smart is determined as follows: P. of D. (500 shares @ $55) ............................ $27,500 ACB (500 shares @ $17.66) . . . . . . . . . . . . $ 8,830 Capital gain ........................................................ $18,670 Taxable capital gain (50% × $18,670) . . . . $ 9,335 Dividend income There is no attribution of dividend income back to Mr. Smart as the transferee is not a spouse or non-arm’s length person, niece or nephew under 18 years old. (iii) Transfer to son Capital gains Taxable capital gain to Mr. Smart is determined as follows: P. of D. ($500 at $70)* . . . . . . . . . . . . . . . $ 35,000 ACB (500 shares at $17.66) ............................. $ (8,830) Capital gain . . . . . . . . . . . . . . . . . . . . . . . $ 26,170 Taxable capital gain (50% × $26,170) . . . .

$ 13,085

* The proceeds are deemed to be fair market value [par. 69(1)(b)].

Son’s adjusted cost base is the amount paid, since sec. 69 is only a one-sided adjustment. The interest on the GICs is income on income and is not attributed back to Mr. Smart. Dividend income Dividend income on the shares will be attributed back to Mr. Smart until the son reaches 18 [ssec. 74.1(2)]. The sale is not exempt because fair market value consideration was not received [ssec. 74.5(1)]. Note, however, that if the son were to realize a capital gain or capital loss on his ultimate sale of the shares while he was under 18 years of age, the capital gain or capital loss would not be attributed back to Mr. Smart since there is no provision similar to sec. 74.2 in respect of minors. (B) Advice: The mistake was transferring shares to a trust for the son at less than fair market value. The problem is that the son has a low adjusted cost base (the actual price paid $40) while the father’s proceeds were high (equal to the fair market value of $70 [spar. 69(1)(b)(i)]). There is the potential for double taxation when the son eventually sells the shares. The best alternative probably would have been to sell some of the shares at fair market value (in order to receive the same $35,000 of proceeds) and to gift the rest, which would have resulted in proceeds and adjusted cost base being equal to the fair market value [spar. 69(1)(b)(ii) and par. 69(1)(c)]. Attribution could have been avoided on the non-gifted shares by ensuring that any debt consideration received bore a rate of interest equal to the lesser of: (a) the prescribed rate, or (b) an arm’s length commercial rate at the time the loan was made.

(1)

2015 2016 2017 2019 2020

# 500 300 100 500 1,400 140 1,540

500 shares @ $10 . . . . . . . . . . . . . . . . . . . . 300 shares @ $15 . . . . . . . . . . . . . . . . . . . . 100 shares @ $20 . . . . . . . . . . . . . . . . . . . . 500 shares @ $30 . . . . . . . . . . . . . . . . . . . .

$ 5,000 4,500 2,000 15,000

stock dividend (140 shares @ $5) . . . . . . . .

700 $27,200

$27,200 / 1,540 = $17.66

CHAPTER 8

— NOTE TO SOLUTION

Introduction to Federal Income Taxation in Canada

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Exercise 7 1. The tax consequences depend upon whether Sandi elects not to have sec. 73 apply. (a) Assuming no election (sec. 73 apply). — Sandi is deemed to have sold the Bell Canada shares for proceeds of disposition equal to her ACB ($1,000 × 40). Hence, no capital gain is triggered. Her husband’s ACB is equal to her ACB. — Any dividends received by her husband on the Bell Canada shares will attribute back to Sandi since the transfer was not at fair market value (sec. 74.1 and 74.5). — If and when her husband sells the shares, there will be attribution of the capital gain calculated on his ACB of $40. — There will be no attribution of income on previously attributed amounts of income. However, capital gains earned on attributed capital gains are attributable (IT-511). (b) Assuming she elects not to have sec. 73 apply. — Sandi’s proceeds of disposition will be deemed to be the FMV (10,000 shares X $65) resulting in capital gain of $25,000 (spar. 69(1)(b)(ii)). — The husband’s ACB will equal the deemed proceeds of $65,000 (par. 69(1)(c)). — Attribution of both income and capital gains as discussed above will continue since Sandi did not receive consideration equal to the fair market value. 2. The sale of the painting to her son for $1,000 will have the following tax consequences: — Sandi will be deemed to have sold the painting to her son at the FMV ($125,000), triggering a taxable capital gain of $42,500 [($125,000 -- $40,000) × 50%] (par. 69(1)(a)). — Her son’s ACB will be $1,000 (the amount paid for the painting). This will very likely trigger a capital gain in five years when the son sells the painting to finance his university education. The capital gain could be as much as $124,000 plus any further increase in value after the date of transfer. Hence, the capital gain of $124,000 may be taxed twice. In this case, a gift of the property would have been better because the son’s ACB would be deemed to be $125,000 (par. 69(1)(c)). — There will be no attribution of income on substituted property for the child as long as the proceeds of disposition are received after he becomes 18 years of age. — There will be no attribution of capital gains in respect of the son no matter when he disposes of the painting. 3. Loan to husband — No attribution of income since the loaned funds were used to produce business income, not property income. — Attribution will apply to the taxable capital gain of $60,000 (50% × ($310,000 -- $190,000)) on the sale of the farm since the loan did not bear a rate of interest equal to the lesser of the quarterly prescribed rate or a commercial rate at the time the loan was made.

Exercise 8 — Mr. S’s current income splitting plan will not work since the attribution rules will apply and any future income and capital gains or losses will be attributed back to him. — The attribution rules would not apply if all of the following conditions were met: (a) Mrs. S paid fair market value consideration for the investment portfolio instead of receiving it as a gift; (b) if the fair market value consideration in (a) included a loan, then interest must be charged on the loan at a rate equal to or greater than the lesser of the prescribed rate of interest at the time of the transfer and the current arm’s length rate and the interest must be paid each year within 30 days after the end of the year; and (c) Mr. S must elect not to have the provisions of subsection 73(1) apply (he was planning to do this anyway to trigger the capital gain).

Ch. 8/Study Guide — Solutions to Exercises

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If the current prescribed rate is relatively low, you might suggest that Mr. S transfer the investment portfolio to Mrs. S and receive a note for the fair market value of the portfolio bearing interest at the prescribed rate, which must be paid in the year or within 30 days after the end of the year. In this manner, any future capital gains and income will be included in Mrs. S’s income, she will have a deduction for the interest paid and Mr. S will have income of the interest received from Mrs. S.

Exercise 9 Capital property A (A) If Mr. Emerson departs prior to June 1, 2023, there will be no capital gain on the capital asset which he brought from the United States by virtue of the 60-month short-term exemption.

ITA: 128.1(4)

(B) If he departs subsequent to June 1, 2023, there will be a taxable capital gain on 50% of the excess of the proceeds of disposition ($12,000) over the fair market value at the time of entry ($5,000), namely, $3,500. Capital property B (A) First, it is necessary to determine whether the capital property acquired in Canada is exempt from immediate departure tax but will be taxed on its ultimate disposition.

ITA: 2(3)

(B) If the property is not exempted then the taxpayer will be taxed at the time of exit from Canada.

CHAPTER 8

Other Sources of Income and Deductions in Computing Income

221

CHAPTER 9

Chapter 9

222

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Ch. 9/Study Guide — Learning Chart

223

CHAPTER 9 — LEARNING CHART

Textbook Example Problems 9-1 Moving expenses 9-2 Child care expenses 9-3 Disability support deduction 9-4 RRSP contribution 9-5 Spousal RRSP withdrawal 9-6 Home Buyers’ Plan 9-7 Retiring allowance Exercises 1 2 3 4 5 6 7 8 9 10

Definition of ‘‘earned income’’ RRSP deduction Investing in or outside of an RRSP Spousal RRSP withdrawals Transfers bet ween deferred plans Moving expenses RRSP deduction Childcare deduction Earned Income RRSP deduction

Assignment Problems 1 Moving expenses 2 Child care expenses 3 Spousal support payments 4 Transfer of RRSP on divorce 5 RRSP 6 RRSP vs. TFSA 7 RRSP 8 Moving expenses 9 Child care expenses 10 Comprehensive 11 Calculate income, provide advice 12 Comprehensive 13 Comprehensive 14 Becoming a resident 15 Comprehensive 16 Reassessment 17 Retirement package

CHAPTER 9

Problem Descriptions

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Ch. 9/Study Guide — Review Questions

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REVIEW QUESTIONS CHAPTER 9

(1) Ms. Tang had been working for the same employer for the past 10 years and was tired of her job. She decided to quit and travel to Australia for a year. On leaving, her employer paid her a lump-sum amount of $15,000, since Ms. Tang had been a good employee of theirs and they were hoping she might come back to work for them when she returned to Canada. Ms. Tang had no intention of working for them again but was grateful for the payment. Comment on how this payment should be taxed. (2) Mr. Everett has worked for the provincial government for the past 35 years and was now eligible for early retirement. As part of his retirement package he is entitled to a lump-sum payment for unused sick days in the amount of $20,000 and unused vacation days of $25,000. On retirement, he is going to receive a cheque for $45,000 as payment for the above amounts. How will this amount be taxed? (3) Mark and Ann have agreed to a separation agreement that requires Ann to pay $2,000 per month to Mark as an allowance for his maintenance. Initially, this payment will consist of $1,500 paid to Mark directly and $500 paid to the financial institution that holds the mortgage on his condominium. Mark may change this arrangement at any time to have the full $2,000 paid to him directly. Comment on the deductibility of these payments. (4) Sam Sider reached an agreement with his employer to pay for his education and living expenses while he returned to university. The agreement was that, if he returned to work for his employer when he graduated, there would be no repayment of the amounts he received. If he did not return to work for his employer, the payments he received would have to be repaid in full. How would this be treated for tax purposes? (5) Mrs. Smith, a 75-year-old widow, has applied for and received the Guaranteed Income Supplement. This payment is based on the fact that her income is below a certain threshold amount. She has asked you to tell her how this is treated for tax purposes. (6) Mr. Singh, a consultant, did some work for ACME Corporation with the agreed-upon fee being $15,000. When the time came for the billing to be done, Mr. Singh sent an invoice to ACME with instructions that the cheque be made payable to his wife. What would your comments be to Mr. Singh and his wife on this arrangement? (7) How do you determine how much of the employer’s contributions to a defined benefit pension plan are deductible? (8) Joe is confused. He is trying to understand the pension rules and he cannot understand why the limit on a money purchase pension plan is based on 18% of this year’s income while the limit for an RRSP is based on last year’s income. EXplain this difference to him. (9) Jennifer wanted to withdraw $20,000 from her RRSP in January in order to buy a new car. She had spent a long time accumulating this amount, but felt that it was more important to buy a car now than accumulate for retirement later. How can she minimize the tax that is withheld on the $20,000 taken out of the plan? (10) Joan had worked for the same employer for 15 years. Joan always contributed the maximum to her RRSP and had no unused contribution room. Two years ago she was fired. She took legal action against her former employer on the basis that it was wrongful dismissal. This year she won her case and was awarded $40,000. She then paid her legal fees of $8,000 and contributed $32,000 to her RRSP as a retiring allowance. She is glad the case has been settled since she has not worked since her dismissal. What would you show on her personal tax return for the year based on this information?

ITA: 60(j.1)

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EXERCISES

Exercise 1

ITA: 63(3), 146(1)

Subsection 248(1) is one of the key definition sections found in the Income Tax Act. Definitions are also found elsewhere in the Act. — REQUIRED Find the section in the Act that contains the definition for ‘‘earned income’’ used in the calculation of the RRSP contribution limits and the definition used in the calculation of the child care deduction.

Exercise 2

ITA: 60(i), 146(1), 146(5)

Don Bickle contributed $5,000 to a spousal RRSP on February 15, 2024. Don’s income for tax purposes for 2022 is as follows: Salary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$70,000 1,200 $71,200

Less: Registered pension plan contributions — defined contribution . . . . . . . .

(2,800)

Employment income — Subdivision a . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rental loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividend income from taxable Canadian corporations grossed up . . . . . . . . . . Interest income — Canada Savings Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . .

$68,400 (5,000) 800 400

Division B income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$64,600

Don’s employer reported a PA of $6,084 in respect of 2022 (reported on Don’s 2022 T4 slip). — REQUIRED Determine the maximum amount Don can deduct on his 2023 tax return in respect of his 2024 contribution to his spouse’s RRSP and the amount, if any, that he can contribute and deduct in respect of his own RRSP.

Exercise 3

ITA: Division B

A taxable investment of $15,000 in bonds yields 4% per year before tax. The same investment can be acquired in a self-directed RRSP (tax sheltered). Assume that the yield is reinvested each year at the same 4% before tax. Further assume that the investment is held for 10 years, at which time the RRSP will be cashed in and taxes paid at 46%. — REQUIRED Which investment approach provides the best cash return?

Exercise 4 Douglas has been contributing $3,000 annually to a spousal RRSP for his wife, Donna, in each of the last siX years, but not this year. The RRSP has grown to $30,000 and Donna has withdrawn $10,000 of the RRSP this year. The withholding tax was $2,000. — REQUIRED Describe the full income tax aspects and consequences of this RRSP withdrawal.

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ITA: 146(1)

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Exercise 5

ITA: 60(i), 60(j.1)

Ivan Reimer received the following amounts for 2023, the year of his retirement:

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Employment income (see (1), below) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Pension income: Lump-sum RPP payment from a defined benefit plan . . . . . . . . . . . . . . . . Superannuation payments (eight monthly pension payments of $3,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Old Age Security pension . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Canada Pension Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retiring allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 7,000 100,000 24,000 8,251 12,460 50,000 8,000 $209,711

Additional Information (1) Ivan resigned his position on April 1, 2023. The employment income for tax purposes above includes a $300 contribution to his employer’s RPP. (2) On April 1, 2023, Ivan had his employer transfer directly the lump-sum payment from the RPP to his RRSP. In addition, Ivan’s employer transferred $20,000 of his retiring allowance directly to his RRSP. (3) Ivan has been employed by the same employer for 15 years. (4) Ivan was 65 on October 31, 2022. (5) Ivan’s employer reported a PA for him of $700 in respect of 2022. Ivan’s earned income for 2022 was $120,000. — REQUIRED Determine the tax consequences of the above transactions for 2023, supported by your computations.

Exercise 6

ITA: 62

Edwin Edwards was transferred from Vancouver to Montreal by his employer on October 1, 2023. The following expenses were incurred by Edwin: Airfare for family . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,300 Moving cost of furniture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000 Cost of disposing of Vancouver home — legal fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500 — real estate commission ........................................................................................ 10,000 Cost of purchasing Montreal home — prepaid realty taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500 — legal fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000 — Quebec transfer tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300 Edwin’s employment income for tax purposes earned in Montreal during 2023 was $7,000. Edwin’s employer reimbursed Edwin for $5,000 of the moving expenses. — REQUIRED Calculate the amount that Edwin can deduct as moving expenses.

ITA: 62

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Exercise 7 On July 1, 2022, Mr. Big Shot took early retirement because of job dissatisfaction. During the rest of 2022 and most of 2023, he was unemployed. However, on November 1, 2023 he obtained an employment position. His income for tax purposes for 2021 to 2023 was as follows: Employment income . . . . . . . . . . . . . . . . . . . . . . . . . . . Pension income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividends from taxable Canadian public corporations . . . . . . . . . . . . . . . . . Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rental loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2021 $ 65,000 $ 0

2022 $ 35,000 $ 22,500

2023 $ 12,500 $ 22,500

$ 15,000 $ 13,500 $ 10,000 $ 6,250 $ (2,500) $ (3,750)

$ 10,000 $ 7,500 $ (6,000)

Mr. Big Shot’s pension adjustment for 2021 and 2022 was $0. On February 15, 2023 he contributed $18,000 to a spousal registered retirement savings plan (RRSP) of which he claimed $15,500 for 2022 and plans to claim $2,500 for 2023. In November and December 2023, Mr. Big Shot contributed $600 to his new employer’s definedbenefit registered pension plan to which his employer also contributed, and $536 to the Canada Pension Plan. On November 1, 2023, Mr. Big Shot received a reassessment notice in respect of his 2022 RRSP deduction reducing the amount claimed from $15,500 to $11,250. — REQUIRED (a) Determine whether the $11,250 reassessment amount is correct. (b) Determine the deductible RRSP amount for 2023.

Exercise 8 Ms. Antibellum, a single parent, supports her three children, ages 3, 6, and 11, who live with her. Ms. Antibellum paid the following amounts in respect of care of the children during 2023: Babysitting services — local independent person during her working days $8,000 Babysitting during certain evenings and weekends ........................................... $1,200 Camp fees for 3 weeks for children ages 6 and 11........................................... $2,700 Ms. Antibellum provides you with her sources of income for tax purposes: Employment income Gross salary Stock option Low-interest loan benefit

$ 26,000 $ 4,000 $ 2,500 $ 32,500 Registered pension plan contribution $ (3,200) $ 29,300 Share of partnership income from a retail store . . . . . . . . . . . . . . . . . . $ 7,000 Rental of a basement apartment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 9,000 Support payments received in respect of the children . . . . . . . . . . . . . . $ 18,000 Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,000 $ 68,300

— REQUIRED (a) Determine the maximum child care deduction for Ms. Antibellum for 2023. Show all parts of the calculation. (b) EXplain why you excluded any of the above amounts in your calculation for (a), above.

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Exercise 9

CHAPTER 9

Mrs. Worker, a computer consultant, did some work for Macrohard Inc. The agreed fee for her work was $12,000. Her husband is out of work; therefore, she invoiced Macrohard Inc. and asked that it make the cheque payable to her husband. Mrs. Worker plans to have the $12,000 reported on her husband’s tax return. — REQUIRED Discuss how the CRA would treat this $12,000 item.

Exercise 10 George Cosmo has unused RRSP contribution room of $35,000 available for his 2023 taxation year. He decides that, during 2023, he will contribute $35,000 to his RRSP in the following manner: He will transfer the following shares to his RRSP: ABC Public Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . XYZ Public Corporation . . . . . . . . . . . . . . . . . . . . . . . . . .

FMV $ 25,000 $ 10,000 $ 35,000

ACB $ 10,000 $ 25,000

— REQUIRED What are the tax consequences to George resulting from the above action?

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ASSIGNMENT PROBLEMS

Problem 1

ITA: 62(3)

Diane Weber is employed as Personnel Director of B. Ltd., an international corporation. Diane was living in Vancouver at the beginning of last year, but B. Ltd. moved her to Hamilton effective December 1. Diane rented a three-bedroom townhouse in Vancouver. She purchased a two-bedroom house in Hamilton on December 20th. Diane has supplied you with the following information concerning her moving costs: Air transportation for Diane . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Moving costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Temporary living expenses (hotel and meals) in Hamilton for 20 days Storage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lease cancellation fee paid to Vancouver landlord . . . . . . . . . . . . . . . . . Legal fees to purchase new home . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Property taxes paid from December 21–31 . . . . . . . . . . . . . . . . . . . . . . . Moving allowance paid by B. Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Diane’s net employment income in Hamilton December 1–31 . . . . . . . . .

$3,000 3,100 2,500 1,250 1,200 3,600 400 4,000 5,600

What is the deductible amount of moving expenses that Diane can claim in her personal income tax return for the year of the move?

Problem 2

ITA: 63

Charles Hughes was a university student in full-time attendance for 30 weeks and worked as a salesman for the balance of the year. His wife, Cathy, was also employed. The Hughes have four children: Sharon 17, Shawn 14, Sally 6 and Stephen 4. Child care expenses for the year amounted to $200 per week for 52 weeks. Charles’ and Cathy’s receipts and withholdings are summarized below:

Gross salary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable fringe benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Scholarship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Student loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Charles

Cathy

$23,000 850 200 3,600 2,500

$47,000 4,000 — — —

Charles

Cathy

$ 3,800 2,000

$13,700 3,700

Deductions from Charles’ and Cathy’s employment income were:

Income taxes withheld . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . RPP contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Calculate the child care expenses deduction allowed to Charles and Cathy for 2023.

Problem 3 Uriah and Ursalla Underhill decided to terminate their marriage of 10 years. On June 1 Uriah moved out. From the period of June 1 to October 31, Uriah paid Ursalla $900 per month, made up of $200 for the support of Ursalla and $700 for their two children. On November 1, Uriah and Ursalla signed a written separation agreement which confirmed the $900 a month payment. In addition, the agreement provided that Uriah would pay the monthly mortgage payment of $400 on the home which is in Ursalla’s name and all medical expenses for the children. During November and December Uriah made the appropriate payments as per the written agreement and paid $100 of dental bills in respect of the children. Discuss the tax implications of the above facts for both Uriah and Ursalla.

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ITA: 56(1)(b), 56.1, 60(b), 60.1

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Problem 4 Liz and Richard have ended their marriage and are now living apart. They have sold their house and divided the proceeds, but they now need to deal with Richard’s RRSP. They have agreed that Richard needs to transfer $100,000 from his RRSP to Liz as part of the equalization payment.

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They would like you to explain the tax consequences of this transfer.

Problem 5

ITA: 146(5)

Diana Capriati, a Canadian resident for income tax purposes, has the following income for 2021 and 2022: Income from employment Gross salary . . . . . . . . . . . . . . . . . . . . Less contribution to employer’s RPP Income from property Taxable dividends from Canadian public corporations . . . . . . . . . . . . . . . . . . Gross-up (38%) . . . . . . . . . . . . . . . . . . Bank interest received . . . . . . . . . . . . . Rental income — gross . . . . . . . . . . . . Deductible rental expenses . . . . . . . . . Other income Alimony (spousal support) payments received . . . . . . . . . . . . . . . . . . . . . . . Loss from business Share of loss from partnership . . . . . . . RRSP Deduction . . . . . . . . . . . . . . . . .

2021

2022

$130,000 $135,000 (1,500) (3,000) 128,500 132,000 32,000 12,160 44,160 3,000 47,160 25,000 (18,000) 54,160

20,000 7,600 27,600 5,000 32,600 30,000 (12,000) 50,600

10,000

(30,000) (20,000) (15,000) $147,660 $172,600

Diana has asked you to determine the maximum RRSP contribution that she can deduct in 2023. Assume that Diana was an active member of the partnership and that her pension adjustment for 2021 and 2022 was $4,000 and $7,000, respectively. Diana’s 2021 RRSP deduction for $15,000 was the maximum available for 2021. She has also contributed and deducted the maximum available to her for 2020 and all prior years and therefore did not have unused RRSP deduction room on her 2021 Notice of Assessment. She did not make an RRSP contribution for 2022, and has not made any RRSP contributions during the 2023 calendar year. Diana put $10,000 into her self-administered RRSP on February 12, 2024.

Problem 6

ITA: 146(1), 146.2

The following table provides information relating to three individuals who each plan to invest $4,500 per year, before tax, starting in 2023. Each individual’s before-tax rate of return on a 10-year investment is 8%. Note that each has a different marginal tax rate today (Year 0). However, in 10 years, all are expected to have a marginal tax rate of 40%. A Earned income ........................... $65,000 Marginal tax rate (Year 0) ........... 45% Marginal tax rate (Year 10) . . . 40% Before-tax rate of return ............... 8%

Taxpayer B $45,000 40% 40% 8%

C $25,000 27% 40% 8%

You have been asked to do the following: (A) Compute the future value of the investment for each taxpayer assuming: (i) The individual does not contribute to an RRSP but invests the after-tax proceeds of the $4,500 earned income in a tax-free savings account (TFSA). (ii) The individual contributes to a self-directed RRSP and withdraws the amount in Year 10. (B) Should each individual contribute to an RRSP or to a TFSA?

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Problem 7 Mr. Rui retired from his job with Wise and Foresighted Consulting Ltd. on February 28, 2023. Mr. Rui expects his 2023 income for tax purposes to be as follows: Employment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ITA: 60(i), 60(j.1), 146(5), 146(5.1), 146(8.2), 146(8.3), 147.3(4), 147.3(9)

$ 7,000

Pension income: Monthly superannuation (10 months of $3,450) . . . . . . . . . . . . . . . . . . . .

34,500

Old Age Security . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Canadian Pension Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

8,251 12,100

Farming income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

20,000

Income from rental of apartment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

10,800

Royalty income from books written by Mr. Rui . . . . . . . . . . . . . . . . . . . . . . .

14,200

Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

12,000

Total income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$118,851

Additional Information (1) Mr. Rui’s 2023 employment income is net of an RPP contribution of $300. His PA for 2023 is expected to be $600. (2) Mr. Rui will be 71 in February 2024. His wife is now 67. (3) In 2023, Mrs. Rui withdrew $6,000 from her RRSP. Mr. Rui had made the following contributions to Mrs. Rui’s RRSP: January 2023 — $2,000; April 2022 — $1,000; February 2021 — $1,000; December 2020 — $3,000. Mr. Rui did not deduct the January 2023 contribution in 2022. (4) Mr. Rui’s employer reported a PA for him of $7,000 in 2022. His earned income in 2022 was $66,000. (5) Mr. Rui has unused RRSP deduction room from prior years of $5,000. Mr. Rui has asked you to do the following: (A) Determine the tax implications of Mrs. Rui’s $6,000 RRSP withdrawal. (B) Determine his maximum tax deductible RRSP contribution for 2023. What additional RRSP contribution should he make for 2023? (C) What should he contribute to his RRSP for 2024? (D) What additional planning steps would you advise him to take in connection with his RRSP in 2024?

Problem 8 Sue and George Shaker lived in Halifax, Nova Scotia, while George completed his combined law and MBA degree at Dalhousie University. The Shakers purchased a home in Halifax when they first moved to Nova Scotia. Due to contracting mononucleosis in his second year of the program, George completed his degree in December 2023 rather than in the spring of 2023. George excelled in the program and had numerous job offers. He finally accepted a job with NorthAm Co. in Toronto. In order to convince George to accept the job, NorthAm Co. offered to pay the Shakers an amount equal to any loss that they incurred on the sale of their Halifax home and provide them with a $10,000 moving allowance. Sue has been working for an insurance company in Halifax while George has been attending school. Sue intends to find work in Toronto, but will be unable to continue working for the same insurance company.

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ITA: 62; IT-178R3; Income Tax Folio S1-F3-C4

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Two Air Canada tickets (return Halifax to Toronto) . . . . . . . . . . . . . . . . . . . . Motel room, 7 days @ $75 per day . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Meals, 7 days @ $50 per day . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Car rental . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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George accepted the job with NorthAm Co. in September 2023. During October 2023, George and Sue flew to Toronto to look for a home. They spent a week in Toronto and on the fifth day managed to find and purchase a home with the purchase contract closing on December 15, 2023. The remaining two days were spent arranging for painting and cleaning of the new home. Their expenditures on that trip were: $ 1,200 525 350 350

George and Sue managed to sell their Halifax home. That sale closed on December 15, 2023. The statement of account from the lawyer (dated January 15, 2024) revealed the following expenses: Real estate commission . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Legal fees, old home . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Legal fees, new home . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Land transfer tax, new home . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$7,000 2,000 2,800 1,000

The house in Halifax was sold for $340,000. The Shakers had originally paid $360,000 for the house. NorthAm Co. provided a cheque for $27,000 in February 2024 to reimburse them for the loss and the real estate commission. (NorthAm Co. did not include the legal costs when calculating the loss eligible for reimbursement.) Subsequent to finalizing the sale of their Halifax home and George’s completion of his exams, Sue and George packed up their car and drove to Toronto. The trip took 7 days due to a leisurely pace and some bad weather delays, and since their home was not ready when they arrived, they stayed in a nearby motel for 11 days. The cost of trip and stay in motel was as follows: Meals, 18 days @ $100 (substantiated by receipts) .................................................... $1,800 Motel room, 18 days @ $80 ........................................................................................ 1,440 Gasoline (2,000 kilometres driven) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250

In late December, the Shakers paid a moving bill consisting of $6,200 for the actual move and $250 for storage. George received the $10,000 allowance for moving expenses in December 2023. He commenced work for NorthAm Co. in January 2024 at a salary of $80,000 per year. Sue commenced work for Toronto Insurance Co. in September 2024 at a salary of $85,000 per year. Sue and George have asked you to advise them on whether they can claim a deduction for moving expenses and if so calculate their allowable moving expenses for both 2023 and 2024. They are also wondering if the loss reimbursement is taxable. Assume that all expenditures made were reasonable and can be substantiated by receipts.

Problem 9

ITA: 63

Nina Diamond and Len Dirkfeld are married and have five children: Lindsay age 18, Trevor age 15, James age 7, Ben age 5, and Rebecca age 3. During 2023, they paid a nanny $250 per week for 50 weeks to look after their children while they worked. During July, they paid $3,000 ($1,500 each) for Trevor and James to go to an overnight summer camp for four weeks. In addition, they paid their child Lindsay $300 to babysit the other children at various times when they worked late. Len is a physician and has his own practice. Nina worked full-time as a computer consultant during the first eight months of the year. In September, she went back to university on a full-time basis for 13 weeks. On December 11, her courses were finished and she went back to work.

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Introduction to Federal Income Taxation in Canada

234 Nina and Len’s incomes are summarized below:

Salary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Employment expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Employment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Business income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rental income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . RRSP contribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income under Division B . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Nina $74,000 3,000 (800) $76,200

Len

$137,000 3,000 6,000 (5,000) (10,000) 2,000

$73,200

$136,000

Nina and Len have asked you how Nina’s return to school in 2023 will impact the child care deduction on their tax returns for the year. The tax partner has asked you to consider their query and to calculate the maximum 2023 child care deductions they can claim. They would also like to know how your answer would change if Nina went back to university for 13 weeks on a part-time basis rather than a full-time basis. Assume Nina took a minimum of 12 hours of courses each month, but do not redo all the calculations.

Problem 10 In late 2022, Dr. Elaine Matthews separated from her husband. She maintained full custody of the couple’s only child, a seven-year-old girl. Since May 1, 2007, Dr. Matthews had been working as a public health consultant for the Oshawa region. Around the middle of 2023, she had chosen to take advantage of a severance package from the Oshawa region. She accepted a staff position at Joseph Brant Memorial Hospital in Burlington, Ontario and moved directly from Oshawa to Burlington on September 1, 2023. She sold the former family home in Oshawa on September 15, 2023. Her husband had rented an apartment in Oshawa in late July 2023. Dr. Matthews has some experience preparing her own tax returns but she has been particularly busy in recent months. She started her 2023 return but quickly decided she simply did not have time to finish it. She requested your assistance in completing her return. You met with Dr. Matthews to go over her tax information related to 2023 and determined that she had correctly calculated her income under Subdivisions a, b, and c of Division B to total $158,488. Included in this correct computation were the following items: Salary (from former employer) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Salary (from Joseph Brant Memorial Hospital) . . . . . . . . . . . . . . . . . . . . . . . Taxable benefits under section 6 of the Income Tax Act . . . . . . . . . . . . . . . Registered pension plan contributions (defined benefit plan) . . . . . . . . . . . . Consulting income (reported as business income) . . . . . . . . . . . . . . . . . . . . Interest income from investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable dividends from investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Share of rental loss from childhood home inherited from her parents . . . . . . Net taxable capital gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest paid on investment loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loss from limited partnership investment (rental property) . . . . . . . . . . . . .

$ 96,000 60,000 1,743 (6,750) 8,000 540 1,250 (1,495) 4,800 (2,400) (3,200) $158,488

She provided you with the following additional details relating to 2023: Miscellaneous income: Severance from former employer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 41,538

Transfer of RPP accrued from former employer: Her former employer made a direct transfer of her accumulated RPP benefits (within prescribed limits) to her RRSP; her former employer had made vested contributions for the years 2007 through 2023 ..........................$210,000

¶9,850

ITA: 56(1)(a), 60(b), 60(i), 60(j.1), 60(o), 60.1, 62, 63, 146(1), 146(5), 146(8.2), 147.3

Ch. 9/Study Guide — Assignment Problems

$ 2,000

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Spousal support: Under the terms of her separation agreement signed in September 2023, Dr. Matthews paid the following amounts for support of her husband: Support ($500 a month for September–December) . . . . . . . . . . . . . . . . . . Rent on his new Oshawa apartment ($750 a month for September–December) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

235

3,000

Moving expenses from Oshawa to Burlington: Gas for house-hunting trips (four trips made during late August 2023) . . . $ 40 Selling costs of former Oshawa home (owned 100% by her; sold September 15, 2023): Real estate commissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 12,000 Legal fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,050 Costs of purchasing new Burlington home: Legal fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 850 Land transfer tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,250 Costs of moving herself and her household effects: Moving van to transport belongings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 600 Gas to drive herself and her daughter (120 km driven) . . . . . . . . . . . . . . . 60 200 Hotel (2 nights while new home was being painted and cleaned; 2 × $100) Meals (same two days as above 2 × $55) . . . . . . . . . . . . . . . . . . . . . . . . . 110 You have determined that the distance from her new home to Joseph Brant Hospital is 3.5 kilometres. The distance from Joseph Brant Hospital to her former home was 115 kilometres. Care of her daughter: Part-time nanny employed January 1–August 31 . . . . . . . . . . . . . . . . . . . . YMCA overnight summer camp for two weeks in July while nanny was on vacation ($200 a week) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fall term (September–December) tuition fees for private school (excluding before and after school daycare) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Before and after school daycare for September–December (provided on premises of private school) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fall term (September–December) transportation to private school . . . . . .

$ 8,976 400 4,000 720 1,200

Registered retirement savings plan contributions: Personal contributions through employment (March–December 2023) . . . . 10,000 Personal contributions through employment (January–February 2024) . . . 16,000 Her 2022 earned income for RRSP purposes was $134,000; her employer had reported a pension adjustment on her 2022 T4 of $9,500; she had no unused RRSP deduction room or undeducted balance of RRSP contributions at the start of 2023. Legal fees paid: Legal representation during separation proceedings to establish requirements to make support payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,600 Appeal of her 2021 income tax assessment (which she won) . . . . . . . . . . 1,200 You have been asked to complete the calculation of her income under Division B. Show all calculations whether or not they are necessary to the final answer. EXplain briefly any items not used in your calculations.

Problem 11

ITA: 5, 6, 8, 18, 56(1)

Sibbald Kay, age 30, earned $48,000 last year as a dental hygienist for Hi Care Dental Associates. During the year, Sibbald also received director’s fees of $600, and incurred the following expenses: Uniforms purchased for employment purposes $480 Parking expenses ($80/month) ..................................$960 Hygienist association fees ..........................................$280

¶9,850

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Sibbald also earned interest income of $3,200 from holding a $50,000 cash balance in T-bills and paid $1,200 in interest expense relating to a loan for an RRSP contribution. Sibbald has not repaid this loan because she believes that saving is more important. Sibbald also has 600 shares of Battery Inc. in her self-directed RRSP. During the year, she sold 400 shares at $20 for a capital gain of $6,000. She withdrew the proceeds of disposition and purchased living room furniture. Sibbald has asked you to calculate her income for tax purposes, and provide her with tax-planning opportunities for the upcoming years.

Problem 12

ITA: Subdivision b, 248(1)

Mariah Holt, a management consultant, provided you with the following statement for the year ended December 31: Fees received (gross) . . . . . . . . . . . . . . Salaries and benefits expense . . . . . . . . Liability insurance expense . . . . . . . . . . Office expense . . . . . . . . . . . . . . . . . . . Office equipment . . . . . . . . . . . . . . . . . . Automobile expenses . . . . . . . . . . . . . . . Interest expense (loan for business use) Professional courses . . . . . . . . . . . . . . . Beginning undepreciated capital cost Automobile (Class 10.1) . . . . . . . . . . . Office equipment (Class 8) . . . . . . . . .

$145,000 55,500 5,000 1,200 1,000 1,000 10,500 1,400 20,000 30,500

For the year, Mariah drove her automobile 30,000 kilometres, of which 15,000 kilometres were driven for business purposes. Mariah and her sister purchased a commercial rental property (joint 50/50 ownership) on December 5. The cost of the property was as follows: (1) land $950,000, (2) building $500,000, and (3) furnishings $3,000. The rental income and expenses for the 26 days were as follows: (1) rent $24,000, (2) operating expenses $20,000, and (3) interest expense $6,250. Mariah, a single parent of two children aged three and five, paid $800 per month to a babysitter to care for the two children in her home. In January, Mariah had purchased her first home for $415,000 and paid $1,900 to a moving company to move 45 kilometres closer to her consulting office. She withdrew $20,000 from her RRSP under the Home Buyers’ Plan. Mariah has asked you to: (a) Calculate her net income for the taxation year. (b) Identify any area of her income that may be controversial, particularly with the CRA.

Problem 13 Ms. Sui is an executive of a large public retail corporation, Clothes to You Ltd., situated in Dundas, Ontario. Ms. Sui is not married. However, she has two adopted children, ages 8 and 10, who reside with her. Ms. Sui has provided you with the following information for 2023: Clothes To You Ltd.: Gross salary ................................................................................................................$150,000 Commission income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,000 Canada Pension Plan contributions (including $631 of CPP enhanced contribution) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3,754) Employment Insurance premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,002) Registered pension plan contributions (money purchase) . . . . . . . . . . . . . . . (6,000) Income taxes deducted ...........................................................................................(55,000)

¶9,850

ITA: 5, 6, 8, 12, 20, 39, 40(2), 56, 60, 75, 146

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(1) Clothes To You Ltd. provides Ms. Sui with an automobile. The annual lease cost of the car, including HST, is $25,400. Ms. Sui is reimbursed for her operating expenses when using the car for business. Clothes To You Ltd. also pays for any insurance, licence fees and repairs and maintenance related to the operation of the automobile. The operating expenses for the year totalled $6,200, including HST. She used the car 10,000 kilometres for pleasure and 30,000 kilometres for business. She is charged $200/month for the use of the car and operating costs. (2) Ms. Sui received stock options in the year. She has the option to purchase 20,000 shares at $3.50/share. The value of the shares at the date of the issue of the option was $3.50/share. Ms. Sui has not yet exercised any of her options. (3) Ms. Sui received a piece of artwork worth $850, including HST, from the company at Christmas time. (4) Clothes To You Ltd. paid $1,300, including HST, for her membership in a fitness club. The corporation also paid Private Health Insurance premiums of $350. Investment Receipts: Interest income ......................................................................................................................... $1,800 Dividends received from Canadian-resident public corporations............................................. 7,500 Dividends from U.S. corporation — net of 15% withholding tax (in Cdn. $) . . . . . . . . 680 Other Items: (1) Annuity payments under contract from Profound Life Assurance Co. The capital portion of the annuity was $650 ....................................................................... $2,000 (2) Net proceeds on the sale of her house on March 15, 2023 — net of real estate commission of $12,000 ......................................................................... $188,000 The house cost $90,000 in 2010. She had previously sold her cottage in 2012, giving the cottage the maximum designation as a principal residence in order to eliminate the taxable capital gain. (3) At Christmas 2022, Ms. Sui gave each of her children a 6%, $2,000 five-year bond. Expenditures/Losses: (1) Investment counsellor’s fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,100 (2) Interest on bank loan to purchase shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

850

(3) Registered retirement savings plan contribution . . . . . . . . . . . . . . . . . . . . . . . . . . .

14,000

Ms. Sui’s earned income in 2022 was $170,000. The PA on her 2022 was $7,000. (4) Ms. Sui incurred meals and entertainment expenses . . . . . . . . . . . . . . . . . . . . . . . . .

8,300

(5) Rental loss (before CCA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3,500

(6) Ms. Sui invested in a limited partnership tax shelter in 2023. The loss per form T5013 is $3,200. She invested $5,000 in the partnership units in early 2023. (7) Registered retirement savings plan contribution ................................................................. 14,000 Ms. Sui’s earned income in 2022 was $170,000. The PA on her 2022 was $7,000. Ms. Sui has asked you to calculate her income for tax purposes for 2023.

Problem 14

ITA: 63

Ed Sigmond was transferred from England to Ottawa by Pharmadyne Supplies Inc. on April 1, to assume the permanent position as Vice President, Canadian operations. Ed was a permanent resident of England prior to the move. His earnings for the year are as follows: Gross salary — January 1 to March 30 Income tax paid in England . . . . . . . . . Gross salary — April 1 to December 31 Income tax withheld . . . . . . . . . . . . . . . CPP/EI withheld . . . . . . . . . . . . . . . . . . Donations to United Way withheld . . . .

$ 12,000 (3,200) $ 72,000 (21,000) (4,757) (400)

¶9,850

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Ed’s spouse, Laura, arrived in Ottawa on July 15, with three children (all seven years of age or older). On August 1, she resumed her full-time studies at the University of Ottawa, where she was awarded a $2,500 scholarship. In England, she had attended the University of Cambridge from January 1 to April 30. In England, Laura paid $1,000 per month for a nanny for the children. In Canada, she took her children to the local daycare for $1,360 per month. The Sigmonds also incurred the following moving expenses: Airfare/lodging — house hunting in Ottawa . . . . . . . . . . . . . . . . . . . . . . . . Airfare — family move . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Moving van fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Legal fees and land transfer taxes on acquiring the Ottawa home . . . . . . . Meals and hotel expenses (12 days prior to employment) . . . . . . . . . . . . .

$3,500 7,000 3,200 5,500 3,800

Ed is having some problems in calculating his and Laura’s income for Canadian tax purposes, and has come to you for assistance. He has asked you to calculate his income for tax purposes.

Problem 15

ITA: Division B

Ms. King had a busy year in 2023. During the year, she formally separated from her husband and retained custody of her five-year-old daughter, Kelly. She also decided that she needed a fresh start in another city, so she quit her job in Belleville, Ontario, and got a new job in Windsor. Ms. King and her daughter moved to Windsor, Ontario, in November 2023. She has asked you to help her estimate her 2022-2023 income for tax purposes. In order to help you, she has prepared the following list of all the transactions that she thinks might be of interest to you. (1) Her employment income from her employer in Belleville for the first 11 months of 2023 was $85,000. Her deductions at source included CPP/EI of $4,757 (including $631 of CPP enhanced contribution) and income tax of $11,000. Before she left the Belleville employer, a public company, she exercised a stock option that she had for 800 shares. When this option had originally been granted, the share price was $15. The exercise price of the option was $17. At the time she exercised the option, the market price was $25. She immediately sold these shares on the open market for $25. (2) Her new employer in Windsor agreed to pay some of her moving expenses, but in order to simplify things, they were going to give her an allowance of $8,000. She was responsible, then, for her own expenses. Her moving costs were as follows: Moving company charges ...................................................................................... $5,500 Gas for trip to Windsor at the time of the move (600 km driven) . . . . . . . 75 Motel in Belleville for one night on the day of the move . . . . . . . . . . . . . . 75 Meals during the one-day move to Windsor . . . . . . . . . . . . . . . . . . . . . . . 100 Lease cancellation charge in Belleville . . . . . . . . . . . . . . . . . . . . . . . . . . . 200 $5,950 She had made a trip to Windsor to look for an apartment for her and Kelly and she had incurred the following expenses: Gas for trip to Windsor and return ......................................................................... $150 Motel costs in Windsor ........................................................................................ 150 Meals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75 $375 (3) Her income from her new employer in Windsor during the month of December was $5,000. (4) During the year she incurred the following expenses for the care of Kelly: Food and clothing ................................................................................ $6,000 Babysitter costs while she was at work..................................................... 3,000 (5) Ms. King incurred legal fees of $3,200 to establish her right, under the Divorce Act, to support payments in connection with the finalization of the separation agreement. She feels that this was well spent, since her lawyer was successful in getting her husband to pay child support to her for Kelly in the

¶9,850

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amount of $800 per month, starting in February 2023. So far, her husband has been making these payments on time.

CHAPTER 9

(6) She also had trouble with her 2021 tax return and had to pay her previous accountant $400 to deal with the CRA. It turns out that the CRA has correctly assessed her return. (7) She is totally confused by the RRSP rules, so she wants you to tell her what the maximum amount is that she can contribute to her RRSP for 2023. She wants you to assume that she will make these payments within the time deadlines. (8) Five years ago, Ms. King inherited some shares in a Canadian-resident public company, Facai Ltd., from her mother. She believed that the shares were capable of making money for her. She sold the shares in 2023, in order to put money into a mutual fund that a friend recommended. Her mother had paid $5,000 for these shares in 2004 and at the time of her mother’s death, the shares were worth $60,000. Ms. King sold them for $180,000. Ms. King received cash dividends from these shares during the year in the amount of $9,058. (9) One of her good friends had been a battered wife, so Ms. King had donated $2,000 to the local registered charity which protects battered women. (10) Ms. King gave you a copy of her 2022 tax return and it showed employment income of $55,000, child care expenses of $2,000 and taxable dividends of $10,000. She made the maximum RRSP contribution for 2022 and earlier years and did not have any unused RRSP contribution room or undeducted RRSP contributions at the end of the year. Ms. King has asked you to calculate her income for 2023. E Xplain why you omitted any amounts from your calculations. Show all calculations.

Problem 16

ITA: Division B

Cam Renaz, a self-employed geologist, is a single parent with full custody of his two daughters, Sharee and Susanna (ages 13 and 15). During the past year, Cam retained the full-time services of a nanny to care for them while he worked. Unfortunately, this was a difficult year in Cam’s field and his earnings were low. To assist in financing his living expenses, he withdrew $12,000 from his RRSP. He also settled with his wife and she paid him $20,000 as a lump sum in exchange for being relieved of any liability for future alimony payments. To save even more money, Cam prepared his own income tax return, instead of using his accountant’s services. Below is a summary of Cam’s income tax information: Consulting income, net of expenses . . . . . . . . . . . . . Car purchased — used 40% for business use . . . . . . . Nanny’s salary ($1000/month) . . . . . . . . . . . . . . . . . . RRSP withdrawals (gross) . . . . . . . . . . . . . . . . . . . . . Canadian dividends — cash amount (Non-eligible dividends from CCPCs) . . . . . . . . . . .

$28,000 (18,000) (12,000) 12,000 1,500

When Cam filed his income tax return, he deducted the nanny expense from his consulting income, and wrote off 40% of the cost of the car as business expense. He did not report the RRSP withdrawals because 20% tax was withheld at source. When Cam received his notice of assessment from the CRA, he was shocked to see that he owed substantially more income tax. The following comments were made in his notice of assessment: ●

Child care expenses are not deductible as a self-employed business expense and have been disallowed.

● Cannot deduct price of car as a business expense, and the $7,200 deducted has been disallowed. ● Your dividend income has been increased by $225. ● Our records indicate that you withdrew $12,000 from your RRSP and received $20,000 from your

ex-spouse for alimony; these amounts have been added to your income.

Cam does not understand why the CRA is assessing him this way. He particularly recalls his accountant telling him that the nanny expenses would be tax deductible.

¶9,850

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Compute Cam’s net income, considering the legislation, common law and administrative practice, and the correct income tax treatment of each of the items creating problems in Cam’s income tax return.

Problem 17 Myron Van Doulis, age 42, just left your office with his spouse, Jennifer Barnes. Over the past several years Myron, a former VP at TNS Communications, has been successfully promoted and now earns $220,000 annual salary. Jennifer is a lawyer but is currently self-employed. She continues to pay her law society dues, hoping that someday she will return to her profession. Myron’s life changed drastically when the president, accompanied by a security officer, guided him from his office with a $120,000 severance package. The presidents of TNS and MIC both agreed that Myron’s work ethic and performance were less than marginal when compared with the performance of MIC’s senior vice president and abruptly ended his employment. While the couple’s children (ages 8, 10, and 13) have been in school, Jennifer has been working on the development of a few unique software packages for specialized legal services. Her software was tested and favourably accepted by a large international law firm. Jennifer now has a lucrative proposal from a leading software publishing company. Over the past month, Myron has had time to reflect, ponder, and examine his future needs. The current market value of Myron’s net assets are as follows: Cash ................................................................................... $ 13,000 Treasury bills and bonds (held within his TFSA with no additional contribution room) . . . . . . . . . . . . . . . . . . . . 120,000 Speculative stocks (cost $95,000) . . . . . . . . . . . . . . . . . 4,000 RRSP: Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149,000 House (cost $410,000) . . . . . . . . . . . . . . . . . . . . . . . . . . 1,840,000 Bank loan for trading . . . . . . . . . . . . . . . . . . . . . . . . . . (140,000) Net assets ............................................................................... $1,986,000 Myron’s most immediate concern is his severance pay. He has a few options. His marginal tax rate this year will be 50% and, in 20 years, when he retires, he estimates a marginal tax rate of 40%. (a) In the details of Myron’s severance package, MIC is willing to pay an $80,000 retirement allowance. Assume for the purposes of this case that all of the $80,000 may be contributed to his RRSP due to Myron’s unused RRSP room. Myron can invest the $80,000 in the Province of British Columbia strip bonds with an annual yield to maturity (YTM) of 5%. MIC has also agreed to pay a cash settlement of $40,000. Currently, the annual GIC rate is 4%. (b) Alternatively, MIC is willing to provide Myron with 12,000 shares of ITT, a Canadian public corporation, currently trading at $8. The shares pay an annual 5% dividend; the company expects growth of about 4% per year. This assumes that the new vice president will improve the financial returns and reap greater rewards in the derivative marketplace. Myron feels like escaping for a few years. Myron believes that the government will continue to raise his federal income tax rates. He also believes that the cost of health care and education will increase dramatically. Myron just finished reading the best-selling book, Take Your Money and Run. He’s thinking of selling his home and purchasing a yacht outfitted with communications technology. According to the book, Take Your Money and Run, he could sever all ties (for about two years), transfer his assets and severance to a tax haven, and incorporate offshore. The company could rent a home in Canada for the children and their grandparents to live in while the children complete their education. The technology on board would permit his wife to communicate with her publisher (although she insists that she would have to spend at least four months of the year in Canada, visiting the children). Further, Myron can continue his adventurous trading in the options and derivative markets. One last problem: the CRA has disallowed his business loss of $90,000 in last year’s income tax return. His trading in the options market generated losses of $90,000, including commission expenses. The CRA has assessed the loss as a capital loss because, in the prior year, Myron had reported his $22,000 in profits from trading in the options market as a capital gain and not as business income. Draft a report to Myron, detailing and quantifying where possible, the income tax position he faces. Include the financial quantification of the two retirement packages he has been offered.

¶9,850

ITA: Division B

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CHAPTER 9 — DISCUSSION NOTES FOR REVIEW QUESTIONS ITA: 56(1)(a)(ii), 248(1) ‘‘retiring allowance’’

(2) The accumulated sick days will qualify as a ‘‘retiring allowance’’ and be taxed as such. However, the unused vacation days will not qualify under this definition, according to the Interpretation Bulletin, and will be taxed as employment income. As employment income, the amount will be treated as earned income for RRSP contribution room calculations. The retiring allowance will not be included in earned income for the determination of RRSP contribution room.

ITA: 6(3), 56(1)(a)(ii), 248(1) ‘‘retiring allowance’’; IT-337R4 par. 5

(3) Under this agreement, the $500 in monthly fees paid to the financial institution will qualify as an allowance and treated as spousal support even though Mark has discretion as to where the $500 is paid. The payments are (1) made in the year under a written agreement, (2) the expense was incurred for the maintenance of Mark. Ideally there should be a reference in the written agreement to 56.1(2) and 60.1(2). In addition to the $1,500, this amount is part of the monthly spousal maintenance payment specified in the agreement, all of which is deductible and taxable to Mark.

ITA: 60.1(2)

(4) The loan would have to be included in employment income when received. Such amounts are not awards and are not subject to the rules for scholarships and research grants. As a result, neither the full exemption for scholarships nor research expenses are available as deductions. Any repayment of this repayable award is deductible as a repayment of employment income provided the conditions of that paragraph are met.

ITA: 5(1), 6(3), 8(1)(n); Income Tax Folio S1-F2-C3 — Scholarships, Research Grants and Other Education Assistance

(5) The Guaranteed Income Supplement would fall into the category of "social assistance payments" since it is based on an income test. As a result, the payments are included in net income, but there is a corresponding deduction to exclude it from taxable income. The effect of these two provisions is to raise Mrs. Smith’s income to a point that no one can claim her as a dependant, but at the same time not to make Mrs. Smith taxable on this amount.

ITA: 56(1)(u), 110(1)(f)

(6) The $15,000 will be taxed in Mr. Singh’s hands on an indirect payment and not in Mrs. Singh’s hands.

ITA: 56(2)

Income Tax Folio: S3-F9-C1 — Lottery Winnings, Miscellaneous Receipts, and Income (and Losses) from Crime

ITA: 56(1)(n), 56(1)(o)

(7) Defined benefit pension plans are approved by and registered with the CRA. Once the CRA has agreed to the terms of the plan, the amount that the company can deduct is determined by an actuary who certifies the amount that is necessary to fund the accruing benefits of the plan. (8) The explanation is based on the fact that the two pension systems are integrated and the integration is based on how rich your pension plan is. The richness of your pension plan is determined by the Pension Adjustment calculation. For this system to work, the pension calculation has to come first. So, your maximum pension contribution is based on your current income. Then, early in the following year your pension adjustment (PA) is calculated. Finally, your RRSP limit is determined, based on your earned income and PA, both of which relate to the prior year. (9) The Regulations set the withholding rates based on the amount of the withdrawal — 10% of the amount if it is $5,000 or less; 20% if the amount is between $5,000 and $15,000; and 30% if the amount exceeds $15,000. The rates are one-half of these amounts in Quebec. Based on this formula, the withholdings would be 30% of $20,000 or $6,000. Instead, if she were to withdraw four payments of $5,000, then the tax withheld would amount to only 10% of $20,000 or $2,000. In both cases the $20,000 withdrawn will have to be included in her income for the year and the same amount of ultimate tax will have to be paid. The tax will have to be funded from other sources to allow for the $20,000 to be spent for the car.

ITR: 103(4), 103(6)

CHAPTER 9

(1) The payment was made to Ms. Tang ‘‘upon or after retirement of a taxpayer from an office or employment in recognition of her long service’’ and as such should qualify as a retiring allowance and be included in income. An Interpretation Bulletin states that ‘‘the cessation of employment for any reason is considered as being retirement or loss of employment’’. Therefore, even though she quit, this amount should still qualify as a retiring allowance.

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Importantly, it should be noted that the amount removed from the RRSP cannot be replaced, so the opportunity to earn investment income on that amount sheltered tax free in the RRSP will be lost. Alternatively, the withdrawal will have to be increased for the amount of the tax to be paid. The necessary withdrawal would be $20,000/(1 -- t), where t is her marginal tax rate. If she has funds saved in a TFSA, it would be better for her to withdraw funds from that account. The withdrawals would be tax free and the TFSA room will be replenished in the next calendar year. (10) The following items would show up on her personal tax return: (a) the $40,000 would be included in income as a retiring allowance; and (b) the $8,000 of legal fees could be deducted. The $32,000 (net of legal fees) retiring allowance is not eligible for direct transfer to her RRSP and deduction as a contribution to the RRSP. As a result, she will have an over contribution which will attract a penalty of 1% per month in the RRSP, unless she removes the over contribution on a timely basis. Note also that the retirement allowance will not be included in earned income for the RRSP contribution room calculation

ITA: 60(o.1)

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CHAPTER 9 — SOLUTIONS TO EXERCISES Exercise 1

ITA: 63(3), 146(1)

CHAPTER 9

The definition of ‘‘earned income’’ is found in two places in the Act, subsections 146(1) and 63(3). The definition found in subsection 63(3) relates to child care expenses. The definition of earned income contained in subsection 146(1) is used in the calculation of the RRSP contribution limit and is quite different from the definition contained in subsection 63(3). You will note that section 146, entitled ‘‘Registered Retirement Savings Plans’’, appears in Division G — Deferred and Other Special Income Arrangements. The definition of ‘‘earned income’’ pertaining to the child care expense deduction can be seen to reflect the economic activity that the government is encouraging when taxpayers incur child care expenses. The definition of earned income is more limited relative to the definition applicable to RRSP contributions. Earned income is limited to: employment, carrying on business (in an unincorporated form), or studying where student income like a net research grant is obtained. The definition of ‘‘earned income’’ pertaining to an RRSP can be seen to reflect, conceptually, a source of income that requires some amount of active involvement in the earning process, rather than a passive source, like a passive investment in stocks or bonds earning dividends or interest. Employment and income from carrying on a business are included as well as spousal support, rental income, postdoctoral fellowship income and royalty income in respect of a work on invention.

Exercise 2 The maximum amount that Don is able to deduct in respect of a spousal RRSP for 2023 is his annual contribution limit, less any contributions made to his own RRSP in respect of the year. Don’s annual contribution limit for 2023 is calculated as the lesser of 18% of his 2022 earned income (i.e., $11,916 as calculated below) and the RRSP dollar limit for 2023, which is $30,780, less the PA reported by his employer in respect of 2022 of $6,084. Don’s earned income for 2022 is calculated as: Employment income — Subdivision a ....................................... $68,400 Add: RPP contribution . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,800 $71,200 Rental loss....................................................................................................... (5,000) Earned income .............................................................................................. $66,200 18% thereof ...................................................................................... $11,916

Therefore, Don is able to deduct $5,832 (i.e., $11,916 --- $6,084) of RRSP contributions in 2023. Since he has already contributed $5,000 to a spousal RRSP, he can either contribute $832 to his own RRSP, or an additional $832 to the spousal RRSP for 2023 before March 1, 2024.

Exercise 3 To calculate the after-tax rate of return for the first investment alternative — the bond held outside of an RRSP — you must multiply the pre-tax rate of return by (1 -- t). Therefore, the after-tax rate of return will be 2.16% (4% (1 -- 0.46)), or $324. As the annual after-tax yield is reinvested at the same pretax 4%, the compounded yield is $3,574 (i.e., $15,000 (1.0216)10 -- $15,000). Inside the RRSP, the 4% interest compounds unhindered by tax, and in 10 years the RRSP amount grows to $7,204 (i.e., $15,000 (1.04) 10 -- $15,000); however, income taxes must be paid on withdrawal from the RRSP at 46% equaling $3,314 and yielding $3,890. The RRSP approach produces the better after-tax yield, $3,890 versus $3,574 outside the RRSP.The after-tax yield could be maximized if the RRSP withdrawal were made in a tax year when the applicable marginal tax rate is lower than 46%.

ITA: 146(1)

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Exercise 4 As this was a spousal RRSP, it is subject to the three-year rule. Douglas will be required to report $6,000 as his income. Under the three-year rule, Douglas’s income is the lesser of (A) and (B).

ITA: 146(1)

(A) Spousal RRSP contributions, current year $0; preceding two taxation years $6,000. (B) RRSP withdrawn $10,000. Donna will report the remaining $4,000 of income ($10,000 -- $6,000). While income is reported by Douglas, the income tax withholding of $2,000 remains as a credit in Donna’s tax return.

Exercise 5 Mr. Reimer is able to contribute $20,900 to an RRSP for 2023 [(lesser of 18% of his earned income from 2022 (i.e., 18% of $120,000 = $21,600 and $30,780) less his 2022 PA of $700]. He may make this annual contribution to either his own or a spousal RRSP, as long as the total of the contributions does not exceed $20,900. These contributions may be made in the year or within 60 days of December 31, 2023. He does not have to include the lump-sum transfer from his RPP in his income nor does he get an offsetting deduction, as long as it is eligible to be transferred.

ITA: 147.3(4), 147.3(9)

The $20,000 amount transferred to Mr. Reimer’s RRSP could be applied towards his 2023 RRSP contribution room and taken as a deduction on his 2023 personal return. It would be necessary to review Mr. Reimer’s 2022 tax return to determine his unused RRSP contribution room at the end of 2022 and his 2023 RRSP contributions to determine this. Any over contribution would need to be removed from the RRSP.

Exercise 6 Allowable moving expense deduction: (A) 2023 Travelling cost — air fare . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,300 Household effects — transporting . . . . . . . . . . . . . . . . . . . . . 1,000 Selling costs of Vancouver residence — legal fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500 — real estate commission ........................................................... 10,000 Allowable purchase cost of Montreal residence — legal fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000 — Quebec transfer tax . . . . . . . . . . . . . . . . . . . . . . . . . . 300

ITA: 62(3)(a) ITA: 62(3)(b) ITA: 62(3)(e)

ITA: 62(3)(f )

Total potential deductions ................................................................ $14,100 Less Amount paid by the employer not included income . . . . . . . .

$ 5,000

ITA: 62(1)(c)

$ 9,100 Deduction restricted to income from new work location — 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 7,000

ITA: 62(1)(f )

(B) 2024 Balance deductible from income from the new location only in 2024

2,100 $ 9,100

ITA: 62(1)

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Exercise 7 (i) Amount deductible for 2022 would be the reassessed amount of $11,250 calculated as the least of:

(b) $29,210 Limit (c) 18% × amount of 2021 earned income ($62,500)* = $11,250 *Earned income in 2021 Employment income . . . . . . . . . . . . . . . . . . . . . . . . . . $ 65,000 Rental loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (2,500) $ 62,500

Note that Mr. Big Shot’s pension adjustment for 2021 was $0. (ii) The amount deductible for 2023 would be $5,625 which is the least of: (a) $6,750 ($18,000 -- $11,250) un-deducted contributions from February, 2023 (b) $30,780 limit (c) 18% of × amount of 2022 earned income ($31,250)* Less: $0 (PA for 2022) = $5,625 *Earned income in 2022 Employment income . . . . . . . . . . . . . . . . . . . . . . . . . . $ 35,000 Rental loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (3,750) $ 31,250

Mr. Big Shot has made excess contributions to his RRSP as of February 2023 in the amount of $18,000 -- [2022 deduction] $11,250 -- [2023 deduction] $5,625 = $1,125. Since this is below the $2,000 allowable limit for excess contributions, no penalties will apply.

Exercise 8 (i) Least of: (a) qualifying amounts paid $8,000 + ($125 × 3 weeks) + ($200 × 3 weeks) = $8,975 (b) ($8,000 × 2 children) + ($5,000 × 1 child) = $21,000 (c) 2/3 × ($32,500 + $7,000) = $26,333 (ii) Babysitting of $1,200 excluded on the assumption that these expenditures were not for the purpose of earning income. Registered pension plan contributions ignored since only income inclusions not deductions are included in ‘‘earned income’’ for this deduction. The following sources of income are not included in ‘‘earned income’’ by virtue of the definition. Rental of basement apartment . . . . . . . . . . . $ 9,000 Support payments ................................................. $ 18,000 Interest income . . . . . . . . . . . . . . . . . . . . . . $ 5,000

CHAPTER 9

(a) $18,000 Contribution

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Exercise 9 Subsection 56(4) would apply to cause the $12,000 to be taxed in Mrs. Worker’s hands and not in Mr. Worker’s hands. One should note that IT-440R2, paragraph 10, threatens to have the $12,000 taxed in both of their hands if there was a deliberate attempt to evade or avoid tax.

Exercise 10 George will have an RRSP deduction available to him of $35,000. He can use this deduction against his 2023 total income or he may choose to carry some or all of it forward. He will be deemed to have disposed of his shares at fair market value. This will cause a taxable capital gain of $7,500 (($25,000 -- $10,000) × 1/2) on the ABC Public Company shares. The capital loss of $15,000 ($10,000 -- $25,000) on the XYZ Public Corporation shares will be deemed to be $0 by virtue of clause 40(2)(g)(iv)(B).

Chapter 10 Computation of Taxable Income and Taxes Payable for Individuals CHAPTER 10

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CHAPTER 10 — LEARNING CHART Problem Descriptions Textbook Example Problems 10-1 Employee stock option 10-2 Net capital losses 10-3 Deduction of loss carryovers 10-4 Deduction of loss carryovers 10-5 Personal tax credits for dependants 10-6 Medical tax credits 10-7 Medical tax credits for dependants 10-8 Transfer of education credits 10-9 Tax on Old Age Security 10-10 Transfer of credits to spouse 10-11 Taxable income and credits — ordering rules 10-12 Comprehensive 10-13 Comprehensive 10-14 Working income tax benefit 10-15 Minimum tax Exercises 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21

Identif y sources of income Loss carryovers Calculate income for tax purposes Calculate income, taxable income, tax payable Personal credits Withdrawal from RPP Transfer of credits to spouse Transfer of dividends Foreign and dividend tax credits Minimum tax Marginal tax rate Minimum tax Becoming resident in Canada Calculate taxable income, personal credit base amount Taxable income of an individual Individual taxes payable Income, taxable income, taxes payable for an individual Capital gains deduction, personal tax credits, donations — charitable and political Capital gains deduction, personal tax credits, donations — charitable and political Sale of investments; attribution Sale of investments; attribution

Assignment Problems 1 Dependent credit 2 Tuition credits 3 Exempt income, non-capital loss 4 Income and taxable income, ordering rules

Ch. 10/Study Guide — Learning Chart

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Problem Descriptions Credits Dependent credit Credits — single parent, inf irm child Medical expenses Credits Credits for U.S. university Credits for U.S. and Canadian universities Pension vs. dividends, OAS claw back Minimum tax Stock option — Division C deduction Loss carryover Allowable business investment loss Marginal tax rates Pension splitting Income, ordering rules Income and taxable income, ordering rules Income and taxable income, ordering rules Income and taxable income, ordering rules Subdivision e deductions; taxable income for an individual; personal tax

CHAPTER 10

5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23

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Ch. 10/Study Guide — Review Questions

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251

REVIEW QUESTIONS

(1) Ms. Gnu, a new client of yours, has brought in her tax information and is confused. In prior years, she has had some financial difficulties and has lost money in a number of her business ventures. As a result, she has some net capital and some non-capital losses. This year, she earned some income, but she does not know how to decide which losses to apply against this income. What advice do you have for her? (2) Evan earns $160,000 of employment income and has come to you to talk about his investment income. He earns $10,000 of dividend income from a Canadian-resident public corporation in the year. He wants you to tell him what his marginal tax rate is on this dividend income. (3) Phil earns $160,000 of employment income and has come to you to talk about his investment income. He earns $10,000 of interest income in the year. He wants you to tell him what his marginal tax rate is on this interest income. (4) Karen earns $160,000 of employment income and has come to you to talk about her investment income. She realized a $10,000 capital gain in the year and wants you to tell her what her marginal tax rate is on this capital gain.

CHAPTER 10

(5) Ms. Aarts is a painter who specializes in watercolours. In the artistic tradition, she does not make a great deal of money. In fact, she has never made over $20,000 of taxable income in any year. This year is no exception. She expects to have taxable income of $20,000 but she is also planning to donate one of her watercolours to a local charity to be used in one of their fundraising events. The value of the painting is $8,000 and her cost of the painting is $200. She has heard that there are special rules for artists making charitable donations of their work but she does not know if these rules will help her. She does not make any other donations. What is your advice? (6) During the year Patricia had full-time employment income from employer A of $75,000 and from employer B of $65,000. Both employer A and employer B each deducted $3,500 from her salary for CPP. What impact will the CPP contributions for her employment income have on her personal tax return?

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EXERCISES

Exercise 1

ITA: 3

Paragraph 3(a) of the Income Tax Act requires that all non-capital sources of income be included. It is necessary to disclose each source of income in the computation of net income for tax purposes. Consider the following: (a) Dividend income from a CCPC. (b) Loss from a sole proprietorship. (c) Cashier’s income from a grocery store. (d) Commissions earned from sales with a real estate company. (e) Research consulting fees. (f) Rental income earned on a single dwelling. (g) Bonus income. (h) Gain on the sale of land by a real estate development company. (i) Profit from the sale of shoes earned in an incorporated company. (j) Employment insurance income. (k) Dividend income earned from a foreign investment. (l) Tips earned as a hair stylist.

— REQUIRED Identify the source of income for each of the above.

Exercise 2

ITA: 3, 111

The following information has been provided by your client, Ms. Campbell.

2021

2022

2023

Capital gains (CG) . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$37,500

$50,000 $11,250

Capital losses (CL) (excluding BIL) . . . . . . . . . . . . . . . . Business investment loss (BIL) . . . . . . . . . . . . . . . . . . .

15,000 —

— 30,000

22,500 —

Additional Information (1) The above capital gains do not include capital gains from qualified farm property or qualified small business corporation shares. (2) Ms. Campbell had a $7,500 net capital loss realized in 2018. (3) Ms. Campbell has not had a taxable capital gain prior to 2020. (4) Ms. Campbell had a property loss of $7,000 in 2021 and property income of $1,000 and $2,000 for 2020 and 2022, respectively.

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— REQUIRED (A) Determine Ms. Campbell’s net income for tax purposes from the sources indicated for 2021 to 2023. (B) Determine the optimal claim of Net capital losses as a Division C deduction to use for 2021 to 2023. Note Ms. Campbell has only her basic personal tax credit.

Exercise 3

ITA: 3, 111

Consider the following two taxpayer situations: Taxpayer A Gross salary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $45,000 Interest income ................................................................ 2,000 Self-employed income (assume for tax purposes) 5,000 Loss from business . . . . . . . . . . . . . . . . . . . . . . . . Charitable donations ........................................................ (280) Income tax paid . . . . . . . . . . . . . . . . . . . . . . . . . . (15,000) Net cash flow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $36,720

B $15,000 (18,000) (3,200) ($6,200)

— REQUIRED

Exercise 4

ITA: Divisions B and C

Mr. Ethan Benjamin has provided you with a list of various sources of income, losses, deductions, and credits for the purpose of determining his basic federal tax. Inclusions: His share of tax profit from a partnership business . . . . . . . . . . . . . . . . . . . . . . . . . . . . $10,000 Canadian bank interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000 Retiring allowance from a former employer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000 Gross salary from new employer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70,000 Director’s fee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000 Taxable capital gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000 Taxable benefits from employment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000 Rental income from a triplex . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25,000 Deductions, Losses, and Tax Credits: Mortgage interest on triplex ........................................................................................................ 23,000 Canada Pension Plan contributions tax credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 469 Canada Pension Plan enhanced contribution deduction . . . . . . . . . . . . . . . . . . . . . . . . . 631 Property taxes and insurance on triplex . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,500 Non-capital losses from a previous year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,000 Allowable capital loss for this year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,000 Net capital losses from a previous year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000 Maintenance costs for triplex . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,500 Contribution to employer’s registered pension plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,000 Basic personal and spousal tax credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,500 Fees to a professional engineering society . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300 Employment Insurance premiums tax credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 143 Tuition tax credit for night course on computer applications . . . . . . . . . . . . . . . . . . . . 68 Charitable gifts tax credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 550 Canada employment tax credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205 — REQUIRED (A) Determine the income, taxable income and basic federal tax based on the above correct information using the ordering rules in sections 3, 111.1, and 118.92. (B) Cross-reference each amount to the appropriate section of the Act.

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CHAPTER 10

Compute each taxpayer’s net income for the year, utilizing the aggregating formula of section 3 of the Income Tax Act. Where necessary, compute the net capital loss or the non-capital loss.

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Exercise 5

ITA: 118, 122.6, 122.61; IT-513R

Dan, age 50, supported the following persons during 2023:

Wife, Dolly, age 45 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Son, Don, age 24 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Son, Dave, age 20, infirm and living with Dan and Dolly . . . . . . . . . . Daughter, Doris, age 17 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Son, Dan Jr., age 14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mother, age 83, infirm and living with Dan and Dolly . . . . . . . . . . . . .

Net income for tax purposes $3,000 3,800 3,200 2,800 0 7,000

Don is attending university; Dave has been unemployed most of the year; and Doris and Dan Jr. attend high school. Ages are given as of the end of 2023. — REQUIRED Determine Dan’s total federal personal tax credits under section 118 for 2023.

Exercise 6 Sally was employed for a little under two years at the Banff Springs Hotel as a bellhop. When Sally resigned her position, she withdrew her total contributions of $800 from her employer’s pension plan. Sally’s contribution to this plan for her last year was $300.

ITA: 8(1)(m), 56(1)(a), 118(3)

— REQUIRED Determine the tax consequences of the above situation.

Exercise 7

ITA: 118.8

Tina, age 72, has income for tax purposes from the following sources in 2023: Pension income: Old Age Security pension ..................................................................... $8,251 Canada Pension Plan.............................................................................. 2,310 Registered pension plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 350 $10,911 Investment income: Canadian bank interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100 Total Division B income ............................................................................................. $11,011 — REQUIRED Determine the amount Tina can transfer to her husband Tom in 2023.

Exercise 8

ITA: 82(3)

Henry, a resident of your province, cannot decide whether it would be advisable to elect to include in his income, his wife’s cash dividends of $900 received from Canadian-resident public corporations. This is her only income for 2023. — REQUIRED Determine whether Henry should elect under subsection 82(3) for 2023 assuming his federal marginal tax rate is 29%.

Exercise 9 The following selected information has been taken from the 2023 tax return of Adam, who is a bachelor: Income — Division B ..................................................................................................$166,800 Taxable income ........................................................................................................... 160,800 Basic federal tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33,681 Included in the Division B income was foreign interest of $1,500. Withholding tax of $225 had been deducted by the foreign government. This income is not subject to an international tax agreement.

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ITA: 126(1)

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Also included in the computation of Division B income were $300 of dividends received from Canadian-resident public corporations. Included in the computation of taxable income were deductions for net capital losses carried forward of $6,000.

ITA: 111(1)(b)

— REQUIRED Determine the amount of the federal foreign tax credit that can be claimed.

Exercise 10

ITA: Division E, E.1

Compute the federal tax at the top bracket, under minimum tax and regular Part I tax for 2023 on $1,000 of: (A) interest; (B) cash dividends from Canadian-resident public corporation; (C) capital gains.

Exercise 11

ITA: 117(2), 120

— REQUIRED Calculate Jacob’s marginal tax rate using the federal and notional provincial rates provided in this chapter.

Exercise 12

ITA: Division E, E.1

The following is a correct calculation of Betty’s Division E tax payable for 2023: Employment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividends from Canadian-resident public corporation . . . . . . . . . . . . . . . . . . Gross-up @ 38% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CCA enhanced contribution deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loss created by resource property shelter . . . . . . . . . . . . . . . . . . . . . . . . . .

$160,170 30,000 11,400 (631) (102,909)

Net income for tax purposes and taxable income . . . . . . . . . . . . . . . . . . . . .

$ 98,030

Tax on first on next

$ 8,004 9,157

$ 53,359 44,671

.................................... @ 20.5% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 98,200

Less tax credits: Basic personal (15% × $15,000) . . . . . . . . . . . . . . . . . . . . . . . Employment Insurance premiums (max.) (15% × $1,002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CPP contributions (max.) (15% × $3,123) . . . . . . . . . . . . . . . Dividend tax credit (6/11 × $11,400) . . . . . . . . . . . . . . . . . . . . Employment (15% of $1,368) . . . . . . . . . . . . . . . . . . . . . . . . .

$ 17,161

$2,250 150 469 6,218 205

Division E tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(9,292)

$ 7,869

— REQUIRED Determine if Betty is subject to minimum tax in 2023.

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Marginal tax rates, or the tax rate applicable to the next dollar of income earned, are relevant to many decisions. Jacob earns $98,000.

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Exercise 13

ITA: 63, 118

Mr. and Mrs. Ataila immigrated to Canada on May 1 (not a leap year). Mr. Ataila earned $12,400 in Argentina and $72,400 as a senior geologist in Canada. Mrs. Ataila is a homemaker, and mother of three children over the age of 6. Her child care expenses totalled $4,580 for the time she spent planning her entry into the workforce. Mr. and Mrs. Ataila have approached you for assistance with their Canadian tax returns.

— REQUIRED Discuss what you believe are the areas of their returns that they are most interested in.

Exercise 14

ITA: 63, 118

Pierino’s wife died last year. Her income for the year was $28,000. Pierino has a 15-year-old dependent son, James. Pierino works for the Saskatoon Transit Commission and earns $65,000 yearly. He also has a part-time business operation on which he has a loss of $5,250. Pierino contributed $10,000 to his RRSP by transferring some shares in Public Co. Ltd. to his self-administered RRSP. The ACB of the shares was $6,000. He has $3,000 in net capital losses being carried forward.

— REQUIRED Calculate Pierino’s taxable income and the base amounts of his personal tax credits. Ignore any CPP and EI contributions.

Exercise 15 The following selected information has been taken from the tax records of Ms. Cheryl: Employment income (loss) Rental income (loss) . . . . . . . . . . . . . . . . . . . . . . . Business income (loss) . . . . . . . . . . . . . . . . . . . . . . Capital gains (capital losses): Listed personal property . . . . . . . . . . . . . . . . . Other personal-use property . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other deductions: Spousal support paid . . . . . . . . . . . . . . . . . . . .

2021 2022 2023 $ 15,000 $ 20,000 $ 25,000 $ 4,000 $ (2,000) $ 2,000 $(32,000) $ 15,000 $ 14,000 $ 5,400 $ 5,000 $ 6,000

$ (7,000) $ 3,600 $ (3,000) $ 2,000 $ 12,000 $ (7,600)

$ 9,000

Additional Information (1) Losses carried forward from 2020: Non-capital losses arising in 2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net capital losses arising in 2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 42,000 $ 23,000

(2) The 2023 capital loss of $7,600 includes a business investment loss of $3,000.

— REQUIRED Determine the income for each of the above years according to section 3. Then determine the taxable income for each year in accordance with the ordering rules of Division C.

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Exercise 16 Theresa Taxplan has the following sources of income and deductions for 2023. She is single with no dependants. She made $780 in charitable donations in 2023, which is consistent with prior years’ donation amounts. Employment income for tax purposes* . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 70,000 Grossed-up Canadian dividends** . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,000 Taxable capital gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 51,000 Foreign investment income*** . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 10,000 Business loss ........................................................................................................... $ (59,539) RRSP contribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (9,000) Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (3,000) CPP enhanced contribution deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (469) Net and taxable incomes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 64,000 * Employment Insurance premiums of $953 and CPP contributions of $3,039 and CPP enhanced contributions of $461 withheld. ** From Canadian-controlled private corporations; 15% dividend gross-up and 9/13 dividend tax credit.

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*** $1,500 tax withheld thereon.

— REQUIRED Calculate Theresa’s federal income tax payable for 2023.

Exercise 17 The following is a summary of Mrs. Smith’s income for 2022 and 2023.

Employment income . . . . . . . . . . . . . . . . Retiring allowance . . . . . . . . . . . . . . . . . . Interest income . . . . . . . . . . . . . . . . . . . . Cash dividends from Canadian public corporations . . . . . . . . . . . . . . . . . . . . . . . . . Canada Pension Plan received . . . . . . . . . Old Age Security pension received . . . . . .

2022 $ 32,000 $ 0 $ 6,000

2023 $ 28,000 $ 10,000 $ 6,000

$ 0 $ 0 $ 0 $ 38,000

$ 9,000 $ 2,000 $ 3,120 $ 58,120

Mrs. Smith retired from Hudson’s Bay Company on July 1, 2023, at age 65. She had been employed by Hudson’s Bay as a merchandise buyer since July 30, 1995. She has never been a member of a pension plan. She had unused RRSP deduction room at the end of 2022 of $4,000. During 2022, she contributed $5,000 to her RRSP plan. In February 2024, she contributed $12,000 to a spousal RRSP. Mr. Smith retired two years ago and has an annual net income of $30,000. — REQUIRED Calculate Mrs. Smith’s federal tax payable for 2023. She wishes to claim the maximum deductions and credits available to her to reduce her tax liability. Assume a combined CPP and EI credit of ($1,708 + $600) × 15% = $346. Additionally Mrs. Smith has an CPP enhanced contribution deduction of $259.

Exercise 18 Mr. Black is a widower with five children, ages 22, 18, 16, 11, and 9. The 22-year-old attended Queen’s University for eight months in 2022. The tuition fees were $5,000. The 22-year-old and the 18year-old were the only children with income in 2023. They each had net income of $8,000. — REQUIRED With the information provided, compute the maximum federal non-refundable tax credits that may be claimed by Mr. Black in 2023. Show all your calculations.

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Exercise 19 Mr. Green made the following contributions during 2023: Cancer Society . . . . . . . . . . . . . . . . . . . . $ 100 Church . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,000 Liberal Party of Canada . . . . . . . . . . . . . . $ 200 University of Waterloo . . . . . . . . . . . . . . . $ 1,000 United Way . . . . . . . . . . . . . . . . . . . . . . . $ 3,000 Conservative Party of Canada . . . . . . . . . $ 200 His net income for 2023 after deducting his $16,500 RRSP contribution was $132,000. He makes similar charitable donations on an annual basis. — REQUIRED By what amount do the above contributions reduce Mr. Green’s federal tax liability for 2023? Show all your calculations.

Exercise 20 During 2023, Lot Saluk sold his 500 shares of a small business corporation, Downer Ltd., for $2 per share. He had acquired these shares for $20 per share in 2020. Lot claimed capital gains deductions of $1,000 in 2004 and $2,000 in 2006 only. His only income for 2023 is interest income of $600 and employment income of $15,000. — REQUIRED Calculate Lot Saluk’s taxable income for 2023 and show all calculations.

Exercise 21 Adam owns the following assets: Upper Public Corp. shares . . . . . . . . . . . . . . . . . . . . Rental building . . . . . . . . . . . . . . . . . . . . . . . . . . . .

FMV $ 40,000 $900,000

UCC $ 0 $400,000

UCC $ 50,000 $500,000

— REQUIRED For each of the following three scenarios, determine: (a) the income tax consequences to Adam on the disposition in 2023; (b) the income tax cost of the asset to the first acquirer; and (c) the income tax consequences of the subsequent events. Scenario #1: Adam sells the rental building to his daughter, age 23, for $850,000. She earns $6,000 rental income annually from the building. Later, she disposes of the building at a substantial gain. Scenario #2: Adam sells the shares to his wife for $40,000 cash. She receives $4,000 in dividends on the shares and then sells them for $45,000. Scenario #3: Adam gifts the shares to his 11-year-old nephew, and the nephew receives $4,000 in dividends.

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259

ASSIGNMENT PROBLEMS

Problem 1

ITA: 118; IT-513R

Jack and Jill were married on December 1, 2023. Jill and her two children of a previous marriage moved into Jack’s home. Jill’s children are 14 and 16 and have no income. Jack and Jill have the following income for tax purposes for 2023: Prior to the marriage Jack . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $33,000 Jill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,800

Subsequent to the marriage $3,000 800

You have been asked to: (A) Determine the optimum personal tax credits under section 118 for both Jack and Jill for 2023. (B) How would your answer change in 2024 if the income levels remain the same?

Problem 2

ITA: 118.6, 118.8, 118.9

Determine the amount Sammy can transfer under section 118.8 or 118.9 to another qualified person. List the potential persons to whom Sammy can transfer his tuition tax credits.

Problem 3

ITA: 2(2), 3, 111

Blake, a recent accounting program graduate, earned the following during the year: Gross income from employment . . . . . . . . $ 7,000 Provincial lottery winnings ............................. 2,500 Capital gain on ABC shares ............................ 1,200 Inheritance from grandmother ..................... 12,000 Interest income from inheritance .................. 800 Blake has asked you to: (a) Calculate his net income for tax purposes for the year. (b) Calculate his taxable income for the year. Assume that Blake has a non-capital loss carryforward from last year of $3,000.

Problem 4

ITA: 3, 111

The following information has been provided by your client, Mr. Stanley Norman: Employment income . . . . . . . . . . . . . . . . . . . . . . . . . . Property income (loss) . . . . . . . . . . . . . . . . . . . . . . . . Capital gains (CG) . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital losses (CL) (excluding BIL) . . . . . . . . . . . . . . . Business investment loss (BIL) . . . . . . . . . . . . . . . . . .

2021 2022 $75,000 $80,000 (4,000) 3,000 144,000 — 18,000 22,500 36,000 54,000

2023 $ 90,000 (6,000) 160,000 80,000 —

Additional Information (1) The above capital gains do not include capital gains from qualified farm property or qualified small business corporation shares. (2) Mr. Norman had a $21,000 net capital loss which was realized in 2018. (3) Mr. Norman did not have a capital gain prior to 2021. Dealing with each item line-by-line across the years, rather than one year at a time: (A) determine Mr. Norman’s income from the sources indicated for 2021 to 2023 according to the ordering rules in section 3, and

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Sammy, who was a resident of Canada and who attended the University of Alberta on a full-time basis for eight months during 2023, has employment income for tax purposes of $5,000. He paid tuition fees of $1,800 in 2023. Withheld from his income were $79 in Employment Insurance premiums and $74 in CPP contributions.

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(B) determine Mr. Norman’s taxable income from the sources indicated from 2021 to 2023 after amending the returns.

Problem 5 Mrs. Plant, age 47, is married and has three children: Amanda, age 24, Joan, age 17, and Courtney, age 16. Her own income for tax purposes of $60,000 includes employment income of $68,000.

ITA: 56(1)(u), 56(1)(v), 74.1(1), 110(1)(f), 118, 118.3, 118.6, 118.9, 122.6, 122.61

Amanda has been certified as impaired by a medical doctor. Her only income is $7,000 from social assistance payments relating to her disability. She took a university course on a part-time basis for four months. Mrs. Plant paid her tuition fees of $300. Joan attended a university on a full-time basis in another city for eight months, had employment income for tax purposes of $4,200 from a summer job while living at home and received a $2,500 scholarship. Mrs. Plant paid Joan’s tuition fees of $3,000 and Joan paid her own moving costs to and from the university which were $150 each way. Courtney, who is attending high school, had employment income for tax purposes of $2,800 from summer employment and a part-time job. Mr. Plant, age 50, has been certified as physically impaired and infirm as a result of a workplace accident. He has the following sources of income: Worker’s Compensation payment ................................................................................. $5,000 Cash dividends from shares of Canadian-resident public corporations purchased with Mrs. Plant’s savings .......................................................................... 4,000 Bank account interest earned from reinvestment of dividend income . . . . . . . .

100

Mrs. Plant has asked you to calculate the non-refundable tax credits available to her for 2023. Compute Joan’s taxable income to determine if any of her tuition credits will be available to Mrs. Plant. Prepare detailed calculations supporting your claim. All ages are given as of the end of 2023.

Problem 6

ITA: 118(4)

Angelina and Romeo are the divorced parents of Maria, who is 10 years old. Angelina and Romeo have joint custody and Maria lives every second month with the other. Both Angelina and Romeo have claimed Maria for the wholly dependent person (equivalent to spouse) tax credit. Is the claim by Angelina and Romeo allowed?

Problem 7 Mrs. Jackson, age 66, separated from her husband on October 17, 2023. She started receiving support payments from Mr. Jackson of $2,500 per month in November 2023. All of the support payments made commencing in November 2023 are considered to be pursuant to the divorce settlement. Of the $2,500 monthly payment, $1,000 is for the support of their daughter, Rachel. (In 2023, Mr. Jackson earned a salary of $100,000 per year and also earned other investment income.) Mrs. Jackson has income of $26,200. Their eldest daughter Rachel is 40 and infirm and lives with Mrs. Jackson since she is severely mentally handicapped. She has been certified as impaired by a medical doctor. A part-time attendant helps care for Rachel at a cost of $12,000 per year. Rachel has no income. her.

Mrs. Jackson would like to know what tax credits related to her daughter Rachel are available to

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Problem 8

ITA: 118.2

Mr. Jennings provides you with the following medical expenses and additional information for himself and members of his family who live with him, when he asks you to prepare his 2023 tax return. Assume that you have correctly computed the incomes under Division B for 2023 as follows: Mr. Jennings ................................................................................................................ $65,000 Mrs. Jennings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 Son, age 19 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000 Son, age 15 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,000 Daughter, age 14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,800 Medical expenses for 2023: February May June July

Prescription drugs for daughter . . . . . . . . . . . . . . . . . . . . . $ 20 Doctor’s bill paid for son, 15 . . . . . . . . . . . . . . . . . . . . . . . 15* Chiropractor’s bill for the past year.............................................. 1,150* Glasses for Mr. and Mrs. Jennings ..................................................300 $1,485

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Medical expenses to March 31, 2024: February March

Orthodontist fee for daughter ..................................................... $2,550 EXpenses relating to older son’s car accident: Hospital.............................................................. $1,500 Surgery ................................................................ 1,000 Drugs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200 2,700*

Additional expenses anticipated by May 31, 2024: (a) Additional medical bills from son’s accident . . . . . . . . . . . . . . . . . . . . . . . . (b) Eyeglasses for his younger son and daughter ($225 each) . . . . . . . . . . . . . (c) Dental bills (2/3 for Mr. & Mrs. Jennings) . . . . . . . . . . . . . . . . . . . . . . . . . . (d) Chiropractor’s bill for the past year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 750* 450 375 1,050

* EXcess over provincial plan payments.

Discuss the tax implications of Mr. Jennings claiming the above medical expenses for each of 2023 and 2024. Assume that all income amounts for 2024 will be the same as those for 2023.

Problem 9

ITA: 82, 118, 118.8

Mr. and Mrs. Reid, ages 55 and 50, received the following income during 2023: Mr. Reid: Employment income (commission) . . . . . . . . . . . . . . . . . . . . . . . . . . . . Employment expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investment income: Canadian interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividends received (in Cdn. $): Canadian-resident public corporations . . . . . . . . . . . . . . . . . . . U.S. corporations (net of 15% withholding tax) . . . . . . . . . . . .

$15,000 (13,000) 2,000 1,000 680

Mrs. Reid: Employment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investment income: Canadian interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividends received from Canadian-resident public corporations . . . .

65,000 1,000 2,000

Calculate Mrs. Reid’s federal tax, ignoring the foreign tax credit and ignoring the election to include spousal dividends.

ITA: 82(3)

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Problem 10 Pamela is 38 years old and lives in Welland, Ontario. She commutes daily to Niagara University, in Niagara Falls, New York. She is completing a full-time Masters in Education that is 12 consecutive months in duration. Her tuition fees are the equivalent of C$20,000 per year.

ITA: 118.5(1), 118.6; Income Tax Folio S1-F2-C2 — Tuition Tax Credit

Advise Pamela if she can claim the tuition fees on her personal income tax return. Your answer should be supported with appropriate references to the Act.

Problem 11 Stuart presents to you the following information concerning tuition fees paid for 2021, 2022, and 2023: 2021 2022 2023

Harvard University, Masters in Business Administration, fall term . . . . . . . . . . Harvard University, Masters in Business Administration, winter and fall terms Harvard University, Masters in Business Administration, winter term . . . . . . . . Re-read fee for failed course . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Make-up course at Harvard for failed course, July–August . . . . . . . . . . . . . . . . Income tax course at University of Toronto, fall term; the tuition fee of $500 was paid through a scholarship that Stuart received from his father’s employer, Universal EXports Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fitness course taken at a local secondary school in Ontario . . . . . . . . . . . . . . .

ITA: 118.5; Income Tax Folio S1-F2-C2 — Tuition Tax Credit

$15,000 30,000 15,000 300 3,000

500 35

Discuss the tax implications of the above tuition fee payments.

Problem 12

ITA: Division B, C, E

Clare and Alan, both age 70, widowers, and retired successful businesspeople, love to argue. The one fact that they agree upon is that they pay too much income tax. They both receive $8,251 of Old Age Security and $9,000 of Canada Pension Plan payments each year. Clare has $62,000 of income from a registered pension plan. Alan receives $62,000 in dividends from the active business income taxed at the low rate in his incorporated business, a CCPC, which is now managed by his son. Determine which one of the two pays the most federal income tax for 2023.

ITA: 82(3)

Problem 13

ITA: Division E, E.1

Dawn, a client of yours, generally has employment income from her company and some investment income. In early 2023, you arranged Dawn’s affairs such that she would crystallize her remaining $500,000 of capital gains exemption on qualified small business corporation shares. Dawn does not pay EI. For 2023, her income is estimated as follows: Employment income (CPP $3,123 + 631 enhanced contribution) . . . . . . . . Dividends from Canadian-resident public corporations . . . . . . . . . . . . . . . . Gross-up @ 38% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable capital gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . RRSP contribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CCP enhanced contribution deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital gains deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 72,670 20,000 7,600 250,000 (21,909) (19,500) (631) (250,000)

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 58,230

Calculate what effect, if any, minimum tax will have on Dawn’s 2023 federal tax payable.

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Problem 14 Once again, you have been asked for advice on employee stock options by two different clients. This is a continuation of Assignment Problem 2 in Chapter 3 and Assignment Problem 2 in Chapter 7. (1) Omer is part of the management team of a Canadian public company and is eligible for the employee stock option plan. A few years ago he received an option on 1,000 shares. The option requires him to pay the option price of $30 (the value at the time the option was granted) for the shares at the time he exercises his option. Omer exercised the option three years ago when the shares were worth $35 and has sold the shares this year for $45. He has asked you to tell him the effect of this option on his taxable income for all the years. (2) Hilda is part of the management team of a Canadian-controlled private company and is eligible for the employee stock option plan. A few years ago she received an option on 1,000 shares. The option requires her to pay the option price of $30 (the value at the time the option was granted) for the shares at the time she exercises her option.

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Hilda exercised the option three years ago when the shares were worth $35 and has sold the shares this year for $45. She has asked you to tell her the effect of this option on her taxable income for all years.

Problem 15 Nate has come to you for tax advice for 2023. He has identified the following income for 2023 and would like you to calculate the effects of the above on his income, taxable income, and loss carry forward for the year. Employment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 40,000

Lottery winnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3,000

Stock option benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5,000

Division C deduction for stock option . . . . . . . . . . . . . . . . . . . . . . . . . .

(2,500)

Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(60,000) 15,000

Allowable capital loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(20,000)

Inheritance from his grandmother . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

12,000

Dividends

1,000 150

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross-up . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Problem 16 Natalia has the following income for 2023: Employment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 40,000

Stock option benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5,000

Division C deduction for stock option . . . . . . . . . . . . . . . . . . . . . . . . . .

(2,500)

Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(60,000)

Taxable capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

15,000

Allowable business investment loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(20,000)

Dividends

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross-up . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,000 150

Calculate the effects of the above on Natalia’s income, taxable income, and loss carry forward for the year.

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Problem 17 The accounting firm you work for is preparing a booklet on personal tax, and the tax partner has asked you to prepare some of the material. She has asked you to calculate a generic marginal tax rate for individuals in the top tax bracket for each of the following types of income. Assume $1,000 of each type of income is earned. Employment Business Interest Eligible dividends Other Canadian dividends Capital gains To be able to move this into the publication easily she has asked you to use the following format: Tax Brackets Tax Rates By Bracket Federal rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provincial rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Federal + provincial dividend tax credit = gross up Marginal Tax Rates Employment

over $235,675 33% 17% 50%

Business Interest

% %

Eligible dividends Non-eligible dividends Capital gains

% % %

Problem 18 Harry and Shia are married. Both are retired and over 65 years old. They have the following income in 2023: Harry Shia Company pension . . . . . . . . . . . . . . . . . . . $120,000 $ – Canada Pension Plan . . . . . . . . . . . . . . . . 12,100 6,000 Old Age Security . . . . . . . . . . . . . . . . . . . 8,251 8,251 Registered Retirement Income Fund . . . . . 12,000 They have asked you to calculate the amount of federal tax they will pay on this income in 2023. Part 1: Do not split pension income as allowed. Report it as shown above. Part 2: Split pension income as allowed (refer to Ch. 9). Hint: Only calculate the personal, married, age, and pension credits. Remember to calculate any tax on Old Age Security income.

Problem 19 Jeffrey Lowe is an associate in a local law firm. He also has a number of sources of income from various investments and sideline businesses. Jeffrey has provided you with the following information for 2023: Salary from law practice ................................................................. $120,000 Business loss ......................................................................................... (7,500) Gross rents received from rental property......................................... 25,000 Operating expenses on rental property ............................................ (31,000) Capital gain on sale of shares ............................................................. 10,000 Net interest income ............................................................................... 9,000 Allowable capital loss (including allowable business investment loss of $6,000)............ (11,000) Contribution to RRSP ........................................................................... (1,000) Share of net income from duplex rental property (owned by Jeffrey and his sister) ................................................ 15,000 Net capital losses from 2017................................................................ (3,000) Jeffrey has asked you to calculate his 2023 net income for tax purposes in accordance with the ordering rules in section 3 of the Income Tax Act.

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ITA: 2(2), 3, 111

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265

Problem 20

ITA: Division B, C

The following tax information is extracted from Mrs. Hawkins’ books and records: Employment income (before effects of items below) . . . . . . . . . . . . . . . . . . . Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital gains (on securities) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deductible carrying charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . EI Contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CCP contribution ($3,123 + $631 enhanced contribution) . . . . . . . . . . . . . . .

$89,000 5,000 9,900 1,000 1,002 3,754

The following balances are losses carried forward from December 31, 2022:

CHAPTER 10

Non-capital loss arising — 2017 ....................................................................................... $24,000 — 2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26,000 — 2021 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,000 Total non-capital losses ............................................................................................... $78,000 Net capital loss arising in 2022 .................................................................................. $12,000

During the latter part of 2023, Mrs. Hawkins moved from Montreal to Toronto to commence working for Leaves Co. Ltd. She received a $100,000 housing loan from Leaves Co. Ltd., which she used to help purchase a house in Toronto. Mrs. Hawkins received the interest-free loan on October 1, 2023. Mrs. Hawkins previously worked for Les Habitants Co. Ltée (a public company). Prior to leaving Les Habitants Co. Ltée on April 15, Mrs. Hawkins exercised the stock option that she held in Les Habitants Co. Ltée. Mrs. Hawkins was able to purchase 2,000 listed common shares of Les Habitants Co. Ltée for $4 per share (the fair market value of the shares at the time the option was granted). The shares were trading at $10 per share at the time she exercised her option to purchase the shares. Assume that the prescribed interest rate for the last quarter of 2023 is 1%. Calculate Mrs. Hawkins’ income and taxable income in 2023, in accordance with the ordering rules of Divisions B and C. Ignore any effects of any leap year.

Problem 21

ITA: 3, 111, 111.1

The following selected tax information has been taken from the books and records of your client, Mr. Weilman, who is 51 years old. Employment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other business income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . Property income: Canadian interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rental income from real property (loss) . . . . . . . . . . . . . . . Capital gains (capital losses):* Listed personal property . . . . . . . . . . . . . . . . . . . . . . . . . . . Other personal-use property . . . . . . . . . . . . . . . . . . . . . . . . Other capital property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other deductions: RRSP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Support of former spouse . . . . . . . . . . . . . . . . . . . . . . . . . .

2022 2023 $ 60,000 $ 75,000 (14,000) (23,000) 7,000 3,000

16,000 (4,000)

6,000 2,000 6,000

20,250 (4,000) (45,000)

1,000 7,000

3,000 7,000

* The 2023 other capital property loss includes a business investment loss of $24,000.

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The following balances are losses carried forward from December 31, 2021: Non-capital loss arising in 2019 ................................................................................. $63,000 Net capital loss arising in 2020 .................................................................................... 25,000 Listed personal property loss arising in 2019 . . . . . . . . . . . . . . . . . . . . . . . . . 5,000 Mr. Weilman was not a member of a registered pension plan and, hence, his pension adjustment for the relevant years was $0. His earned income for 2021 was $33,250. Prepare a schedule for the calculation of income and taxable income for 2022 and 2023, in accordance with the ordering rules under Divisions B and C, after applying any loss carryforward and loss carryback provisions through an amended return. (Deal with each item line-by-line across the years, rather than computing income one year at a time.)

Problem 22 Ms. Isabelle Cardin had a tumultuous year in 2023. She broke her engagement early in the year and quit her job. She moved to a resort area to take a waitress job and to start up a fitness instruction business. She has had the following items correctly calculated and classified as either inclusions, deductions or tax credits for the purposes of determining her taxable income and federal tax. Inclusions: Benefit received from Employment Insurance program . . . . . . . . . . . . . . . . . . . . . . . . $ 600 Board and lodging provided by employer during busy season of resort . . . . . . . . . . . . 8,000 Bonus from resort employer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500 Business revenue from fitness instruction fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,000 Gratuities as a waitress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,100 Interest on Canada Savings Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 775 Rental revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,000 Salary received as a waitress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,000 Taxable capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,750 Retiring allowance from previous employer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800 Deductions, Losses, and Tax Credits: Allowable capital loss ..................................................................................................................... 4,500 Capital cost allowance on fitness business equipment ................................................................ 1,300 Capital cost allowance on rental building ..................................................................................... 1,200 Charitable gifts tax credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Child care expenses........................................................................................................................ 1,800 Canada Pension Plan tax credit contributions on employment earnings . . . . . . . . . . . . . 63 Canada Pension Plan enhanced contributions deduction . . . . . . . . . . . . . . . . . . . . . . . . 64 Medical expenses tax credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Business expenses of earning fitness instruction fees . . . . . . . . . . . . . . . . . . . . . . . . . . 900 EXpenses of objection to a tax assessment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 Interest on funds borrowed to pay expenses of earning fitness instruction fees . . . . . . . 75 Maintenance on rental property .................................................................................................... 1,100 Mortgage interest on rental property ............................................................................................ 2,500 Moving expenses ............................................................................................................................. 1,700 Non-capital losses from previous year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600 Personal tax credit ......................................................................................................................... 2,250 Property tax on rental property .................................................................................................... 1,000 Employment Insurance premiums tax credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 Union dues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100 Canada employment credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205 You have been asked to: (A) Determine the income, taxable income and basic federal tax based on the above correct information using the ordering rules in sections 3, 111.1, and 118.92. (B) Cross-reference each amount to the appropriate section of the Act.

Problem 23 Mr. I.M. Leaving formally separated from his wife early in 2022. Custody of his four children, aged 18, 13, 12, and 11 was given to him as part of an agreement worked out with his wife in family court. To make a fresh start, effective March 31, 2023 he resigned his position in Toronto, where he had been employed by the same employer since November 1984, and took a position in Kanata near Ottawa. In previous years, he had always prepared his own tax return, but because of the extraordinary events of 2023, he was having some difficulty with the calculation of his income and taxes payable. He has come

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ITA: 245; Division B, C

Ch. 10/Study Guide — Assignment Problems

267

to you for help with these calculations, having already correctly calculated his income under Subdivision a, b, and c of Division B as follows: Subdivision a Salary (from both employers in 2023) . . . . . . . . . . . . . . . . . . . . . . . . Taxable group term life insurance premium paid by both employers Less: RPP — (both employers) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Subdivision b Business income: Share of partnership income (drawings of $4,000) Property income: Net rental loss from apartment building . . . . . . . . . . . . . . . . . . . Grossed-up dividends from taxable Canadian public corporations Canada Savings Bond interest . . . . . . . . . . . . . . . . . . . . . . . . . . .

550

$75,000 $75,550 (5,100)

$70,450 $ 8,500

$(4,500) 1,250 600 (2,650) 250

(2,900)

$ 5,600

$ 6,000 5,000 500

CHAPTER 10

Less: interest on loan to buy shares . . . . . . . . . . . . . . . . . . . . . . . . . . Subdivision c Taxable capital gains net of allowable capital losses Sale of shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sale of cottage owned jointly with wife for past 5 years (after principal residence exemption) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sale of painting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

11,500 $87,550

Additional Information (1) He had the following additional receipts during 2023: A lump-sum payment out of the RPP of his former employer who had made vested contributions for the last 10 years (including 2023) transferred directly to his RRSP .............................................................................................................................. $20,000 A retiring allowance for long service from his previous employer ..................................... 60,000 $80,000 (2) He made the following selected payments in respect of 2023: RRSP contribution for 2023 (Assume earned income in 2022 was the same as for 2023 and his pension adjustment for 2022 was $5,000) $70,000 Legal fees: — representation in family court ...................................................................... $4,500 — appealing a tax assessment, which he lost . . . . . . . . . . . . . . . . . . . . . 1,250 Charitable donations (consistent with prior years) . . . . . . . . . . . . . . . . . Maintenance payments for wife by virtue of agreement made pursuant to a court order. Total of monthly payments for her maintenance ...................................... $8,000 Total of monthly payments directly to owner of her apartment . . . . 4,709

5,750 $ 1,250

12,709

(3) Mr. Leaving had net capital losses of $11,466 in 2007, which he has not used. (4) Mr. Leaving has never had a capital gain or loss before, nor has he ever claimed any of his capital gains exemption. (5) Mr. Leaving had the following amounts withheld from his employment wages: Canada pension plan premiums ($3,123 + $631 enhanced contribution) .................. $3,754 Employment insurance premiums ................................................................................ $1,002 (6) Mr. Leaving’s oldest child, Scott, attends Queen’s University and paid $64,000 in tuition fees for eight months of full-time attendance during 2023. Scott earned gross employment income of $2,500 during the summer. No deductions were taken from his pay. (7) Mr. Leaving’s other children do not have any income. — REQUIRED Complete the following calculations. Show all calculations whether or not they are necessary to the final answer. (1) Calculate the Subdivision e deductions for Mr. Leaving. (2) Calculate his taxable income and show all deductions to arrive at his taxable income. (3) Calculate his federal taxes payable.

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CHAPTER 10 — DISCUSSION NOTES FOR REVIEW QUESTIONS (1) There is no ordering that is required to be followed when choosing among the different kinds of losses, except that the oldest losses are always applied first. Generally, the rule of thumb is that the most restricted losses are claimed first. The factors that would have to be taken into account in making this decision are as follows: (a) Does she have the kind of income needed to offset the losses? She would need net taxable capital gains to offset net capital losses. (b) Which losses are going to expire first? Net capital losses can be carried back three taxation years and forward indefinitely and non-capital losses can be carried back three taxation years and forward twenty taxation years. (c) What is the likelihood that she will realize the type of income needed in future years to offset those losses she decides not to claim this year? If she uses up her non-capital losses this year and not her net capital losses, what is the likelihood that she will have a taxable capital gain in the future? (2) His marginal tax rate on dividend income would be: Cash dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross-up 38% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$10,000 3,800

Taxable dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$13,800

Federal tax @ 29% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividend tax credit @ 6/11 × $3,800 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Basic federal tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provincial tax @ 17% of $13,800 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provincial dividend tax credit @ 5/11 × $3,800 . . . . . . . . . . . . . . . . . . . . . . . .

$ 4,002 (2,073) $ 1,929 2,346 (1,727)

Total tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 2,548

His marginal tax rate on these dividends is $2,548/$10,000 = 25.5%. (3) His marginal tax rate on interest income would be: Interest earned . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$10,000

Federal tax @ 29% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provincial tax @ 17% of $10,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 2,900 1,700

Total tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 4,600

His marginal tax rate on this interest is $4,600/$10,000 = 46%. (4) Her marginal tax rate on capital gains would be: Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$10,000

Taxable capital gain ( /2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 5,000

Federal tax @ 29% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provincial tax @ 17% of $5,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 1,450 850

Total tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 2,300

Her marginal tax rate on this capital gain is $2,300/$10,000 = 23%.

ITA: 111(3)(b)

Ch. 10/Study Guide — Discussion Notes for Review Questions (5) The Act allows an artist to designate the proceeds of the piece of art that is not established to be cultural property at anywhere between the cost and the fair market value, in this case between $200 and $8,000. Looking at the two alternatives:

269 ITA: 118.1(7)

(a) if she designates $200 she will report no net business income since her proceeds equal her cost. However, she will receive a donation receipt for $200 which is worth a federal credit of $200 × 15% = $30; (b) if she designated $8,000 as the proceeds, she would report an additional $7,800 in business income and pay an additional federal tax of $7,800 × 15% = $1,170. However, she will also receive a donation receipt for $8,000 which will generate a federal credit of $200 × 15% + $7,800 × 29% = $2,292. On a net basis she would have a net federal credit from this alternative of $2,292 -- $1,170 = $1,122. On a net basis, she would be further ahead to designate the full $8,000 as the proceeds. She would receive an incremental benefit of $1,092 (i.e., $1,122 -- $30) plus the provincial tax effect. If the work of art is a cultural gift, the Act deems the artist to have received proceeds of disposition equal to the cost. However, the legislation would entitle the artist to a credit based on the certified fair market value of the work. As a result, no business income needs to be reported on the disposition and a credit based on the full value is available.

ITA: 118.1(7.1)

(6) Patricia will receive a personal credit of $456 equal to 15% times the maximum CPP contribution for the year of $3,039. She will receive a tax deduction for her CPP enhanced contribution to a maximum of $461. The excess beyond $3,500 will be refunded to her since it will be an overcontribution.

ITA: 118.7

ITA: 118.1(1)

CHAPTER 10

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CHAPTER 10 — SOLUTIONS TO EXERCISES Exercise 1 (a) Property income

ITA: 3

(b) Business income (c) Employment income (d) Employment income (e) Business income (f) Property income (g) Employment income (h) Business income (i) Business income (j) Other income (k) Property income (l) Employment income

Exercise 2 (A)

2021 Income from non-capital sources (≥0): Property income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2022

2023

$ 2,000

ITA: 3(a)

$ 1,000

Net taxable capital gains (≥0). Taxable capital gains (see Schedule 1, Part (A), below) . . . . . . . . . . . . . . . Allowable capital losses . . . . . . . . . . . . . . . . . . . . . . . . .

ITA: 3(b)

$18,750 $25,000 (7,500) $ 0

$ 5,625 (11,250)

$11,250

$25,000

Total income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Losses from non-capital source and ABIL: Property loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ABIL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$12,250

$25,000

$ 2,000

$ $

$(7,000) $ (15,000) $

Division B income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (B) Deduct: Net capital losses (see Schedule 1, Part (B) below for maximum) . . . . . . . . . . . . . Non-capital losses . . . . . . . . . . . . . . . . . . . . . .

$12,250

$ 3,000

$ 2,000

$ $

Taxable income (max. equal to personal tax credit base)

$12,250

$ 3,000

2021 2022 (A) Net taxable capital gains Taxable capital gains (TCG) ......................... $18,750 $ 25,000 Allowable capital losses (ACL) ........................ (7,500) —

2023

ITA: 3(b) ITA: 3(d )

0 0

25,000

0 0

$ 2,000

SCHEDULE 1

$11,250

5,625 (11,250)

(5,625)

ITA: 3(e)

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271

(B) Net capital losses 2021

2022

2023

Lesser of: (i) Net TCGs for the year . . . . . . . . . .

$11,250

$25,000

(ii) Total of adjusted net CLs . . . . . . .

$ 7,500

$7,500

ITA: 111(1)(b), 111(1.1)(a), 111(8)(a)

Max claim (lesser amount) . . . . . . . . . .

$7,500

No deduction because of personal credit . . .

2021 Net CL . . . . . . . . . . . . . . . . . . . . $ 7,500 Utilized in 2021 . . . . . . . . . . . . . . – Available in 2024 . . . . . . . . . . . . . $ 7,500

2023 $5,625 N/A $5,625

Total $13,125 – $13,125

Exercise 3 Taxpayer computation of net income for tax purposes Paragraph 3(a) Section 5 Employment income . . . . . . . . . . . . . . . . . . . . . . . . . . Section 12 Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Section 9 Net income from a business . . . . . . . . . . . . . . . . . . . . . Paragraph (d ) Current-year business loss . . . . . . . . . . . . . . . . . . . . . Net income for tax purposes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-capital loss carryforward Current business loss ($18,000) -- loss utilized ($15,000) = . . . . . . . .

$45,000 2,000 5,000

$15,000

$52,000

(15,000) 0 $(3,000)

Charitable donations are a non-refundable tax credit and reduce taxes payable.

Exercise 4 DIVISION B Par. 3(a) Subdivision a Sec. 5 Par. 6(1)(a) Par. 6(1)(c) Less: Par. 8(1)(i ) Par. 8(1)(m) Subdivision b Sec. 9 Par. 12(1)(c) Subdivision d Par. 56(1)(a) Par. 3(b) Subdivision c Par. 38(a) Par. 38(b)

Salary . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable benefits . . . . . . . . . . . . . . . . . . Director’s fees . . . . . . . . . . . . . . . . . . . .

$ 70,000 3,000 5,000

Professional engineering fees . . . . . . . . . Registered pension plan contributions

Business income — share of partnership tax profits . . . . . . . . . . . . . . . . . . . Canadian bank interest . . . . . . . . . . . . .

300 4,000

$ 10,000 3,000

$ 78,000 4,300 $ 73,700

13,000

Retiring allowance ............................................................. 20,000 Total par. 3(a) income ................................................... $106,700 Taxable capital gain . . . . . . . . . . . . . . . . Allowable capital loss . . . . . . . . . . . . . . .

$ 20,000 (2,000)

18,000 $124,700

ITA: 3, 111

CHAPTER 10

Note: No Net CL was claimed in 2021 or 2022 as income was below the personal credit level.

Introduction to Federal Income Taxation in Canada

272 Par. 3(d ) Subdivision b Ssec. 9(2):

Par. 3(e)

Par. 60

Rental loss Rental revenue . . . . . . . . . . . . . . . . . . . $ 25,000 Less: EXpenses Par. 20(1)(c) Mortgage interest.................. (23,000) Par. 18(1)(a) Taxes and insurance . . . (4,500) Par. 18(1)(a) Maintenance . . . . . . . . (1,500) (4,000) CCP enhanced contrib. deduction .................................

(631)

Division B income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Par. 111(1)(a) Non-capital loss . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,000 Par. 111(1)(b) Net capital loss ........................................................... 5,000 Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Federal tax after credits Tax on $106,718 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax on next $5,613 @ 26% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax before credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$121,331

Sec. 118(1) Sec. 118(10) Sec. 118.7 Sec. 118.7 Sec. 118.5 Sec. 118.1

(9,000) $112,331 $ 18,942 1,459 $ 20,401

Personal credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Canada employment credit . . . . . . . . . . . . . . . . . . . . . . . CPP contributions credit . . . . . . . . . . . . . . . . . . . . . . . . EI premium credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tuition credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Charitable donation credit . . . . . . . . . . . . . . . . . . . . . . .

(4,500) (205) (469) (150) (68) (550)

Basic federal tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 14,459

Exercise 5 (A) Personal tax credits

ITA: 118

Basic personal tax credit base . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dolly’s tax credit base: $15,000 -- $3,000 . . . . . . . . . . . . . . . . . . . . . . . . . Don:(1) over 18 years old and not infirm . . . . . . . . . . . . . . . . . . . . . . . . . Dave: Canada caregiver credit base:(2) . . . . . . . . . . . . . . . . . . . . . . . . . . Mother: Canada caregiver credit base(3) . . . . . . . . . . . . . . . . . . . . . . . . .

$15,000 12,000 0 7,999 7,999

Total tax credit base(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$42,998

Total personal tax credits @ 15% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 6,450

ITA: 118(1)(a) ITA: 118(1)(a) ITA: 118(1)(d ) ITA: 118(1)(d ) ITA: 118(1)(c.1)

— NOTES TO SOLUTION (1) Don’s father may claim the transferred tuition fee credits, since Don’s income tax will be completely offset by his basic personal tax credit. (2)

Because Dave is an adult child (18 and over), the base is $7,999.

(3)

Base is $7,999.

(4) An impairment tax credit of $1,414 ($9,428 × 15%) is also available in respect of the mother and son Dave, if their impairment is certified by a medical doctor.

ITA: 118.9(1)

ITA: 118(4)(d) ITA: 118.3(1)

Exercise 6 $300 contribution is an employment deduction. $800 is pension income. A pension credit is not available since the amount is not from a life annuity, as required in the definition of ‘‘qualified pension income’’.

ITA: 8(1)(m) ITA: 56(1)(a) ITA: 118(3), 118(7)

Ch. 10/Study Guide — Solutions to Exercises

273

Exercise 7 Tax payable by Tina: Division B income and taxable income .............................................................. $11,011 Federal tax 15% of $11,011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: basic personal tax credit ............................................................ $2,250 other tax credits (age ($1,259), pension (15% × $350)) 1,312 Federal tax payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Transferable tax credits available: Age credit (15% of $8,396) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Pension credit (15% of $350) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total credits available to Tina’s husband . . . . . . . . . . . . . . . . . . . . . . . . . Less: federal tax payable net of basic personal tax credit ($1,522 -- $2,160) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 1,652 (3,562) $ 0 $1,259 53 $1,312 — $1,238

Exercise 8 Income increased by grossed-up dividend ($900 × 1.38) . . . . . . . . . . . . . . . . .

$1,242

Increase in federal tax @ 29% of $1,242 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less increase in tax credits: Married credit with election [15% of ($15,000 -- $0)] $ 2,250 Married credit without election [15% of ($15,000 -- $1,242)] . . . . . . . . . . . . . . . . . . ( 2,064) $ 186 6 Dividend tax credit ( /11 × $342) . . . . . . . . . . . . . . . . . . . . . . . . . 187

$ 360

Net federal tax reduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ITA: 82(3)

373 13

Therefore, the election should be made in this case, although it is marginal.

ITA: 82(3)

Exercise 9 Federal foreign tax credit lesser of: (i) $225 (ii)

$1,500 $166,800 -- $6,000

× ($33,681 + $62*) =

$315

}

$225

* The dividend tax credit is equal to 6/11 of the gross-up of $114 (i.e., 0.38 × $300).

Exercise 10 Regular Part I Tax (A) $1,000 interest . . . . (B) $1,000 cash dividend ($1,380 grossed up) (C) $1,000 capital gains ($500 taxable capital gains) . . . . .

Minimum Tax

($1,000 × .33)

$333

($1,380 × .33) $455 DTC (207)

$248

($500 × .33)

$165

($1,000 × .15)

$150

($1,000 × .15)

$150

($500 + $300) × .15

$120

Exercise 11 Jacob’s marginal tax rate is 32.5% (20.5% + 12%) where the provincial marginal tax rate is assumed to be 12%.

ITA: 117(2), 120

CHAPTER 10

Tom would also be eligible for the married credit of 15% of $3,989 ($15,000 -- $11,011) on his tax return (assuming his income is $165,431 or less for the year).

Introduction to Federal Income Taxation in Canada

274

Exercise 12 Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Add: CCA loss on resource property shelter . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: gross-up of dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Adjusted taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Basic exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Minimum tax before minimum tax credit (15% of $149,709) . . . . . . . . . . . . . . . . Less basic minimum tax credits: Basic personal (15% × $15,000) ............................................................ $2,250 Employment Insurance premiums . . . . . . . . . . . . . . . . . . . . . . . . 150 CPP contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 469 Employment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205 Minimum amount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 98,030 102,909 $200,939 (11,400) $189,539 $(40,000) $149,539 $ 22,431

3,074 $ 19,357

Betty’s Part I tax will be her minimum amount of $19,357 with $11,488 ($19,357 -- $7,869) carried forward and applied to reduce tax payable in a subsequent year.

Exercise 13 Since Mr. and Mrs. Ataila were resident in Canada for 245 days, their non-refundable tax credits will be prorated by 245/365. For Mr. Ataila this includes the basic personal tax amount of $15,000 and the spousal amount of $15,000 and the Canada Employment credit of $1,368. Mr. and Mrs. Ataila are considered residents of Canada only for the time since May 1, and will be taxed on their worldwide income from that date forward. Any income earned during the four months prior to May 1 that they were non-resident will not be subject to tax in Canada.

ITA: 118, 63

The child care expenses are only deductible if Mrs. Ataila has earned income, is in attendance of full-time studies at an educational institution, or is mentally or physically unable to care for the children. If Mrs. Ataila attended full-time studies in order to obtain a job in the workforce, then her husband may claim the child care expenses.

Exercise 14 Pierino’s taxable income is: Salary from Saskatoon Transit . . . . . . . . . . Business loss . . . . . . . . . . . . . . . . . . . . . . . Taxable capital gain . . . . . . . . . . . . . . . . . Total income . . . . . . . . . . . . . . . . . . . . . RRSP contribution . . . . . . . . . . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . . . . . . Net capital losses forward . . . . . . . . . . . . . Taxable income . . . . . . . . . . . . . . . . . . . Personal tax credit base amounts Basic personal tax credit base . . . . . . . . Canada employment credit . . . . . . . . . . . Eligible dependant (ETM) . . . . . . . . . . .

ITA: 118, 63

$ 65,000 (5,250) 2,000 (50% ($10,000 -- $6,000)) $ 61,750 (10,000) $ 51,750 (2,000) (maximum of taxable capital gains) $ 49,750 $ 15,000 1,368 15,000 $ 31,368

Exercise 15 Par. 3(a)

2021

2022

2023

— Sum of all incomes from non-capital sources: Employment income .......................................... $ 15,000 Rental income . . . . . . . . . . . . . . . . . . . . . . 4,000 Other business income . . . . . . . . . . . . . . . — Total par. 3(a) ................................................. $ 19,000

$ 20,000 — 15,000 $ 35,000

$ 25,000 2,000 14,000 $ 41,000

Ch. 10/Study Guide — Solutions to Exercises

Par. 3(b)

275 2021

2022

2023

— LPP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — PUP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — Other

— $ 2,500 3,000

— — $ 6,000

$ 1,000(1) 1,000 (2,000)

Total par. 3(b) . . . . . . . . . . . . . . . . . . . . .

$ 5,500

$ 6,000

Par. 3(a) + par. 3(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . Par. 3(c) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 24,500 $ 41,000 $ 41,000 (9,000) (9,000) (9,000)

Net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Par. 3(d ) — ABIL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — Business loss . . . . . . . . . . . . . . . . . . . . . . . — Rental loss . . . . . . . . . . . . . . . . . . . . . . . .

$ 15,500 $ 32,000 $ 32,000 — — (1,500)(2) (32,000) — — — (2,000) —

Division B income . . . . . . . . . . . . . . . . . . . . . Par. 111(1)(b) — net capital loss(3) . . . . . . . . . Par. 111(1)(a) — non-capital loss(4) . . . . . . . .

$ 0 $ 30,000 $ 30,500 $ (5,500) (6,000) $ 0 — (8,315) (14,132) $

$ 15,685

16,368

(1) The 2022 listed personal property loss of $7,000 was applied to the listed personal property gains of 2021 ($5,400), leaving $1,600 to be applied to 2023, which resulted in a capital gain of $2,000 of which 1/2 was included in income. (2) ABIL — 1/2× BIL ($3,000) minus disallowed portion ($0) = $1,500 (3) Lesser of:

2021

2022

2023

(i) Net TCGs for the year . . . . . . . . . . . .

$ 5,500

$ 6,000

(ii) Total adjusted net CLs* . . . . . . . . . . .

$23,000

$17,500

$11,500

Lesser amount . . . . . . . . . . . . . . . . . . . . .

$ 5,500

$ 6,000

* Net capital loss continuity schedule: Net CL from 2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$23,000

Utilized in 2021 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,500) Available in 2022 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $17,500 Utilized in 2022 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (6,000) Available in 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $11,500 Realized in 2023 [$2,300 -- ($1,000 + $1,000)] . . . . . . . . . . . . . . . . . . . . . 300 Available for carryforward . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $11,800 (4) Non-capital loss — 2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 42,000 2021 Subsection 111(8) ‘‘non-capital loss’’: Business loss for the year (2021) . . . . . . . . . . . . . . . . . . . . . . . . . $32,000 Add: net capital loss claimed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,500 Less par. 3(c) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (15,500) Non-capital loss for 2021 (carry forward to 2022) . . . . . . . . . . . . . . . . . . . . . 2022 application** ($24,000 -- $14,398 -- 1,287) . . . . . . . . . . . . . . . . . . . . . . .

22,000 (8,315)

Carried forward to 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2023 application** ($30,500 -- $15,000 -- 1,368) . . . . . . . . . . . . . . . . . . . . . . .

$ 55,685 (14,132)

Balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 41,553

** This amount leaves enough taxable income to be offset by the personal tax credit and the Canada employment amount

CHAPTER 10

— NOTES TO SOLUTION

Introduction to Federal Income Taxation in Canada

276

Exercise 16 (A) Regular Part I tax on first $53,359 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . on next $10,641 @ 20.5% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 8,004 2,181

$64,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less personal tax credits: Basic personal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,250 Canada employment credit . . . . . . . . . . . . . . . . . . . . . . . . . . . 205 Employment Insurance premiums (15% of $1,002) . . . . . . . . . 150 CPP contributions (15% of $3,123) . . . . . . . . . . . . . . . . . . . . . 469 Charitable donations: 15% of $200 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 30 29% of ($780 -- $200) ................................................... 168 198

$10,185

452 Dividend tax credit (9/13 × $652 (gross up)) . . . . . . . . . . . . . Basic federal tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: foreign tax credit lesser of: (a) $1,500 $10,000 (b) × ($6,461 + $452) = $1,080 $64,000

3,724

}

$ 6,461

1,080* $ 5,381

* The unused foreign taxes paid of $1,500 -- $1,080 can be claimed on a provincial tax return subject to a similar formula to the federal formula above and any balance still not claimed can potentially be claimed under ss. 20(11) as a deduction in computing income.

Exercise 17

Mrs. Smith’s income as given in the question .................................................................. $58,120 Dividend gross-up $9,000 × 0.38 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,420 RRSP deductions: Par. 60(j.1) Lesser of (i) the retiring allowance received $10,000 (2,000) (ii) $2,000 × 1 year = $2,000 . . . . . . . . . . . . . . . . . . . . Undeducted contributions = 12,000 + 5,000--- 4,000 = $13,000 Par. 60 CPP enhanced contribution deduction . . . . . . . . . . . . . . . . . . . . . . . . (259) Par. 60(i) Least of (i) $29,210 (ii) 18% × $32,000 = . . . . . . . . . . . . . . . . . . . . $ 5,760 Unused deduction room at end of 2021 . . . . . . . . . . . . . . . . . . . . . 4,000 $ 9,760

(9,760)

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Division C deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

49,521 0

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$49,521

Federal tax $49,521 × 15% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-refundable tax credits: Basic ......................................................................................................$15,000 Age $8,396 -- 15% × ($49,521 -- $42,335) = . . . . . . . . . . . . . . . . . . 7,318 22,318 × 15% Canada employment credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CPP & EI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividend tax credit (6/11 × $3,420 (gross up)) . . . . . . . . . . . . . . . . . . . . . . . .

$ 7,428

Federal tax payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 1,664

(3,348) (205) (346) (1,865)

Ch. 10/Study Guide — Solutions to Exercises

277

Exercise 18 Federal non-refundable Tax Credits Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Wholly dependent person [equivalent to spouse] for one child under age 18 with no income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tuition fee amount transferred from 22-year-old* . . . . . . . . . . . . . . . . . . . . . . . . .

*Tuition fees paid . . . . . . . . . . . . . . . . . . Child’s taxable income . . . . . . . . . . . . . . . Less: basic amount . . . . . . . . . . . . . . . . . Tuition Fees available for transfer . . . . . .

$5,000 $ 8,000 (15,000) $ 0 $5,000

Maximum transferable . . . . . . . . . . . . . . .

$5,000

$15,000 15,000 5,000 $35,000 @15% $ 5,250

Exercise 19

Political Donations Liberal Party of Canada . . . . . . . . . . . . . . . . . . . . . . . . . . Conservative Party of Canada . . . . . . . . . . . . . . . . . . . . . Credit equal to 75% of the first $400 . . . . . . . . . . . . . . . .

200 @ 15% 7,900 @ 29%

$ 30 2,461 $2,321

$ 200 200 $ 400 $ 300

Exercise 20 Employment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 15,000 $ 600 $ 15,600 $ 3,000 $ 12,600

Less: Allowable Business Investment Loss (par. 3(d )) . . . . . . . . . . . . Taxable income for 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Allowable business investment loss Proceeds of disposition (500 × $2) . . . . . . . . . . . . . . . . . . . . . . . . . . Adjusted cost base (500 × $20) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Business investment loss (par. 39(1)(c)) . . . . . . . . . . . . . . . . . . . . . . Less: Disallowed portion of BIL (ssec. 39(9)) capital gains deduction claimed in 2004 ($1,000) + capital gains deduction claimed in 2006 ($2,000) multiplied by inclusion rate for 2023 Allowable business investment loss (par. 38(c))

$ 1,000 $10,000 $ 9,000

$(3,000) $ 6,000 ×1 /2 $ 3,000

Exercise 21 Scenario #1 (a) Subparagraph 69(1)(b)(i) will deem Adam’s proceeds to be equal to the fair market value of the rental building, $900,000.

CHAPTER 10

Charitable Donations Cancer society . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 100 Church ...................................................................................... 4,000 University of Waterloo .................................................................. 1,000 United Way ................................................................................... 3,000 $8,100

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Adam will have recaptured depreciation of $100,000 (UCC of $400,000 less the lower of cost, $500,000, and proceeds, $900,000). Adam will have a taxable capital gain of $200,000 (1/2× $900,000 -- $500,000)). (b) The ACB of the asset to Adam’s daughter will be the amount she paid for the building — $850,000 — since the Act does not make a corresponding adjustment to her ACB. (c) There will be no attribution of annual rental income back to Adam under ssec. 74.1(2) because his daughter is over 18 years of age. When his daughter disposes of the building, the capital gain will not attribute back to Adam. Scenario #2 (a) Since the sale is to a spouse, ssec. 73(1) will apply to deem Adam’s proceeds of disposition to be equal to his cost of $50,000 so that no loss will arise on the disposition. If Adam elected out of ssec. 73(1) for proceeds of $40,000, the capital loss would be denied as a superficial loss under sec. 54. (b) Adam’s wife’s ACB is also $50,000 due to ssec. 73(1). If Adam elects out of ssec. 73(1) the superficial loss of $10,000 is added to the adjusted cost base of $40,000 for a total of $50,000. (c) The dividend received and the capital loss arising on the disposition of the shares by Adam’s wife will be attributed back to Adam under provisions 74.1 and 74.2, respectively. Section 74.5 exempts from the attribution rules income or capital gains arising from property transferred for fair market value consideration (i.e., $40,000 cash) provided that the transferor elects that ssec. 73(1) not apply. Scenario #3 (a) Subparagraph 69(1)(b)(ii) provides that an inter vivos gift by Adam to a non-arm’s length person results in deemed proceeds of disposition equal to the fair market value of the gift. Therefore, Adam will realize a capital loss of $10,000. The superficial loss definition in sec. 54 will not apply to deny the loss to Adam because the nephew is not an affiliated person. (b) The nephew’s ACB is also the FMV of $40,000 by virtue of par. 69(1)(c). (c) Subsection 74.1(2) attributes to Adam the income on the shares transferred to any related minor or niece or nephew (in this case the $4,000 dividend received by the nephew). However, there is no attribution of capital gains realized on property transferred to minors. The dividend attribution will cease in the year the nephew turns 18.

Chapter 11 Computation of Taxable Income and Tax After General Reductions for Corporations

CHAPTER 11

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CHAPTER 11 — LEARNING CHART Problem Descriptions Textbook Example Problems 11-1 Calculate non-capital loss 11-2

Calculate taxable income and loss carryovers

11-3 Non and net capital losses 11-4 Calculate taxable income 115 Provincial taxable income 11-6 Foreign tax credit 11-7

SR&ED Investment tax credit

11-8

SR&ED Investment tax credit with proxy amount

Exercises 1

Calculate taxable income

Maximizing charitable donations

Calculate non-capital losses

Calculate net capital losses

Calculate net and non-capital losses

Calculate taxable income

Business foreign tax credit

Calculate Part I tax — various sources of income

Investment tax credit

Federal abatement & permanent establishment

Assignment Problems 1 Taxable income 2

Permanent establishment

Income from business with SR&ED

Tax payable, ITC

Schedule 1 reconciliation and taxable income

Tax payable — provincial allocation

Tax payable

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REVIEW QUESTIONS

(1) Mr. Clements has been trying to prepare the corporate tax returns for his company and cannot seem to get the treatment of charitable donations sorted out. He cannot find the place to put the tax credit for the donations and he is not sure what the limits are. Can you help him? (2) If a company finds that it has non-capital loss carryovers that are going to expire in the next few years, what tax planning steps can be taken to use up some of these losses without selling the company or buying another company? (3) There are two basic types of restrictions on losses available for carryover. What are these restrictions and how do they affect the application of losses? (4) What are the two main objectives of tax legislation impacting the taxation of corporations? (5) MultiCo Inc. has permanent establishments in Ontario and Alberta. The Alberta operation normally accounted for 20% of the allocation of taxable income. However, in the current year, a salesman in Ontario sold a large order to a customer in Alberta and the goods were shipped directly from Ontario. How does this special sale impact the allocation to Alberta? (6) Since residents of Canada are taxable on their world income, why does Canada give a foreign tax credit for taxes paid to another country? (7) In the calculation of the non-business foreign tax credit the ‘‘tax otherwise payable’’ calculation includes a reduction for the 10% federal abatement. Why? (8) Lossco Inc. has a loss from operations for the year while at the same time earning interest of $5,000 from the United States on which $750 of tax was withheld. How can Lossco treat the $750 of foreign tax paid on its tax return?

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EXERCISES

Exercise 1

ITA: 110.1, 111

Generous Limited has income (loss) under Division B of $(7,350) in 2021, $22,050 in 2022, and $14,700 in 2023. During this period it made donations to registered charities of $2,625 in 2021, $4,700 in 2022, and $12,000 in 2023. It also made a donation of ecologically sensitive land valued at $19,700 to the Government of Canada in 2022. The company began operations in 2021. — REQUIRED Compute the corporation’s taxable income for the years indicated.

Exercise 2

ITA: 110.1, 111

Determined Limited predicts, with reasonable accuracy, its income under Division B before capital cost allowances will be: $100,000 in 2021, $115,000 in 2022, and $132,250 in 2023. Capital cost allowances available are expected to be $200,000 in 2021, $170,000 in 2022, and $150,000 in 2023. It made charitable donations of $10,000 in 2017 and $11,500 in 2018, which it could not absorb before 2021. — REQUIRED How can the company maximize its charitable donation deduction while minimizing the taxes it pays in the period shown? (Hint: Take advantage of the loss carryover rules.)

Exercise 3

ITA: 111(8)

TPM Limited has computed the following income (loss) for the year ended December 31, 2023: Loss from business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(129,000) Income from property including dividends of $10,750 received from taxable Canadian corporations . . . . . . . . . . . . . . . . . . . . . . . . 32,250 Capital gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46,400 Capital losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (12,000) Business investment loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (16,000) The corporation has a net capital loss of $27,000 arising from 2017. — REQUIRED

Exercise 4

CHAPTER 11

Compute the corporation’s non-capital loss for the current year. ITA: 111(8)

CLR Limited had a large allowable capital loss of $51,750 on one transaction during its current taxation year ended December 31. In addition, the following information pertains to its situation for the current taxation year: Income from business ........................................................................................ $155,250 Income from property ............................................................................................ 17,000 Taxable capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,700 Allowable business investment loss (not included in above allowable capital loss) .................................................................................... (8,300) — REQUIRED Compute the corporation’s net capital loss for the current year.

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Exercise 5

ITA: 111(1), 111(1.1)

Abigail Corporation has income from business of $55,500 and a taxable capital gain of $37,000 in 2023. It also has the following losses: Non-capital losses (expiring beyond 2023) ...................................................... $ 82,500 Net capital losses (2017) ...............................................................................$ 40,000 — REQUIRED How much of the above losses will be available for carryforward after this year?

Exercise 6

ITA: 3, 110.1–112

Reconsider example problem 11-3 of FT Limited in ¶11,035 of chapter 11. If $3,378 less capital cost allowance had been taken in 2022, all $23,000 of the inter-company dividends could have been deducted, pursuant to section 112, in 2022. — REQUIRED Recalculate the taxable income of the corporation for the years indicated after taking $3,378 less in capital cost allowance for Class 8 in 2022. Comment on whether the corporation is in a better tax position at the end of 2023 with respect to capital cost allowance and taxable income under this alternative.

Exercise 7

ITA: 110.1, 111, 112

Plego Limited, a Canadian corporation, had its net income under Division B computed as follows for the year ending December 31: Par. 3(a)

Par. 3(b)

Income from non-capital sources: Income from business operations . . . . . . . . . . . . . . . $ 66,625 Income from foreign property . . . . . . . . . . . . . . . . . 7,175 Dividends from taxable Canadian corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,300 Net taxable capital gains . . . . . . . . . . . . . . . . . . . . . . . 30,750

Income under Division B............................................................................ $116,850 During the year the corporation made charitable donations of $80,000. Its carryforward position from the previous year was as follows: Charitable donations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $10,250 Non-capital losses (realized in the prior year) . . . . . . . . . . . . . . . . . . 61,500 Net capital losses (realized in 2017) . . . . . . . . . . . . . . . . . . . . . . . . . 27,000 — REQUIRED Compute the corporation’s taxable income for the current year. ITA: 111(4), 111(5), 111(5.1), 249(4)

Exercise 8 EXporter Limited is a Canadian public company carrying on a part of its business through an unincorporated branch in Japan. Its income from that business in Japan for the current taxation year ended December 31 was 54,025,200 yen. The corporation paid income tax instalments on that income during the year of 21,610,080 yen. During the year the exchange rate was 1 yen = C$0.012. During its current taxation year ended December 31, EXporter’s income under Division B was $2.5 million excluding the income from Japan. During the year, the corporation received dividends of $100,000 from taxable Canadian corporations. This amount was included in the computation of Division B income. The corporation was also able to deduct $25,000 of its net capital losses carried forward. There was no foreign investment income during the year. Taxable income earned through a permanent establishment in Canada comprises 75% of total taxable income. — REQUIRED Compute the corporation’s foreign business tax credit for the year.

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ITA: 126

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Exercise 9 Maxprof Limited is a Canadian public company with the following income under Division B for its taxation year ended December 3, 2023: Wholesaling income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign business profits (before $36,800 in taxes paid) . . . . . . . . . . . . Dividends from taxable Canadian corporations . . . . . . . . . . . . . . . . . . . Dividends from foreign investments (before $25,875 in taxes withheld) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Canadian interest income (investment income) . . . . . . . . . . . . . . . . . . Income under Division B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ITA: 110–112, 123, 124, 125.1, 126, 127

$1,495,000 115,000 517,500 172,500 345,000 $2,645,000

During the year the company made donations of $69,000 to registered charities and $5,750 to federal political parties. It was carrying forward non-capital losses of $127,600. It is considered to earn 86% of its taxable income in Canada, as computed by the Regulation. — REQUIRED Compute the federal Part I tax payable for the current year.

Exercise 10

ITA: 127

Consider the following data: Qualified current expenditures eligible for investment tax credit . . . $90,000 Taxable income before qualified current expenditures . . . . . . . . . . . $300,000 Federal tax rate after abatement and reduction . . . . . . . . . . . . . . . . 15% — REQUIRED Compute the amount of the investment tax credit that will be deductible for the year and the net federal Part I tax payable after the investment tax credit.

Exercise 11

CHAPTER 11

Canco Inc. is a Canadian corporation with its head office in Ontario. Its factory premises and a warehouse are also located in Ontario. The company manufactures metal containers which are sold throughout Canada and the United States. The company rents public warehouse space in Saskatoon, Saskatchewan and in Poughkeepsie, New York. The company has no employees at the warehouses. All goods are handled by warehouse personnel. The company has a Canadian sales force responsible for all Canadian sales. A sales representative is employed in each province and reports to a sales manager in Ontario. Each sales representative operates from his home, and the company’s name does not appear on the premises. The company does not reimburse the sales representatives for any portion of the costs of operating from their homes. All orders are submitted to head office for credit approval. Head office provides the appropriate warehouse with shipping instructions. The company employs a sales representative in Poughkeepsie, New York. This employee also operates from his home. His address and telephone number are listed in the Poughkeepsie phone book under the company’s name. The company reimburses him for the cost of household expenses related to the use of his home office. The employee is authorized to accept orders on behalf of the company. He also arranges shipments. In addition to taxable income of $300,000, Canco has provided the following information with respect to its fiscal year ended December 31: Sales: Saskatchewan warehouse . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,000,000 Poughkeepsie warehouse . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,000,000 Ontario warehouse . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000,000 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $10,000,000 The Saskatchewan warehouse makes shipments to all provinces west of Ontario. The Ontario warehouse sells to all other provinces and its sales also include $250,000 of shipments to a customer in Florida. The Poughkeepsie warehouse ships only within the U.S.

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Salaries and wages: Factory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,000,000 Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300,000 Administrative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200,000 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,500,000 All factory and administrative salaries are paid to employees in Ontario. The sales salaries include $20,000 to each of the 10 provincial sales representatives and $100,000 to the U.S. sales representative. — REQUIRED (A) Determine where Canco has permanent establishments by reference to the Income Tax Act and applicable Regulations. Where relevant, state your reasons for determining why Canco does not have a permanent establishment in a particular place. (B) Based on your conclusion in (A), compute the taxable income allowable to each province and the United States, and the amount deductible under subsection 124(1) from corporate tax otherwise payable. Show all calculations.

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ASSIGNMENT PROBLEMS

Problem 1

ITA: 3, 110.1–112

The following data summarize the operations of Red Pocket Limited for the years of 2020 to 2023 ended September 30. 2020

2021

2022

2023

Income (loss) from business . . . . . . . . . . . . . . $54,000 $32,000 $(75,000) $62,500 Dividend income — Taxable Canadian corporations . . . . . . . . . . . . . . . . . . . . . . . . 42,500 22,500 18,000 10,500 Taxable capital gains . . . . . . . . . . . . . . . . . . . 11,000 2,500 5,000 9,000 Allowable capital losses . . . . . . . . . . . . . . . . . . 2,000 4,500 3,500 — Allowable business investment loss . . . . . . . . . 3,750 — — — Charitable donations . . . . . . . . . . . . . . . . . . . . 23,000 9,000 3,000 13,000 The corporation has a net capital loss balance of $9,000 which arose in 2017. Compute the taxable income for Red Pocket Limited for the years indicated and show the amounts that are available for carryforward to 2024.

Problem 2

ITA: 124; ITR: 400

The taxpayer, whose head office was in Manitoba, manufactured and sold various types of residential and industrial fans. Local sales agencies were maintained in Ontario and in Quebec. At the Ontario agency, two qualified representatives handled business under the company name. They were authorized to sign quotations. Contracts could be made, terms of payment arranged and credit given without reference to the head office in Winnipeg. The company name was displayed for public visibility, was used on the agents business cards, and contact information for the agents was listed on a webpage for the Ontario agency. The Ontario agency, occupying one-half of a building with warehouse facilities, maintained an inventory worth about $60,000. Orders for standard-sized fans were filled from stock-intrade. Orders for large fans were filled from the head office in Winnipeg. The Quebec agency was substantially similar to that in Ontario. You have been asked to determine whether or not the company has a ‘‘permanent establishment’’ in the provinces of Ontario and Quebec. In reaching a conclusion, you should compare this situation with the case of M.N.R. v. Sunbeam discussed in this chapter.

61 DTC 1053 (EX. Ct.)

CHAPTER 11

Problem 3 Joe’s Widget Manufacturers Inc. (JWMI) is an established manufacturing company with a growing research and development (R&D) department. JWMI is a Canadian-controlled private corporation with no associated companies. The research part of the business is new and the company’s accountant has no experience dealing with the tax implications of the expenditures in this area. He has correctly computed the company’s net income for tax purposes before specific R&D related adjustments as $657,000 and would like your input on the impact of the transactions described below. For the year ended December 31, 2023, the following R&D related expenditures were made. Description

Amount

Purchase of lab machinery and lab equipment .................................. $450,000 Purchase of a new building to house laboratory ................................ . 120,000 Salaries of lab staff ................................................................................. 100,000 Operating costs directly related to the lab ............................................. 40,000 For financial accounting purposes, the salaries and operating costs, net of the investment tax credit below, have been expensed. The lab machinery, equipment and building are used 100% for R&D activities. The lab machinery and equipment have been capitalized for accounting purposes and are being amortized over an eight-year period. Thus, amortization expense of $56,250 was recorded for accounting purposes on the lab machinery and equipment. Amortization expense was recorded on the building. Capital cost allowance for the lab machinery and equipment in Class 53 has been deducted in computing net income for tax purposes. The company is eligible for investment tax credits at a rate of 15% and has correctly determined that they are eligible for investment tax credits at this rate on all of the above expenditures with the exception of capital expenditures. For accounting purposes, the company’s accountant has netted the investment tax credits against the related expenditures as follows.

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Expenditure

Gross amount

ITC

Amount recorded for accounting purposes

Lab machinery and equipment . . . Building . . . . . . . . . . . . . . . . . . . . Salaries of lab staff . . . . . . . . . . . . Operating costs of lab . . . . . . . . . .

$450,000 120,000 100,000 40,000

— — 15,000 6,000

$450,000 120,000 85,000 34,000

You have been asked to explain to JWMI’s accountant what adjustments are necessary to compute income for tax purposes for the years ended December 31, 2023 and 2024.

Problem 4 Infotech is a public company in its first year of business in the information technology industry. It operates out of a plant in Ottawa, Ontario. In 2023, it incurred $2.2 million of SR&ED expenses which qualifies for deduction under subsection 37(1) of the Act.

ITA: 12(1)(t), 37, 127(5)–(11); ITR: 2900

Infotech’s federal income tax rate after abatement is 15%. Its income before deducting the $2.2 million claim under section 37 is $3.2 million. You have been asked to: (A) Compute the maximum investment tax credit available to Infotech in 2023. (B) Compute the company’s net federal Part I tax payable after the investment tax credit, assuming a maximum section 37 deduction is claimed. (C) Determine the amount, if any, of the investment tax credit carryover. (D) Compute the company’s deduction or income inclusion in the following year if no further SR&ED expenditures are made.

Problem 5 The controller of Video Madness Inc., a Canadian public corporation, has prepared the accounting income statement for the year ended April 30, 2023: VIDEO MADNESS INC. INCOME STATEMENT FOR THE YEAR ENDED APRIL 30, 2023 Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cost of sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $523,000 Administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185,000 Operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other income and expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provision for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$995,000 (708,000) $287,000 55,000 $342,000 (102,000) $240,000

Other Information (1) Included in the calculation of ‘‘Administrative expenses’’: (a) Interest on late income tax payments . . . . . . . . . . . . . . . . . . . . . . . . . $ 435 (b) Amortization (maximum capital cost allowance of $159,500) ....................... 114,900 (c) Club dues for the local Country Club . . . . . . . . . . . . . . . . . . . . . . . . . . 1,750 (d) Federal political contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,500 (e) Donations to registered charities ....................................................................... 22,500 (f) Property tax with respect to vacant land not being used in the course of the business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000 (g) Life insurance premium with respect to the president (the company is the beneficiary; not required for financing) . . . . . . . . . . 1,950 (2) Included in the calculation of ‘‘Other income and expenses’’: (a) Landscaping of grounds around new premise . . . . . . . . . . . . . . . . . . . . 4,800 (b) Fees paid with respect to the investigation of a suitable site for the company’s manufacturing plant . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,500 (c) Dividends received from taxable Canadian corporation ................................... 64,300

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ITA: 9–20, 38–55, 110.1–112, 111(4), 111(5), 111(5.1), 249(4)

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(d) Gain from the sale of another piece of land, used in the business, sold for $200,000 in March (purchased for $73,800) ........................................ 126,200 (e) Loss on sale of investments held as capital property purchased for $85,000 and sold for $75,000 ................................................................................ 10,000 (3) Loss carryforwards from 2022 are: (a) Non-capital losses ............................................................................................... 72,800 (b) Net capital losses (realized in 2017) ................................................................. 50,000

You have been asked to prepare a schedule reconciling the accounting net income to income for tax purposes and taxable income. Indicate the appropriate statutory reference for your inclusions or exclusions.

Problem 6

ITA: 123, 124, 126

Barltrop Limited is a Canadian public company involved in the software consulting business. Its controller provided you with the following information related to its current taxation year ended December 31:

$263,000

Canadian investment royalty income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

11,000

U.K. non-foreign affiliate dividend income (before $3,000 tax withheld) . . . .

20,000

Taxable dividend received from non-connected Canadian corporations . . . . .

5,000

Taxable capital gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

7,000

Charitable donations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

100,000

Unused foreign tax credit in respect of U.S. . . . . . . . . . . . . . . . . . . . . . . . . .

3,000

Net capital losses carried forward arising in 2017 . . . . . . . . . . . . . . . . . . . .

8,000

CHAPTER 11

Income under Division B from consulting business including $100,000 earned in U.S. operations (before deducting $16,000 U.S. tax paid) . . . .

Barltrop Limited has permanent establishments in the United States, British Columbia, and Alberta. Its gross revenues and salaries and wages data have been allocated as follows:

British Columbia

Alberta

United States

Gross revenues . . . . . . . . . . . . . . . . . . .

$3,000,000

$4,000,000

Salaries and wages . . . . . . . . . . . . . . . .

500,000

300,000

200,000

Assume that the British Columbia and Alberta corporation tax rates are both 10%. Also, assume that taxable income for British Columbia and Alberta is computed on the same basis as federal taxable income. Gross revenues exclude income from property not used in connection with the principal business operation of the corporation. You have been asked to calculate the total tax payable by the company for the 2023 taxation year, including provincial tax. Show all calculations.

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Problem 7 Up, Up and Away Limited is a public corporation that distributes hot air balloons in the Province of New Brunswick. For the year ended September 30, 2023, its accounting income statement was as follows: Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cost of sales and other expenses including CCA . . . . . . . . . . . . . . . . Operating profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income before taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provision for taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ITA: 123, 124, 125.1, 126, 127(5)

$1,225,000 (745,000) $ 480,000 173,500 $ 653,500 (200,725) $ 452,775

Selected Additional Information (1) Other income includes: Dividends from taxable Canadian corporation .................................................. $ 60,000 Canadian interest income ...................................................................................... 52,500 Foreign interest income, net of withholding taxes of $10,000 ............................ 61,000 (2) Up, Up and Away Limited has a non-capital loss carryforward of $255,545. (3) Donations to registered charities were $9,755 (deducted from accounting income). tax.

You have been asked to calculate the total taxes payable for 2023 using an 11% provincial rate of

Problem 8 Tecniquip Limited is a public corporation whose head office is located in Toronto, Ontario. The activities of the corporation are carried on through permanent establishments in the provinces of Ontario and Alberta. For the year ended December 31, 2023, Tecniquip Limited obtained the following results: Income from distribution operations in Ontario............................................ $1,000,000 Income from distribution operations in Alberta ..............................................1,040,000 $2,040,000 Canadian-source interest income (investment) . . . . . . . . . . . . . . . . . . 32,000 Taxable capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000 Taxable dividends from taxable Canadian corporations . . . . . . . . . . . . 15,000 Net income under Division B .......................................................................... $2,097,000 In computing income from distribution, the corporation claimed a deduction of $150,000 under subsection 37(1) of the Act for SR&ED. No SR&ED expenditures are expected to be made in 2024. During the year, the corporation made charitable donations totalling $50,000 and claimed noncapital losses of $60,000 and the net capital losses carried forward from 2018 of $6,000. You have been asked to calculate the federal Part I tax payable. Show all calculations, whether or not necessary to your final answer.

¶11,850

ITA: 123, 124, 125.1, 126, 127(5)

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291

CHAPTER 11 — DISCUSSION NOTES FOR REVIEW QUESTIONS (1) Charitable donations are tax credits only on personal tax returns. On corporate tax returns they are deductions under Division C. Donations up to 75% of net income plus 25% of the amount of a taxable capital gain and 25% of recapture in respect of gifts of capital property with appreciated value can be deducted in the year. If the charitable donations are in excess of this amount then the excess can be carried forward for five years. (2) Income can be increased in the current year by not claiming some of the optional deductions for tax purposes. For example, the deductions for the allowance for bad debts, CCA, or scientific research and experimental development expenditures can be foregone in order to increase income. These deductions will be available in future years and will not be lost. Also, the CRA will allow the revision of some permissive deductions for prior years. In addition, the company could consider the sale of any redundant assets to generate income through recapture and/or capital gain.

ITA: 110.1

IC 84-1

(3) The first restriction is on the type of income against which the loss carryover can be deducted, and the second restriction is on the number of years a loss can be carried over. Net Capital Losses: Applied against taxable capital gains only; carried back 3 years and forward indefinitely. Non-capital Losses: Applied against all sources of income; carried back 3 years and forward 20 taxation years. (4) The two main objectives are: (a) alleviate double taxation through the integration of legislation impacting corporate taxation and personal taxation; and (b) provide tax incentives to corporations.

(5) The gross revenue from that sale will be attributed to Alberta since, even though the sale was handled from Ontario, the order was delivered to a province in which the company had a permanent establishment. (6) The theory is that the country where the income is earned has the first right to tax the income. Then, in order to prevent double taxation when Canada also taxes this income, a credit is given in Canada for the foreign taxes paid.

ITR: 402(4)(a)

(7) Investment income (non-business income) may be taxed in the foreign country even though there is no permanent establishment in that country often through a withholding tax. Canada assumes that this investment income, other than from real property, is earned through its permanent establishment in Canada and, therefore, considers this income to be earned in a province for purposes of section 124. Foreign business income, on the other hand, is assumed to be earned in a permanent establishment in the foreign country and, therefore, is not eligible for the federal abatement. (8) Since Lossco does not have any net income or Canadian income tax, it cannot claim a foreign tax credit. No carryover is allowed for non-business income tax. However, the corporation can deduct the foreign taxes which will increase its loss for the year. This deduction will at least provide the benefit of the foreign taxes being carried forward as part of the non-capital losses.

ITA: 126(1) ITA: 20(12)

CHAPTER 11

See the text in ¶11,100 of Chapter 11 for discussion related to alleviating double taxation and providing tax incentives to corporations.

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292

CHAPTER 11 — SOLUTIONS TO EXERCISES Exercise 1 2021

2022

$(7,350)

2023

Income under Division B . . . . . . . . . . Deduct: charitable donations limited by 75% of income above — carried forward . . . . . . . — current . . . . . . . . . . . . .

$22,050

$14,700

0 0

$ 2,625 4,700

unlimited charitable donations — carried forward . . . . . . . — current . . . . . . . . . . . . .

0 0

— $ 3,675 $14,725(2) (14,725) —

0 (7,325) $11,025(1) (11,025)

(3,675)(3)

non-capital loss from 2021(4) . . . . . . . . . . . . . . .

Taxable income . . . . . . . . . . . . . . . . .

— NOTES TO SOLUTION (1)

Limited to 75% of $14,700 = $11,025; $975 is available to carry forward five years to 2028.

(2)

If the donation of the land gave rise to a capital gain, the taxable portion would be included in the amount of income under Division B. The company may deduct $14,725 related to the donated land as it is not limited to 75% of net income. The remaining balance of $4,975 can be used in 2023 or carried forward for five years. In this scenario, we have used $3,675 in 2023 to reduce taxable income to $0. (3)

$1,300 ($19,700 -- $14,725 -- $3,675) is available to carry forward four more years to 2027.

(4)

$7,350 is available to carry forward 20 taxation years to 2041.

Exercise 2 2021 Option A: Claiming maximum charitable donations Income before CCA . . . . . . . . . . . . . . . . . . . . . . . . . . CCA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2022

2023

$ 100,000 $115,000 $132,250 (200,000) (101,667)(1)(116,917)

Income (loss) under Division B . . . . . . . . . . . . . . . . . Charitable donations: — Carried forward . . . . . . . . . . . . . . . . . . . . . . — Current . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-capital loss carried forward from 2021 . . . . . . . .

$(100,000) $ 13,333

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Option B: Non-capital loss utilization Income before CCA . . . . . . . . . . . . . . . . . . . . . . . . . CCA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income (loss) under Division B . . . . . . . . . . . . . . . . Charitable donations: — carried forward . . . . . . . . . . . . . . . . . . . . . . — current . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-capital loss carried forward from 2021 . . . . . . . Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . .

0 0 N/A

$ 15,333

(10,000)(1) (11,500)(1) 0 0 (3,333) (3,833)(2) 0

$100,000 $115,000 $132,250 (107,167)(3) (86,333) (132,250) $ (7,167) $ 28,667

0 0 N/A

(21,500) 0 (7,167)(3)

0 0 0

Ch. 11/Study Guide — Solutions to Exercises

293 2021

2022

2023

Option C: Maximum donation and non-capital loss utilization Income before CCA . . . . . . . . . . . . . . . . . . . . . . . . . CCA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income (loss) under Division B . . . . . . . . . . . . . . . . Charitable donations: — Carried forward . . . . . . . . . . . . . . . . . . . . . . — Current . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-capital loss carried forward from 2021 . . . . . . .

$100,000 $115,000 $132,250 (107,166) (101,667) (116,917) $ (7,166) 0 0 N/A

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 15,333

(10,000)(4) (11,500)(4) 0 0 (3,333) (3,833)

Summary Total donations claimed . . . . . . . . . . . . . . . . . . Total CCA claimed . . . . . . . . . . . . . . . . . . . . . . Unclaimed non-capital loss . . . . . . . . . . . . . . . .

$ 13,333

Options A

$ 21,500 418,584 92,834

$ 21,500 325,750 0

— NOTES TO SOLUTION (1)

CCA amount selected to provide sufficient Division B income for a deduction of charitable donations (maximum of 75% of Division B income). The 2017 charitable donations would, otherwise, expire after 2022. (2)

$92,834 ($100,000 - $3,333 - $3,833) of non-capital loss from 2021 remains.

(3)

Determined by looking forward to 2022 and creating the maximum non-capital loss in 2021 that can be fully utilized in 2022. (4) Uses the five-year carryforward of charitable donations to the maximum — i.e., the $11,500 donations of 2018 may be carried forward to 2023, as in Option A.

Sum of: loss from business................................................................................................$129,000 allowable business investment loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000 dividends deductible under sec. 112 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,750 net capital loss deducted [$27,000 -- $17,200 = $9,800 remaining] . . . . . . 17,200(1) $164,950 Less: income from property ............................................................................ $32,250 net taxable capital gains [1/2 × ($46,400 -- $12,000)] . . . . . . . . . . 17,200(1) (49,450) Non-capital loss for the year.............................................................................................$115,500

— NOTE TO SOLUTION (1) The corporation may deduct the net capital loss from income even though it has no impact on the taxable income. However, the deduction is restricted to the net taxable capital gain for the year. Once deducted, the net capital loss can be included in the non-capital loss computation.

Exercise 4 Allowable capital loss (excluding ABIL) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: taxable capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Add: unutilized allowable business investment loss in respect of which the carryover period expires in the year (i.e., the 10th carryforward year) . . . . Net capital loss for the year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 51,750 (4,700) $ 47,050 0 $ 47,050

CHAPTER 11

Exercise 3

Introduction to Federal Income Taxation in Canada

294

Exercise 5 Income from business . . . . . . . . . . . . . . . . . . . . . . . Taxable capital gains . . . . . . . . . . . . . . . . . . . . . . . . Income under Division B . . . . . . . . . . . . . . . . . . . . . Less: net capital losses . . . . . . . . . . . . . . . . . . . . . . . non-capital losses . . . . . . . . . . . . . . . . . . . . . . Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Option A(1) $55,500 37,000 $92,500 (37,000)(2) (55,500) Nil

Option B(1) $55,500 37,000 $92,500 (10,000)(2) (82,500) Nil

Summary: Unutilized non-capital losses . . . . . . . . . . . . . . . Unutilized net capital losses . . . . . . . . . . . . . . .

$27,000 3,000(2)

Nil $30,000(2)

— NOTES TO SOLUTION (1) In Option A, maximum net capital losses are claimed before non-capital losses. In Option B, maximum non-capital losses are claimed before net capital losses. (2)

2017 net capital loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Utilized in 2023 (limited to TCG) . . . . . . . . . . . . . . . . . . . . . . . .

Option A $40,000 (37,000)

Option B $40,000 (10,000)

Available to carryforward . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 3,000

$30,000

Exercise 6 2022 Net income (loss) per financial accounting statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . Add total of items not deductible for tax purposes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less CCA ($3,378 less in 2022) . . . . . . . . . . . . . Income for tax purposes . . . . . . . . . . . . . . . . . . Inter-company dividends . . . . . . . . . . . . . . . . . . Charitable donations (max. 75% of income): Carried over . . . . . . . . . . . . . . . . . . . . . . . Current . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-capital loss carryover . . . . . . . . . . . . . . . . Taxable income . . . . . . . . . . . . . . . . . . . . . . . .

$23,000

2023

$(53,000)

$126,000

127,7001 $ 74,700 51,700 $ 23,000

240,5001 $366,500 51,316 $315,184

0 0 0

23,000 0

Taxable income originally computed . . . . . . . . .

$25,000 15,000 25,000 18,000

83,000 $232,184

$232,860

2022

2023

2,700 15,000 105,000 5,000

$ 113,000 3,000 25,000 95,000 4,500

$ 127,700

$ 240,500

Items not deductible are:

Provision for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . Withholding tax on foreign dividends . . . . . . . . . . . . . . . . . . . . Charitable donations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization of bond discount . . . . . . . . . . . . . . . . . . . . . . . .

Ch. 11/Study Guide — Solutions to Exercises

295

Conclusion: This calculation produces better results. All of the inter-company dividends are fully deductible in 2022 with the reduction of the capital cost allowance by $3,378. Both options allowed, in total, an equal amount of non-capital losses and donations to be claimed over the two-year period. Although the original calculation enabled $2,702 (i.e., $55,078 + $50,640 -- $51,700 -- $51,316) more capital cost allowance to be claimed in total over the two years, the original calculation could not utilize $3,378 of the potential dividend deduction. Claiming $3,378 in additional CCA in 2022 should be saved for future years. This alternative increases the future CCA write-offs by $2,702 as shown below. Building Class 1: 6%

Equipment Class 8: 20%

UCC, January 1, 2023 . . . . . . . . . . . . . . . . CCA (total deduction: $51,316) . . . . . . . . UCC, January 1, 2024 . . . . . . . . . . . . . . . .

$ 246,667 (14,800) $ 231,867

$ 182,578* (36,516) $ 146,062

UCC originally computed . . . . . . . . . . . . .

$ 231,867

$ 143,360

Capital cost allowances were computed as follows: 2023: 2024:

* $179,200 + $3,378.

Exercise 7

— NOTES TO SOLUTION (1) The balance of $2,612 ($80,000 -- 77,388) in current charitable donations may be carried forward to the next five years. (2)

These carried-over losses may be claimed in a different sequence and in different amounts from that shown. For example, if there is little prospect of future capital gains, the corporation might deduct the net capital loss carryforward before deducting the non-capital loss as follows: subtotal ......................................................................................................................... $16,912 net capital losses ................................................................................................................. (27,000) non-capital losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0

The balance of the net capital losses may be carried forward indefinitely but are restricted as they can only be applied to the extent there are taxable capital gains in the year. If a corporation does not have taxable capital gains in the future, the net capital loss cannot be deducted. Non-capital losses can be carried forward for 20 years. The $61,500 in non-capital loss carryforwards were incurred last year so there the carryforward period would be 19 years. If a corporation does not have taxable capital gains on a regular basis, it might make better sense to use the net capital losses this year and carry forward the entire amount of the non-capital loss to a future year. Net capital losses claimed are added to the non-capital loss balance carried forward thereby preserving the non-capital loss for future use.

CHAPTER 11

Division B income ..............................................................................................................$116,850 Less: charitable donations limited to 75% of $116,850 or $87,638 — carried forward ......................................................................... $10,250 — current . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77,388(1) (87,638) dividends from taxable Canadian corporations ....................................................... (12,300) subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 16,912 non-capital losses(2) .............................................................................................(16,912) net capital losses(2) (not to exceed the taxable capital gains for the year) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (0) Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0

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296

Exercise 8 Income from Japan in Canadian dollars (54,025,200 yen × 0.012) . . . . . . .

$ 648,302

Total income under Division B ($2,500,000 + $648,302) ..................................... $3,148,302 Less: Dividends deductible under sec. 112........................................ $100,000 Net capital losses carried forward (adjusted to current year inclusion rate) . . . . . . . . . . . 25,000 125,000 Taxable income ....................................................................................................... $3,023,302 Tax @ 38% ......................................................................................................... $1,148,855 Less: Federal tax abatement (10% of 75% of $3,023,302) ................................... (226,748) General tax reduction @ 13% of 3,023,302 . . . . . . . . . . . (393,029) Net tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 529,078

Foreign Business Tax Deduction Least of: (a) amount paid (21,610,080 yen × 0.012) . . . . . . . . . . . . . . . . . income from Japan × (b) Div. B income minus s. 112 ded. and net capital loss ded.

$648,302 $3,148,302 -- ($100,000 + 25,000)

$ 259,321

tax otherwise payable before abatement minus general rate reduction ($1,148,855 -× $393,029)

(c) Part I tax otherwise payable before abatement minus foreign non-business tax credit ($1,148,855 -- $393,029 -- 0) . . . . . . .

$ 162,076 $ 755,826

Therefore, the foreign tax deduction is $162,076.

Exercise 9 Income under Division B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Charitable donations . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 69,000 Taxable dividends deductible under sec. 112 ............................ 517,500 Non-capital losses ........................................................................ 127,600

$2,645,000

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$1,930,900

Tax @ 38% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Federal tax abatement (10% of 86% of $1,930,900) . . . . . . . . . . . . .

$ 733,742 166,057

Less: Non-business foreign tax credit (see Schedule 1) . . . . . . $ 25,676 Business foreign tax credit (see Schedule 2) . . . . . . . . . . 26,093 Tax reduction (13% of $1,930,900) ......................................... 251,017 ........................................... Part I tax payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

714,100

$ 567,685

302,786 $ 264,899

Schedule 1: Non-business foreign tax credit Lesser of: (a) amount paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(b)

foreign non-business income tax otherwise payable × Div. B income minus s. 112 ded. after abatement minus and net capital loss ded. general tax reduction $172,500 = × $316,668(1) . . . . . . . . $2,645,000 -- ($517,500 + 0)

25,875

25,676

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Schedule 2: Business foreign tax credit Least of: (a) amount paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

36,800

tax otherwise payable foreign business income × before deductions (b) Div. B income minus s. 112 ded. minus general tax and net capital loss ded. reduction =

$115,000 × ($733,742 -- 251,017) $2,645,000 -- ($517,500 + 0)

$ 26,093

— NOTE TO SOLUTION (1)

$733,742 -- $166,057 -- $251,017

Exercise 10 The total investment tax credit is 15% of $90,000 = $13,500. Taxable income before qualified current expenditures . . . . . . . . . . . . . . . . . . . . Less: qualified current expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$300,000 90,000

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net federal tax: @ 15% of $210,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: investment tax credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$210,000 $ 31,500 $(13,500)

Part I tax payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 18,000

Note that the $13,500 of investment tax credit will be brought into income in the following year.

Exercise 11

CHAPTER 11

(A) Permanent Establishments (i) Ontario: — The corporation has a fiXed place of business including the head office, factory premises, and warehouse which qualify as permanent establishments [Reg. 400(2)]. (ii) Saskatchewan: — A public warehouse that belongs to another corporation is not a fiXed place of business because Canco has no control over such a warehouse. — The sales representative in Saskatchewan does not operate from a fiXed place of business of the corporation. — He operates from his home, which is not identified to the public as Canco’s place of business since the company’s name does not appear on the premises. — The office in the home was operated at the sales representative’s own expense — the sales representative does not have general authority to contract, because head office must give credit approval [Reg. 400(2)(b)]. — The sales representative does not have a stock of merchandise owned by the corporation from which he regularly fills orders, because head office arranges shipping from a warehouse [Reg. 400(2)(b)]. (iii) Other provinces: — Sales representatives work on the same basis as described for Saskatchewan and, therefore, there is no fiXed place of business and no permanent establishment in the other provinces. (iv) Poughkeepsie, New York: — The fiXed place of business is the office maintained by the sales representative in his home. — It is identified to the public as the corporation’s office by the phone book listing. — The company pays the cost of maintaining the office in his house. — Furthermore, Reg. 400(2)(b) applies because the sales representative has authority to contract by the acceptance of orders. — As in the case of Saskatchewan, the public warehouse is not a fiXed place of business.

Introduction to Federal Income Taxation in Canada

298 (B) Allocation of Taxable Income Ontario . . . . . . . . . . . . New York . . . . . . . . . .

Gross revenue Amount % $ 7,750,000 77.5 $ 2,250,000 22.5 $10,000,000 100.0

Salaries & wages Amount % $1,400,000 93.3 100,000 6.7 $1,500,000 100.0

Ontario: ........................ 85.4% of $300,000 = $256,200 New York: ...................... 14.6% of $300,000 = 43,800 $300,000 Ssec. 124(1) abatement: 10% of $256,200 = $25,620

Average percentage 85.4 14.6 100.0

/2 (77.5 + 93.3) = 1 /2 (22.5 + 6.7) =

Chapter 12 Integration for Business and Investment Income of the Private Corporation

CHAPTER 12

299

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300

CHAPTER 12 — LEARNING CHART Problem Descriptions Textbook Example Problems 12-1 Small business deduction 12-2 Specified investment business 12-3 Related groups of companies 124 Associated corporations 12-5 Associated corporations 126 Associated corporations 12-7 Associated corporations 12-8 Connected corporations 12-9 Refundable Part I tax 12-10 Refundable dividend tax on hand 1211 Part I tax, RDTOH dividend refund Exercises 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

Identif y type of income Arm’s length Associated corporations Sharing small business deduction Associated corporations Calculate Part I tax Calculate Part I tax, RDTOH, dividend refund Investment income — personal vs. corporate Interest income from US subsidiary Association Association Association Part IV Tax; Dividend Refund Intercompany payments Type of income, Part IV tax Type of income

Assignment Problems 1 Corporate tax rates 2 Explain small business deduction 3 Explain dividends 4 Explain investment income 5 Personal services business 6 Corporate tax — public vs. CCPC 7 Part IV tax 8 RDTOH, dividend refund 9 Active business vs. property income 10 Associated corporations 11 Associated corporations 12 Tax payable 13 Tax payable 14 Dividend refund 15 Comprehensive

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Problem Descriptions 16 17 18 19 20 21 22 23 24 25

Find the errors Identif y types of income Identif y types of income Incorporating investments Associated corporations Errors in RDTOH calculation SR&ED Incorporate or not Share ownership Comprehensive corporate tax

CHAPTER 12

302

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Ch. 12/Study Guide — Review Questions

¶12,800

303

REVIEW QUESTIONS

(1) EXplain the purpose behind the concept of integration. (2) It has been said that ‘‘perfect integration depends on the existence of two factors in the tax system’’. Briefly explain what they are. (3) The dividend gross-up and tax credit has been described as the major tool of integration in the Act. Give a brief explanation of how it works in theory. (4) What is the purpose of the small business deduction? (5) The small business deduction amount is calculated as the least of 3 amounts. Give an example of when the amount in paragraph 125(1)(b) will result in a lower limit for the small business deduction than paragraph 125(1)(a). (6) List some tax and non-tax advantages of incorporation. (7) List some tax and non-tax disadvantages of incorporation. (8) Mr. Mould has just started up a manufacturing operation to supply parts to the auto industry. Given his need for start-up capital, he is happy that his tax rate is reduced by both the small business deduction of 19% and the general rate reduction of 13%. Comment. (9) Are there any tax rules that prevent an individual from deferring tax on portfolio dividends by flowing them through a corporation? (10) What are five tools that are used in the tax laws to integrate the taxation of investment income earned through a corporation? (11) Theoretically, what does the 15% or 38% gross-up on dividends from taxable Canadian corporations represent? (12) Theoretically, what does the dividend tax credit represent? (13) EXplain how integration theoretically works if a $1,000 capital gain is realized in a CCPC. (14) Mr. Orville owns all the shares of Holdco which in turn owns all of the shares of Opco, a CCPC carrying on an active business in Canada. In recent years, Opco has done very well and its income is well in excess of the business limit. Last year Mr. Orville paid a dividend of $150,000 from Opco to Holdco. However, since he needed the cash in Opco to expand, he loaned the money back to Opco and charged 10% interest. The interest charged to Opco amounted to $15,000 in the year. How will this interest income be taxed in Holdco? (15) A number of years ago a reorganization was undertaken so that now A Ltd. owns voting preferred shares in B Ltd. These preferred shares have only 7% of the votes and are now only worth 7% of the value. The other shares of B Ltd. are owned by the son of the only shareholder of A Ltd. Are A Ltd. and B Ltd. connected?

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EXERCISES

Exercise 1

ITA: 125(7)

The taxpayer company carried on the business on a comparatively small scale of lending money on mortgages. The company was operated by two individuals who also owned and managed a number of other companies. All the companies operated out of the same office premises and used more or less the same office staff and equipment. The taxpayer company had no full-time employees. It was listed in the telephone directory but did no direct advertising. No attempt was made to keep track of the amount of time spent by the office staff on the work of each company and no specific charge was made for office space, use of telephones and equipment or staff. The company made loans to potential borrowers referred to it by independent agents. Its clientele came mainly from those who found it difficult to obtain loans through the normal commercial channels. The agents had a general idea of the sort of loans which might be acceptable, but because those were relatively high-risk loans, the company had to examine them very carefully. Occasionally, an outside appraisal was made, but normally someone from the company would visit the property to examine it. Often considerable negotiations as to terms were involved. Post-dated cheques for five years would be obtained from borrowers and turned over to the bank as collateral for the company’s line of credit. For the year in question, the company held three mortgages involving $11,084. The sale of a small property, interest and other income resulted in total income of $4,609. Net income before taxes was shown as $3,479. The mortgages outstanding and net income of the company increased continuously from the year in question to the present time. During the year in question, the company’s line of credit at the bank was estimated at $7,500 to $15,000, but it is now $25,000.

— REQUIRED From the facts provided in the case, determine the type of business that is carried on by the company under the current legislation.

Exercise 2 (A) By reference to provisions of the Income Tax Act, determine which of the following individuals or groups of individuals are not at arm’s length with Alpha Corporation Limited: (i) Mr. Beta, who owns 25% of the shares of Alpha and is not related to any other shareholders. (ii) Mr. Beta and his brother, who together own 55% of the shares of Alpha and they are not related to any other shareholder. (iii) Mr. Delta, who has an option to purchase all of the shares held by Mr. Beta and his brother anytime during the next three years. (iv) Mr. Epsilon, who has an option to purchase all of the shares held by Mr. Beta and his brother from their estates within five years of their death. (B) By reference to provisions of the Income Tax Act, determine under which of the following conditions Tau Corporation Limited and Lambda Corporation Limited do not deal with each other at arm’s length: (i) Tau is controlled by two brothers, A and B, and Lambda is controlled by A. (ii) Three unrelated individuals together control Tau and one of these individuals controls Lambda. (iii) Tau is related to Sigma Corporation Limited and Sigma is related to Lambda.

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ITA: 251

Ch. 12/Study Guide — Exercises

305

Exercise 3

ITA: 251, 256

Consider each of the following unrelated cases: (A) Ava owns 55% of the shares of Jay-one Ltd. and 70% of the shares of Jay-two Ltd. Jay-one Ltd. owns 60% of the shares of Jay-three Ltd. The remaining shares in all three corporations are owned by persons unrelated to Ava. (B) Abigail owns 30% of the common shares of Benco Ltd. and all of the shares of Rayco Ltd. The other 70% of the common shares of Benco Ltd. are owned by Abigail’s cousin. However, Abigail’s mother owns all of the voting preferred shares of Benco Ltd. and has sufficient votes to elect more than 50% of the Board of Directors of Benco Ltd. (C) Adam owns 100% of the shares of Adamco Ltd. and 25% of the shares of Kidco Ltd. His daughter and son-in-law each own 20% of the shares of Kidco Ltd. and the remainder of the shares are owned by persons unrelated to all three. (D) Sister One and Sister Two each own 50% of Sisco Ltd. and 25% of Cousco Ltd. Each sister has a daughter over the age of 18 who owns 25% of Cousco Ltd. — REQUIRED In each unrelated case, determine whether the corporations named are associated. Substantiate your answer by reference to specific provisions of subsection 256(1).

Exercise 4 Alpha and Beta are two sisters living in Halifax. While Alpha controls Taxit Ltd., Beta owns 25% of the shares of the corporation. Beta also owns 100% of the shares of Sibling Ltd. The active business income for Taxit during the current taxation year was $465,000 and for Sibling was $560,000. The taxation years for both corporations end December 31.

ITA: 125(1), 256(1), 256(2.1)

— REQUIRED How much should each company claim as a small business deduction on their active business income for the taxation year? What planning could be done to improve their circumstances?

Exercise 5

ITA: 251, 252, 256

The common shares of Chutzpah Enterprises Limited were owned by the three Chutzpah brothers as follows: Aleph Chutzpah . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40% Bett Chutzpah . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

40%

Gimmel Chutzpah . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20%

The common shares of Schlock Sales Limited were owned by the following: 45%

Dallied Chutzpah . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

45%

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Bett Chutzpah . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Unrelated person . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10% Aleph Chutzpah is married to Dallied Chutzpah. — REQUIRED Determine whether the two corporations are associated. Substantiate your answer by reference to specific provisions of subsection 256(1).

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Exercise 6

ITA: 123–126

The following data pertains to Moosonee Company Limited, a Canadian-controlled private corporation for its fiscal year ended December 31, 2023: Canadian-source business income.............................................................................$110,000 Canadian investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,000 Income under Division B ............................................................................................ 117,000 Taxable income all of which is earned in Canada . . . . . . . . . . . . . . . . . . . . . 79,700 — REQUIRED Compute the federal Part I tax payable plus provincial tax at a 4% rate for 2023, if all of the business income is considered to be active. Moosonee Company Limited is not associated with any other corporation. What is the effective tax rate applicable to the types of income earned by the corporation in the year. EXplain why.

Exercise 7

ITA: 123–127, 129, 186

Ay Ltd. is a Canadian-controlled private corporation with a December 31, 2023 fiscal year end. The company operates in Alberta. Taxable income for the year is calculated as follows: Canadian-source business income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividends from CCPCs: Non-connected corporations (eligible) . . . . . . . . . . . . . . . . . . . . . . . . . . . Wholly owned corporation which received a dividend refund of $4,000 as a result of paying the dividend* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Canadian-source investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Canadian-source taxable capital gains (from investments, non-active) . . . . . Income under Division B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: donations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 40,000 taxable dividends from CCPCs . . . . . . . . . . . . . . . . . . . . . . 50,000 non-capital losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,000 net capital losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000

20,000 100,000 20,000 $260,000

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$135,000

$ 90,000 30,000

125,000

*The dividend refund was from the non-eligible RDTOH balance of the wholly owned subsidiary. Both the refundable dividend tax on hand accounts had a zero balance at the end of the previous year. No dividends were paid in the preceding year. Non-eligible dividends of $70,000 had been paid during the current year to the only shareholder, an associated corporation which has only income from investments. Assume investment income in the prior year was the same as the investment income earned in the current year. — REQUIRED (A) Compute the federal Part I tax and provincial tax at a 3% rate (using federal taxable income as the tax base) payable by the company for the 2023 taxation year. (B) Compute the two refundable dividend tax on hand balances at the end of the year and the dividend refund for the taxation year. (C) What is the effective tax rate applicable to the types of income earned by the corporation in the year. EXplain why. (D) EXplain the refundable dividend tax on hand additions and the dividend refund. What should the company consider doing in 2024 to maximize the dividend refund for the 2024 taxation year end.

Exercise 8 Dana Toews lives in a province with a 12% provincial corporate tax rate and owns an investment portfolio that generated the following Canadian-source income during the year: Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,000 Portfolio dividends from non-connected CCPCs (non-eligible) .................................. 15,000 Capital gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,000

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ITA: Part I, IV

Ch. 12/Study Guide — Exercises

307

If she were to incorporate her investments, her cash needs would require that $15,000 of the corporation’s after-tax profits be distributed as a dividend. The corporation will retain and reinvest the remainder. She already has taxable income of $20,000 from other sources. She has federal personal tax credits of $2,460 and provincial tax credits of $1,640. Assume the provincial tax brackets are the same as the federal tax brackets for individuals. — REQUIRED Compare the total personal tax on the income from the portfolio with the total tax if a corporation owned the securities.

Exercise 9 Johnson & Co Ltd. holds all the issued shares in Johnson & Co (USA) Inc. Two years ago, the Canadian corporation advanced $100,000 in the form of a loan to the US corporation. The US corporation pays Johnson & Co interest at the rate of 5%. This 5% is comparable to the cost of borrowing at a US bank, but is less than the prescribed interest rate under the Canadian Act. Assume that rate is 7%. (Ignore any subsection 17(1) considerations.) — REQUIRED EXplain the tax obligations of the Canadian corporation relative to this 5% interest.

Exercise 10 In each of the following unrelated situations, determine whether A Ltd. is associated with B Ltd. Provide reasons for your answer. (a) Joan owns 70% of the voting shares of A Ltd. and 30% of the voting shares of B Ltd. Another 25% of the voting shares of B Ltd. are owned by A Ltd., and the remaining 45% of the shares of B Ltd. are owned by strangers.

ITA: 123.3, 126, 129(1), 129(6), 256

(b) John owns 100% of the shares of A Ltd. and Jill owns 100% of the common shares of B Ltd. John owns 100% of the non-voting, redeemable, retractable, 5% preference shares issued by B Ltd. These shares were issued for $80,000 in 2000, when the prescribed rate of interest was 7%. The redemption value of the shares is $80,000. John and Jill are husband and wife. (c) Joe owns 100% of the shares of A Ltd. and his son, Jack, age 20, owns 100% of the shares of B Ltd. B Ltd. markets the products manufactured by A Ltd. Prior to the incorporation of B Ltd., in 2009, A Ltd. marketed its own products. Jack is currently attending the University of Waterloo and thus, his father carries on the day-to-day operations of B Ltd. and makes the necessary business decisions for Jack. (d) Jim and Jane are cousins. They each own 50% of the common shares of A Ltd. A Ltd. owns 100% of the common shares of X Ltd. John, Jim’s father, owns 100% of the common shares of B Ltd., as well as preferred shares of X Ltd. valued at $50,000. The value of all the shares of X Ltd. is estimated to be $80,000.

Exercise 11 For each of the following situations, determine whether or not the corporations are associated, and provide references to the Income Tax Act to support your conclusions. (Assume each corporation has a December 31 year end.)

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(i) Are A Co. and B Co. associated? (ii) If the 26% shareholdings in B Co. were held in A Co., would A Co. and B Co. be associated?

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Exercise 12 Consider the following unrelated fact situations. (A) Chiquita and Clorilda are sisters who have not spoken to each other in forty years. Chiquita lives in Dundas and owns all of the common shares of a corporation retailing bicycles and related equipment. Clorilda lives in Yellowknife and owns all of the common shares of a corporation retailing snowmobiles and related equipment. Clorilda owns the only preferred share outstanding in Chiquita’s corporation. This share is only worth $100 and carries no voting right or special dividend privileges, but it is convertible into 10 common shares.

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(B) Caspar and Carter are brothers who each own 100% of the common shares of their respective corporations, Caspar’s Corporation Ltd. and Carter’s Corporation Ltd. In addition, they each own 30% of Ceecombo Corporation Ltd. The remaining 40% is owned by persons who are unrelated to Caspar or Carter. Ceecombo Corporation Ltd. earns only investment income. (C) Chauncey, Clarabelle, and Clyde are siblings who each own 20% of the voting shares of Xerxes Ltd. Basil, Bertha, and Bambi are the other brother and sisters of Chauncey, Clarabelle, and Clyde. Basil, Bertha, and Bambi each owns 25% of the voting shares of Xylona Ltd. In addition, Chauncey and Clarabelle each owns 12.5% of the voting shares of Xylona Ltd. Unrelated parties own the unspecified amounts of shares in Xerxes Ltd. (D) Alphonso owns 100% of the voting shares of One Corporation Ltd., which carries on business in Northwestern Ontario. Althea, who is married to Alphonso, owns 100% of the voting shares of Another Corporation Ltd. which carries on business in Manitoba and was formed to provide geographic diversification. The two corporations are in the same business and use the same business name and logo, although they deal with separate clientele. When Another Corporation Ltd. was formed, Althea used money given to her by Alphonso to acquire the shares. In addition, One Corporation Ltd. loaned Another Corporation Ltd. both equipment and funds for operations. Since Althea’s experience with business was limited, her corporation was managed by a former employee of One Corporation Ltd. who had moved to Manitoba after a divorce. Each year, salaries and bonuses were set so that net profit for each corporation remained at about $500,000. (E) The common shares of Yolanda Ltd. are 50% owned by Eunice and 50% owned by Fifi who is not related to Eunice. Eunice owns all of the non-voting preferred shares of Yolanda Ltd., but as a result of this added investment, she has a tie-breaking vote in the event that the two shareholders are opposed in a vote of the common shareholders in a meeting of the Board of Directors. Eunice also owns 55% of the fair market value of all of the issued shares of Zerlinda Ltd., the other shares being owned by unrelated parties. (F) Edbert owns 60% of the shares of Una Ltd. and 25% of the shares of Velda Ltd. His cousin Filbert owns 50% of the shares of Velda Ltd. Edbert holds an option to acquire all of the shares of Velda Ltd. owned by his cousin if his cousin dies. The unspecified holders of shares in both corporations are unrelated parties. — REQUIRED Determine whether the corporations involved in the above independent fact situations are associated. State clearly all of the reasons supporting your opinion and all the appropriate authority in the Income Tax Act and/or the cases (if necessary) that apply to this topic.

Exercise 13 Mr. Stevens owns 100% of the shares of Stevens Holdings Inc. (SHI) which owns 100% of Fancy Operating Ltd. (FOL). Both SHI and FOL have a December 31 year end. The following information pertains to the December 31, 2023 year ends (neither company paid any dividends in 2022):. Stevens Holdings Inc. — balance in the non-eligible RDTOH and the eligible RDTOH account at December 31, 2022 was $8,000 and $0, respectively — received taxable non-eligible dividend from FOL of $75,000 — received taxable eligible dividend from Canadian Pacific Ltd. of $8,000 on October 31, 2023

CHAPTER 12

— earned interest income of $12,000 — realized a capital gain of $42,000 — paid a capital dividend of $10,500 and a taxable non-eligible dividend of $50,000 to Mr. Stevens on February 15, 2023 Fancy Operating Ltd. — balance in the non-eligible RDTOH and the eligible RDTOH account at December 31, 2022 was $2,000 and $0, respectively — earned active business income of $80,000 and interest income of $7,000 — paid taxable non-eligible dividends to SHI of $75,000 on July 15, 2023

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— REQUIRED (i) Calculate the dividend refund for FOL for 2023. (ii) Calculate the Part IV tax for SHI for 2023. (iii) Calculate the dividend refund for SHI for 2023.

Exercise 14 Mr. C.A. Smith is a Chartered Professional Accountant and is the sole shareholder and employee of C.A. Managem Inc., a corporation that provides administrative services to Public Company Limited (Public). Public formerly employed Mr. C.A. Smith as its Vice-President, Finance. Mr. C.A. Smith also owns all the shares of C.A. Buildem Inc. (Buildem), which has 10 full-time employees. Buildem operates a small construction business. C.A. Buildem Inc. fully owns C.A. Holdem Company Ltd., an investment company that has no employees and earns interest income from a loan to CA Buildem Inc. and other sources, as well as from portfolio dividends from taxable Canadian corporations. C.A. Managem Inc. also provides administrative services to C.A. Buildem Inc. and C.A. Holdem Company Ltd. — REQUIRED Indicate, with reasons, the types of income being earned by each corporation. Describe how each type of income will be taxed, including refundable taxes, if any. Ignore any proration of taxes and surtaxes. Assume that the business limit has not been exceeded.

Exercise 15

ITA: 125, 129, 186, 256(1)

Sunlight Limited is owned 50% by H Ltd. and 50% by W Ltd. The two holding companies are 100% owned by Mr. Bennett and Mrs. Bennett, respectively. Sunlight Limited derives all of its income from active business carried on in Canada. It rents facilities from H Ltd. to which it pays $120,000 in annual rent, deducting this amount as a business expense. Sunlight also pays dividends to the two holding companies which is the only other income of those corporations. — REQUIRED (A) What is the nature of the rental income to H Ltd.? (B) Is there a Part IV tax liability for the two holding companies on the dividends received from Sunlight Limited?

Exercise 16 Janna Management Limited owns a building most of which it rents to Rayna Consulting Services Limited which carries on an active business. Janna and Rayna each own 50% of both corporations. Janna Management Limited also provides managerial, administrative and maintenance services to the unincorporated professional practice of Dr. Adam. The result of these transactions is that Janna Management Limited receives 60% of its income from rent and 40% from providing services and has available an excess business limit for the purposes of the small business deduction. The services provided to the professional practice are provided by Janna, Rayna and four other full-time employees. — REQUIRED Determine the nature of its income and the deductions from tax available to Janna Management Limited.

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ITA: 125, 129, 256

Ch. 12/Study Guide — Assignment Problems

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ASSIGNMENT PROBLEMS

Problem 1 You are working on your CPA firm’s tax publications and have been asked to compare the corporate tax rates for active business income earned by the following: — a Canadian public company, — a CCPC with income below $500,000 and — a CCPC with income above $500,000. Assume a generic provincial tax rate that you can support.

Problem 2 You are working on your CPA firm’s tax publications and you have been asked to calculate the small business deduction and then explain how it works. (1) What is the purpose behind the small business deduction? (2) Does this deduction result in savings or a deferral? EXplain (3) The purpose behind each of the components of the calculation. (4) The purpose behind the associated company rules. (5) If income is over the annual business limit should the company declare a bonus to reduce the income back down to the annual business limit? Use the following assumptions: — Active business income ............................................................... $600,000 — Taxable income ............................................................................. 300,000 — Small Business Deduction limit ................................................... 200,000 — Personal marginal tax rate on employment income . . . . . .

50%

— Personal marginal tax rate on eligible dividends . . . . . . . .

31%

— Personal marginal tax rate on non-eligible dividends ................... 42.5% — Corporate tax rate on ABI below $500,000 . . . . . . . . . . . .

13%

— Corporate tax rate on ABI above $500,000 . . . . . . . . . . . .

28%

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1. Calculate the amount of bonus needed to reduce taxable income to the point where all of the taxable income is eligible for the small business deduction. 2. Assuming that the bonus is declared and paid, calculate the personal tax on the bonus received by the individual and their after-tax cash. 3. Assuming that the bonus is not declared, then calculate the amount of corporate tax the company will pay on the amount of the bonus identified in step 1. Then calculate the corporate after-tax cash on this bonus amount not paid. Pay this after-tax cash as a dividend and calculate the amount of personal tax on this dividend and the after-tax cash.

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Problem 3 Staying with the tax publication, assuming Canadian portfolio dividends received are $100,000 and are eligible dividends: — EXplain how Canadian dividend income is taxed in a public corporation. — EXplain how Canadian dividend income is taxed in a CCPC. (1) Why are dividends deductible under Division C? (2) What is the purpose of Part IV tax? Is it a permanent or temporary tax? To whom does it apply? (3) Why might there be Part IV tax on dividends from connected corporations? (4) What is the purpose behind the Refundable Dividend Tax On Hand (RDTOH)? (5) Why doesn’t Part IV tax apply to public companies? (6) How does the Dividend Refund fit in?

Problem 4 Staying with the tax publication, assuming interest income of $10,000 and capital gains of $40,000: — EXplain how investment income, other than dividends, is taxed in a public corporation. — EXplain how investment income, other than dividends, is taxed in a CCPC. (1) What type of income is included in Aggregate Investment Income (AII)? (2) How is AII calculated? (3) What is the purpose behind the Additional Refundable Tax (ART)? (4) What is the purpose behind the Refundable Dividend Tax On Hand (RDTOH)? (5) Why don’t ART and RDTOH apply to public companies? (6) How does the Dividend Refund fit in?

Problem 5 Compare the taxation of active business income and personal services business income assuming income of $100,000. What is the purpose behind taxing ‘‘personal services business’’ income differently? Compare the calculation of income and tax payable between an individual earning employment income and a corporation earning personal services business income. For the individual’s income assume a tax rate of 31% on non-eligible dividends and 50% on business income.

Problem 6 First Gear Inc. is a corporation located in Saint John, New Brunswick that distributes automotive parts in the Maritime Provinces. It is owned by John Robinson who lives in Saint John. For the year ended December 31, 2023, its accounting income statement is as follows:

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Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cost of sales and other expenses including CCA . . . . . . . . . . . . . . . . . Operating profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income before taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provision for taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$1,225,000 (725,000) 500,000 208,500 708,500 (200,725)

Net income after tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 507,775

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Selected Additional Information (1) Other income includes: Portfolio dividends from Canadian public corporation (eligible) . . . . . . . $ 85,000 Canadian interest income on long-term bonds .................................................. 123,500 $208,500 John is confused about how income in his corporation is taxed. He wants to understand it so he can make better decisions. He has asked you to explain how the different types of income earned by First Gear are taxed. Then he wants you to calculate the corporate tax liability and provide any advice you think is appropriate related to the refundable tax. Personally, he is in the top tax bracket (50%). Assume the provincial corporate tax rate is 4% on income eligible for the small business deduction and 12% on other income. For purposes of the small business deduction, assume investment income earned in the prior year is the same as the amount earned in the current year. You agree that you will: (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

Problem 7

ITA: 186

EX Ltd., a Canadian-controlled private corporation, received a non-eligible taxable dividend of $90,000 from its Canadian subsidiary Little EX Ltd. The subsidiary had paid a total dividend of $120,000 and had received a dividend refund from non-eligible RDTOH of $18,000. Compute the Part IV tax payable by EX Ltd.

Problem 8

ITA: 123–127, 129, 186

Why Limited is a Canadian-controlled private corporation operating solely in Newfoundland and Labrador. For its taxation year ended December 31, 2023, the company reported the following income under Division B: Active business income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable capital gain (non-active) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Canadian-source interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable portfolio dividends from Canadian-resident public corporations (eligible) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 97,000 37,500 45,000

Income under Division B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$198,250

The corporation is carrying forward the following amounts: Non-capital losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net capital losses (arising in 2018) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 40,000 52,000

18,750

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The balance in both refundable dividend tax on hand accounts at December 31, 2022 was $0. On November 30, 2023, the company paid $112,500 in taxable dividends (all non-eligible) to its shareholders all of whom are individuals. The taxable portfolio dividends of $18,750 were received on November 1, 2023. (A) Compute the federal Part I tax and provincial tax at a 4% rate for income eligible for the small business deduction and a 12% rate for income not eligible for the small business deduction payable by the company for 2023. For purposes of the small business deduction, assume investment income earned in the prior year is the same as the amount earned in the current year. (B) Compute the refundable dividend tax on hand balance as at December 31, 2023, and compute the dividend refund for 2023.

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Problem 9

ITA: 125(7)

The taxpayer company, a private corporation, owned and operated a small shopping centre from which it received rental income. There were seven separate tenants, only one of them being what is sometimes referred to as a ‘‘Triple A’’ tenant, namely, a Canadian bank. The corporation, through its principal officer, negotiated all the leases, took care of all the complaints from the tenants and arranged for the maintenance of the shopping centre. It required some activity by the company almost daily. The rental income of the company was mainly for use of the property, but also, to a much lesser extent, for services and other things supplied by the company such as heat, repairs, etc. From the facts provided in the case, determine the type of income that the corporation derives from the business that it carries on under the current legislation.

Problem 10 Consider each of the following unrelated cases, involving the ownership of the common shares of Canadian-controlled private corporations, for taxation years of all corporations ending on December 31: (A) Leah Ltd. owns 55% of the shares of Elaine Ltd. (B) Ms. Miriam owns 51% of the shares of Abigail Ltd. and 60% of the shares of Ethan Ltd. (C) Ms. Irene and Mr. Mordechai each own 50% of the shares of Clare Ltd. In addition, they each own 50% of the shares of Philip Ltd. Ms. Irene and Mr. Mordechai are not related. (D) Mrs. Lyn owns 60% of the shares of Jay Ltd. and Mrs. Sarah owns the other 40%. Mrs. Lyn and Mrs. Sarah each own 50% of the shares of Alex Ltd. Mrs. Lyn and Mrs. Sarah are not related. (E) Janna Ltd., Rayna Ltd. and Adam Ltd. each own 1/3 of the shares of Stan Ltd. Janna Ltd. and Rayna Ltd. each own 50% of the shares of Jonathan Ltd. (F) Ms. Ruth owns all of the shares of Rick Ltd. Ms. Ruth owns 25% of the shares of Daniel Ltd. and Ms. Ruth’s daughter, Elana, who is over 18 years old owns the other 75%. (G) Mr. Joshua owns 100% of the shares of Gord Ltd. and Ms. Dahlia owns 100% of the shares of Rosalyn Ltd. Mr. Joshua and Ms. Dahlia each own 30% of the shares of Rebecca Ltd. The other 40% of the shares of Rebecca Ltd. are owned by Eden, who is not related to any of the others. Mr. Joshua is the brother of Ms. Dahlia’s husband. (H) Mrs. Yael owns 60% of the shares of Benjamin Ltd. and 30% of the shares of Livi Ltd. Another 25% of the shares of Livi Ltd. are owned by Benjamin Ltd. and the remaining 45% of the shares of Livi Ltd. are owned by Joy, who is not related to any of the others. (I) Ms. Daniella owns 60% of the shares of Elizabeth Ltd. and 25% of the shares of Ava Ltd. Ms. Samara, who is not related to Ms. Daniella, owns the other 75% of the shares of Ava Ltd. Ms. Daniella holds an option to buy all of the shares owned by Ms. Samara at any time in the next 10 years. (J) Mr. and Mrs. Jonathan each own 50% of Isabelle Ltd. Mr. Jonathan and his two brothers and one sister each own 25% of Maya Ltd. In each of the above unrelated cases determine whether the corporations are associated. Substantiate your answer by reference to the specific conditions in the provisions of section 256, and consider all possible alternatives.

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ITA: 256

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Problem 11

ITA: 256

Consider each of the following unrelated cases, involving the ownership of shares of Canadiancontrolled private corporations. Assume all of the issued shares are common shares unless specifically stated otherwise. (A) Rachel and Monica, friends, each own 50% of the issued shares of A Ltd. In addition, Rachel owns 80% and Monica owns 20% of the issued shares of B Ltd. (B) Charlie and Claudia are siblings. Charlie owns 80% of A Ltd. which in turn owns 40% of B Ltd. Claudia owns 60% of B Ltd. (C) Bob, Bill, and Bert are three brothers who share equally the income of a professional partnership. The partnership owns 100% of the shares of A Ltd. Bert owns 100% of the shares of B Ltd. (D) Anne and Barbara are sisters. They each own 100% of their respective corporations, A Ltd. and B Ltd. A Ltd. and B Ltd. each own 40% of the shares of C Ltd. (E) Valerie, Brandon, and Claire are strangers. They each own 1/3 of the shares of A Ltd. Brandon owns 40% of the shares of B Ltd. The remaining 60% are owned by Claire. Claire also owns 100% of the shares of C Ltd. (F) Valerie and her two nieces each own 25% of the shares of A Ltd. Valerie’s husband, Dilon, and his nephew each own 50% of the shares of B Ltd. Dilon also owns the remaining 25% of the shares of A Ltd. (G) Father owns 100% of the shares of F Ltd. His son, Sean, age 17, owns 100% of the common shares of S Ltd. F Ltd. owns 30% of the issued preferred shares of S Ltd. The preferred shares have the following characteristics: ● non-voting, ● dividend rate fiXed at 3%, ● redeemable at $1,000 per share, and ● issue price $1,000 per share.

The prescribed rate of interest was 5% at the time the preferred shares were issued. You have been asked to determine which of the corporations are associated and substantiate your answer by reference to specific provisions of the Act.

Problem 12

ITA: 123–126

The accountant, Ryan Mailling, of Double-D Retailing Ltd. (DRL), a Canadian-controlled private corporation, has requested your assistance with respect to the calculation of the company’s Part I tax payable. Ryan has provided you with the following information. (1) DRL is not associated with any other corporation. (2) For DRL’s current December 31 taxation year end, the corporation correctly reported:

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Active business income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investment income Canadian . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Charitable donations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net capital loss deducted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-capital loss deducted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$320,000 24,000 9,000 2,000 10,000 323,000

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(3) Taxable capital employed in Canada in the prior year was $11.9 million. (A) Ryan has asked you to calculate the federal Part I tax payable for the taxation year ended December 31, 2023. Show all calculations whether or not relevant to the final answer. For purposes of the small business deduction, assume investment income earned in the prior year is the same as the amount earned in the current year.

Problem 13 Neville Ltd. is a Canadian-controlled private corporation which was incorporated in 2007 with a December 31 year end. In 2023, Neville Ltd. earned net income of $250,000 before taxes for accounting purposes. Included in the calculation of that amount were the following items:

ITA: 110.1–112, 123–126, 127(3)

Canadian active business income..............................................................................$159,000 Dividends from taxable Canadian subsidiary corporations . . . . . . . . . . . . . . . 8,000 Other Canadian investment income: — rental income ....................................................................................................$115,000 — interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,000 — royalty income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000 — taxable capital gain (non-active) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,000 Income under Division B ...........................................................................................$307,000 Donations to registered charities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The company also has the following opening balances: 2017 Net capital loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Charitable donations carried forward from last year . . . . . . . . . . . . . . . . .

$ 60,000 $ 10,000 10,000

Assume investment income earned in the prior year is the same as the amount earned in the current year. Neville Ltd. had $8 million of taxable capital in Canada for the prior year. You have been asked to calculate the federal Part I tax and provincial tax payable by Neville Ltd. for 2023. Show all calculations. Assume the provincial tax rates are 4% for active business income eligible for the small business deduction and 12% for all other income.

Problem 14

ITA: 123–127, 129, 186

The following selected information has been taken from the records of Sharp Ltd., a Canadiancontrolled private corporation, for its fiscal year ended December 31, 2023. (1) Income for tax purposes: Active business income (retailing) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Canadian bond interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable dividends received from taxable Canadian corporations . . . . . . . . . . Taxable capital gains (non-active) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$170,000 20,000 40,000 30,000

Net income under Division B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$260,000

(2) Division C deductions claimed: Donations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,000) Net capital losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,000) Non-capital losses ......................................................................................................... (13,000) Taxable dividends received from taxable Canadian corporations ............................. (40,000)

(3) Taxable income ........................................................................................................... $200,000

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(4) Part I tax payable is $26,900 including additional refundable tax of $3,200. In computing Part I tax, the following deductions were made: Small business deduction ........................................................................................... $32,300 (5) Summary of taxable dividends received from taxable Canadian corporations:

Date received Aug. 1, 2023 . . . . . . . Oct. 1, 2023 . . . . . . . .

Payer A Ltd. B Ltd.

% of voting shares owned 6% 80%

Amount of eligible Dividend refund dividends received by received payer corp. $20,000** $30,000 20,000 5,000* $40,000

*The refund came from the eligible RDTOH of B Ltd. **An eligible dividend. (6) Summary of dividends paid by Sharp Ltd.: Type of dividend Taxable non-eligible dividend . . . . . . Tax-free ssec. 83(2) dividend . . . . . . Taxable eligible dividend . . . . . . . . .

Amount $60,000 20,000 24,000

Date declared July 15, 2023 Oct. 15, 2023 Dec. 15, 2023

Date paid Aug. 15, 2023 Nov. 15, 2023 Jan. 15, 2024

(7) Sharp’s non-eligible refundable dividend tax on hand balance at December 31, 2022, was $12,000. The dividend refund for 2022 was $4,000. The opening balance in the eligible RDTOH account is $0. The opening GRIP balance is $0. For purposes of the small business deduction, assume investment income earned in the prior year is the same as the amount earned in the current year and that Sharp will use all the small business deduction available. You have been asked to compute the dividend refund for 2023.

Problem 15

ITA: 123–127; 129, 186

Multi Enterprises Ltd. is a Canadian-controlled private corporation whose fiscal period coincides with the calendar year. For the year 2023, the company’s taxable income was calculated as follows: $220,000 11,000 20,000 17,000 9,000 4,000 14,000 5,000 $300,000

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Income from distributing net of CCA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividends from taxable corporations: (a) connected corporation, dividend payment triggering a dividend refund from its non-eligible RDTOH of $2,750 to the wholly owned subsidiary (b) non-connected corporation (portfolio dividends) (eligible) . . . . . . . . . Taxable capital gain (non-active) ........................................................... $29,000 Allowable capital losses ............................................................................. 12,000 Royalties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Recapture of CCA on disposal of sales equipment . . . . . . . . . . . . . . . . . . . . Income from rental of an apartment building (no full-time employees and tenants provide virtually all of their own services) . . . . . . . . . . . . . . . . . . Interest charged on accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income for tax purposes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: net capital losses carried over . . . . . . . . . . . . . . . . . . . . . $ 7,000 non-capital losses carried over .................................................... 10,000 donations ..................................................................................26,000 dividends from taxable Canadian corporations .......................... 31,000 Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

74,000 $226,000

At December 31, 2022, there was a $0 balance in both the eligible and non-eligible refundable dividend tax on hand accounts. The company paid $72,000 in non-eligible dividends during 2023 to individual shareholders.

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The company is not associated with any corporation and has a permanent establishment in New Brunswick. You have been asked to: (A) Compute the federal Part I tax and assumed provincial tax at a 4% rate on active business income eligible for the small business deduction and 12% for all other income. Show in detail the calculation of all deductions in the computation, using a separate schedule for each special deduction. For purposes of the small business deduction, assume investment income earned in the prior year is the same as the amount earned in the current year. In calculating the small business deduction list all ineligible items of income, if any, and indicate the amount of the business limit available for the subsidiary. (B) Compute the refundable dividend tax on hand balance as at December 31, 2023, showing, in detail, your calculations and compute the dividend refund for 2023.

Problem 16

ITA: 110.1–112, 123–127

The controller of Tek Enterprises Ltd. provided you with the following information: Tek Enterprises Ltd. Income For the fiscal year ended December 31, 2023 Canadian wholesaling income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Canadian retail business income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable capital gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest income: Canadian long-term bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest on accounts receivable outstanding for more than 30 days in the Canadian retail business . . . . . . . . . . . . . . . .

$251,500 90,000 4,500 $20,000 5,000

Dividend income: From taxable Public Canadian corporations(1) . . . . . . . . . . . . . . . From foreign corporations (before foreign tax of $1,800) (Tek Enterprises Ltd. owns less than 5% of the shares) . . . . . . . .

$ 9,000 12,000

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(1)

25,000

21,000 $392,000

Tek owns less than 10% of the shares (eligible dividends).

Notes: (1) Tek Enterprises Limited is a CCPC. It is not associated with any corporations. (2) The following items were deducted in the computation of Canadian wholesaling income above: SR&ED expenditures (current in nature) ................................................................. $50,000 (3) The taxable capital gain was calculated as follows: Marketable securities Proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gain (Loss) . . . . . . . . . . . . . . . . . . . . . . . .

$15,000 3,000 $12,000

Equipment $

200 3,200 $ (3,000)

Total $15,200 6,200 $ 9,000 × 1/2 $ 4,500

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(4) The corporation has net capital losses (incurred in 2013) of $13,000. You assigned a junior staff member to calculate the federal Part I tax payable for Tek Enterprises Ltd. The following is his calculation. Net income........................................................................................................... $392,000 Dividends................................................................................................................(21,000) Donations ...............................................................................................................(75,000) Net capital losses ......................................................................................................... (13,000) Taxable income ..........................................................................................................$283,000

Basic federal tax (40% × $283,000) .........................................................................$113,200 Abatement: Taxable income . . . . . . . . . . . . . . . . . . . . . . $ 283,000 × 10% $ 28,300 $141,500 Foreign tax credit: Lesser of: (a) Foreign tax paid = $1,800 Foreign income $12,000

× $141,500 = $5,356 $283,000 + $21,000 + $13,000 Small business deduction: 19% × the least of: (a) Active business income: Wholesaling business . . . . . . . . $251,500 Cdn. retail business . . . . . . . . . 90,000 (b)

(1,800)

$341,500 (b) $283,000 -- (4 × $1,800)

$275,800 $500,000

(52,402)

General rate reduction (13% × $283,000)......................................................................... (28,300) Federal Part I tax payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 58,998

Write a memo in point-form explaining to the junior staff member the errors in his calculation. HINT: Do the calculations correctly and compare your results to the results of the junior staff member. Then explain the errors.

Problem 17

ITA: 125, 129, 186, 256

Carl owns 100% of the issued shares of Compunet. He incorporated Compunet earlier this year to provide computer consulting services to Vitamins Inc., a retailer of energy-producing vitamins. Prior to the incorporation of Compunet, Carl headed the computer service division of Vitamins Inc. One hundred per cent of the issued shares of Vitamins Inc. are owned by Carl’s cousin, Vince.

CHAPTER 12

Carl’s daughter, Sulee, received a degree in computer science from the University of Toronto in April and has been employed by Compunet as a computer consultant since then. Sulee and Carl work well together. They are the only employees of Compunet. Compunet owns a warehouse. One-half of the warehouse is rented to Vitamins Inc. and the remainder is rented to Mindblasters, a wholly owned subsidiary of Compunet. Mindblasters is a successful retailer of computer games. During the current year, Compunet received taxable dividends from Mindblasters and paid taxable dividends to Carl. Carl has asked you to determine the type(s) of income being earned by Compunet, the rate of tax for each type and any refunds available.

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Problem 18

ITA: 125, 129, 256

Lemon Ltd. provides management services for Toys-4-U Limited (Toys), a retailer of educational toys, and for certain other corporations described below. Les Lemon is the sole shareholder and only employee of Lemon Ltd. Prior to this year, Les had been employed by Toys as vice-president of financial and administrative services. Les owns all of the common shares of Rental Ltd. (Rental), which is in the business of renting commercial properties. Rental has no employees, except for Les, and subcontracts all maintenance and administrative services. Rental’s income for tax purposes can be broken down as follows:

Lemon Ltd. ........................................................................................................................ 10% Cheap Leasing Ltd. (see below) .................................................................................. 25% Arm’s length parties ......................................................................................................... 65% 100%

Les is also involved with Cheap Leasing Limited (Cheap), which is in the business of leasing educational equipment. The ownership of the common shares of Cheap is as follow:

Les Lemon ................................................................................................................ 25 shares Lucy Lemon, Les’ wife ............................................................................................. 20 shares Lemon Ltd. ............................................................................................................... 30 shares Larry Lemon, Les’ uncle .......................................................................................... 10 shares Arm’s length parties ................................................................................................ 15 shares

Cheap derives approXimately 80% of its income from the educational equipment leasing business. The balance of its income is interest from a loan to Toys. Cheap has four employees in addition to Les. All of the above corporations are Canadian-controlled private corporations and have December 31 year ends. You have been asked to identify the various sources of income for the above corporations indicating the reasoning behind your conclusions. Also indicate the federal tax rate and any refundable taxes applicable to each income source.

Problem 19 Mr. Humphries, a resident of a province with a 40% effective combined federal and provincial corporate tax rate (before the additional refundable tax), has just won a lottery prize of $750,000. He is considering the following investment of these funds: $200,000 of bonds yielding 8% and $550,000 of common shares of Growth Unlimited Limited (a CCPC earning active business income less than the business limit), which pay a dividend to yield 5%. Having taken a course in security analysis, Mr. Humphries can predict with great confidence that he will realize a 10.5% capital gain on the shares within the year. He will hold a less than 10% interest in the shares of the company. Mr. Humphries currently has other taxable income of $30,000. He has federal personal tax credits of $2,371, and provincial personal tax credits of $1,640. Advise Mr. Humphries on whether he should use an investment corporation with a permanent establishment in the province of which he is a resident to hold the securities he proposes to purchase. Include in your analysis the realization of the predicted capital gain. Use 2023 federal rates and the provincial tax rate brackets that are provided in Chapter 10. Also, consider any non-quantitative factors that may be relevant to the decision.

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ITA: Part I, IV

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Problem 20

Elle is Peter’s wife and John is Peter’s brother. Susana and Beatrice are Peter and Elle’s daughters, and both are over 18. Susubea Ltd.’s preferred shares are voting and have a value of $1,500,000 and the common shares held by Susana and Beatrice have a value of $100,000. — REQUIRED EXamine the information in the above diagram and determine whether the corporations involved are associated. Clearly state the reasons supporting your conclusions.

Problem 21 The following calculation of refundable dividend tax on hand (RDTOH), at the end of 2022 has been done incorrectly by a junior staff. You are required to draft a memorandum explaining what was done incorrectly (see required).

Refundable Portion of Part I Tax (for year ended December 31, 2023) Aggregate Investment Income (AII) Net TCG for the year — additional equipment . . . . . . . . . . . . . .

$ 8,000

— securities . . . . . . . . . . . . . . . . . . . . . . .

13,000

$ 21,000

Property income (Cdn. and foreign) $ 39,000

— Rental income — Note 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . .

56,000

— Interest — T Bills (investment of excess cash from business)

7,000

— bonds of connected, not associated corporations

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— Eligible dividends from non-connected taxable Cdn. Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

16,000

— Profit on sale of land not used in business . . . . . . . . . . . . . .

110,000

— Bond interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

9,350

237,350 $258,350

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Least of: 1. 302/3% × AII = 302/3% × $258,350 . . . . . . . . . . . . . . . . . . . . .

$ 79,227

2. 30 /3% × ($350,000 -- 94,136) . . . . . . . . . . . . . . . . . . . . . . . .

$ 78,473

3. Part I tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$107,406

Least amount = $78,473 RDTOH, beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

RDTOH, end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 78,473

Notes and Additional Information: Note 1 Rental income arose from seasonal excess warehousing space of 11%. The warehouse is normally used in the company’s active business. Note 2 Foreign taxes equal the foreign tax credit claimed and foreign funds are in Canadian dollars. — REQUIRED (A) Draft a memorandum, in point form, explaining in your own words what was done incorrectly; why it was done incorrectly, and how it should be done correctly. Assume that all input numbers in themselves are correct. (B) Recalculate Aggregate Investment Income and Refundable Part 1 Tax. (C) Recalculate the Eligible RDTOH and Non-eligible RDTOH balance assuming that the beginning balance is $0. (D) Determine the dividend refund if an eligible dividend of $20,000 and a non-eligible dividend of $45,000 had been paid by the corporation during the year.

Problem 22 Natalia, a resident of Canada, owns 100% of the shares of New Age Limited (NAL). NAL carries on scientific research and experimental development (SR&ED) activities with respect to finding the ingredients for a cream which will reduce fat and tone muscles when massaged into the skin. During its fiscal year ended December 31, 2023, NAL incurred the following costs related to its SR&ED activities: Salaries for research technicians and assistants . . . . . . . . . . . . . . . . . . . . . . Materials consumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Supplies consumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Small equipment purchased for the laboratory . . . . . . . . . . . . . . . . . . . . . . . A special machine purchased to miX the ingredients in a temperature controlled environment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$600,000 200,000 40,000 80,000 100,000

The machine and the lab equipment will have no value when the research project is completed. Additional overhead costs were incurred in 2023 because of the SR&ED project. The accounting system was not sophisticated enough to properly allocate these expenses. Overhead expenses for the year totalled $500,000. NAL paid Natalia a bonus of $40,000 in 2023 in addition to her salary of $80,000. Natalia spent 25% of her time on the SR&ED project in 2023. NAL does not expect to have any taxable income for 2023. It had taxable income of $100,000 in 2022. Its taxable capital does not exceed $10 million. It is not associated with any other corporation. You have been asked the following: (A) Which of the above costs incurred by NAL in 2023 qualify for deduction under subsection 37(1) as qualifying SR&ED expenditures? (B) Determine the amount of ITCs and refundable ITCs for 2023.

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ITA: 37, 127(5)–(11), 127.1

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Problem 23

ITA: 123–125, 129, 186

You recently met Susan Taylor at a cocktail party. As a result of your conversation with her, Susan has come to you for tax advice. She wants to know how her income will be taxed. She also wants to know whether she should incorporate and earn the same types of income through a corporation called High Income Limited. She would be the sole shareholder and only employee of that corporation. Susan has received various types of income in 2023. These incomes are as follows: ● Interest income from GIC — $5,000 ● Dividend income from a publicly traded corporation (eligible) — $10,000 ● Capital

gains from selling public company shares — $20,000

● Susan owns 40% of all the issued and outstanding common shares of Stage Lighting Limited

(Stage). Her best friend, Mary, who lives in Ontario, owns the rest of the common shares. The company is in the business of manufacturing customized lighting products. She received $20,000 in dividends (for which Stage did not receive any dividend refund) from Stage this year. All income earned by Stage is eligible for the small business deduction.

Susan would like to understand whether she should incorporate a holding company to earn the four different types of income mentioned above. Susan runs a small fashion store selling high-end handmade scarves. The business is operated as a sole proprietorship. Active operations started four years ago and the business started to make sizable profit last year. The estimated taxable retail income in 2023 is $200,000. Susan would like to know whether she should incorporate this business. Additional Information and Assumptions Assume that the effective combined federal and provincial corporate tax rates for 2022 on the following types of income are: ● Active business income (ABI) (eligible for the small business deduction)

38% -- 10% -- 19% + 5% (net provincial) . . . . . . . . . . . . . . . . . . . . . . . . . . . .

14%

● Aggregate Investment Income

38% -- 10% + 102/3% + 14% (provincial) -- initially . . . . . . . . . . . . . . . . . 522/3% -- 302/3% -- ultimately when dividends paid . . . . . . . . . . . . . . . . . .

522/3% 22%

The non-taxed portion of the capital gain is added to the capital dividend account. Dividends can be paid out of the balance of this account with no tax cost to the recipient shareholder. Assume that, if the ABI increases to the point where it exceeds $500,000 (small business deduction), then the effective federal rate on the ABI in excess of the small business limit will be: ● Combined federal and provincial rate:

38% -- 10% -- 13% (general rate reduction) + 14 (provincial) . . . . . . .

29%

Assume that the effective combined federal and provincial personal tax rates for 2023 are: ● The effective combined federal and provincial personal tax rate:

50%

CHAPTER 12

Top marginal rates 33% (federal) + 17% (provincial) . . . . . . . . . . . . . ● Effective combined federal and provincial tax rate for dividends

Non-eligible [for dividends paid after 2022] ................................................................. 42.5% Eligible ..................................................................................................................... 31.0% You have agreed with Susan that you will draft a memo analyzing the tax implications of the above situation. Your memo will address and conclude on the following issues: (A) Based on the theory and a conceptual understanding of incorporation, determine whether Susan can save and/or defer income tax by incorporating a holding company to earn interest

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income, dividend income from a public company, capital gains from selling public company shares, and dividend income from Stage Lighting Limited. (B) Based on the theory and a conceptual understanding of incorporation, determine whether Susan can save and/or defer income tax through incorporation of her fashion business. (C) Discuss some of the general (i.e., not specific to Susan) quantitative and qualitative pros and cons of incorporation.

Problem 24 Mickey and Nicki Waterloo are husband and wife entrepreneurs. Most of the time, when they start a business, they will do so with another person, in order to let that person handle the day-to-day business matters and, also, to provide a potential buyer at some point in the future. Usually this other person will have a shareholding in the operating company, but Mickey and/or Nicki will maintain control. It is, also, usual for each company to have a shareholder agreement with a buy/sell provision that calls for a corporate repurchase on death, disability, bankruptcy, or retirement. Maximizing the use of the small business deduction is also a goal. At this time, Mickey and Nicki have the following interests, which are all held through a holding company (Holdco) owned 100% by Mickey. (1) Holdco owns 20% of a company called Sales Co. Inc. The other 80% is owned by Joe Shea, who runs the company. In order to finance the operations, Holdco has invested $100,000 in non-voting preference shares with a redemption value of $100,000 and a dividend rate of 8%. (2) Holdco and Fred Smith have shared ownership of two companies. Holdco owns 90% of Retail One Inc. and 10% of Retail Two Inc., while Fred owns the other 10% of Retail One Inc. and 90% of Retail Two Inc. Mickey and Nicki share ownership in two companies. Mickey owns 40% of Ours Inc., Nicki owns 100% of Mine Inc., and Mine Inc. own 60% of Ours Inc. Both Mickey and Nicki are actively involved in these businesses. On the advice of their lawyer, they set up a discretionary trust for their two children, Dick, who is 12 years old, and Jane, who is 10 years old. This trust borrowed money from the bank (with personal guarantees from Mickey and Nicki) and bought treasury shares from a newly incorporated company, Kids Are Fun Inc. This company sells games through a retail store. It was capitalized with a loan from Nicki. Advise Mickey and Nicki of the tax implications of the share ownerships outlined above on the small business deduction.

Integrative Case Problem 25 It is January 15, 2024 and you just finished a meeting with the tax partner of your CPA firm, Lin & Robson Associates LLP and new clients Jeff and Caroline Samson. The Samsons live in Winnipeg, Manitoba and have 2 children in elementary school. Jeff (age 36) and his wife Caroline (age 35) wholly own Jets Traders Ltd. (Jets). They each own 50% of the common shares of the corporation which they incorporated while in university in 2007. The shares were issued on incorporation for $1,000, $500 paid by each of Jeff and Caroline. The company is located in Winnipeg, Manitoba and operates a large distribution business that sells sports memorabilia to stores in Ontario and Manitoba. The company owns a building in Winnipeg which houses the company’s head office and warehouse space. The company also owns a warehouse in Ontario which is currently rented to a 3rd party for $36,500 a year. In the meeting, Jeff provided the draft income statement for the corporation’s fiscal year ended December 31, 2023 (AppendiX A). Jeff would like to know when his corporate and HST returns and payments are due. He also is not sure what information the firm needs to prepare the returns and would like some guidance. The tax partner has asked you to analyze the information Jeff has provided and prepare a draft memorandum for the tax file including a preliminary list of the Schedule 1 and Division C adjustments that will impact the corporate return and a list of additional information that should be requested.

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Jeff indicated that he and Caroline received salaries of $100,000 and $50,000 respectively from their companies for the year. Their only sources of income for 2023 are the salaries and dividends from Jets and another company Sports Freaks Inc. (SFI) discussed below. In the meeting, Jeff asked about a real estate sale that occurred in 2023. The sale involved 3 acres of land purchased in 2020 that was adjacent to the Jets Winnipeg warehouse. The land included an abandoned house that was occupied by the previous owner before his death. Jeff who was friends with the executor of the previous owner’s estate bought the property thinking at the time that he might want to expand the Winnipeg warehouse space. Over the past couple of years, Jets was able to optimize its distribution processes to implement a just-in-time purchasing system. As a result, the company now has excess warehouse space in both Manitoba and Ontario. Jets paid $150,000 (a bargain price) for the property in 2020 including legal and land transfer taxes and sold it this year for $455,000 net of the real estate commissions and legal fees. Jeff is wondering about the tax treatment of this disposition and has asked if there is additional information you will need from him. As well, the partner has asked that you identify any HST/GST considerations associated with the sale. The royalty income on the income statement relates to a license that Jets owns for the use of Winnipeg sports team logos. Printing companies in Winnipeg and the surrounding area pay royalties to Jets for the use of logos on sports t-shirts and other types of clothing. Sometimes, Jets purchases products from customers of these printing companies for its distribution business. Jeff owns 100% of a small sports retailer, SFI operating out of IG Field at the University of Manitoba. Jeff provided the 2022 tax return for SFI and the company had $50,000 of taxable income for its December 31, 2022 taxation year end. SFI has never had any passive income. The tax partner has asked you to consider how much small business deduction will be available to Jets and SFI for 2023 and 2024. During the year, Jets sold some properties in 2023. Jeff provided the following cost and selling price information. You were able to obtain the UCC balance information from the 2022 tax return for Jets that he provided:

2022 Property Sold

Cost

Selling Price

Warehouse Equipment Franchise

$152,500 $227,000

$175,500 $330,000

December 31, 2022 UCC Balance Class 8 Class 14.1

$145,000 $202,000

The warehouse equipment was acquired in 2019 and was used in the distribution business. The franchise was acquired in 2021 and was a retail franchise Jets owned in Winnipeg. Jeff would like to better understand the tax treatment of each type of income earned by Jets and the type of tax and tax rate that will apply. He would also like to understand the impact of the dividends paid to Jeff and Caroline (noted in the additional information below) on the corporate tax liability for Jets. He would like to know what tax rate will apply to the dividends received by each of them in 2023 and how much after-tax cash they have available for personal use from the 2023 dividend payments. The tax partner has asked you to consider if the dividends could have been better planned for 2023 to reduce the marginal tax rate and resulting personal tax. [Ignore TOSI for purposes of this analysis.]

CHAPTER 12

The corporation uses ASPE for financial reporting purposes and the taxes payable method of accounting for income taxes. Jeff knows that the tax provision booked in the financial statements needs to be adjusted. The tax partner has asked you to determine the financial reporting entries that would be needed assuming dividends are likely to be paid in the future. Once the tax returns are prepared, the entries can be adjusted for the total tax liability determined. For now, the partner has asked you to use $270,000 as the total federal and provincial tax payable (before instalments) for the corporation for 2023 as an estimate. Assume personal provincial tax rates from Chapter 10. Additional information provided by Jeff or found in the 2022 corporate return: (a) Jets made a donation to a registered charity of $12,500 during the year. (b) Four quarterly non-eligible dividends of $45,000 were declared at the end of each calendar quarter of 2023 and paid within two weeks of their declaration. The last quarterly dividend of 2023 was paid in January 2024 and a non-eligible dividend of $30,000 declared in the last quarter of 2022 was paid in January 2023.

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(c) The combined taxable capital of Jets and SFI for tax purposes was $9,000,000 at December 31, 2022. (d) The balance in the tax accounts on January 1, 2023 were: Net capital losses from 2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,500 Non-eligible refundable dividend tax on hand . . . . . . . . . . . . . . 2,000 Eligible refundable dividend tax on hand . . . . . . . . . . . . . . . . . 5,750 General rate income pool . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,000 — REQUIRED (A) Assess the situation (B) Identify the issues (C) Analyze the issues (D) Advise/recommend

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APPENDIX A Jets Traders Ltd. Draft Income Statement 31-Dec-2023

2023

2022

Revenues

1,436,000

1,234,000

Cost of Sales

692,300

437,600

Gross Profit

743,700

796,400

Administrative expenses

144,700

236,000

Depreciation & Amortization

95,000

85,900

$504,000

$474,500

Other Income Royalty income

15,000

Interest on accounts receivable

14,500

12,300

Rental income

36,500

Interest on long term bonds

10,000

Dividends on public company shares

9,000

85,000

15,000

88,800

305,000

Gain on sale of property, plant, equipment

126,000

Net income before tax

1,020,000

563,300

Current taxes

(214,000)

(48,000)

Net income after tax

806,000

515,300

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Gain on sale of land investment

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CHAPTER 12 — DISCUSSION NOTES FOR REVIEW QUESTIONS (1) The purpose of integration is to avoid the double taxation of income earned through a corporation. Integration should cause the total tax paid by a corporation and its shareholders to be equal to the total tax paid by an individual who carries on the same economic activity directly and not through a corporation. The system should be neutral as to the form of organization used. (2) Perfect integration depends on: (a) When the corporation itself pays tax, the shareholder must include in income and pay tax on the full pre-tax income earned by the corporation and then get a full credit for all the income tax paid by the corporation. (b) All after-tax income would have to be either paid out as dividends in the year earned or taxed in some manner at the shareholder level in that year to avoid the indefinite deferral of tax that might otherwise be available if the corporate rates were lower than individual tax rates. This would equate the position of the shareholder with the position of the proprietor, partner or owner of investments who must pay tax on income from his or her economic activity whether or not it is distributed. (3) The gross-up is intended to add to the actual dividend received by the individual shareholder an amount equal to the total income tax paid by the corporation on the income that gave rise to the dividend. Thus, the grossed-up dividend is intended to represent the corporation’s pre-tax income. The shareholder will pay tax on the grossed-up dividend at his or her personal rate. The tax credit is intended to give the shareholder credit for the total tax paid by the corporation on the shareholder’s behalf. This procedure is intended to equalize the tax paid on the income that is flowed through the corporation to its shareholders with the tax paid on the same income that is earned directly. When the gross-up is 15% and the total (i.e., federal and provincial) corporate tax rate is 13%, integration is theoretically perfect. When the gross-up is 38% and the total (i.e., federal and provincial) corporate tax rate is 27.5%, integration is, also, theoretically perfect. (4) The purpose of the small business deduction is to help small CCPCs retain capital in order to expand their businesses. This is accomplished by using a relatively low corporate tax rate after the small business deduction to defer tax until the income is paid out as a dividend. A lower tax rate in the corporation increases the after-tax cash retained in the corporation which enables the corporation to reinvest in the business. (5) Paragraph 125(1)(a) deals with active business income for Division B income (net of expenses) while paragraph 125(1)(b) starts off with taxable income. Therefore, if there are Division C deductions such as donations or loss carryforwards then paragraph 125(1)(b) could be lower. (6) Some advantages of incorporation are: ● ●

●

limited liability except for personal guarantees; tax savings if the combined corporate tax and the personal tax on the dividend is less than the personal tax would be on the same income; tax deferral if the corporate tax rate is less than the personal tax rate on that income; income splitting with family members as employees or shareholders (beware of the attribution rules and the tax on split income);

●

estate freezing;

●

availability of registered pension plans to the owner;

●

separation of business and personal activities;

Ch. 12/Study Guide — Discussion Notes for Review Questions

●

greater flexibility as to the timing and type of income received personally;

●

continuity of separate legal entity;

●

deferral of accrued capital gains on transfer of shares to a spouse;

●

access to financing;

●

availability of capital gains exemption on QSBCS; and

●

availability of deferral of capital gains on shares of an SBC.

331

(7) Some disadvantages of incorporation are: ●

●

tax cost if combined corporate tax rate is over 13% for income eligible for the small business deduction and 27.5% for other business income; a prepayment of tax at lower levels of personal income on business income not eligible for the small business deduction;

●

a prepayment of tax and a tax cost of earning investment income in a corporation;

●

additional legal and accounting costs;

●

inability to deduct losses against personal income — this disadvantage may be offset somewhat by the availability of the ABIL;

●

greater difficulty in accessing cash generated by the business for personal use; and

●

inability to invest in RRSPs and TFSAs in a corporation.

(8) He will not be able to get the general rate reduction on income eligible for the small business deduction. In addition, the question does not indicate whether this venture is incorporated. If it is not, then these deductions are not available since they are only available to incorporated businesses.

ITA: 125.1(1)(a)

(9) Part IV tax of 381/3% on portfolio dividends prevents a significant deferral of tax. If the individual has a lower personal tax rate than 38 1/3%, then deferral is not achieved since the individual would have paid a lower rate of tax if they earned the dividend income themselves. If an individual has a personal tax rate higher than 38 1/3% then some deferral is achieved. (10) (a) Refundable Part I tax; (b) Part IV tax; (c) Dividend gross-up and tax credit; (d) Refundable dividend tax on hand; and (e) Dividend refund.

(12) The dividend tax credit is intended to give the shareholder credit against his or her taxes for the taxes paid by the corporation on the income from which the dividend was paid. Since the gross-up theoretically takes the dividend up to the pre-tax corporate income level, the dividend tax credit is needed to reduce the individual tax by the theoretical amount of corporate tax already paid on that income. At a corporate tax rate of 13%, for example, tax of $13 would be paid on corporate income of $100. The gross-up of 15% would take the individual’s income on that dividend of $87 back up to the $100 of corporate pre-tax income level. Assuming a provincial dividend tax credit of 4/13 of the gross-up, the total dividend tax credit would be 13% of the grossed-up dividend or $13. Thus the dividend tax credit represents the underlying corporate tax paid on the dividend.

CHAPTER 12

(11) The gross-up is intended to place the shareholder in an income position equivalent to that of the corporation before it paid corporate taxes. At an assumed corporate tax rate of 13% or 27.5%, the 15% or 38% gross-up, respectively, represents the underlying corporate tax. This is added to the after-tax dividend to tax, theoretically, the pre-tax corporate profits in the hands of the individual shareholder.

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Introduction to Federal Income Taxation in Canada

(13) Of the $1,000 capital gain, $500 is not taxable and is allocated to the capital dividend account to be paid out to the shareholders tax-free as a capital dividend. This provides for the tax-free receipt of this $500 whether the capital gain is realized in the corporation or by the individual directly.

ITA: 82(3)

The remaining $500 is theoretically taxed at an approXimate initial rate of Part I tax of 40%. An additional refundable tax of 102/3% is also levied and added to this account. Then, 302/3% of the income is classified as refundable Part I tax and added to the refundable dividend tax on hand account. Dividend payments result in a return to the corporation of 381/3% of dividends that are paid. This would leave an effective tax rate in the corporation on taxable capital gains of 20% which is higher than the 13% level at which perfect integration results. (14) Ordinarily the interest would be taxed at the full rate of 40% (38% -- 10% + 12% assumed provincial) plus the 102/3% additional refundable tax under Part I with part of this being classified as refundable Part I tax and added to the refundable dividend tax on hand account. However, since the two companies are associated and the interest is being deducted against the active business income of Opco, the deeming rules will deem the interest income to be active business income and not eligible for the refundable tax treatment. (15) While A Ltd. does not have more than 10% of the votes and value of B Ltd., A Ltd. does have control, since A Ltd. and the son of the only shareholder are related and do not deal at arm’s length. Thus, over 50% of the voting shares belong to a person with whom A Ltd. does not deal at arm’s length.

ITA: 129(6)

ITA: 186(2)

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CHAPTER 12 — SOLUTIONS TO EXERCISES Exercise 1 [Note: The facts of this case are those of The Queen v. Rochmore Investments Ltd. However, the legislation under which the case was decided did not contain a definition of ‘‘active business’’ or ‘‘specified investment business’’.]

76 DTC 6156 (F.C.A.)

Under the current legislation, ‘‘active business’’ is defined to exclude ‘‘a specified investment business’’ in such a way that if a business is not a specified investment business (and is not a personal service business), it is an active business. Note that the definition includes an adventure in the nature of trade and is only applicable in respect of the small business deduction.

ITA: 125(7), 248(1)

In this particular case, the facts indicate that it is carrying on a specified investment business. It would appear that the principal purpose of the corporation’s business is to derive income from interest on mortgage loans. It does not appear to be carrying on the business of a credit union and it is not in the business of leasing movable property. If it did, the corporation would be considered to be carrying on an active business. Since the corporation had no full-time employees, it cannot escape the definition of a specified investment business, to be treated as an active business, through paragraph (a) of the definition, which requires more than five full-time employees. The only possibility for escape is in paragraph (b) of the definition of ‘‘specified investment business’’. If the taxpayer company did not have more than five full-time employees because another corporation associated with it provided the services to the taxpayer corporation that would otherwise be performed by its own full-time employees, then the taxpayer corporation could be considered as carrying on an active business. In this case, the two principal operators of the taxpayer corporation own and manage a number of other companies. Further facts are required to determine if any of these other corporations are associated with the taxpayer corporation and if such an associated corporation provides services that would otherwise be provided by more than five full-time employees of the taxpayer corporation. This seems unlikely given the facts outlined in the case.

ITA: 125(7)

The taxpayer corporation, therefore, is likely carrying on a specified investment business. It is not carrying on a personal services business because it is not likely that the principals of the taxpayer corporation would reasonably be regarded as employees of the persons to whom the mortgage loans were made.

Exercise 2 ITA: 251(2)(b)

ITA: 251(2)(b)(ii), 251(6)(a) ITA: 251(5)(b)(i)

ITA: 251(5)(b)(i)

ITA: 251(2)(c)(iii), 251(5)(c), 251(6)(a)

ITA: 251(3)

CHAPTER 12

(A) (i) Mr. Beta is at arm’s length with the corporation because his 25% ownership does not give him control. However, paragraph 251(1)(b) could always apply if the facts indicate that the non-related persons are not dealing at arm’s length at a particular moment in time. (ii) Mr. Beta and his brother are not at arm’s length with the corporation. Mr. Beta and his brother form a related group; since they are siblings, each is related by blood. (iii) Mr. Delta is not at arm’s length with the corporation because of the share purchase option. This provision deems Mr. Delta to control Alpha Corp. unless the exceptions in this subparagraph are met. (iv) Mr. Epsilon is at arm’s length with the corporation because of the exception, which is contingent on the death of Mr. Beta, unless paragraph 251(1)(b) applies, as described in (i), above. (B) (i) The corporations are not at arm’s length. This subparagraph applies where Lambda Corp. is controlled by a person (i.e., A) and Tau Corp. is controlled by a related group (i.e., A and B). A is related to himself for purposes of share ownership and to his brother. (ii) The corporations are at arm’s length because subparagraph 251(2)(c)(iv) does not apply where there is an unrelated group of persons controlling one corporation, unless the person controlling the other corporation is related to each member of the unrelated group. For example, if two first cousins control one corporation and their grandfather controls the other, the two corporations would be related. Of course, factual non-arm’s length can always apply as described in (A)(i), above. (iii) The corporations are related and, hence, they are not at arm’s length. This provision deems two corporations to be related where each corporation is related to another common corporation.

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Exercise 3 (A) Jay-one Ltd. and Jay-two Ltd. are associated, both being controlled by the same person. Jayone Ltd. and Jay-three Ltd., are associated. Since Ava has voting control of Jay-one Ltd. and Jay-one Ltd. in turn has voting control of Jay-three Ltd., then Ava controls Jay-three Ltd. Therefore, all three corporations are controlled by the same person. As a result of this application of the association rule in paragraph 256(1)(b), the election under subsection 256(2) is not available to Jay-one Ltd., because Jaythree Ltd. and Jay-two Ltd. are associated without subsection 256(2).

ITA: 251(1)(b), 256(1)(a), 256(1)(b)

(B) Benco Ltd. and Rayco Ltd. are associated under paragraph 256(1)(c). Benco Ltd. is controlled by Abigail’s mother and Rayco Ltd. is controlled by Abigail. Abigail and her mother are related. Abigail owns at least 25% of the shares, which are not of a specified class, of both corporations.

ITA: 256(1)(a), 256(1)(c)

(C) Adamco Ltd. and Kidco Ltd. are associated. Adamco Ltd. is controlled by Adam. Kidco Ltd. is controlled by the group consisting of Adam, his daughter and his son-in-law. Adam is related to himself, to his daughter and to his son-in-law. Adam owns at least 25% of the shares which are not of a specified class of Kidco Ltd.

ITA: 252(1)(e), 256(1)(d), 256(1.5), 251(6)(a), 251(6)(b)

(D) Since both corporations are controlled by a group, paragraph 256(1)(e) is the only possibility for association. However, while Sisco Ltd. is controlled by a related group of sisters, Cousco Ltd. is not controlled by a related group. The two sisters as a group do not control Cousco Ltd. One sister and her daughter do not control the company. Finally, cousins and aunts and nieces are not related by the rules. Therefore, the condition in paragraph 256(1)(e) fails and the two corporations are not associated unless subsection 256(5.1) can be used with the argument that control in fact is exercised by Sister One and Sister Two through direct or indirect influence on their daughters or unless subsection 256(2.1) is invoked on the basis that one of the main reasons for the separate existence of the two corporations is to reduce taxes.

ITA: 251(6)(a)

ITA: 251, 252

Exercise 4 Taxit and Sibling are associated:

ITA: 256(1)(c)

— each corporation is controlled by one person; — the person who controlled one was related to the person who controlled the other; — one of these persons owned not less than 25% of the shares which are not of a specified class of each corporation. Since the two corporations are associated, they must share the small business deduction on a maximum of $500,000 of active business income. The Act requires that the corporations file an agreement, in prescribed form, allocating the $500,000 business limit. If an agreement is not filed within the time period indicated in subsection 125(4), that subsection empowers the Minister to make an allocation. They could each gain their eligibility for the small business deduction on a full $500,000 by having Beta reduce her holdings in Taxit to below 25% or by having Beta convert her holdings in Taxit to shares of a specified class (i.e., in essence, non-voting preferred shares). However, this strategy would work only as long as there are no factors present of the kind that would enable the deeming provisions to apply.

ITA: 125(3)

ITA: 256(2.1)

Exercise 5 Since neither corporation is controlled by one person, and both corporations are not controlled by the same group of persons, the only provision in subsection 256(1) that can potentially apply is paragraph 256(1)(e). That paragraph sets out three conditions, each of which must be met by the facts of the case for association. (1) Each corporation must be controlled by a related group. — The group of brothers controlling Chutzpah Enterprises Limited is related. The group consisting of Bett and Dalled Chutzpah controlling Schlock Sales Limited are related as brother-in-law and sister-in-law or by paragraph 251(6)(a) and paragraphs 252(2)(b) and (c). Therefore, the condition is met. (2) Each of the members of one of the related groups was related to all of the members of the other related group. — Consider the group consisting of Aleph and Bett Chutzpah which is a related group controlling Chutzpah Enterprises Limited and the group Bett and Dalled Chutzpah which is a related group controlling Schlock Sales Limited. Aleph is related to his brother Bett, as discussed above, and to Dalled. Bett is related to himself and his sister-in-law, Dalled, as discussed above. Therefore, the condition is met.

ITA: 251(2)(a), 251(6)(a) ITA: 251(6)(b)

ITA: 251(2)(a), 251(6)(a), 256(1.5)

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(3) One or more members of both related groups must own, either alone or together, not less than 25% of the issued shares of any class, other than a specified class, of shares of the capital stock of the other corporation. — Bett, who is a member of both related groups, owns alone the minimum 25% of the shares necessary to meet this condition. Common shares are not shares of a specified class.

ITA: 256(1.1)

Exercise 6 Part I tax payable Part I Tax on Taxable Income Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 79,700

Tax @ 38% on $79,700 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deduct: Federal tax abatement (10% of $79,700) . . . . . . . . . . . . . . . .

$ 30,286 7,970

Net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 22,316

Additional refundable tax (ART) — 10 /3% × lesser of: 2

(a) AII . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,000 (b) TI -- SBD income amount (Schedule 1) A . . . . . . . . . $

Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deduct small business deduction (see Schedule 1) ........ 15,143 General reduction (see Schedule 2) . . . . . . . . . . . . . . $ 0

$ 22,316

Part I federal tax payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provincial tax @ 4% of $79,700 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 7,173 3,188

Total tax payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 10,361

Schedule 1: Small Business Deduction 19% of the least of: Income from an active business ................................................................ $110,000(I) Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 79,700(II)

Business limit ............................................................................................. $500,000(III) Small business deduction — 19% of $79,700 = $15,143 Schedule 2: General Reduction Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 79,700 Less: income eligible for the small business deduction ........... $79,700 AII . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

7,000

(86,700) $

0 $

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

The effective tax rate is 13% ($10,361/$79,700). All of the income of the corporation for the year is subject to the low corporate rate of tax applicable to income eligible for the small business deduction. The reason for this is that the company has Division C deductions which reduce the Division B income of $117,000 to $79,700. These deductions may include loss carryovers or donations. As a result, the company will not pay additional refundable tax on the investment income. When calculating tax the Division C deductions will reduce aggregate investment income ahead of active business income eligible for the small business deduction because of the limitation noted as A above.

CHAPTER 12

13% of $0 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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Exercise 7 (A) Part I Tax on Taxable Income Tax @ 38% of $135,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$51,300

Deduct: federal tax abatement (10% of $135,000) . . . . . . . . . . . . . . . . . . . . .

13,500

Net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$37,800

Additional refundable tax (ART) (Schedule 1):

10,667

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$48,467

Deduct: small business deduction (see Schedule 2) . . . . . . . . . . . . . . . . . . . .

General reduction (Schedule 3) . . . . . . . . . . . . . . . . . . . . . . . . . . . .

0 4,550

Part I tax payable (federal) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$43,917

Provincial tax @ 3% of $135,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4,050 $47,967

Deduct: dividend refund (Schedule 3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(26,833)

Total tax payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$21,134

Schedule 1: Additional refundable tax: 102/3% X lesser of: (a) AII: Investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$100,000

Taxable capital gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

20,000

Eligible dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

30,000

Less: Net-capital loss carryforward . . . . . . . . . . . . . . . . . . . . . . . . . .

(20,000)

Eligible dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(30,000)

Aggregate investment income . . . . . . . . . . . . . . . . . . . . . . . . .

$100,000

(b) Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$135,000

Less the amount eligible for the SBD . . . . . . . . . . . . . . . . . . . . . . .

(0) $135,000

Lesser of two amounts × 102/3% -- $100,000 × 102/3% . . . . . . . . . . . . . .

$ 10,667

Schedule 2: Small Business Deduction: 19% of least of: Income from active business [$260K -- (100K + 20K + 50K)] . . . . . . . . .

$ 90,000(I)

Taxable income ...................................................................................................$135,000(II) Business limit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

0(III)

Small business deduction — 19% of $0 lesser of (I), (II), and (III) . . . . .

There is a reduction to the small business deduction limit for CCPCs (and their associated corporations) that have significant passive income in the prior year. For CCPCs with passive investment income in excess of $50,000 in the prior year, the small business deduction will be reduced by $5 for every $1 of investment income over $50,000. Adjusted aggregate investment income for the purposes of the SBD is calculated below.

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Adjusted AII for SBD (assuming the current year investment income is consistent with the prior year). Taxable capital gains (non-active) . . . . . . . . . . . . . . . . . . . . . . . $ 20,000 Less allowable capital losses in the current year . . . . . . . . . . . .

–

Investment income ................................................................................. 100,000 Portfolio dividends ................................................................................... 30,000 AAII . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 150,000 Reduction in SBD limit AAII . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 150,000 less base ......................................................................................... 50,000 AAII in excess .............................................................................. 100,000 Reduction in SBD limit $100,000 × $5 . . . . . . . . . . . $ 500,000 SBD limit: $500,000 less $500,000 . . . . . . . . . . . . . . . . . . . . . . . $

–

Schedule 3: General Reduction Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 135,000 Less: income eligible for the SBD . . . . . . . . . . . . . . . $ AII . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

0 100,000 (100,000)

Net ................................................................................................ 35,000 13% of Net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4,550

(B) Refundable Portion of Part I Tax Least of: (a) 302/3% × aggregate investment income (302/3% × $100,000) . . . . . .

$ 30,667

(b) Taxable income .................................................................... $135,000 Less: amount eligible for SBD . . . . . . . . . . . . . . . . . . . . .

(0)

302/3% × $135,000 = $ 41,400 (c) Part I tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 43,917

Refundable portion of Part I tax — The least . . . . . . . . . . . . . . . . . . . . . . . .

$ 30,667

Taxable dividends subject to Part IV tax: Non-connected corporations × 381/3 ($30,000 × 381/3%) . . . . . . . . . . . .

$ 11,500

Connected corporations to the extent of share of dividend refund to payer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4,000

Total Part IV tax payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 15,500

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Part IV Tax on Taxable Dividends Received

Introduction to Federal Income Taxation in Canada

338 RDTOH and Dividend refund

Eligible RDTOH –

Opening balance as of January 1, 2023 . . . . . . . . Refundable Part I tax . . . . . . . . . . . . . . . . . . . . . Part IV tax on connected dividends* . . . . . . . . . . Part IV tax on portfolio dividends @381/3% . . . . . .

11,500

Balance at the end of December 31, 2023 — prior to refund . . . . . . . . . . . . . . . . . . . . . . . . . Dividend refund is equal to the total of three amounts: 1. The lesser of: ● 381/3% × total of all eligible dividends paid in the year . . . . . . . . . . . . . . . . . . . . . . . . ● Its eligible RDTOH balance at the end of the year . . . . . . . . . . . . . . . . . . . . . . . . . . plus 2. The lesser of: ● 381/3% × total of all non-eligible dividends paid in the year ($70,000 X 381/3%). . . . . . ● Its non-eligible RDTOH balance at the end of the year . . . . . . . . . . . . . . . . . . . . . . . . plus 3. either: ● if 381/3% of non-eligible dividends is in excess of non-eligible RDTOH at the end of the year, the lesser of: – the amount in excess – the amount by which it eligible RDTOH balance at the end of the year exceeds the amount in 1, if any ● in any other case, $0 . . . . . . . . . . . . . . . . The total dividend refund is . . . . . . . . . . . . . . . .

Noneligible RDTOH $ – 30,667 4,000

11,500

26,833 34,667

34,667

–

26,833

– 11,500 $ – $ 26,833

* The paying corporation received a dividend refund from the non-eligible RDTOH balance. Part IV tax paid on the dividends from the wholly owned corporation will be added to the noneligible RDTOH. (C) The taxable income of the corporation consists of active business income that in this case is not eligible for the small business deduction and aggregate investment income. The tax liability of $47,967 consists of tax on the aggregate investment income of $100,000 at a rate of 41 2/3% (38% -- 10% + 102/3% + 3%) of $41,667 and tax on active business income at a high corporate rate of 18% (38% -- 10% - 13% + 3%) of $6,300 [Note that the question is using a provincial rate of 3% for all types of income of the corporation]. The mechanics of the corporate tax calculation result in the Division C deductions reducing the company’s active business income ahead of aggregate investment income. The company has paid non-eligible dividends of $70,000 that result in a partial refund of available non-eligible RDTOH. The non-eligible RDTOH includes the refundable Part I tax on the aggregate investment income and the dividend refund from non-eligible RDTOH received by the connected corporation related to the $20,000 dividend received by the corporation. Non-eligible dividends must be used to completely refund the non-eligible RDTOH pool before a refund of eligible RDTOH is possible. At December 31, 2023, the company will have a GRIP balance of $25,200 [$25,200 ($35,000 X 72%)]. In 2024, a dividend of $25,200 could be paid and designated from GRIP as an eligible dividend. This would result in a refund of the $9,660 of eligible RDTOH ($25,200 X 38 1/3%). Eligible dividends would be preferable to shareholders as the marginal personal tax rate is lower than for non-eligible dividends. In addition, a non-eligible dividend of $20,437 [($34,667-$26,833)/38 1/3%] could be paid to result in a refund of the $7,834 non-eligible RDTOH balance ($20,437 X 38 1/3%) at December 31, 2023. Further 2024 dividend payments resulting in dividend refunds from either pool could be considered depending on the additions to one or both RDTOH pools for refundable Part 1 tax or Part IV tax in 2024.

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Exercise 8 Personal Tax if Investment Income is Earned Personally Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,000 Dividends grossed up (1.15 × $15,000) .............................................................................. 17,250 Taxable capital gains (1/2 × $6,000) ........................................................................................3,000 Incremental taxable income ............................................................................................... $27,250 Income from other sources ............................................................................................. 20,000 Taxable income ................................................................................................................... $47,250 Federal tax on total taxable income of $47,250 Tax on first $47,250 (15%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: dividend tax credit (9/13 × 15% of $15,000) . . . . . . . . . . . . . . other personal tax credits . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 7,088 $ 1,558 2,460

Basic federal tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provincial tax Tax on first $47,250 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,725 Less: dividend tax credit (4/13 × 15% of $15,000) . . . . . . . . . . . . . . $ 692 other personal tax credits . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,640

$ 3,070

Provincial tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total tax on taxable income of $47,250 . . . . . . . . . . . . . . . . . . . . . . . . A

$ 2,393 $ 5,463

Taxation of Income From Investment Portfolio Through a Corporation Available cash

Corporation Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable capital gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 7,000 15,000 3,000

Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$25,000

Less: dividends [sec. 112] . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

15,000

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$10,000

$25,000(1)

Tax under Part I @ 40% (38% -- 10% + 12%) . . . . . . . . . . . . . . . . . . $ 4,000 Additional refundable tax at 102/3% of $10,000 ($7K + $15K + $3K -- $15K) . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,067 Tax under Part IV @ 381/3% of $15,000 . . . . . . . . . . . . . . . . . . . . . . . 5,750 10,817 ........................................................................................... (1) Retained in corporation $14,183 Non-eligible RDTOH: Part I (302/3% of ($7K + $15K + $3K -- $15K)) . . . . . . . . . . . . . . Part IV (381/3% × $15,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 3,067 5,750

8,817(2) $23,000(2)

Shareholder Taxable dividend (per requirements) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross-up (15% of $15,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$15,000 2,250

Incremental taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$17,250

Income from other sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

20,000

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$37,250

CHAPTER 12

Available for distribution to shareholders as taxable dividend . . . . . . . . . . . . . .

Introduction to Federal Income Taxation in Canada

340

Federal tax on total taxable income of $37,250 Tax @ 15% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: dividend tax credit (9/13 × 15% of $15,000) ......................................... $1,558 other personal tax credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,460

$ 5,588 (4,018)

Basic federal tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provincial tax Tax @ 10% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: dividend tax credit (4/13 × 15% of $15,000) . . . . . . . . $ 692 other personal tax credits . . . . . . . . . . . . . . . . . . . . . 1,640

$ 1,570

Total tax on taxable income of $37,250 ($1,570 + 3,725 - 2,332) . . . . . . . . . . . .

$ 2,963

Total Taxes Paid Through corporation: Corporation after refund on $15,000 of dividends paid ($10,817 -- 381/3% × $15,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Shareholder . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 5,067 2,963

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 8,030

Received directly by the individual (A) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 5,463

$ 3,725 (2,332)

In conclusion, the total income tax paid is less when held as an individual rather than through a corporation. There is a tax cost to incorporating investment income. — NOTES TO SOLUTION (1)

Ignores the non-taxable portion of capital gain which can be distributed tax free.

(2)

Note that a non-eligible dividend of $23,000 will result in a full dividend refund of $8,817 (i.e., $23,000 × 381/3%), that was added to the NERDTOH for the year.

Exercise 9 The two corporations are considered associated for Canadian tax purposes. Generally, interest income received from an associated corporation that is deductible in computing that corporation’s active business income would be considered active business income. However, as the interest is US-sourced, and not from a ‘‘source in Canada’’, and is not deductible in computing active business income in Canada, it will be considered investment income to the Canadian corporation and not income from an active business. Hence, the small business deduction will not apply. The interest will be subject to the full corporate tax rate, including the 102/3% additional refundable tax on investment income. The addition to non-eligible RDTOH (302/3%) will also apply.

Exercise 10 (a) Joan controls A Ltd. Therefore, Joan controls 55% of the votes (30% directly and 25% indirectly) of B Ltd. The companies are associated by par. 256(1)(b), as both are controlled by the same person. A Ltd. and B Ltd. are also associated by par. 256(1)(d ). Joan controls A Ltd. The related group of Joan and A Ltd. control B Ltd. In respect of each corporation, Joan owns at least 25% of the shares. (b) A Ltd. and B Ltd. are not associated, because the 25% cross-ownership test is not met as the preference shares are ‘‘shares of a specified class’’ as defined in ssec. 256(1.1). That is, they are non-voting shares that have a fiXed dividend rate (5%) which does not exceed the prescribed rate in effect at the time the shares were issued (7%), and the amount which can be received on redemption is equal to the consideration paid for the shares. John may be in a position to control B Ltd. by ownership of the preference shares. If the financing provided by John is critical to B Ltd. and, if B Ltd. is unable to replace it elsewhere, then John would have undue influence since, by exercising his right to retract the shares, he could cripple the business. Thus, John would control B Ltd. by ‘‘de facto control’’ (ssec. 256(5.1)). If this is the case, John would control A Ltd. and B Ltd. and they would be associated, (par. 256(1)(b)).

ITA: 256 ITA: 129(6)

ITA: 123.3, 129(1)

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(c) It appears that Joe would have ‘‘de facto control’’ (ssec. 256(5.1)) of B Ltd. since he controls the day-to-day operations and without the marketing rights to A Ltd.’s product, B Ltd. would have no business. Even without ‘‘de facto control’’, it is likely that the CRA would deem A Ltd. and B Ltd. to be associated by virtue of ssec. 256(2.1), arguing that it may reasonably be considered that one of the main reasons for the separate existence of those corporations is to reduce the amount of taxes that would otherwise be payable. (d) If the preference shares are ‘‘shares of a specified class’’, then A Ltd. and B Ltd. are not associated. If the preference shares are not ‘‘shares of a specified class’’, then A Ltd. and B Ltd. are associated by ssec. 256(2), unless X Ltd. elects not to be associated with A Ltd. and B Ltd. A Ltd. controls X Ltd; therefore, A Ltd. and X Ltd. are associated by par. 256(1)(a). If the preference shares are not ‘‘shares of a specified class’’, then B Ltd. owns shares of X Ltd. having more than 50% of the FMV of all shares issued by X Ltd. This deems B Ltd. to control X Ltd. by spar. 256(1.2)(c)(i). Therefore, B Ltd. and X Ltd. would be associated by par. 256(1)(a). Thus, A Ltd. and B Ltd. would be associated with the same corporation, X Ltd., at the same time and, thus, would be deemed to be associated with each other by ssec. 256(2).

Exercise 11 (a) B Co. controls C Co. — 256(1)(a): associated A Co. controls B Co. — 256(1)(a): associated A Co. controls C Co. — 256(1)(a): associated (b) A Co. and B Co. are controlled by the same person — 256(1)(b): associated. (c) Each of the corporations is controlled by the same group — 256(1)(b): associated. (d) Each of the corporations is controlled by the same group — 256(1)(b): associated. Subparagraph 256(1.2)(b)(i) ensures that a corporation controlled by one person will be considered controlled by the group, notwithstanding that one person in the group (Mr. A.) controls one of the corporations himself (M Co.). (e) Both D Co. and E Co. are controlled by the same group of persons, i.e., A Co. and B Co. — 256(1)(b): associated (f)

Mr. A. is related to his son and Mr. A. owns not less than 25% of B Co. — 256(1)(c): associated

(g) Each of the corporations is controlled by a related group. Each member of one of the related groups is related to all members of the other related group. Mrs. A, who is a member of both related groups, owns, in respect of both corporations, not less than 25% of the issued shares of any class, other than a specified class. — par. 256(1)(e): associated. (h) (i) Mr. A controls A Co. Mr. A is related to each member of a group that controls B Co. Mr. A owns, in respect of both corporations, not less than 25% of the issued shares of any class, other than a specified class. — 256(1)(d ): associated. Paragraph 256(1.2)(d ) deems Mr. A. to own 100% of the 26% of the shares in B Co. owned by A Holdco.

(i)

A Ltd. and X Ltd. are not associated, even though one person (X) controls one corporation and is related to the person who controls the other corporation (A, his brother), since neither person owns at least 25% of the other’s corporation. Par. 256(1)(c) — not associated Par. 251(6)(a) — related X Ltd. and Y Ltd. are associated, since the controlling shareholder of X Ltd. is related to each member of a group that controls Y Ltd. (i.e., himself and his spouse), and X owns at least 25% of the shares outstanding in both X Ltd. and Y Ltd.

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(ii) A Co. and B Co. are associated under par. 256(1)(b). Mr. A controls both A Co. and B Co. Mr. A controls A Co. directly through his 60% share ownership. Mr. A controls B Co. through the 26% held ‘‘indirectly’’ via A Co. and the 25% held directly for a total of 51%. Note that Mr. B can be considered to ‘‘indirectly’’ control all 26% of the shares held by A Co. in B Co. because Mr. A has voting control over A Co. and can thus dictate to A Co. how it manages and/or votes its ownership in B Co.

Introduction to Federal Income Taxation in Canada

342 Par. 256(1)(d ) — associated

Par. 251(6)(b) — related Y Ltd. and Z Ltd. are associated, since the controlling shareholder of Z Ltd. is related to each member of a group that controls Y Ltd. (i.e., his mother and himself), and Z owns at least 25% of the outstanding shares of both Y Ltd and Z Ltd. Par. 256(1)(d ) — associated Par. 251(6)(a) — related X Ltd. and Z Ltd. are associated, since they share a common association with Y Ltd. Ssec. 256(2) — associated unless Y Ltd. elects not to be associated with X Ltd. and Z Ltd. Z Ltd. and B Ltd. with ZB Ltd.: (1) are not associated. Although both Z Ltd. and B Ltd. are each controlled by one person, Z and B respectively, neither is related to each member of the controlling group of the other corporation (i.e., ZB Ltd.). Z and B are deemed to be related to themselves for purposes of determining control but are not related to each other since they are cousins. Sec. 251 related Par. 251(5)(c) (2) although the technical rules above would not associate the corporations, they can be deemed associated under ssec. 256(2.1), if one of the main reasons for the separate existence is to reduce taxes levied under the Income Tax Act. Note: All the above situations in which no association was found would have to be reviewed in light of the concept of de facto control (ssec. 256(5.1)). (j)

The corporations are associated by virtue of paragraph 256(1)(b) since RA Inc. and FK Inc. are both controlled by the two sisters, Ruth and Alice. Ruth owns 50% of RA Inc. and Alice owns 50% of RA Inc. Together, they control RA Inc. Ruth owns 20% of FK Inc. and is deemed to own the 30% of FK Inc. owned by Fay by virtue of subsection 256(1.3). This results from the fact that Fay is Ruth’s daughter, she is under 18 years of age and it is not reasonable to consider that Fay manages the business and affairs of FK Inc. without a significant degree of influence by Ruth. Therefore, Ruth owns 50% and Alice owns 20% of FK Inc. Together they control FK Inc. (k) B Ltd. and C Ltd. are associated by virtue of par. 256(1)(b) as they are both controlled by Bill. C Ltd. and K Ltd. are associated by virtue of par. 256(1)(a) since C Ltd. is deemed to control K Ltd. by spar. 256(1.2)(c)(i) because C Ltd. owns shares of the capital stock of K Ltd. having a fair market value of more than 50% of the fair market value of all issued and outstanding shares of K Ltd. Bill is deemed to own the shares of K Ltd. which are owned by C Ltd. by virtue of par. 256(1.2)(d ). Thus, K Ltd., C Ltd., and B Ltd. are all associated with each other by virtue of par. 256(1)(b) as they are all controlled by the same person: Bill. C Ltd. and K Ltd. are also associated by virtue of par. 256(1)(c). C Ltd. is controlled by Bill, and K Ltd. is controlled by Ellen, who is related to Bill. Bill meets the 25% share ownership test in K Ltd. (through the preferred shares) by virtue of paragraph 56(1.2)(d ). Note that the preferred shares are not specified because they are voting shares. C Ltd. and K Ltd. are also associated by virtue of paragraph 256(1)(d ). Bill is related to Rose and Ellen, a related group that controls K Ltd. Paragraph 256(1.2)(d ) again deems Bill to own 100% of the preferred shares of K Ltd. Note: Section 256(2) is not applicable, as B Ltd. and K Ltd. are associated by virtue of par. 256(1)(b)).

Exercise 12 (A) — Sisters are related [spar. 251(2)(a)(i) and par. 251(6)(a)]. — All of the conditions for association in paragraph 256(1)(c) are met as follows: (i) each corporation was controlled by one person through the common shares; (ii) the person, who controlled one corporation, was related to the person who controlled the other (sisters); (iii) one of those persons (Clorilda) owns not less than 25% of the shares of any class, other than a specified class (through her preferred share in the bicycle corporation and her common shares in her own corporation) of each corporation;

Ch. 12/Study Guide — Solutions to Exercises

CHAPTER 12

— the preferred shares are not a specified class because they are convertible [par. 256(1.1)(a)]. (B) — All of the conditions for association between Caspar’s corporation and Ceecombo Corporation in par. 256(1)(d ) are met as follows: (i) Caspar’s Corporation was controlled by one person; (ii) Ceecombo Corporation was controlled by a group of persons (Caspar and Carter) and Caspar was related to each member of the group because he is related to his brother [spar. 251(2)(a)(i) and par. 251(6)(a)] and to himself [ssec. 256(1.5)]; (iii) Caspar owns not less than 25% of the shares of any class, other than a specified class, of each corporation. — Similarly, using the same logic, Carter’s Corporation and Ceecombo Corporation are associated [par. 256(1)(d )]. — Since Ceecombo Corporation is associated with Caspar’s Corporation and Carter’s Corporation is associated with Ceecombo, Caspar’s Corporation is associated with Carter’s Corporation [ssec. 256(2)]. — However, Ceecombo Corporation should elect annually not to be associated with either Carter’s Corporation or Caspar’s Corporation, since it cannot use the small business deduction with investment income. (C) — Paragraph 256(1)(e) sets out three conditions each of which must be met for association and all are met as follows: (i) each corporation must be controlled by a related group — brothers and sisters are related [spar. 251(2)(a)(i) and par. 251(6)(a)] and, hence, the condition is met; (ii) each member of a related group must be related to all members of the other related group — again, all of the brothers and sisters are related as above and, hence, the condition is met; (iii) one or more persons who were members of both of the related groups either alone or together, must own not less than 25% of the issued shares of any class other than a specified class — Chauncey and Clarabelle are members of both related groups; — together, Chauncey and Clarabelle own not less than 25% of the shares of any class of Xylona Ltd. and of Xerxes Ltd. (D) — The corporations are not associated under the technical rules of sec. 256, unless ssec. 256(5.1) applies, as discussed below. — They may be deemed to be associated if it may reasonably be considered that one of the main reasons for the separate existence is tax reduction [ssec. 256(2.1)]. — Arguments for the taxpayer (see Covertite case (79 DTC 136)): (i) separate existence for geographic diversification, (ii) new corporation in a new geographic location, (iii) business dealt with separate clientele, (iv) key employee in Manitoba corporation. — Arguments against the taxpayer (see Alpha Forming case (83 DTC 5021)): (i) Althea borrowed from Alphonso, (ii) Althea had limited experience in the business, (iii) use of the same business name and logo, (iv) setting of remuneration just under SBD limits, (v) only shareholder of each corporation is the spouse of the other. — The corporations may be associated, if Alphonso is considered to control Another Corporation in fact [par. 256(1)(b)] — this can only be determined on the basis of further facts; — One Corporation, which is controlled by Alphonso, may be in a position to exercise influence over Another Corporation through the loan arrangements for equipment and funds used to establish Another Corporation; — Another Corporation is managed by a former employee of One Corporation, and that person may be subject to influence by Alphonso;

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— the exception in ssec. 256(5.1) would not apply because Another Corporation and the controller, Alphonso, are not at arm’s length; — a decision either way is possible. (E) — The two corporations are associated, because they are both controlled by Eunice [par. 256(1)(b)] — Eunice controls Yolanda Ltd. either: — because she owns more than 50% of the fair market value of all the issued shares [spar. 256(1.2)(c)(i)], or — because of her casting vote [ssec. 256(5.1)]. — Eunice controls Zerlinda Ltd., because she owns more than 50% of the fair market value of all the issued shares [spar. 256(1.2)(c)(i)]. (F) — The two corporations are not associated: — paragraph 256(1)(b) does not apply, because the option held by Edbert is not exercisable until the death of his cousin and, hence, par. 256(1.4)(a) does not deem Edbert to own the shares he has under option; — paragraph 256(1)(d ) does not apply because cousins are not related individuals under ssec. 251(6).

Exercise 13 (i) Calculate the dividend refund for FOL for 2023. RDTOH and Dividend refund — FOL FOL and SHI are connected, therefore any dividend refund received in FOL will affect the RDTOH balances in SHI. First we determine the Part I and Part IV tax in FOL, then the dividend refund. Once we have those amounts, we can determine the dividend refund for SHI.

Opening balance as of January 1, 2023 . . . . . . . . . . . . . . . . Refundable Part I tax (302/3% × $7,000) . . . . . . . . . . . . . . . Balance at the end of December 31, 2023 — prior to refund ................................................................................ $

Eligible RDTOH –

–

Non-eligible RDTOH $ 2,000 2,147 $

Dividend refund (schedule 2) . . . . . . . . . . . . . . . . . . . . . . . Balance at the end of December 31, 2023 . . . . . . . . . . . . . . $

4,147 –

Schedule 2 — Dividend refund is equal to the total of three amounts: 1. The lesser of: ● 381/3% × total of all eligible dividends paid in the year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0 ● Its eligible RDTOH balance at the end of the year . . . $ 0 plus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2. The lesser of: ● 381/3% × total of all non-eligible dividends paid in the year [$75,000 X 381/3%] . . . . . . . . . . . . . . . . . . . . . . . $ 28,750 ● Its non-eligible RDTOH balance at the end of the year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,147 plus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3. Either: ● if 381/3% of non-eligible dividends is in excess of noneligible RDTOH at the end of the year, the lesser of: ● the amount in excess ................................................. $ 24,603 ● the amount by which its eligible RDTOH balance at the end of the year exceeds the amount in 1, if any $ 0 ● in any other case, $0 . . . . . . . . . . . . . . . . . . . . . . . . . The total dividend refund is . . . . . . . . . . . . . . . . . . . . . . . .

4,147

–

4,147

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(ii) Calculate the Part IV tax for SHI for 2023. Canadian Pacific Ltd. dividends ($8,000 X 381/3%) . . . . . . . . . . . . . . . . FOL dividends — connected Dividend refund received of $4,147 × 100% . . . . . . . . . . . . . . . . . . . . .

Part IV tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3,067 4,147 7,214

(iii) Calculate the dividend refund for SHI for 2023.

Opening balance as of January 1, 2023 . . . . . . . . . . . . . . . . Refundable Part I tax (302/3% × $33,0001) . . . . . . . . . . . . . . Part IV tax on connected corporations from NERDTOH refund . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Part IV tax on portfolio dividends ............................................ Balance at the end of December 31, 2023 — prior to refund . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $

Eligible RDTOH –

Non-eligible RDTOH $ 8,000 10,120 4,147

3,067 3,067

Dividend refund is equal to the total of three amounts: 1. The lesser of: ● 381/3% × total of all eligible dividends paid in the year ................................................................................ $ 0 ● Its eligible RDTOH balance at the end of the year . . . 3,067 plus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2. The lesser of: 1 ● 38 /3% × total of all non-eligible dividends paid in the year [381/3% × $50,000] ........................................................ $ 19,167 ● Its non-eligible RDTOH balance at the end of the year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22,267 plus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3. Either: ● if 381/3% of non-eligible dividends is in excess of noneligible RDTOH at the end of the year, the lesser of: ● the amount in excess ................................................. $ 0 ● the amount by which its eligible RDTOH balance at the end of the year exceeds the amount in 1, if any $ 0 ● in any other case, $0 . . . . . . . . . . . . . . . . . . . . . . . . . The total dividend refund is . . . . . . . . . . . . . . . . . . . . . . . .

22,267

19,167

Notes: (1)

75,000 8,000 12,000 21,000

AII in Net income for tax purposes . . . . . . . . . . . . . . . . . . . . . . . . . . . . less Division C deductions Dividends from connected corporation . . . . . . . . . . . . . . . . . . . . . . Dividends — portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

AII in taxable income (Division C) . . . . . . . . . . . . . . . . . . . . . . . . . . . .

116,000 (75,000) (8,000) 33,000

CHAPTER 12

Aggregate Investment Income (AII) Dividends from connected corporation . . . . . . . . . . . . . . . . . . . . . . Dividends — portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable capital gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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In this case, the taxable income would also be $33,000 and Part I tax would be higher than 302/3% of AII for the purposes of calculating the refundable portion of Part I tax. After the dividend refund, the ERDTOH balance would be 3,067 and the NERDTOH balance would be $3,100 of SHI on January 1, 2024.

Exercise 14

C.A., Managem Inc. (a) Carrying on a personal services business by virtue of paragraph 125(7) with respect to the income from Public. (i) as the sole employee of C.A. Managem Inc., Mr. Smith provides services on behalf of C.A. Managem Inc., (ii) Mr. Smith is a specified shareholder of C.A Managem Inc. by virtue of subsection 248(1), since he owns not less than 10% of the issued share capital. (iii) Mr. Smith would reasonably be considered as an employee of Public because he was formerly an employee of that company, (iv) C.A. Managem Inc. and Public are not associated corporations. Taxed at full corporate rates under Part I on personal services business income (not eligible for the small business deduction or general rate reduction), plus an additional 5% tax under s.123.5 — C.A. Managem Inc. may deduct only salary paid to Mr. Smith, the cost of any benefit or allowance paid to him, amounts expended in connection with selling property or negotiating contracts (as required by subparagraph 18(1)(p)(iii)) and legal fees incurred in collecting amounts owing to it on account of services rendered; (b) Carrying on an active business by virtue of its association with C.A. Buildem Inc. and C.A. Holdem Company Limited by virtue of par. 256(1)(b), and since Mr. Smith controls each corporation either directly or indirectly, ●

●

consulting income from C.A. Buildem Inc. and C.A. Holdem Company Limited is not personal services business by virtue of the exception in paragraph (d ) of the definition in subsection 125(7) that the services are rendered to associated corporations; therefore, this income is active business income by virtue of the definition of active business in ssec. 125(7); and income from associated companies is eligible for the 19% small business deduction under subsection 125(1) to the extent of the amount of the $500,000 business limit allocated to Managem Inc. in the associated group.

C.A. Buildem Inc. (a) Associated with C.A. Holdem Company Limited by virtue of par. 256(1)(a). (b) Income is from an active business (by reference to the various definitions in subsection 125(7), with 10 full-time employees, any income earned by C.A. Buildem Inc. must be active business income) (i) consulting fees deductible from active business income, (ii) income is eligible for the 19% small business deduction under subsection 125(1).

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(c) If C.A. Buildem Inc. receives dividend income from C.A. Holdem Company Limited, then this dividend can be deducted from Part I taxable income by virtue of subsection 112(1). Since Buildem Inc. owns 100% of C.A Holdem Company Limited, the two companies are connected, as defined in subsection 186(4) since C.A. Buildem, owns more than 10% of the votes and value. Therefore, C.A. Buildem Inc. has a liability for Part IV tax under par. 186(1)(b) only if C.A. Holdem Company Limited receives a dividend refund as a result of the dividends paid. C.A. Holdem Company Limited (a) Interest income would ordinarily be income from property: (i) interest is deductible from active business income of C.A Buildem Inc., (ii) interest is deemed by spar. 129(6)(b)(i) to be income of C.A Holdem Company Limited from active business. (iii) C.A. Holdem Company Limited is eligible for the 19% small business deduction on its deemed active business income under subsection 125(1), to the extent of the amount of the business limit allocated to C.A. Holdem Company Limited in the associated group. (b) The remaining income of C.A. Holdem Company Limited is from property or a specified investment business by virtue of par. 125(7)(e) since the corporation has no employees and an associated corporation cannot meet the services test: (i) interest income is taxed at full corporate rates under Part I plus 102/3% additional refundable tax and is eligible for refundable tax treatment of 302/3%. A dividend refund is received when dividends are paid; (ii) the dividend income is excluded from Part I taxable income by virtue of ssec. 112(1); however, the dividends would likely be subject to Part IV tax of 381/3% since C.A. Holdem Company Limited likely has only a portfolio interest (less than 10% voting power) in the companies it invests in. These dividends are also eligible for refundable tax treatment as described above.

Exercise 15 (A) Sunlight Limited and H Ltd. are associated. H Ltd. is controlled by one person, Mr. Bennett. He is related to each member of the group, H Ltd. and W Ltd. that controls Sunlight Limited, because he is related to H Ltd. which he controls and he is related to W Ltd., which is controlled by his wife. Also, he owns not less than 25% of the shares of Sunlight Limited through his ownership of shares in H Ltd. These shares are not specified shares. By a similar analysis, Sunlight Limited and W Ltd. are associated.

ITA: 256(1)(d)

Since the rental income would be deductible as an expense from the income of an active business of an associated payer, it will not be income from property of the recipient. It will be deemed to be income from an active business of the recipient, H Ltd. Since H Ltd. has only dividend income it will be eligible for the small business deduction in respect of the rental income as long as it is allocated a part of the business limit of the associated corporations.

ITA: 129(6)(a)(i)

ITA: 251(2)(b)(i), 251(2)(b)(iii) ITA: 256(1.2)(d)

ITA: 129(6)(b)(i) ITA: 125(1)

(B) Since Sunlight is connected with both holding companies there will be no Part IV tax liability owing by H Ltd or W Ltd on dividends received from Sunlight unless Sunlight gets a dividend refund as a result of the dividends it pays. However, Sunlight earns only active business income which is not subject to refundable taxes and dividend refunds.

Exercise 16

CHAPTER 12

(A) Rent from RCSL: (i) RCSL is associated with JML; (ii) RCSL deducts the rent from its active business.

ITA: 256(1)(b)

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Therefore, the rent is deemed to be income of JML from an active business, eligible for the small business deduction. (B) Services fee from Dr. Adam: (i) JML’s income from providing services would be considered income from an active business unless further facts indicate that it is carrying on a personal services business; (ii) the business of providing services would be a personal services business if one or both of the shareholders of JML, who are specified shareholders (because they own at least 10% of the shares of JML), performed the services and would be regarded as an employee of the professional practice of Dr. Adam, unless those services are provided by more than five fulltime employees of J.M.L. and these employees are employed throughout the year. Therefore, if the services fee is considered income from an active business, it would qualify for the small business deduction.

ITA: 125(1), 129(6)(b)(i)

Shareholder-Manager Remuneration and Tax Planning for the Owner-Manager

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CHAPTER 13

Chapter 13

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CHAPTER 13 — LEARNING CHART Problem Descriptions Textbook Example Problems 13-1 Shareholder benefit 132 Shareholder benefit 13-3 Shareholder loan 13-4

Shareholder loan

13-5

Shareholder loan — deemed interest benefit

13-6 Salary vs. dividends Exercises 1

Bonus payable and unpaid amounts

Shareholder loan

Shareholder loan — series of transactions

Shareholder loan — car

Automobile benefit

Salary vs. dividends

GA AR

Shareholder loans

Shareholder loans and unpaid amounts

Owner/manager remuneration: salary vs. dividends

Shareholder benefit and HST

Tax on split income

Ch. 13/Study Guide — Learning Chart

351

Problem Descriptions

Salary vs. dividends

GA AR

Shareholder benefit

Shareholder loans — treasury shares, boat, motorhome

Shareholder/employee loans — treasury shares, house, vehicle

Shareholder loans — house, not a specified employee

Incorporation, compensation

Incorporation, compensation — TOSI

Salary/dividend planning

Owner/manager advice

Tax planning, GA AR

Integrative Case — Purchase of a business, compensation

Employment income — stock options, low interest loans, company car, car allowance

Tax on split income

CHAPTER 13

Assignment Problems

352

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Ch. 13/Study Guide — Review Questions

¶13,800

353

REVIEW QUESTIONS CHAPTER 13

(1) Mr. Tal owns a small manufacturing company that has suddenly become very profitable. This year his accountant has told him to declare a bonus to himself of appro Ximately $150,000 in order to reduce his corporate income to the business limit. Mr. Tal would also like to increase his contributions to his RRSP in the next few years. His dilemma is that he also needs the money in his business in order to finance an expansion. What should he do? Assume that the provincial corporate income tax rate is 12% on income in excess of the small business deduction limit. (2) Ms. Su owns a distributing company that is earning well over $500,000 each year. She has been declaring a bonus to herself each year but is now rethinking this strategy. What items should she consider when deciding whether to pay the bonus or leave the money in the company? Assume that the provincial corporate income tax rate is 12% on income in excess of the small business deduction limit. (3) What is the range of fiscal year ends that might be chosen to allow the owner of a company to declare a bonus and be taxed on it personally in either of two calendar years? (4) What are the five criteria for the deductibility of bonus accruals as decided in the Totem Disposal case? (5) Mr. Chow is the sole shareholder of CHB Inc. His wife’s brother has just come to him and asked to borrow some money in order to start up his professional accounting practice. Mr. Chow has decided to have CHB Inc. lend his wife’s brother $20,000 on October 31, 2023, with interest only for the first two years and then principal repayments of $10,000 per year starting in the third year. The fiscal year end of the company is December 31. Discuss the tax implications of the loan. (6) Ms. Leftwick is the President and sole shareholder of a construction company. She has two vice-presidents who are not related to her. As part of their compensation package she has agreed that all employees of the company are entitled to an interest-free loan from the company of up to $25,000. Ms. Leftwick herself has taken her $25,000 loan and purchased a boat. The two vice-presidents have also received $25,000 loans each and used them for personal purposes. Comment. (7) If your province of residence were to declare a tax holiday for all CCPCs, what impact would this have on compensation for your owner-manager clients? (8) How much personal tax will a single individual pay on $30,000 of non-eligible dividend income if that is his or her only source of income and his or her only non-refundable tax credit is his or her personal credit. Refer to the Overview for this chapter for the applicable federal/provincial combined graduated tax rates and Chapter 10 for the basic personal tax credit base.

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¶13,825

EXERCISES

Exercise 1

ITA: 78

SLP Ltd. declared a bonus payable of $10,000 to Mr. Schneider, its president and majority shareholder, on September 30, 2023, its fiscal year end. If the bonus is paid it will be subject to payroll withholding tax using the tables provided by the CRA. — REQUIRED (A) If the corporation is to get a deduction with no future consequences for the bonus payable, by what date must the bonus be paid? (B) What are the consequences of not paying the bonus by this date? (C) Assume that, instead of a bonus, the amount owing to Mr. Schneider is rent, properly included in income on the cash basis, on the only rental property he owns and rents to the corporation: (i) If the corporation is to get a deduction with no future consequences for the rent payable, by what date must the rent be paid? (ii) What are the consequences of not paying the rent by this date? (iii) How can these consequences be avoided without paying the rent?

Exercise 2

ITA: 15(2), 80.4

Mr. Nesbitt relocated his private business, Leverage-Lovers Limited, to Alberta from Ontario at the end of May 2023. As a result of the move, the corporation made the following loans on June 1, 2023, to Mr. Nesbitt, the president and majority shareholder: (a) a $75,000 loan at 2% interest per year with a five-year term but amortized over a 25-year period to purchase a house in the new location; (b) a $5,000 loan at 5% interest per year with no definite term to buy furniture for the new house; and (c) a $10,000 loan with no interest but with a five-year term to buy previously unissued, fully paid shares from the corporation. The corporation uses the calendar year as its fiscal year, and by the end of 2024, all the loans described were still outstanding. Any interest required to be paid on the loans at the indicated rates was paid in 2023. Assume that the prescribed rates applicable to shareholder loans during 2023 were: 1st quarter, 4%; 2nd quarter, 3%; 3rd quarter, 4%; and 4th quarter, 4%. Ignore the effects of the leap year, if applicable. — REQUIRED Discuss the tax consequences in 2023 of the loan described if Mr. Nesbitt received the loans: (A) by virtue of his employment; (B) by virtue of his shareholdings.

Exercise 3

ITA: 15(2), 20(1)(j)

Mr. Sims is a shareholder of Wandrex Ltd. which has a December 31 year end. Consider the following transactions in his shareholder loan account: Date December 31/Year 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . January 31/Year 2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . April 30/Year 2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . June 30/Year 3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . September 30/Year 3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . March 31/Year 4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . November 30/Year 4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . May 31/Year 5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . November 30/Year 5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . July 31/Year 6 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . December 31/Year 6 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¶13,825

Loan (repayment) $ 0 20,000 25,000 (15,000) (17,000) (12,000) 10,000 (11,000) 23,000 (14,000) 0

Balance $ 0 20,000 45,000 30,000 13,000 1,000 11,000 0 23,000 9.000 9,000

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— REQUIRED

(B) If there has not been a series of loans and repayments, how would the amounts differ from the above? How would you argue there was no series of loans and repayments?

Exercise 4

ITA: 15(2), 80.4; ITR: 4300

Colton Marlach is a major shareholder and senior executive of Burlon Ltd. He was required to use a car about 60% for the duties of his employment. On April 1, under a plan available to the five other senior executives of the corporation, he was granted a car loan of $35,000 at a rate of interest of 1% per annum and agreed to annual repayments on the anniversary day of $7,000 for principal and monthly payments of interest at the end of each month. During the year, he faithfully made the monthly interest payments for seven months but neglected to make the interest payments for the last two months of the year. — REQUIRED What are the income tax consequences to the taxpayer? Assume that the prescribed rates were as follows: First quarter ..................... 1% Second quarter ................. 1%

Third quarter . . . . . . . . 2% Fourth quarter . . . . . . . 3%

Ignore the effects of the leap year, if applicable.

Exercise 5

ITA: 6(1)

Consider the data provided in EXhibit 13-3 in ¶13,032. — REQUIRED Analyze the situation if the employment use of the car is 20,000 out of 30,000 km.

Exercise 6 Payton Hewitt is the sole shareholder and employee of Conduit Corporation Ltd. which operates a processing business in a province with a 4% corporate rate (i.e., a combined corporate rate of 13%) on its income. The corporation has income of $30,000 before salaries and corporate taxes which is eligible for the small business deduction. Mr. Hewitt has no other income and has personal credits of $3,750 for the basic personal credit and $342 for the employment credit where applicable (combined federal and provincial). He requires all of the income generated by the business. Refer to the Overview for this chapter for the applicable federal/provincial combined graduated tax rates.

ITA: 82(1), 117, 121, 123–125

— REQUIRED Consider the following three remuneration alternatives: (A) all salary, (B) all dividends, and (C) $10,000 in salary and the remainder in dividends. Compare the net cash to Mr. Hewitt for these alternatives ignoring payroll deductions applicable to salary paid to an employee.

Exercise 7 Aaron Storey is a sole proprietor generating $80,000 in income before taxes from a processing business operating in a province with a 4% corporate rate (i.e., a total corporate rate of 13%). Aaron budgets for living expenses of $3,100 per month. Currently, his only tax credits are the basic personal credit and the employment credit where applicable. The business has a December 31 taxation year end.

ITA: 82(1), 117, 121, 123–125

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CHAPTER 13

(A) If it is assumed that these transactions result in the conclusion that there is a series of loans and repayments, compute the principal amounts that must be included or the repayments that may be deducted for each of the years indicated according to the guidelines in IT-119R4.

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356 — REQUIRED

(A) Compute the tax that would be paid if he continues to operate the business as an unincorporated proprietorship. (B) Compare your answer in (A) with the total tax that would be paid if he incorporates the business and remunerates himself by the following alternative methods: (i) $40,000 in salary; and (ii) $40,000 in dividends. Ignore payroll deductions. Assume that Aaron’s only other income is $700 of interest income. Refer to the Overview for this chapter for the applicable federal/provincial combined graduated tax rates and Chapter 10 for personal tax credit bases.

Exercise 8

ITA: 245

Gortis Production Ltd., a Canadian-controlled private corporation, paid its shareholder-manager, Herb, a salary of $250,000 which reduced the corporation’s income to $499,500 for the taxation year. The amount of the salary is considered to be reasonable. — REQUIRED Determine whether the general anti-avoidance rule (‘‘GAAR’’) would apply in this situation.

Exercise 9 Over the past two years, your client, a lawyer in sole practice, has developed several software packages for the preparation of legal contracts. At a recent small-business seminar, your client learned that she could pay her spouse and children a salary. By doing so, your client’s total tax paid as a family unit would drop substantially. — REQUIRED If tax is avoided, how would the general anti-avoidance rule affect the transactions?

Exercise 10 Grace Ravens is a shareholder and a senior executive of Max Marketing Ltd., which has a December 31 year end. On June 1, 2022, the corporation provided her with the following loans under a policy for loans to executives of the corporation: (i) a $100,000 loan at 1% interest per year with a five-year term, with principal repayments of $10,000 due December 31 each year, to purchase a new house in downtown Toronto which she lives in; (ii) a $10,000 loan at 3% interest per year with no definite terms of repayment to purchase furniture for her new home; and (iii) a $20,000 loan at no interest with a three-year term to buy additional, previously unissued shares of Max Marketing Ltd. from treasury. On December 31, 2022, she repaid $10,000 principal on the house loan and $1,000 principal on the furniture loan as well as the interest due on the loans. On December 31, 2023, Grace paid $10,000 principal on the house loan and $1,000 principal on the furniture loan. On January 15, 2024, she paid interest on the house and furniture loans for the year ended December 31, 2023. In summary, the remaining balances at the noted dates are as follows: House loan . . . . . . . . . . . . . . . . . . . . . . Furniture loan . . . . . . . . . . . . . . . . . . . Stock loan . . . . . . . . . . . . . . . . . . . . . .

January 1, 2023 $90,000 9,000 20,000

January 1, 2024 $80,000 8,000 20,000

Assume the prescribed rates of interest for 2023 were as follows: 1st quarter — 2%; 2nd quarter — 2%; 3rd quarter — 3%; and 4th quarter — 3%. The prescribed rate on June 1, 2022 was 3%. — REQUIRED Calculate the tax consequences in 2023 to Grace Ravens of the loans described above.

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Exercise 11

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You have been assigned the audit of Revel Limited, a Canadian-controlled private corporation, for the 2023 taxation year. Its year end is December 31. At the outset of your audit, Mr. Newton, the company’s sole shareholder and president, informed you that he had just finished a correspondence course in taxation and that all the corporate accounting and taxation matters were well in hand. Your audit (March 2024), however, revealed the following: Salary paid to Mr. Newton .......................................................................... $285,000 Salary paid to Mr. Cane, Mr. Newton’s common law spouse who is responsible for part-time marketing activities ......................................... 145,000 Royalty payable to Mr. Newton — Accrued in 2022 ...................................... 20,000 — Accrued in 2020 ...................................... 30,000 The royalty expense was deducted in computing the income of the corporation. In addition, you discovered that the following loans, each secured by a promissory note, had been made during the 2023 taxation year: ●

●

A $200,000, 1% loan, dated July 1, 2023, made to Mr. Newton in his capacity as President to enable Mr. Newton to purchase a new home for the couple’s occupancy. Other senior employees are eligible for loans on similar terms. The loan was repayable over 10 years in equal instalments of principal payable on the anniversary date, but with interest payable monthly. A $15,000 non-interest-bearing loan, dated September 1, 2023, made to Mr. Newton. The loan was repaid on January 31, 2024. Further investigation of prior years revealed that loans in similar amounts had continually been taken out and repaid in subsequent years. A $2,500 non-interest-bearing loan, dated October 1, 2023, made to Mr. Cane for the purpose of enabling them to purchase a ticket for a Caribbean cruise.

Assume that the prescribed interest rate for the first quarter of 2023 was 2%; for the second quarter, it was 1%; for the third quarter, it was 2%; and for the fourth quarter, it was 3%. — REQUIRED Discuss the tax implications for 2023 of the foregoing information providing any advice to Mr. Newton that you consider necessary. Support your answer with calculations where appropriate and provide reasons for your conclusions.

Exercise 12 Mr. Washington is the sole shareholder and manager of Ink Inc., a Canadian-controlled private corporation. The corporation which operates a distribution business is expecting profits for the current year of around $580,000. Mr. Washington is wondering if the corporation should pay him salary and/or dividends for the current year. — REQUIRED What are some of the considerations that should be taken into account in advising Mr. Ink as to whether he should be paid salary and/or dividends for the current year?

Exercise 13 Spencer Stapleton owns 50% of the outstanding shares of Stapleton Estates Limited. His sister, Tracy, owns the other 50%. During the winter months, the company’s construction activities are rather slow so Spencer uses this time to design new homes for the spring. At the beginning of January, to keep the company’s largest subcontractor busy over the long winter months, he asked the subcontractor to build an addition to his ski chalet so that he can use it to entertain guests. The controller of Stapleton Estates Limited has expensed the $400,000 + HST invoice from the subcontractor. Spencer had told the controller to treat the invoice as a business expense. — REQUIRED If the CRA were to discover this transaction during its audit, how would it reassess? Assume that HST at a rate of 13% applies for 2023 in the province in which Spencer resides.

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Exercise 14 Mr. and Mrs. Bartlett, both in their 40s, each own 50% of the common shares of their operating company, Bartco. Bartco is an engineering firm. Mr. Bartlett and his team of engineers design and manage the construction of food processing plants in Southwestern Ontario. Mrs. Bartlett has never been involved in Bartco’s operations and is an employee of a local community college. The shares of Bartco were issued for $100 in total to the Bartletts when the company was incorporated. At the end of 2023, Bartco paid out $30,000 of non-eligible dividends to each of the Bartletts on their common shares. — REQUIRED Part A: How will the dividends be taxed on the Bartlett’s 2023 personal tax returns? Part B: How would the result change if Bartco instead operated a construction business that was in the business of constructing food processing plants?

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ASSIGNMENT PROBLEMS

Problem 1

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Jamal Uppal graduated last year from computer engineering at the University of Waterloo. While a student, for his last work term he opted to start his own business developing a new web-based platform for corporate tax information collection and preparation with his father who is a CPA. Jamal incorporated the business January 1, 2023 and owns 100% of the common shares of the company. For its first year of operations, the pre-tax profit for Jamal’s incorporated business, TaxIntel Ltd. will be $50,000 for the December 31, 2023 year end. Jamal would like to receive all of the after-tax profits as either a dividend or salary before the end of the year to pay for his personal expenses. Jamal does not have any other source of income in 2023. TaxIntel Ltd. is negotiating a contract with two major accounting firms. If successful, Jamal projects his business income will be significantly higher for 2024. If this comes to fruition, he would like to increase his salary to $180,000 starting January 1, 2024 and also pay a salary of $40,000 to his father for some of the work he will be doing. Jamal projects $600,000 of business income for 2024 after the salary payment. He would plan to leave a minimum of $435,000 of after-tax cash in the corporation for reinvestment in the business after paying out a year-end bonus or dividend. He would like you to explain the pros and cons of the bonus option relative to the dividend option. He is also wondering if it would be better to retain all of the business income after salary payments in the corporation in 2024. The provincial corporate tax rate on active business income is 4% if it is eligible for the small business deduction and 12% if it is not. E Xplain any payroll withholdings implications but exclude the calculations from your quantitative analysis. — REQUIRED (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

Problem 2

ITA: 245; ITR: 4301(c)

Consider each of the following independent fact situations. (1) Adam Aref has contributed the maximum amount to an RRSP on the first business day of each year in respect of the previous year and shortly thereafter has withdrawn the funds. (2) Bill Sheridan loaned his wife $1,000,000 five years ago through a non-interest bearing promissory note. His wife invested the funds in GICs and earned $80,000 of interest income which was properly attributed to him, except for any compound interest. Bill gave his wife another cash amount to cover the income tax on the compound interest. (3) Wells Ltd. is owned 100% by Mrs. Hogart. Stieb Ltd. is owned by Mrs. Hogart’s husband and minor children. Wells Ltd. made an interest-free loan out of its taxable surplus to Stieb Ltd. Stieb Ltd. used the proceeds of the loan to earn property income. (4) Traub has $200,000 of investments and a mortgage on his personal home for a similar amount. Traub sold the investments, paid off the mortgage, and reborrowed to acquire the investments. (5) Andy made a loan to his adult child’s corporation, Vancouver Hockey Puck Ltd., in order to avoid attribution, since the corporation used the funds to earn property income. — REQUIRED Discuss whether the general anti-avoidance rule (‘‘GAAR’’) applies to the above situations.

Problem 3

ITA: 245; IC 88-2

Consider each of the following independent fact situations: (1) An individual transfers his or her unincorporated business to a corporation primarily to obtain the benefit of the small business deduction. (2) An individual provides services to a corporation with which he or she does not deal at arm’s length. The company does not pay a salary to the individual because payment of a salary would increase the amount of a loss that the company will incur in the year. (3) A taxable Canadian corporation, which is profitable, has a wholly owned taxable Canadian corporation that is sustaining losses and needs additional capital to carry on its business. The subsidiary

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could borrow the monies from its bank but the subsidiary could not obtain any tax saving in the current year by deducting the interest expense. Therefore, the parent corporation borrows the money from its bank and subscribes for additional common shares of the subsidiary and reduces its net income by deducting the interest from its business. (4) Profitco and Lossco are taxable Canadian corporations. Lossco is a wholly owned subsidiary of Profitco. Lossco has non-capital losses that would be deductible if Lossco had income. In order to generate income in Lossco from which its non-capital losses may be deducted, Profitco borrows from its bank and uses the monies to subscribe for common shares of Lossco. Lossco lends these monies to Profitco at a commercial rate of interest. Profitco repays the bank. The amount of share subscription is not in excess of the amount of monies that Lossco could reasonably be expected to be able to borrow for use in its business on the basis solely of its credit from an arm’s length lender. (5) Each of two private corporations owns less than 10% of the common shares of a payer corporation that is to pay a substantial taxable dividend. The payer corporation will not be entitled to a dividend refund on the payment of the dividend. None of the corporations is related to any of the others. The private corporations form a corporation, Newco, transfer their shares of the payer corporation to Newco in exchange for common shares of Newco, and elect under subsection 85(1) (assume that this is done correctly to avoid tax on the transfer) in respect of the transfer. Following the transfer of the payer corporation’s shares to Newco, Newco will be connected with the payer corporation. The payer corporation pays the dividend to Newco, free of Part IV tax. Newco pays the same amount to the private corporations as a dividend, free of Part IV tax. The primary purpose of the transfer of the shares is to avoid the Part IV tax which would be payable if the dividend were received directly by the private corporations. (6) The owner of land inventory has agreed to sell the property to an arm’s length purchaser. The purchaser wants to buy the property for cash, but the owner does not want to have the profits recognized in the year of sale. The owner sells the land inventory to an intermediary company deferring receipt of the proceeds of disposition of the land for several years after the date of sale. In this way, a reserve can be claimed under paragraph 20(1)(n). The intermediary sells the land to the third party for cash. The owner receives interest from the intermediary in respect of the monies received by the intermediary from the third party. — REQUIRED For each of these fact situations, advise whether the part of the general anti-avoidance rule (‘‘GAAR’’) that asks the question ‘‘can it reasonably be considered that the transaction would not result, directly or indirectly, in a misuse of the provisions of the Act or an abuse having regard to the provisions of the Act read as a whole’’ applies.

Problem 4 Mia Gibbons is president of Pump You Up Ltd., a private corporation she started and owns. Mia has recently signed a lease for an upscale downtown condominium which she intends to move into next month. Mia has arranged for Pump You Up Ltd. to pay the $2,000 monthly rental for the condominium. No other employees have their rent paid by the company. Pump You Up Ltd. also pays for life insurance premiums for Mia. The company holds the policy, and on Mia’s death the insurance proceeds will be paid to the corporation. Mia’s daughter, Mimi, started attending university during the year. Mia had the company pay Mimi $9,000 so she could pay for her tuition costs. Mia has asked you to explain the income tax and HST consequences to Mia and to Pump You Up Ltd. of the condominium rental, payment to her daughter and the life insurance premiums paid by the company. For the next meeting you agree that you will: — REQUIRED (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

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ITA: 15(1), 18(1)

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Problem 5

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Kristie owns 35% of Big City Developments Inc. (‘‘BCD’’), which has a December 31 year end. She is also an employee of the company. On March 31, Year 1, she purchased her shares of BCD from treasury for $150,000. BCD lent her all the funds for the share purchase at an interest rate of 1%. She is required to repay the loan at the rate of $25,000 each January 1. On May 15, Year 1, BCD loaned Kristie $75,000 to purchase a new motor home and boat. Since she is a significant shareholder, she was not required to repay any of the loan in Year 1 or Year 2. At the end of Year 3, Kristie repaid $25,000 of the loan. You have agreed to calculate the income tax implications to Kristie as a result of receiving these loans for Years 1, 2, and 3, assuming the prescribed rate of interest for shareholder loans was 2% throughout all the years. (Ignore the effects of a leap year, if applicable.) Assume that the loans are received because of Kristie’s employment and not because of her shareholdings (i.e., other employees have received or are eligible to receive similar loans).

Problem 6 It is February 2024 and, as the auditor for Skies Limited, you have discovered several items in your 2023 year-end audit that require further consideration. Skies Limited is a manufacturer located in Stratford, Ontario. Mr. Scott is an 95% shareholder and president of the company which has a December 31 fiscal year end. His son Joe, who is vice-president, owns the other 5% of the shares. They both live in Stratford. Harry is the VP-Sales. He is neither related to Mr. Scott nor is he a shareholder. A significant portion of his income is made up of commissions. Shareholder Loans The records showed that the corporation has made several loans during the year. Each of the following was evidenced by a separate promissory note, duly signed and approved by the Board of Directors: (a) A $300,000 1% loan to Mr. Scott to finance the purchase of a new home, a few blocks from his old home. The note is dated June 1, 2023, and the loan is repayable over 30 years in equal instalments of principal payable on the anniversary date; interest is payable monthly. (b) A $24,000 non-interest bearing loan to Harry to finance the purchase of a car to be used in his employment. The note is dated June 1, 2023; it requires principal to be paid annually, on May 31, over five years. Harry used the vehicle 70% for employment use in 2023. (c) An $18,000 non-interest-bearing loan to Joe to finance the purchase of previously unissued, fully paid shares from the corporation at their fair market value (his 5% interest). The note is dated August 1, 2023, and the loan is repayable in $1,800 annual instalments. Any interest required to be paid on the loans at the indicated rates was paid in 2023. Assume the prescribed rates for 2023 are 4% for the first and second quarters, and 3% for the third and fourth quarters. Assume the prescribed rate for all of 2024 was 2%. Ltd.

Mr. Scott would like to understand the tax implications of these loans to him, Joe, Harry, and Skies

Mr. Scott told you that these are the only employees to receive a loan during the year but that the company has an employee loan plan restricted to senior employees for non-interest bearing loans up to $25,000 for any purpose. Both Harry and Joe received their loans noted above under this plan. For the next meeting you agree that you will: — REQUIRED (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

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Problem 7 In 2023, Sunshine Publishing Ltd., a book publishing company with a fiscal year end on December 31, made a loan of $100,000 to Stuart Sunshine, the president and majority shareholder. Both Stuart and Sunshine Publishing Limited are Canadian residents.

ITA: 15(2), 15(2.3), 15(2.4), 15(2.6), 20(1)(j), 80.4; ITR: 4300(7)

This is the first loan that Stuart ever received from the company, and it helped him finance the purchase of a new home which was built just outside Toronto, 10 kilometres farther from the corporate headquarters than Stuart’s previous home. The loan was made on May 1, 2023, and a mortgage agreement was signed on that date. This agreement requires that the $100,000 owing be repaid over five years in equal instalments of $20,000 on each anniversary date, starting on May 1, 2024, without interest. Early prepayments of principal are allowed. Assume that the prescribed rates applicable to taxable benefits are: 4% for the first quarter of 2023, 4% for the second quarter, 5% for the third quarter, 4% for the fourth quarter, and 5% for all of 2024. (Ignore the effects of a leap year, if applicable.) Stuart has asked you for the following advice: (A) It is now December 2023 and Stuart has asked you to advise him on the tax consequences of the loan. It is not a company policy to make housing loans to employees and no other loans have been made to employees on similar conditions. What are the income tax consequences of this loan to Stuart in 2023 and 2024? (B) If it was a company policy to make such loans to employees and other loans had been made to employees on similar terms and conditions, how would this change your answer to Part (A)? (C) Assume the following facts: it was a company policy to make such loans to employees; other loans had been made to employees on similar terms and conditions; Stuart was a 9.5% shareholder rather than a majority shareholder; he was not related to any shareholders of the company; and the loan was to buy a rental property rather than a home. How would this change your answer to Part (B)?

Problem 8 Nancy Ball presently operates a retailing proprietorship with a December 31 year end and makes $150,000 of net income for tax purposes annually. She is thinking of incorporating her business and has asked for your advice. She lives in a province where the provincial corporate tax rate is 3% of this type of federal taxable income. She has $2,500 of federal personal tax credits, $1,700 of provincial personal tax credits, and no other income. You have agreed that you will do the following: (A) Estimate the personal taxes that Nancy would pay currently on $150,000 of business income compared with the amount of corporate and personal taxes that would be paid if she incorporated her business and only took out a salary of $50,000. Ignore all payroll taxes (e.g., Canada Pension Plan premiums) when making your estimates. (B) Based on your calculations in (A), estimate the amount of personal tax that Nancy defers by keeping the remaining after-tax retained earnings in her company this year. [Hint: compute the additional personal tax that she would pay on a dividend equal to the corporation’s after-tax retained earnings.]

Problem 9 Mrs. Edwards, age 49, presently operates a retailing proprietorship with a December 31 fiscal year end. She expects income for tax purposes of $310,000 from the business. She is considering the incorporation of her business. If she does so, she has been advised that if she makes all withdrawals from the business in the form of $120,000 in salary, she will end up with enough after-tax cash to meet her family’s needs. The business currently requires considerable amounts of working capital and she can only afford to withdraw $120,000 annually to meet her family’s needs regardless. She has come to you for advice on whether she should incorporate her business or not. She would like to know how much tax she will pay in 2023 on her business income and would like to know how that would compare to the amount of tax she would pay if she incorporated and paid out the $120,000 salary. She would also like to know if overall she will save tax if she incorporates and pays out the retained earnings of the company as a dividend in the future. Mrs. Edwards has a husband, Mr. Edwards, age 50, who currently does not work, and two children, one in high school who is 16 years old and another who is in university and is 19 years old. Mrs. Edwards is wondering if she can take advantage of income splitting benefits through salary or dividend payments to her family members if she chooses to incorporate.

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ITA: 82(1), 117, 121, 123–125

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She lives in a province where the provincial corporate tax rate is 3% of federal taxable income eligible for the small business deduction. Ignore any Canada Pension Plan premiums payable on the income. Assume that Mrs. Edwards has combined federal and provincial personal credits of $7,900 (including the spousal credit) and has no other income.

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— REQUIRED (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

Problem 10

ITA: 82(1), 117, 121, 123–125.1

Iris Kroneman approaches you with the following information: (a) She resides in a province with a 3% corporate tax rate (i.e., a total tax rate of 12%) where she owns and operates an incorporated business which generates income in the amount of $140,000 before taxes. (b) She has combined federal/provincial personal tax credits of $7,842, including the employment and the marital status tax credit. (c) She requires $75,000 before taxes for living expenses each year. (d) She wants to maximize her Canada Pension Plan contributions each year. The CPP calculations are as follows: Pensionable earnings (salary) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $66,600 Basic exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3,500) Maximum contributory earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$63,100

Employee rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Maximum contribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5.95% $ 3,754

(e) She wants to make the maximum RRSP contribution based on the earned income you determine she should have. Assume that her earned income for 2022 is the same as for 2023. You have agreed to compare two potential options: ●

Option 1: Salary of $66,600 to maximize her CPP contributions and dividends of $8,400;

●

Option 2: Salary of $75,000.

Include CPP payroll withholding considerations in your quantitative analysis of each option.

Problem 11 Herb Smith, the tax partner, has just talked to you about one of his clients, John Barwell. John has owned his retail store, Aurora Collectibles, for the past four years. Despite a recession, he has been able to do very well with the store by offering customers decorating advice along with the antiques and other unusual items that he sells. Last year, his store earned net income of $325,000. When he first started the business, he set it up as a proprietorship and financed it with a loan of $200,000 from his wife, Alison, and a $175,000 bank operating loan. Currently, both of the loans remain unpaid, since both John and Alison enjoy a lifestyle that uses up all of their cash flow. Both John and Alison agree that they are going to improve their spending habits. They want John to pay off the bank operating loan from the business earnings. Once this is done, any excess cash will be used by John to invest in some property that they will eventually move the store into. Alison isn’t involved in the retail store business. Herb wants you to identify the tax issues and tell him what analysis you propose to do to help John and Alison. He doesn’t want you to get into the numbers yet.

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Problem 12 Charles Wong, the vice-president of Arctic Oil Corporation, loves to minimize his income taxes. He spends much of his time hiring tax professionals to seek to find ways to avoid paying tax. However, the business-purpose and the substance-over-form concepts enacted in the general anti-avoidance rule place a broad restriction on taxpayer behaviour. Charles is having less and less success in his pursuit of ‘‘loopholes’’ in the tax system. You have realized that Charles needs to have a better understanding of the differences between tax minimization through tax avoidance, aggressive tax planning and effective tax planning. Charles may have to change his objective of tax minimization through seeking ‘‘loopholes’’. In your opinion, a better understanding of the concept of substance over form may help him to avoid being caught under the general anti-avoidance rule. As his tax adviser, help Charles to understand this by explaining: ● Tax minimization through tax avoidance and aggressive tax planning, relative to effective tax

planning strategies;

● Why he should change his approach to tax minimization; and ● How he can avoid the application of the GAAR.

Integrative Case Problem 13 On September 30, 2023, David Lin, a tax partner with Lin & Robson LLP in Waterloo, Ontario, came out of a meeting with a client, Samantha Greene. Dr. Greene is a dentist who, since graduating from the University of Toronto dentistry program in 2006, works for a dental practice where she lives in Waterloo, Ontario. The dentist who owns and operates the practice, Mr. Vanderstam, is retiring and would like to sell the practice to Samantha for $950,000 on November 1, 2023. Samantha is not sure if she should purchase the practice personally and operate it as a sole proprietorship or incorporate and have the corporation purchase the dental practice. She wants some advice on how she should structure the purchase. She would also like to understand her tax filing and payment obligations for the business so she can plan her cash flow. David has asked you, a new CPA, to summarize the potential tax and non-tax benefits of incorporation for a follow-up meeting. Samantha is unclear on how she would be compensated if she incorporated. He would also like you to propose some compensation options for her if she purchases the practice in a corporation. Samantha is married and has two children, Mark (14) and Hilary (17). Samantha’s husband, Roger, is a firefighter and earns an annual salary of $150,000. Samantha’s salary from the dental clinic for 2022 was $120,000. Samantha likes to maximize her retirement savings and made the maximum RRSP contribution available to her for 2022 in February 2023. She and Roger would like to prioritize retirement savings and both plan to continue to maximize their RRSP contributions. Roger’s after-tax earnings are sufficient to pay for the family’s personal living expenses and his retirement savings. They have a goal to live on Roger’s income and set aside Samantha’s income for reinvestment in the dental practice and related loan repayments, her retirement savings, mortgage prepayments, and any other savings. The dental practice operated by Mr. Vanderstam is currently not incorporated and Samantha would be purchasing the assets of the business. The purchase price covers the purchase of the inventory, equipment, leasehold improvements, and the goodwill associated with the practice. She would also like to understand how HST works and what she will need to do to meet any HST obligations related to the purchase and for ongoing operations. Samantha has approached the bank for financing. The bank has indicated that it would provide a $950,000 loan with an interest rate of 6% with a personal guarantee from Samantha and Roger. The loan is repayable over ten years with principal payments of $95,000 on October 31 of each year, starting in 2024. Additional principal payments can be made on this loan annually on October 31. If Samantha incorporates, the bank would provide the loan directly to the corporation to be used to purchase the assets. Samantha is wondering if she will be able to repay the loan faster if she incorporates and how long it will take. Neither Samantha or Roger like the idea of having a personal guarantee and would like to eliminate this as soon as possible by repaying the loan. Samantha or her corporation would own the assets and Roger would not have any involvement in the dental practice. Hilary aspires to become a dentist and would like to work part-time at the dental clinic with her mother before she goes to university next fall. The business has two other employees in administrative roles. Samantha would like some guidance on the responsibilities/requirements she will need to meet regarding the employees of the business. Samantha is also wondering if there are any income splitting opportunities if she chooses to incorporate. She would like to help Hilary purchase a

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vehicle and pay for her university living costs from profits of the dental practice in 2024. David mentioned to you after the meeting that family members can own shares of a professional corporation set up for a dentist as long as they are non-voting shares.

CHAPTER 13

The retiring dentist has provided his financial statements to Samantha. Samantha expects that with some of her planned operational changes and improvements the practice will earn appro Ximately pretax income of $300,000 after expenses (including the interest expense on the debt but before any compensation to her). Samantha anticipates that she will need to reinvest in the practice over time to upgrade the leasehold improvements and equipment. David has asked you to address Samantha’s requests and objectives for a future meeting with the client. He has asked you to use 2023 rates and data for any calculations you prepare when performing quantitative analysis. He told you to ignore payroll withholdings in any calculations you prepare. Assume the provincial corporate tax rate applicable to income eligible for the small business deduction is 4% and 12% for income in excess of the small business deduction limit. — REQUIRED Next Meeting Before the next meeting with Samantha, David would like you to: (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

Problem 14 Ganz Ltd., a Canadian-controlled private corporation, has offered Ms. Mogul a new job as vicepresident of marketing beginning January 1, 2023. The controller of Ganz has asked you to determine the tax and HST consequences of the proposed compensation package to both Ganz Ltd. and Ms. Mogul. In addition to salary and commissions, a number of benefits have been offered to Ms. Mogul as part of her package. The remuneration package includes a stock option to purchase 10,000 previously unissued fully paid common shares of Ganz Ltd. at $10 per share. The current FMV is $25 per share. The 10,000 shares will represent less than 1% of the votes and value of all the shares of the company once she exercises the options. Ms. Mogul is not related to any other shareholders of Ganz Ltd. Ms. Mogul will be eligible to exercise 25% of the stock options on April 1, 2023. Under a corporate policy applicable to senior executives, Ms. Mogul will be eligible to receive a loan from Ganz Ltd. for up to $50,000 at 0% interest towards the purchase of the shares. The terms of the loan would require her to repay $10,000 per annum for five years and would be evidenced by a bona fide note. Any outstanding balance would be due in full on termination of employment. Under a corporate policy applicable to senior executives, Ganz Ltd. will also loan Ms. Mogul $250,000 at 2% interest to assist in the purchase of a home in Toronto where Ganz Ltd. is located. Ms. Mogul currently lives in Winnipeg and plans to move to Toronto by the spring of 2023. The interest is payable monthly over 25 years and the principal is repaid in equal annual repayments over 25 years. She is expected to pay for her own moving expenses. Assume the prescribed rate was 3% when the loan is granted and does not fall below 3% for 5 years. Ms. Mogul will be travelling extensively and will be provided with a company car leased by Ganz Ltd. for $900/month including $100/month for insurance. It is anticipated that she will travel 45,000 business kilometres and 5,000 personal kilometres per year. Ganz Ltd. will pay all operating costs, estimated at $300/month. All amounts include HST where applicable. In lieu of reimbursing specific minor travelling expenses (e.g., meals), Ganz Ltd. will pay Ms. Mogul a monthly allowance of $750. More substantial travelling expenses (e.g., airfares and hotels) will be specifically reimbursed. — REQUIRED Before your next meeting with Ms. Mogul, (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

¶13,850

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Problem 15 Mr. Samuel, age 54 and a Canadian resident, owns all of the 600 Class A voting common shares of a holding company. The Samuel Family trust owns all of the 400 Class B non-voting common shares of the holding company. The beneficiaries of the trust are Mrs. Samuel, age 52, and the Samuel’s children, Jonathan, Jonas, and Jane. The trust is discretionary and income is paid out to the beneficiaries at the discretion of the trustees. Jonathan is 15 and lives at home. Jonas is 19 and lives in Kingston while he is a full-time student at university. Jane is 25 and lives part of the year in Waterloo and the other part of the year in Whistler. The holding company owns 100% of the common shares of Samuel Appliances Ltd. (‘‘SAL’’). Both companies have a December year end. SAL is a retailer of large appliances and is located in KitchenerWaterloo. Mr. Samuel works full time for SAL as the President and CEO of the company. Jonathan has never worked for SAL. Jonas works for the company seven weeks during the summer months four days a week and has done so since he was in his last year of high school. Jane works for SAL siX months of the year. The rest of the year she lives in Whistler working for a heli-skiing company. SAL pays year-end dividends to the holding company of $100,000 each year. SAL has only earned income eligible for the small business deduction in prior years and does not have a GRIP balance. Generally, $60,000 is paid out to Mr. Samuel as a dividend on the Class A common shares and $40,000 is paid out to the family trust as a dividend on the Class B shares. In prior years, the trustees of the family trust have made distributions at their discretion to Mrs. Samuel and Jane of $10,000 each and $20,000 to Jonas for his tuition costs each year. Jonathan has not received any income from the trust. Mr. Samuel would again like the trustees to distribute $10,000 to Mrs. Samuel, $10,000 to Jane and $20,000 to Jonas for his 2023/2024 tuition costs at the end of December. Mr. Samuel earns a $250,000 salary from SAL. Mrs. Samuel does not earn any income other than the dividends from the family trust.

— REQUIRED (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

¶13,850

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CHAPTER 13 — DISCUSSION NOTES FOR REVIEW QUESTIONS ITA: 78(4)

(2) (a) If Ms. Su leaves the money in the company, the income over $500,000 will not be eligible for the small business deduction, but it will be eligible for the general rate reduction. The corporate marginal tax rate will be 27% (i.e., 38% -- 10% -- 13% + 12%), which is less than all but the lowest marginal personal tax rate (federal and provincial combined). A tax deferral benefit is available as she is taxed in the highest marginal tax bracket (compare 50% personal tax rate to the 27% corporate tax rate). (b) If Ms. Su declares and pays the bonus the personal marginal tax rate will be 50% (i.e., 33% + 17%) (see ¶10,250 for provincial rates for study guide purposes) because she has other sources of income well over $500,000. (c) Ms. Su can defer approXimately 22.7% (see calculation below) of tax by leaving the income in the company to be taxed. The tax will be deferred until dividends are paid in the future. (d) If Ms. Su leaves the income in the company to be taxed, she will have to pay tax on the dividend when she eventually pays it out. The total corporate and personal tax that will have been paid at that point will be approXimately 49.7%, which is slightly below the 50% personal tax cost of paying out the bonus now, a small tax savings. The tax saving results because the corporate tax rate is below the perfect rate of integration of 27.5% for income above the small business deduction limit. (e) EXample calculation: Corporate income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Corporate tax @ 27% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$1,000 (270)

After-tax income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 730

Dividend paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross-up (38%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 730 277

Taxable dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$1,007

Tax @ 50% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividend tax credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 504 (277)

Net personal tax (i.e., 22.7%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 227

Net cash after tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 503

Total tax ($270 + $227) (i.e., 49.7%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 497

(3) If he or she chooses a fiscal year end on or after July 6, but no later than December 31, then the bonus can be paid within the 179 days in either this calendar year or the next calendar year.

ITA: 78(4)

CHAPTER 13

(1) Mr. Tal can pay the bonus within the 179-day limit and loan the net after-tax amount back to the company. The bonus will provide Mr. Tal with RRSP room, which he could use to reduce taxes in a future period. If he does loan the funds back to the corporation, he should consider charging interest to the company. The interest payments could replace salary and possibly reduce payroll taxes. He should also consider securing the loan. Another option is to leave the money in the corporation and pay combined corporate tax at a rate of 27% [38% -10% -- 13% + 12% provincial]. Leaving the funds in the corporation will allow him to take advantage of a tax deferral benefit of the difference between his personal tax rate and the 27% corporate tax rate.

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(4) The following are the five criteria for the deductibility of bonus accruals as decided in the Totem Disposal case: ●

reasonableness of the bonus in relation to profit and services rendered;

●

payment for real and identifiable service;

●

some justification for expecting a bonus over regular salary (e.g., a company policy);

●

reasonableness of the time between determining profit and establishing the bonus; and

●

a legal obligation to pay the accrued bonus.

(5) Mr. Chow is related to his brother-in-law. Therefore, they are deemed not to deal with each other at arm’s length and the brother-in-law is connected with Mr. Chow. As a result, the conditions in the shareholder loan rule are met (a loan to a person connected with a shareholder) and none of the exceptions are met. The brother-in-law will be required to take the full amount of the loan into income in 2023 since none of it will be repaid by December 31, 2024. The brother-in-law will be able to deduct the $10,000 annual principal repayments in each repayment year. Where there is an income inclusion for the loan balance, the deemed interest benefit is not applicable. If an imputed interest benefit was included in his 2023 tax return, because the interest rate on the loan was below the prescribed rate, it can be removed through an amended return to eliminate the benefit and replaced with the income inclusion for the loan balance.

ITA: 15(2.1), 251(2)

(6) Since Ms. Leftwick is a shareholder and received a loan, the shareholder loan rules apply. Although Ms. Leftwick is an employee, the boat does not fit into one of the exceptions available for a shareholder loan received by virtue of employment. Therefore, Ms. Leftwick will have to take the $25,000 into income unless she repays it within one year from the end of the taxation year in which she received the loan. If she has to include the principal in income then the deemed interest benefit rules will not apply. When she repays the loan, she will be entitled to a deduction for the repayment. The vice-presidents are not shareholders, and the shareholder loan provision will not apply. As employees, they will have a deemed interest benefit calculated at the prescribed rate of interest for the period their loans are outstanding. The benefit will be an employment benefit. If either of the loans is a home purchase loan the interest benefit could be capped at the prescribed rate at the time the loan is made if lower than the actual rate on a quarter-by-quarter basis because the loan would be received by virtue of employment.

ITA: 15(2)

(7) This provincial tax holiday would bring the combined corporate tax rate on income eligible for the small business deduction down to 9% (38% – 10% – 19%), which is below the 13% rate of perfect integration. This would provide a tax incentive (saving) to flowing active business income through a corporation, paying the corporate tax on the income and then paying the after-tax corporate funds as dividends. There would be an advantage to paying dividends instead of salary to the owner due to the fact that the dividend tax credit would be greater than the underlying corporate tax. There would also be a significant tax deferral benefit to leaving funds in the corporation. The personal tax rate would exceed the very low corporate tax rate even if the income earned by the individual were taxed in the lowest tax bracket. (8) With the 15% dividend gross-up his taxable income would be $34,500. The combined federal and provincial tax would be $8,625 at a rate of 25%. Deducting the combined basic personal amount of $3,754 and the dividend tax credit of $4,500 1 (assumed to be equal to the gross-up) would leave a tax liability of $371. 1 (9/13 federal credit + 4/13 provincial credit) × 4,500

ITA: 15(2), 15(2.4) ITA: 20(1)(j) ITA: 80.4(3)(b)

ITA: 15(2.4)(b)–(d), 15(2.6) ITA: 80.4, 80.4(3)(b) ITA: 80.4(1), 6(9)

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CHAPTER 13 — SOLUTIONS TO EXERCISES (A) The bonus must be paid on or before 179 days from the end of the year in which it was deducted. In this case, it must be paid on or before March 28, 2024. (Administrative practice would allow payment on the 180th day.)

IT-109R2, par. 10

(B) If the bonus is not paid on or before March 28, 2024, the corporation may not deduct the bonus in its 2023 taxation year. The bonus may only be deducted when it is paid. (C) (i) The rent must be paid within two years from the end of the year in which it was deducted. In this case, it must be paid by September 30, 2025. (ii) If the rent is not paid by September 30, 2025, the corporation must add the $10,000 to its income for its 2026 taxation year beginning October 1, 2025 (i.e., the third taxation year). This does not cancel the payable, such that if the rent is ever paid, the shareholder will declare the rental income, but there will have been no deduction for the corporation. (iii) An election can be filed before the date on which the corporation must file its tax return for 2026 (i.e., the third taxation year). In this case, that date is March 31, 2027. If such an election is filed, Mr. Schneider will be deemed to have income of $10,000 and to have loaned that amount back to the corporation on October 1, 2025 (the first day of the third taxation year). When the loan is repaid to Mr. Schneider, there are no tax consequences since the amount of the loan has already been taxed. The election can be filed late. However, $2,500 (effectively, a late-filing penalty) will be added back to the income of the corporation for its 2026 fiscal year (the third taxation year). Mr. Schneider’s tax position is not affected by this late-filed election.

ITA: 78(1)(b)

ITA: 78(3)

Exercise 2 (A) By Virtue of Employment Principal Amount — Note that the shareholder loan rule applies in this case because he is a shareholder.

ITA: 15(2)

(a) House Loan The Act would exempt the principal amount of this loan from income since Mr. Nesbitt received the loan in his capacity as an employee (i.e., by virtue of his employment), the purpose of the loan was to purchase a house and bona fide arrangements were made for repayment of the loan within a reasonable time; — however, an interest benefit on a ‘‘home purchase loan’’ would be included in income as shown in the calculation below.

ITA: 15(2.4)(b)

ITA: 80.4

(b) Furniture Loan There is no exemption from income for this loan because it was not repaid within one year of the 2023 taxation year of the corporation;

ITA: 15(2.3), 15(2.4), 15(2.6)

— since the loan is included in income in 2023, there is an exception for the purposes of the imputed interest benefit and, hence, there is no interest benefit.

ITA: 15(2), 80.4(3)(b)

(c) Share Purchase Loan This loan is exempt from income because Mr. Nesbitt received the loan in his capacity as an employee and bona fide arrangements were made to repay the loan within a reasonable time; — no exception to the imputed interest rules, there is an interest benefit as shown in the calculation below.

ITA: 15(2.4)(c)

ITA: 80.4

CHAPTER 13

Exercise 1

Introduction to Federal Income Taxation in Canada

370 Interest Benefit Home Purchase Loan

ITA: 80.4(1)(a), 80.4(4)

Interest on ‘‘home purchase loan’’ made to an officer or employee computed, at lesser of: (i) the prescribed rate in effect during the period in the year that the loan was outstanding, and (ii) the prescribed rate in effect at the time the loan was made. This ‘‘lesser of’’ choice can be made on a quarter-by-quarter comparison of tax rates. In this case, the 3% prescribed rate in June 2023, when the loan was received, is less than the rate for the other two quarters of 2023 in which the loan was outstanding. Therefore, the benefit would be based on the following calculation: June–Dec. 2023: 3% of $75,000 × 214/365 ........................................................................................................................... $1,319 Share Purchase Loan Interest on share purchase loan computed at prescribed rates in effect during the period in the year that the loan was outstanding June 2023: 3% of $10,000 × 30/365 = $ 25 July–Sept. 2023: 4% of $10,000 × 92/365 = 101 227 Oct.–Dec. 2023: 4% of $10,000 × 92/365 = 101 Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,546 Less: interest paid on above loans (2% of $75,000 × 214/365) . . . . . . . . . . . . . . . . 879 Benefit calculated under ssec. 80.4(1) and included in employment income . . . . . . . $ 667 Less: deduction for interest deemed paid on loan to buy shares . . . . . . . . . . . . . . . . 227 Net benefit under Division B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 440

ITA: 80.4(1)(a)

ITA: 61(1)(a), 6(9) ITA: 20(1)(c), 80.5

(B) By Virtue of Shareholdings If Mr. Nesbitt received the loans by virtue of being a shareholder, then all the loans would be included in income in the year that the loans were received, unless the loans were repaid by the end of the fiscal year in which the loans were made. If an imputed interest inclusion were included on the returns for the period the loan was outstanding, the returns would be amended to reverse the interest income inclusion and instead include the loan balance in income in the year the loan was received. For interest benefits, the main difference is that the benefit on the loan to purchase the house would be based only on the prescribed rate in effect during the period in the year that the loan was outstanding and reduced by the amount of interest paid on the loan by the shareholder in the period not later than 30 days after the corporation’s year end. This is because the calculation of the interest benefit by virtue of shareholdings does not take into account the special rules for a ‘‘home purchase loan’’.

ITA: 80.4(2) ITA: 15(2)

ITA: 80.4(2), 80.4(7), 248(1)

Exercise 3 (A) The CRA indicates that it examines the balance in the account at the end of each year of the lender considering a net increase as a loan to be included in the income of the borrower and a net decrease as a repayment to be deducted from the income of the borrower. This approach would result in the following: Lender’s year end Year 2 . . . . . . . . . . . . . . . . . . . . . . . . . Year 3 . . . . . . . . . . . . . . . . . . . . . . . . . Year 4 . . . . . . . . . . . . . . . . . . . . . . . . . Year 5 . . . . . . . . . . . . . . . . . . . . . . . . . Year 6 . . . . . . . . . . . . . . . . . . . . . . . . .

Change from previous year $45,000 (32,000) (2,000) 12,000 (14,000)

ITA: 15(2), 20(1)(j); IT-119R4, par. 34-35

Income [ssec. 15(2.6)] or repayment [par. 20(1)(j)] income repayment repayment income repayment

(B) If there is no series of loans and repayments, then repayments are considered to apply first to the oldest loan outstanding unless the facts clearly indicate otherwise. Applying this approach would result in the following:

IT-119R4, par. 27

Ch. 13/Study Guide — Solutions to Exercises Lender’s Net inclusion year end (or deduction) Year 2 . . . . . . . . . . . . . $25,000

(12,000)

Year 4 . . . . . . . . . . . . .

(12,000) 0

Year 5 . . . . . . . . . . . . .

(1,000) 23,000

Year 6 . . . . . . . . . . . . .

(14,000)

Explanation — only the $20,000 borrowed in Year 2 is repaid within one year of Year 2; the $25,000 loan was not fully repaid within one year, so it must be taken into income in Year 2 — repayment of $12,000 of the $25,000 Year 2 loan previously included — repayment of part of balance of Year 2 loan — Nov. 30/Year 4 loan repaid within one year of Year 4 — repayment of remainder of April 30/ Year 2 loan — full amount of Nov. 30/Year 5 loan, since not fully repaid within one year of Year 5 — repayment of $14,000 of Year 5 loan

CHAPTER 13

Year 3 . . . . . . . . . . . . .

371

Note that these methods of calculation are based on administrative practice and are not stipulated by the Act. Note that based on these methods, while total inclusions net of deductions over the period amount to $9,000 under each alternative, the time pattern of net inclusion is more favourable in this case if there is no series of loans and repayments considered. If the loans are all part of a single running loan account, they are likely a series of loans and repayments. However, if the loans are for separate purposes, with differing repayment or other terms, and the repayments relate to specific loans, the facts might suggest there was no series of loans and repayments.

Exercise 4 Since he is a shareholder of the corporation, the shareholder loan rule applies and the loan that was received by the taxpayer should be included in income. However, the Act provides an exclusion for the $35,000 principal amount of the loan because: — the taxpayer is an employee of the lender; — the loan is to enable him to acquire a motor vehicle to be used by him in the performance of his employment duties; — the taxpayer received the loan because of his employment, not because of his shareholdings, since other employees were eligible for a loan; and — bona fide arrangements were made, at the time the loan was made, for repayment within a reasonable time.

ITA: 15(2) ITA: 15(2.4)(d)

Since the loan is a low-interest loan, the imputed interest benefit rule applies to impute an interest benefit calculated as follows:

ITA: 80.4(1)

April 1 to June 30: 91/365 × 1% of $35,000 = . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 87 July 1 to Sept. 30: 92/365 × 2% of $35,000 =............................................................................................ 176 Oct. 1 to Dec. 31: 92/365 × 3% of $35,000 = ................................................................................ 265 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 528 Less: interest paid (not payable) within 30 days of end of year (214/365 × 1% of $35,000) ....................................................................................................... 205 Net interest benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 323 The Act deems the imputed interest benefit of $323 to have been paid in the year. As a result, a part of the interest will qualify as a deduction of interest paid limited as follows: Lesser of: (a) interest deemed paid ................................................................................... $323 interest paid (214/365 × 1% of $35,000) . . . . . . . . . . . . . . . . . . . . . . . . 205 $ 528 $300 (b) × 214 days of interest paid .............................................................................$2,140 30 Lesser amount × 60% business usage (60% of $528) . . . . . . . . . . . . . . . . . . . . . . . $ 317

ITA: 80.5 ITA: 8(1)(j), 67.2

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Exercise 5 Company Leases Car (Shareholder-Manager Pays Tax on Benefit) Benefit from use of car: standby charge(1) (10,000 km/20,004 km × 2/3 × $8,400) . . . . . . . . . . . . . value of operating costs of personal use(2) . . . . . . . . . . . . . . . . . . . . . . . Incremental taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2,800 1,400 $ 4,200

Tax @ 50% on $4,200 of incremental taxable income . . . . . . . . . . . . . . . . . . .

$ 2,100

ITA: 6(1)(e)

Shareholder-Manager Leases Car Personally Incremental taxable income ($3,880 + $8,400) ......................................................... $12,280 Less: deduction for business use of car [662/3% of ($8,400 + $3,880)] . . . . . . . (8,187) 942 Add: HST rebate (13/113 × $8,187)(3) Incremental taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,035 Tax @ 50% on $5,035 of incremental taxable income . . . . . . . . . . . . . . . . . . .

$ 2,518

Tax net of HST rebate ($2,518 -- $942) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notice that the second alternative is the better for the shareholder by $524.

$ 1,576

From the perspective of the corporation, the corporation is better off with the personal lease of the vehicle comparing the tax savings through a deduction for $12,280 of salary relative to 67% of $12,280 of vehicle expenses. The tax savings to the corporation of the personal lease option are $532. Overall the personal lease of the vehicle saves $1,056 in tax ($524 to the shareholder and $532 under this assumption is to the corporation). Note that there may be good argument for a full deduction of the lease and operating expenses for the lease by the corporation in the case where the corporation incurs those costs on the basis that the costs represent reasonable compensation for the shareholder-manager, are received by virtue of employment, and are thus fully deductible. — NOTES TO SOLUTION (1) This calculation assumes that business usage of 66 2/3% meets the test that the primary distance travelled was for business. Generally, the term ‘‘primarily’’ has been interpreted by the CRA to mean more than 50%. (2) The election includes a benefit of 50% of the standby charge of $2,800 (i.e., $1,400) which is less than 33¢ × 10,000 km or $3,300. (3) In reality, the HST rebate would have to be taken into income in the following year. Note that the present value considerations on the rebate have been ignored. (4) The company would be eligible for a full input tax credit for HST on the lease and operating costs as the vehicle is used primarily for commercial activities. The company will also be required to remit HST on the employee’s standby charge and operating benefit because the full input tax credit is available. HST has been ignored for purposes of the calculations for Option 1. This would reduce the advantage of the second alternative.

Exercise 6 Corporation Income . . . . . . . . . . . . . . . . . . . . . . . . . . Salary . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable Income . . . . . . . . . . . . . . . . . . . . Tax 13% . . . . . . . . . . . . . . . . . . . . . . . . . Available for dividends . . . . . . . . . . . . . . Shareholder Salary . . . . . . . . . . . . . . . . . . . . . . . . . . . A Dividend . . . . . . . . . . . . . . . . . . . . . . . . . B Gross up (15%) . . . . . . . . . . . . . . . . . . . . Taxable Income . . . . . . . . . . . . . . . . . . . . Combined Federal and Provincial Tax (25%) . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividend Tax Credit (assumed equal to gross up . . . . . . . . . . . . . . . . . . . . . . . . . Personal Tax Credits . . . . . . . . . . . . . . . . Net Tax . . . . . . . . . . . . . . . . . . . . . . . . . . C Net Cash to the Shareholder (A+B--C) . . .

Alternative A 30K Salary

Alternative B 30K Dividend

Alternative C Combination

30,000 (30,000) — — —

30,000 — 30,000 (3,900) 26,100

30,000 (10,000) 20,000 (2,600 ) 17,400

30,000 — — 30,000

— 26,100 3,915 30,015

10,000 17,400 2,610 30,010

7,500

7,504

7,503

— (4,092) 3,408 26,592

(3,915) (3,750) 297 26,100

(2,610) (4,092) 801 26,600

ITA: 6(2)

ITA: 6(1)(k)

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Exercise 7 (A) Taxation of Income from Sole Proprietorship Taxable Income (business & interest income) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Federal & Provincial Tax Tax on first $53,359 at 25% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax on next $27,341 at 32.5% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Personal Credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$80,700 13,340 8,886 22,226 (3,750) $18,476

(B) Remuneration alternatives: Salary vs. Dividends Taxation of Income through a Corporation 40K Salary

40K Dividend

Corporation Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Salary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax 13% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Available for Dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Paid as a Dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retained in the Corporation . . . . . . . . . . . . . . . . . . . . . . . . . .

$80,000 (40,000) 40,000 (5,200) 34,800 — 34,800

$80,000 — 80,000 (10,400) 69,600 (40,000) 29,600

Shareholder Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Salary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A Dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . B Gross up (15%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Combined Federal and Provincial Tax (25%) . . . . . . . . . . . . . . Dividend Tax Credit (assumed equal to gross up) . . . . . . . . . . Basic Personal Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Employment Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C

700 40,000 — — 40,700 10,175 — (3,750) (342) 6,083

700 — 40,000 6,000 46,700 11,675 (6,000) (3,750) — 1,925

Net Cash to the Shareholder (A+B--C) . . . . . . . . . . . . . . . . . . .

33,917

38,075

5,200 6,083 11,283

10,400 1,925 12,325

18,476

7,193

6,151

Incorporated Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Shareholder . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Taxes Paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proprietorship Taxes Paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax Deferred through Incorporation . . . . . . . . . . . . . . . . . . . . .

At these rates, salary results in a larger tax deferral relative to Aaron’s current situation. However, he will have $4,158 less after tax funds available to pay for his living expenses. Aaron’s annual living expenses are $37,200. The dividend option will provide him with sufficient after-tax income to cover his expenses. The personal tax on the dividend is negligible because the dividend tax credit almost entirely

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There is almost perfect integration at a corporate tax rate of 13% as long as all of the dividend tax credit is used. As a result, there is very little difference between Alternatives A and C. The full federal dividend tax credit is not used in Alternative B, providing the worst result for the shareholder. The best alternative is Alternative C, the combination option because the dividend tax credit exceeds the corporate tax paid by the corporation. As well, Alternative C results in the use of all of the dividend tax credit. Alternatives A and C will provide the shareholder with RRSP room but will result in payroll costs shared between the corporation and the shareholder. (Note that for Alternative B we have combined the federal and provincial tax calculation for the above calculation. In reality, the federal and provincial tax calculations would be separate calculations and the result would be worse than above, i.e. provincial tax of $297 would result and further reduce the net cash to the shareholder).

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offsets his personal tax. This demonstrates the benefit of dividends over salary at the personal level to individuals in lower tax brackets where the credits will provide a significant offset against the tax on the funds received. The deduction for the salary results in a higher amount of funds retained in the corporation. These funds will ultimately be paid out to the shareholder with corresponding personal tax in the future. Aaron can take advantage of the tax deferral advantage in the meantime because he does not need to distribute all of his business profits from the corporation. He can also save tax if these funds are distributed when he is in the lowest tax bracket rather than the 32.5% bracket in which much of his income as a sole proprietor currently falls into. This makes incorporation a good option for him. If he required all of the $80,000 of business profits to pay for his living expenses, incorporation would not make sense for him from a tax perspective as he would lose this tax deferral advantage.

Exercise 8 The following comments are based on the application of the logic presented in E Xhibit 13-10 to the facts of this situation. (1) Does any other provision of the Act or other rule of law apply to stop the taxpayer from achieving the intended advantage? No, the amount paid is considered to be reasonable and, hence, is not prohibited. Remuneration is considered to be an expense incurred to produce income from business and, thus, is not prohibited.

ITA: 67

(2) Does the transaction result, directly or indirectly, in a tax benefit, i.e., a reduction, avoidance or deferral of tax or an increase in a refund? On the one hand, corporate tax is reduced, but on the other hand the individual receives income subject to tax at a higher rate. However, the reduction of income to the corporation reduces the potential for double taxation on income taxed at more than a 27.5% rate in the corporation which may be considered to be a tax benefit. If it is concluded that there is no tax benefit, GAAR should not apply.

ITA: 245(1)

ITA: 18(1)(a)

(3) Is the transaction part of a series of transactions, which would result, directly or indirectly, in a tax benefit? If the answer to Question 2 is yes, then proceed directly to Question 4. (4) Can the transaction reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit? No, a tax reduction for the corporation was probably the primary purpose. On the other hand, it might be argued that, since the amount paid was reasonable, it is necessary remuneration. (5) Can it reasonably be considered that the transaction would result directly or indirectly in a misuse of the provisions of the Act or an abuse having regard to the provisions of the Act read as a whole? No, ‘‘the Act recognizes the deductibility of reasonable business expenses’’. The March 28, 2023 Federal Budget includes proposed amendments to the GAAR legislation in the ITA to clarify the intended application of the provision, lower the threshold for the determination of an avoidance transaction and require the application of an economic substance test when determining whether a misuse of the provisions or abuse of the ITA as a whole has occurred. The amendments also impose a penalty of 25% of the tax benefit resulting from the transaction subject to GAAR.

Exercise 9 The general anti-avoidance rule allows for transactions or a series of transactions to be disregarded if they are without a bona fide purpose. If your client’s spouse and children are not providing any services to her business, it is obvious that the transactions were arranged primarily to obtain a tax benefit with no bona fide purpose, and they will be disregarded by the CRA. Any tax benefit derived from the transactions will be eliminated. If there is some service being provided to justify a salary, the amount of salary must be reasonable in the circumstance or the deduction by your client can be disallowed without the need to apply the GAAR. In fact, if the unreasonable salaries are still taxed in the hands of the spouse and children, after the expense is disallowed, the result is worse than the application of the GAAR that disregards the payment. The March 28, 2023 Federal Budget includes proposed amendments to the GAAR legislation in the ITA to clarify the intended application of the provision, lower the threshold for the determination of an avoidance transaction and require the application of an economic substance test when determining whether a misuse of the provisions or abuse of the ITA as a whole has occurred. The amendments also impose a penalty of 25% of the tax benefit resulting from the transaction subject to GAAR.

IC 88-2, par. 18

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Exercise 10 This question deals with subsection 15(2) and sections 80.4 and 80.5 of the Act. The effects of leap year are ignored. (i) House loan Paragraph 15(2.4)(b) would exempt the principal amount of this loan from income since Grace Ravens is also an employee, the purpose of the loan was to purchase a house for her occupation, she received the loan in her capacity as an employee (under corporate policy) and bona fide arrangements were made for repayment of the loan within a reasonable time. Section 80.4 would include an interest benefit on an employee loan for 2023 as shown in the calculation below. Since Grace Ravens received the loan by virtue of being an employee, the calculation of the imputed interest benefit would be made under ssec. 80.4(1) at the prescribed rate of interest in effect throughout the year. Subsection 80.4(4), applicable to a home purchase loan, also applies to benefits calculated under ssec. 80.4(1) where the loan is received by virtue of employment. However, in this case the 3% rate on the date the loan was made on June 1, 2022 would result in a larger benefit. January 1 to June 30: July 1 to December 31:

$90,000 × 2% × 181/365 = . . . . . . . . . . . . . . . . . . . . $90,000 × 3% × 184/365 = . . . . . . . . . . . . . . . . . . . .

$ 893 1,361

Gross interest benefit on house loan ........................................................................... $2,254 Less: interest paid on house loan ($90,000 × 1%)......................................................... (900) Benefit calculated under ssec. 80.4(1) and included in income ................................ $1,354

(ii) Furniture loan There is no exemption from income for this loan in ssecs. 15(2.2) to (2.5), and the loan is not exempt by ssec. 15(2.6), because it was not repaid within one year of the 2022 taxation year of the corporation. For 2022, a net amount of $9,000 [$10,000 — included under ssec. 15(2) less $1,000 repaid and deducted under par. 20(1)(j )] is included in her income. For 2023, she can deduct the $1,000 repaid in the year under ssec. 20(1)(j ). Where a loan is included in income, the interest benefit provision is not applicable. (iii) Share purchase loan This loan is exempt from income by virtue of par. 15(2.4)(c) because the proceeds were used to acquire previously unissued shares, she received the loan in her capacity as an employee and bona fide arrangements were made to repay the loan within a reasonable amount of time. There is an interest benefit for 2023 under 80.4(1) as shown in the calculation below. $20,000 × 2% × 181/365 = . . . . . . . . . . . . . . . . . . . . $20,000 × 3% × 184/365 = . . . . . . . . . . . . . . . . . . . .

$ 198 302

Interest benefit on share purchase loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 500

January 1 to June 30: July 1 to December 31:

Section 80.5 would deem this imputed interest benefit to also be interest paid. Paragraph 20(1)(c) would allow a deduction for the interest paid since the loan was used to buy shares. Summary 2023 Total interest benefit ($1,354 + $500) 80.4(1)..............................................$1,854 Repayment of principal on furniture loan 20(1)(j ) ........................................... (1,000) Deductible interest on share purchase loan (deemed paid 80.5) ........................ (500) Net income inclusion for 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 354

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Tax consequences to Grace Ravens for 2023:

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376

Exercise 11 (A)

(B)

Salary to Mr. Newton ............... Section 67 should not apply, as Mr. Newton is the president and sole shareholder. As well, the amount of the salary will be of little concern to the CRA as it places Mr. Newton in a high personal tax bracket. Salary to Mr. Cane ................... Section 67 may apply given nature and extent of duties performed. They should document support for the reasonableness of the amount paid.

(C)

$20,000 royalty payable to [Subsection 78(1)] If not paid in 2024, added to the corporaMr. Newton ............................... tion’s income in 2025. Recommend to pay if possible; otherwise, file joint agreement within si X months of 2025 year end, i.e., June 30, 2026; deemed received and loaned back in 2025.

(D)

$30,000 royalty payable to Would be added to the corporation’s 2023 income unless Mr. Newton ............................... joint agreement filed by June 30, 2024 (siX months after year end of third succeeding year). If no agreement is filed, can late file (and should recommend to file) joint agreement. Result of late filing is that 25% of $30,000 would be added back to corporation’s income in 2023 but 100% is treated as having been paid to Mr. Newton and loaned back to corporation on January 1, 2023. $200,000 loan ............................ Principal amount exempt [par. 15(2.4)(b)] since it is a housing loan for their habitation and bona fide repayment terms exist [par. 15(2.4)(f )]; also, the loan was made in his capacity as an employee [par. 15(2.4)(e)]. Imputed interest for 2023 is calculated as follows:

(E)

Subsection 80.4(1) applies since the loan was made by virtue of his office. Lesser of (computed on a quarter-by-quarter basis): (a) interest at prescribed rate in effect during period in 2023 that loan was outstanding; and (b) interest at prescribed rate in effect at time loan made on July 1, 2023 [ssec. 80.4(4)]. Since the prescribed rate on July 1, 2023 (the date the loan was granted) is less than or equal to the prescribed rates in each of the quarters during the year that the loan was outstanding, the lesser amount will be based on the 2% rate in effect on July 1, 2023 and the imputed income is computed as follows: 184 × 0.02 × $200,000 = $2,016 365 Imputed interest ................................................... $2,016 Less: interest paid for the year 184* × 0.01 × $200,000 = $1,008 365 Net benefit ........................................................ $1,008 *184 days = interest payments made at month-end July through December 2023. The effects of leap year are ignored.

Note: Interest on the $200,000 loan is not deductible since the purpose is not to produce income [par. 20(1)(c)]. (F)

(G)

$15,000 loan . . . . . . . . . . . . . Principal amount is included in income in 2023 [ssec. 15(2)]; ssec 15(2.6) will not apply since the repayment is part of series of loans and repayments.

$2,500 loan . . . . . . . . . . . . . .

No imputed interest, since principal amount included in income [ssec. 80.4(3)]; par. 20(1)(j ) will not apply since the repayment is part of series of loans. Principal amount is included in Mr. Cane’s income in 2023; ssec. 15(2) will apply as the loan is to a person connected to shareholder.

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Exercise 12 Considerations include the following:

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● Mr. Washington’s cash requirements; ● Mr. Washington’s other sources of income; ● Mr. Washington’s personal effective tax rate; ● The corporation’s effective tax rate on income:

- Does it qualify for the small business deduction (‘‘SBD’’)? - Tax deferral benefit is significant for income eligible for the SBD. Funds should be retained in the corporation. - Tax deferral benefit also exists for income above the SBD limit depending on Mr. Washington’s personal tax bracket. - If he doesn’t require funds, it would be better to keep the funds in the corporation to take advantage of the tax deferral benefit (consider the impact on the SBC status of the corporation and the passive income clawback for the small business deduction limit). - If he needs funds, consider the tax cost/savings of dividends taking into account the combined federal/provincial corporate tax rate and Mr. Washington’s personal tax rate on eligible dividends (paid from income above the SBD limit) and non-eligible dividends (for income eligible for the SBD). ● If a bonus is determined to be tax effective, the amount must be reasonable and a legal obligation

to pay the bonus must exist at the end of the taxation year.

● Is the corporation eligible to defer the payment of taxes to 3 months rather than 2 months after

year end or make quarterly tax instalments? If income is above the small business deduction limit, this would require the corporation to pay tax 2 months after year end and make monthly tax instalment payments.

● Mr. Washington may want a salary to be eligible for CPP and RRSP contributions. ● Does Mr. Washington have a CNIL balance for which he needs to receive a dividend in order to

enable him to claim the capital gains deduction in the future?

● RDTOH — to recover the RDTOH, the payment of a taxable dividend is required. Non-eligible

RDTOH can be refunded on the payment of non-eligible dividends, i.e., dividends from income eligible for the small business deduction. Eligible RDTOH can be refunded on the payment of eligible dividends or non-eligible dividends after the non-eligible RDTOH balance is fully refunded. If this company has only business income it is unlikely to have an RDTOH balance.

Exercise 13 The CRA would assess Spencer Stapleton a shareholder benefit under ssec. 15(1) in the amount of $452,000, being the cost of the addition including 13% HST. This income would be treated as income from property in the calendar year that the addition is built. Stapleton Estates Limited would also be reassessed to deny the deduction for the cost to the company of the subcontractor fees under par. 18(1)(a) since the expenses were not incurred to earn income. The expense would be considered to be a personal or living expense and denied under par. 18(1)(h). Penalties under ssec. 163(2) may be levied if the CRA considers the understatement of income to be a result of gross negligence. Note that the overall impact is double taxation because the company will not get a deduction for the cost and the cost is included in the shareholder’s income. The shareholder would have been better to receive deductible salary or bonuses and pay for the expense personally out of the after-tax income.. Under the Excise Tax Act subsection 172(2), where a corporation appropriates any service acquired or performed in the course of commercial activities to or for the benefit of a shareholder otherwise than for fair market value consideration, the registrant corporation is deemed to have made a supply of the service for fair market value and would be required to remit the HST on the shareholder benefit to the Receiver General. However, subsection 172(3) provides that the remittance is not required for a service appropriated by a registrant for the benefit of a person where the registrant is not entitled to claim an input tax credit for the HST paid. An input tax credit would not be available to Stapleton Estates Limited for the HST paid to the contractor as the expenditures are personal expenditures denied as a deduction under 18(1)(h). The remittance would not be required.

ETA: 172(2), (3)

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Exercise 14 Tax on split income (TOSI) applies to split income of a specified individual. Mr. and Mrs. Bartlett are specified individuals because they are both individuals who are residents of Canada at the end of the year. TOSI applies to taxable dividends from a private corporation received either directly or indirectly through a trust or partnership unless the dividends meet the definition of an excluded amount. Part A: An excluded amount includes amounts that are not derived from a related business. Mr. and Mrs. Bartlett’s dividends would be derived from a related business. For Mr. Bartlett, although the business is not carried on by a source individual because Mrs. Bartlett is not involved in the business, Mrs. Bartlett owns not less than 10% of the fair market value of the capital stock of the corporation. Dividends received by Mrs. Bartlett would be considered to be derived from a related business because a source individual (Mr. Bartlett) carries on the business. He also owns not less than 10% of the fair market value of the capital stock of the corporation. For a specified individual who has attained the age of 24 before the year, dividends will be considered an excluded amount if they are derived from an excluded business, from excluded shares or are a reasonable return in respect of the individual. An excluded business is a business where the individual is actively engaged on a regular, continuous and substantial basis in the tax year or any five prior tax years. A person who works in the business at least 20 hours per week during the portion of the year in which the business operates is deemed to be actively engaged. Mrs. Bartlett is not actively engaged in the business of Bartco and dividends received by her are not from an excluded business. Mrs. Bartlett’s shares would not be excluded shares. 90% or more of the income of the corporation appears to be from the provision of engineering services. So although Mrs. Bartlett owns shares that provide for 10% or more of the votes and fair market value of all of the issued shares of the company, the shares do not meet the definition of excluded shares. Therefore, to be an excluded amount, the dividends would need to be considered a reasonable return considering factors such as work performed, property contributed and risks assumed. As Mrs. Bartlett is not involved in the business and does not appear to have contributed property to the business, it is unlikely that her dividends would be considered a reasonable return. Result: Mrs. Bartlett will be subject to TOSI and her dividends will be taxed at the rate of 42.5% for non-eligible dividends paid to her from Bartco. The only credit she could claim in computing the tax on her dividends would be the dividend tax credit. Dividends received by Mr. Bartlett would not be subject to TOSI because they are derived from an excluded business. Part B: Mrs. Bartlett’s shares would meet the definition of excluded shares because the company is not a professional corporation or service business, she owns shares with 10% of votes and value, and all or substantially all of the income of Bartco would not be income derived from a related business. Result: Mrs. Bartlett’s dividends would not be subject to TOSI and would be taxed at the marginal tax rate for her income level. Note that if Mrs. Bartlett doesn’t have other sources of income, her basic personal credit and the dividend tax credit will offset most of the federal and provincial tax on the noneligible dividend received. Mr. Bartlett’s dividends would not be subject to TOSI as the dividends are derived from an excluded business. He will be taxed at the marginal tax rate for his income level.

ITA: 120.4(1), (2)

Chapter 14 Rights and Obligations Under the Income Tax Act CHAPTER 14

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380

CHAPTER 14 — LEARNING CHART Problem Descriptions Textbook Example Problems 14-1 Penalties and interest for late f iling and failure to comply 14-2 Installments — corporation 14-3 Penalties and interest 14-4 Net worth assessment 14-5 Obligation to withhold tax and payroll, HST registration Exercises 1 2 3 4 5 6 7 8 9 10 11 12 13 14

Withholding tax requirements Windfalls Installments — individual Installments — CCPC Penalties — late f iling Notice of Reassessment Compare interest paid to and by CR A Preparer penalties Appeal procedure Interest on tax refunds Instalments — corporation Penalties Filing due date, balance due date, instalments Filing due dates

Assignment Problems 1 Filing deadlines 2 Deadlines for Notice of Reassessment 3 Notice of Objection 4 Back dating 5 Personal instalments 6 Corporate instalments 7 Notice of Reassessment 8 Preparer penalties 9 Withholding tax on compensation 10 Comprehensive

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Introduction to Federal Income Taxation in Canada

382

¶14,800

REVIEW QUESTIONS

(1) In each of the following situations indicate whether the answer is true or false and give a reference to the Act. (a) The taxable income of Unco Inc., a corporation resident in Canada, was zero for the year. As a result, it did not have to file a corporate tax return. (b) Mr. Austen sold his shares in a qualified small business corporation and realized a $200,000 capital gain. The full amount of the gain was eligible for the capital gains exemption leaving his taxable income at zero. He does have to file a tax return for the year. (c) Instalments for individuals are due on the 30th of March, June, September, and December. (2) Mr. Smith paid his first instalment on time but was unable to pay his second one on time. He paid both the second and the third instalments on September 15. Is there any way he can avoid the interest that was charged to him for the late payment on the second instalment? (3) Bearings Inc. has been quite profitable, but this year the corporation realized a business loss that it is going to carry back to the third preceding year. They are also hoping to collect interest from the date they filed the return for that third preceding year. What do you think? (4) Ms. Taylor received a Notice of Reassessment from the CRA to disallow certain expenses that she had claimed. She contacted her accountant who sent a letter to the CRA outlining the basis for the deduction. Both Ms. Taylor and her accountant feel that the deduction will be allowed. Should she also file a Notice of Objection? (5) Murray Corp. has had a bad year. The corporation lost money for the first time in its history and some of its key employees have left. Because of all this confusion Murray Corp. was late in getting its financial records in shape and it did not file its corporate tax returns until seven months after the end of the year. Murray Corp. still needs the cash so it is waiting anxiously for the tax refund from the loss being carried back to the third preceding year. Do you think Murray Corp. will be disappointed? (6) Mark Washington is starting a business and just hired a new sales employee who will receive a $75,000 annual salary. Mark also plans to pay his wife a $20,000 salary for bookkeeping services. The business is not incorporated. Mark is wondering if he has any payroll remittance or other administrative requirements related to the salaries.

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383

EXERCISES

Exercise 1

ITA: 153(1)

List five payments from which the payer must withhold tax.

Exercise 2 Give two examples of a windfall that would reduce an estimate of income in a net worth assessment.

Exercise 3

ITA: 156(1)

In 2023, Mr. Owens projects his income to be $60,000 consisting of employment income of $25,000 and income from a small business of $35,000. He expects that his tax liability will be $9,200 on the business income. During 2021 and 2022 he paid $3,000 and $4,000, respectively, in tax on business income. Is he required to make instalments for 2023? If so, how much must he pay in instalments during 2023 so that he does not incur interest and when must each instalment be paid?

Exercise 4

ITA: 157(1)

Exercise 5 X, Y, and Z filed their personal tax returns on May 5, 2023, for the 2022 year. X and Y are employees and Z is an unincorporated business owner. X determined that he owed and paid $4,700 in tax on that date; Y computed a refund of $2,000; and Z paid $3,500 relating to his balance of tax. What penalties and offences might each be liable for?

Exercise 6 Mr. DeHaan has approached you, on July 12, 2023, for some advice considering a reassessment notice for the 2020 year that he has received. Mr. DeHaan has misplaced the reassessment notice but assures you that it was dated June 15, 2023. In your conversation with Mr. DeHaan, he reveals that he has had considerable difficulty with the CRA in the past, and has had to pay penalties under the Act. Mr. DeHaan is positive that he has complied with the law in this situation and wishes to dispute the assessment.

ITA: 150(1), 162(1), 238(1)

ITA: 152(4), 163, 220(3.1); IC 00-1R

ITA: 162, 163

— REQUIRED (A) Determine what additional information you require from Mr. DeHaan before discussing the relative merits of the particular disputed items. (B) Assuming you accept the engagement, what steps would you immediately take? (C) EXplain to Mr. DeHaan the penalty under section 163.

Exercise 7

ITA: 161, 164

Compare the calculation and tax treatment of interest paid on amounts owing to the CRA and interest paid on refunds by the CRA.

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A corporation that is not an eligible small CCPC has a December 31st taxation year end. In 2021, it paid tax of $158,400. By the end of March 2023, it had computed its tax for 2022 at $237,600. It estimates that it will have to pay $356,400 in tax for 2023. Is the corporation required to make instalments for 2023. If so, how much must it pay in instalments during 2023 and when must each be paid?

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Exercise 8

ITA: 163.2; IC 01-1

You have been engaged by Sid Fisher, a self-employed new client, to prepare an income statement and his tax return. Sid has instructed you to prepare these based on a figure for his total revenue and a list of his business expenditures, which he has provided to you. Based on your quick review of this data, you concluded that the expenditures were consistent with Sid’s type of business and the amounts appear to be reasonable. You prepared the income tax return, showing $100,000 of total revenue and $70,000 of expenses. Subsequently, Sid’s return was selected for audit. The CRA determined that many of the expenses deducted in the return could not be substantiated by adequate records. The CRA concluded that some of these expenditures may not have been made. The CRA, also, discovered that only 65% of the actual revenues of the business had been reported. — REQUIRED Determine whether you are at risk of being assessed under the civil penalties provisions of the Act.

Exercise 9

ITA: 163.2 ITA: 165(1), 169, 172, 180

Outline briefly the full appeal procedure indicating the time allowed between steps in the procedure.

Exercise 10 Mr. Steve Parrott’s only source of income is from his dry cleaning business. In March and June of 2022, he paid instalments of $2,000 each in respect of his 2022 taxes. By September, he realized things were not going well and he would likely have a loss for the year. He, therefore, paid no further instalments. On June 15, 2023, Steve filed his 2022 tax return claiming a loss and a refund of his $4,000 instalments. He also filed a T1A carrying the loss back to 2021. He expects a tax refund of $5,000 from the carryback. — REQUIRED What interest can Steve expect to receive on his tax refunds?

Exercise 11 Mr. Black owns all the shares in Black Inc. Black Inc. is not associated with any other corporations and claims a deduction under subsection 125(1) every year. Mr. Black is aware that you recently attended an excellent tax course and has approached you for advice regarding the following problem. EXactly one year has gone by since Black Inc.’s December 31, 2022 year end and a corporate tax return has not yet been filed. Further, on the advice of his brother-inlaw, the controller, no instalments were made on account of 2022 or 2023. Whenever Mr. Black’s brother-in-law is asked about the situation, he simply replies, ‘‘Don’t worry’’. Mr. Black couldn’t stop worrying, so on April 1, 2023 he had sent a cheque on behalf of the corporation for $5,000 to the CRA on account of 2022 taxes. Black Inc.’s actual/estimated income tax liabilities in respect of 2021 through 2023 are as follows: Actual 2021 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6,000 Estimated 2022 ............................................................................. 12,000 Estimated 2023 ............................................................................. 14,000 — REQUIRED (A) Calculate the payment schedule that should have been followed for 2023 under each alternative available under subsection 157(1), assuming the above estimates of tax prove accurate. (B) Calculate the amount of any penalties that may be assessed against Black Inc. for failing to file the 2022 corporate return by the required date. (Assume the return is filed and tax liability for the year is paid on January 15, 2024.) (C) Determine the minimum instalment amount that should be remitted by January 31, 2024.

Exercise 12 Bogin Wite is the president of Cal Antiques Inc., a company in the business of fabricating original antiques and then selling them across Canada and the United States. The company has been familyowned since April 2009 at which time Bogin was appointed president. Bogin and Cal Antiques Inc. have not prepared and filed tax returns since 2015. On July 14, 2023 Bogin received a notice from the CRA

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ITA: 161

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demanding the filing of all personal and corporate tax returns. He did not comply with the notice and on October 6, 2023, a CRA auditor visited the company’s office in Waterloo, Ontario. After spending five days reviewing corporate and personal records, the auditor prepared a report detailing her findings which included the following information:

Personal and corporate bank loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Estimate of personal net worth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2,000,000

Loans taken by Bogin from the company (ignore section 15 effects) . . . . . . . .

1,500,000

Prior to leaving, the auditor told Bogin very politely that the CRA would be contacting him in the near future. Bogin’s concern over the situation caused him to arrange a meeting with his lawyer and a professional accountant (who was recommended to him by a friend) in order that he might understand his circumstances and plan his course of action.

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— REQUIRED Prepare, in point form, your report to Bogin which will answer the following questions: (A) What could the CRA’s position be regarding penalties and offences? (B) What course of action could Bogin take on receipt of any assessment if he disagrees with its contents? (C) What is a ‘‘net worth assessment’’ and why could it be applied in Bogin’s situation?

Exercise 13 (1) By what date must the tax returns be filed for: (i) corporations? (ii) individuals (other than deceased individuals)? (2) Jean filed her tax return for the 2023 taxation year on March 31, 2024. She received a Notice of Assessment dated on May 24, 2024 disallowing her RRSP deduction. By what date must Jean file a Notice of Objection if she wishes to dispute the assessment? (3) Mr. Pan expects income of $65,000 in 2023, consisting entirely of income from a consulting business. He expects to pay $17,500 in tax in 2023. He paid $11,000 in tax on his 2022 business income and $9,000 in tax on his 2021 business income. How much must Mr. Pan pay in instalments during 2023, and when must each be paid? (4) Taxed Ltd., a CCPC, has a December 31 year end and is not associated with any other corporation. Its federal income tax liability for 2021 was $20,000, and for 2022 it was $26,000. It estimates that it will have to pay $44,000 in federal income tax for 2023. (i) How much must Taxed Ltd. pay in instalments for 2023 and when must each be paid? Assume that Taxed Ltd. paid all of its 2022 instalments on time and in sufficient amount and is eligible for quarterly instalment payments. (ii) When must the final balance of federal income tax for 2023 be paid?

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Exercise 14 What is the filing deadline for each of the following: (a) annual tax return for an individual resident in Canada; (b) unfiled returns for deceased taxpayers; (c) returns for corporations; (d) trust returns; (e) notices of objection for a corporation; (f) section 85 elections; and (g) elections with respect to unpaid amounts.

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ASSIGNMENT PROBLEMS

Problem 1

ITA: 150(1)

When must the tax returns for the following be filed: (a) a corporation, (b) a deceased person (terminal return only), (c) a trust, and (d) an individual?

Problem 2

ITA: 152(4)

An individual filed her 2022 tax return on April 30, 2023. The CRA responded with a Notice of Assessment mailed on May 27, 2023. A public company filed its December 31, 2022 corporate tax return by June 30, 2023. The CRA provided a Notice of Assessment on July 31, 2023. A Canadian-controlled private corporation filed its September 30, 2022 corporate tax return by March 31, 2023. The CRA provided a Notice of Assessment by May 15, 2023. For each of the above, if the CRA wishes to make an additional assessment of tax for 2022, by what date must it issue a Notice of Reassessment? ITA: 165, 169

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Problem 3 Rachel, a new client, requested some assistance with a personal income tax reassessment. The CRA has denied the deduction for her car and home office expenses from employment income. Rachel had provided receipts to a CRA auditor to support the deduction as requested but failed to open a follow up letter from the auditor requesting a copy of her T2200 form and her mileage log. Outline the legal rights that Rachel has with respect to her assessment and the steps she should undertake with the CRA.

Problem 4

ITA: 163(2), 163.2

Mr. Turner visited his accountant Ms. Blackford, on March 31, 2023, to discuss the tax consequences of a recent transaction. On January 10, 2023, Mr. Turner received a dividend of $100,000 from Dot.com Ltd., a company he owns 100%. Ms. Blackford explained that if he had transferred his shares of Dot.com Ltd. to a holding corporation on December 31, 2022, he could have deferred personal tax of $36,000 on the dividend until it was paid out of the holding corporation to him personally. Ms. Blackford indicated that the documentation with respect to the transfer of the shares to the holding corporation and the payment of the dividend to the holding corporation can be back-dated to achieve the result desired. What are the tax consequences of back-dating the documentation with respect to the transfer of the securities?

Problem 5

ITA: 156, 156.1, 161, 163.1

Bert Logan’s daughter Amanda is an accounting student. After a brief review of Bert’s previous tax returns she advised him that he would likely have to begin making income tax instalments for 2023; however, she was uncertain about how these instalments were to be calculated and the consequences of making inadequate instalments. Amanda called one of the tax specialists at her employer firm, First and Partners, for assistance. Amanda provided the following information: (a) 2021 actual tax liability was $8,750; (b) 2022 actual tax liability was $7,640; and (c) 2023 estimated tax liability is $5,520. You have been asked to write a memo, in point form, for partner review explaining the options available to calculate instalment payments for Bert Logan and the consequences if incorrect instalments are made.

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Problem 6

ITA: 157, 162, 163, 163.1

Ruffle Limited, a public company, specializes in the games business. For their fiscal year ended October 31, 2021, the company’s tax liability was $1,054,024. Due to the success of the board game, Run About, the company’s bottom line has increased significantly, resulting in a tax liability of $1,069,036 for the fiscal period ended October 31, 2022. Ruffle Limited’s climb to success came to a halt in the next fiscal year. Due to increased competition, profits are expected to decline and the controller of Ruffle Limited estimates the tax payable for the fiscal period ending October 31, 2023 to be $1,045,000. The controller has asked you, his tax accountant, to provide him with required instalments for the 2023 taxation year.

Problem 7 On September 1, 2023, you started in your new position as manager of taxation for Malic Corporation, a large public company with a December 31 year end. On the second day into the job, Maureen Smythe, the VP Finance, shares with you a folder saved in the company’s networked drive entitled ‘‘Outstanding Tax Items’’. She tells you that the IT department was cleaning up the previous tax manager’s files and found this folder which contains copies of reassessments and statements. She is concerned about the following items found in the file:

ITA: 161, 162, 163.1; IC 00-1R

(a) The corporation’s Notice of Assessment for the 2017 taxation year (dated September 30, 2018) as well as a reassessment, dated April 30, 2023. The reassessment indicates that the corporation has been assessed additional tax for the 2017 taxation year in the amount of $722,500. (b) An instalment statement indicating that for the 2022 taxation year minimum instalments were made for January to October, no instalment was made in November, and an instalment of $1.45 million was made in December. (c) A draft T2 corporate tax return for the company for the 2022 taxation year indicating taxes payable of $12.76 million. Maureen indicated that she doesn’t think that the return was filed. (d) An excel file summarizing information from previous tax returns showing the tax liabilities for the 2019 to 2021 taxation years of $7.5 million, $6.6 million, and $9.2 million, respectively. Ms. Smythe has asked you to review the information and provide her with the following: (A) Comment on the validity of the CRA reassessment. (B) Determine whether there is tax owing for the 2022 taxation year, calculate any late filing penalties, if any, and comment on any late instalment penalties, if any. (C) Discuss the interest charges applicable, assuming a prescribed rate of 4%.

Problem 8 Bill, an accountant, lives in an exclusive neighbourhood where house prices are in excess of $1,000,000. He has recently become friendly with a new neighbour and in March the neighbour hired Bill to prepare his personal tax return. The neighbour gave Bill a T4 reporting $60,000 of income. Thinking that the income was on the low side, Bill asked if this was all the income he had and the neighbour replied that it was. Bill did not ask any further questions but prepared the tax return. When the neighbour’s tax return was audited by the CRA, it was discovered that he had in excess of $300,000 in income for the year. Advise Bill as to whether he is at risk of being assessed under the civil penalty provisions in the Act.

Problem 9 A Canadian university hires a well-known American lecturer to lecture on American history. The work will take approXimately siX weeks and she is to be paid $20,000. You have been asked to determine whether there is a requirement to withhold Canadian tax on the $20,000.

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ITA: 163.2; IC 01-1

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Problem 10 On January 10, 2023, you started your new job as controller for Bordessa Corporation, a Canadiancontrolled private corporation with a December 31 year end. On your first day, the president and ownermanager of the company has asked you to follow up on some personal and corporate tax concerns that he has.

ITA: 153, 162(1), 162(2), 212(1)(d), 233.3; ITR: 108(1.11); IC 77-16R4

(1) In 2022, the company became the exclusive Canadian manufacturer and distributor of menswear designed by a famous US designer. Under the royalty agreement signed January 1, 2022, the company pays the designer a royalty equal to 10% of sales each quarter. Royalty payments are due one month after each quarter end (i.e., on April 30, July 31, October 31, and January 31). A total of $50,000 of royalty payments were paid to the designer in 2022 on the dates required. The president recently realized that tax should have been withheld on the 2022 royalty payments. He wants to know how much the company should remit when it makes its $20,000 January 31, 2023 payment for December and for the failed withholdings from 2022. ITA: 78(3)

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(2) The company accrued a $100,000 bonus payable to the President on its financial statements. This bonus was declared by way of a director’s resolution at the company’s Board of Directors’ last 2022 meeting. The president understands that his bonus must be paid within 180 days after the year end in order for it to be deductible in 2022 and you have verified that this is correct. This is the first time the company has accrued such a bonus and the president wants to know the deadline for the remittance of payroll deductions on the bonus. You do a quick review of payroll remittances for 2021 and 2022 and find that they amounted to about $120,000 in each year. (3) The company also declared dividends of $200,000 to the common shareholders at the Board of Director’s last 2022 meeting. The dividends are to be paid January 25, 2023. The president would like you to ensure that all of the relevant information reporting is prepared correctly. (4) The president tells you that he filed his 2021, 2020, and 2019 tax returns yesterday (January 9, 2023) after receiving a demand to file these returns in December 2022. He is expecting a net refund of $3,050 (see the schedule below). He wants to know whether he will be assessed any penalties for late filing and what the amount of the penalties will be. He tells you that his wife is a self-employed medical doctor.

2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2021 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net refund expected . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Balance due (Refund $) (10,500) 9,200 4,350 (3,050)

(5) During 2022, the president of the company inherited shares in a U.S. corporation from a distant relative who lived in the United States. The value of the stock at the date of the relative’s death was C$120,000. The president has asked you if he has to report this on his 2022 tax return. The stock is held in safekeeping at a stockbroker’s office in Toronto. Report your findings to the president.

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CHAPTER 14 — DISCUSSION NOTES FOR REVIEW QUESTIONS (1) (a) False. All corporations resident in Canada have to file tax returns within siX months of the end of the year.

ITA: 150(1)(a)

(b) True. An individual is required to file a tax return if he or she ‘‘has disposed of a capital property’’. Even if there is no taxable income or tax liability a return must be filed. In addition, Mr. Austen may lose his capital gains deduction in respect of this transaction, if he does not file the return.

ITA: 110.6(6), 150(1)

ITA: 156(1)

(2) An instalment interest offset is available on prepaid or overpaid instalments. However, this credit offset can only be applied against instalment interest owing; it is not refundable and may not be applied against any other debt. To benefit, he would have to pay the December 15 instalment on September 15 which would offset the fact that the June 15 instalment was three months late. In addition, the prescribed interest rate for the last quarter would have to be equal to or greater than the prescribed interest rate for the second quarter.

ITA: 161(2.2)

(3) They will not be able to collect interest for the last three years. Interest will not be received for the period prior to the filing of the tax return for the year in which the request is made to carry the loss back.

ITA: 164(5)

(4) Since the accountant sent a letter to the CRA, it may take some time before a reply is received. If the reply is received late and there is disagreement, it may be too late to file a Notice of Objection. Therefore, it may be prudent to file the Notice of Objection in the first place unless the matter is a minor one.

ITA: 165(1)

(5) In order to amend the tax returns for the third preceding year the company would have had to file form T2A by the time the corporate tax returns are due for the loss year which is siX months after the fiscal year end. However, Murray Corp. did not meet this deadline since it did not file until seven months after the year end. Therefore, the CRA will not have to let the corporation carry the loss back at all. However, the loss will still be available to be carried forward.

ITA: 152(6)

(6) Every person paying a salary is required to withhold a prescribed amount from the payments and remit the withholdings to the Receiver General. Mark will not be a large employer as his remittances will be less than $25,000 a month. As a result, the withholdings are due on or before the 15th day of the month following the salary payment. Small employers with less than $3,000 of average monthly withholdings can opt to remit the withholdings quarterly as long as they maintain a perfect compliance history for 12 months. Mark will need to withhold tax, CPP and EI from both employees’ salaries and remit the amounts. He is also required to pay the employer portion of CPP and EI ($3,754 and $1,002 respectively for 2023 for the sales employee). He will be required to provide T4 slips to both employees and prepare a T4 summary to be filed by February 28, 2024 for the year. He will need to have the employees complete a TD1 when hired to assist in determining the withholdings.

ITA: 153(1); ITR: 107, 108

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CHAPTER 14 — SOLUTIONS TO EXERCISES Exercise 1 Subsection 153(1): (a) salary or wages or other remuneration, including stock option benefits, from employment; (b) a superannuation or pension benefit; (c) a retiring allowance; (d) a death benefit for long service from an employer; (e) an Employment Insurance benefit; (f) a benefit under a supplementary unemployment benefit plan; (g) an annuity payment; (h) a benefit from a deferred profit sharing plan; (i) fees, commissions and other amounts for services;

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(j) a payment under a registered retirement savings plan; (k) certain amounts resulting from an income averaging annuity; (l) a payment from a registered retirement income fund.

Exercise 2 Inheritance, gambling winnings, lottery prize, etc. These are all amounts that are not subject to tax.

Exercise 3 As his net tax owing in the current year and one of the two preceding years is in excess of $3,000, he is required to make instalments. Instalments of $750 (1/4 × $3,000) must be paid by March 15 and June 15 and instalments of $1,250 (i.e., ($4,000 -- 2 × $750) × 1/2) must be paid by September 15 and December 15. The balance of the tax liability must be remitted by the balance-due date of April 30, 2024.

Exercise 4 As the corporation’s estimated taxes payable for the current year and the taxes paid for the preceding year exceed $3,000, instalments are required. The Act would allow the following:

ITA: 157(1)(a)(iii)

(1) January 31 and February 28, 2023 — /12 of $158,400 or $13,200; 1

(2) Last day of March to December 2023 — 1/10 of ($237,600 -- 2 × $13,200) or $21,120; (3) Balance on the last day of the third month after the taxation year end, where a small business deduction was taken by virtue of section 125 in the current or preceding year and the corporation and associated corporations’ aggregate taxable incomes for the preceding year did not exceed the small business deduction limit or the last day of February 2024 in any other case.

Exercise 5 Subsection 150(1): Y and Z will not incur late filing penalties; Y is not required to file since no tax is payable, unless he disposed of capital property but it is sensible to file to receive the tax refund. Subsection 162(1): Failure to file when required — 5% of unpaid tax plus 1% of unpaid tax per complete month past due for a first offence: X — 5% of $4,700 or $235 plus 1% of $4,700 × 0 complete months = $235. Y — 5% of zero = no penalty.

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Z — no penalty as the return is not due until June 15. Interest charges on the unpaid tax from April 30 will, however, apply. Subsection 238(1): Failure to file as or when required — liable on summary conviction to a fine of $1,000 to $25,000 or a fine and imprisonment for up to 12 months; — The taxpayers could be fined if a return was not filed but generally only where there was a demand to file under subsection 150(2) and the person did not comply.

Exercise 6 (A) Facts to be determined: (i) Date of mailing of the 2020 original assessment in order to determine the three-year limit (i.e., the normal reassessment period for an individual).

ITA: 152(4)

(ii) Obtain date of mailing of Notice of Reassessment. (B) Steps to be taken: (i) Procure an engagement letter and request Mr. DeHaan authorize you as his representative with CRA through the CRA website or provide a Form AUT-01 signed consent form which provides permission to discuss Mr. DeHaan’s case with officials of the CRA on the phone or by mail. Alternatively, you can ask the client to approve you as their representative ‘‘Represent a Client’’ through their online CRA account.

Form T1013

(ii) Start discussions with the CRA. (iii) File a Notice of Objection prior to the expiry of the 90-day period based upon the date of mailing determined above (i.e., September 12, 2023, if mailed on June 15, 2023). (iv) Warn Mr. DeHaan that certain second-time offences may carry heavier penalties than the first-time offence. (C) A penalty of 10% of unreported income could be imposed on Mr. DeHaan, if the current reassessment is his second offence within three years of the first offence. Under the CRA’s voluntary disclosure program, a valid voluntary disclosure may result in a waiver of penalties.

ITA: 163(1), IC 00-1R6

Exercise 7 The Act computes interest at a basic prescribed rate plus 4% on amounts owing to the CRA from the earliest date the amount was due until the date it was paid:

ITA: 161

— the interest is not tax deductible. Interest is computed at the same basic prescribed rate plus 2% on refunds by the CRA to noncorporate taxpayers and at the basic prescribed rate to corporate taxpayers:

ITA: 164(3)

— the interest is taxable; — if the interest relates to instalments, an interest offset is computed using the 4% addition, against interest owing on late instalments for interest earned on early instalments. Both interest calculations are based on daily compounding. Interest on the overpayment of taxes for individuals will start to accrue 30 days after the later of the balance due day for the return (i.e., April 30, 2024 for 2023 returns) or the date the return is filed. An individual’s refund interest accruing over a period can be offset by any arrears interest that accrues over the same period, to which the refund interest relates. Hence, only the excess refund interest is taxed to the individual.

ITA: 161(2.2)

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Exercise 8 The CRA has commented on this type of situation. The conclusion is that the good faith defense is available, since the income statement reveals nothing that would lead you to question the validity of the information provided to you. As a result, the preparer penalty would not apply in your situation.

IC 01-1

Use of the flowchart presented in the chapter may be helpful in analyzing this situation and reaching this conclusion.

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Exercise 9 (a) Notice of Objection:

ITA: 165(1)

— to be filed by individual taxpayers and graduated rate estates by the later of: (i) one year after the filing-due date, which is normally April 30 or June 15 except for graduated rate estates and deceased persons, and

ITA: 248(1)

(ii) the 90th day after the mailing date of the Notice of Assessment; — to be filed within 90 days of mailing of Notice of Assessment for all other taxpayers; — a prescribed form is not required. (b) Appeal to the Tax Court of Canada: — 90 days after the date of decision on the Notice of Objection or 90 days after the mailing of the Notice of Objection if there has been no response to it; — may be able to elect the informal procedure under subsection 18(1) of the Tax Court of Canada Act. (c) Appeal to the Federal Court of Appeal (section 17.6 of the Tax Court of Canada Act): — within 30 days from date of mailing of decision of the Tax Court of Canada only if that taxpayer chose the general procedure in the Tax Court of Canada. (d) Appeal to Supreme Court of Canada: — on recommendation of Federal Court of Appeal; — with permission of Supreme Court of Canada.

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Exercise 10 Steve will receive interest on the $9,000 only from 30 days after June 15, 2023 (i.e., July 15, 2023) to the date the refund is issued. In the future if he pays excess instalments, he could consider requesting the excess instalments be transferred to his employer remittance account, if he has employees from whom he withholds tax.

Exercise 11 Part (A) Since Black Inc. did not pay the instalments that it owed for 2022, it did not meet the conditions to be an eligible CCPC for purposes of its 2023 instalment payments. Therefore, monthly instalments were required for 2023.

Par. 157(1)(a) (i) estimated 2023 tax/12 . . . . . . . . . . (ii) actual 2022 tax/12 . . . . . . . . . . . . (iii) first 2 months; actual 2021 tax/12; last 10 months (actual 2022 less first 2 months)/10 . . . .

Instalments Jan./Feb. Mar. — Dec. $1,167 $1,167 1,000 1,000 500

1,100

Balance Total $14,000 12,000 12,000

The instalment base for alternatives (ii) and (iii) is defined [Reg. 5301]. Part (B) Par. 162(1)(a) 5% × ($12,000 -- $5,000) ..................... $350 (b) 1% × 6 × ($12,000 -- $5,000), i.e., July to Dec. . . . . . . . . . . . . . . 420

$770

— subsection 162(1) is applicable as above for a first occurrence; the penalty is doubled for a repeated occurrence within three taxation years [ssec. 162(2)]. Sec. 163.1: penalty for late or deficient instalments — 50% of interest payable under sec. 161 in excess of the greater of $1,000 and 25% of interest payable under sec. 161 if no instalments paid. Ssec. 238(1) On summary conviction (assuming a formal demand to file under 150(2) was ignored): (a) a fine of not less than $1,000 and not exceeding $25,000; (b) imprisonment for a term not exceeding 12 months; or (c) both a fine and imprisonment. Part (C) Monthly instalments will be required for 2024 since the required instalments were not paid for 2023 and, therefore, Black Inc. does not meet all of the conditions to be an eligible CCPC for 2024. The minimum instalment required by January 31, 2024 in this case is the taxes payable for the second preceding taxation year [2022] divided by 12 = $12,000/12 = $1,000. [Spar. 157(1)(a)(iii)]

Exercise 12 (A) Penalties: — Subsection 162(1): failure to file as and when required, based on unpaid tax (5% plus 1% per month for a first occurrence). — Subsection 162(2): repeated assessment of penalties within three taxation years. — Penalty of 10% of unpaid tax plus 2% of unpaid tax per month, not exceeding 20 months. — Interest will also be payable [sec. 161]. — Section 163.1: penalty for late or deficient instalments penalty of 50% of interest payable under sec 161 in excess of the greater of $1,000 and 25% of interest payable under sec. 161 if no instalments paid. Offences: — Subsection 238(1): failure to file as and when required (fine of $1,000 to $25,000 and/or up to 12 months imprisonment on summary conviction).

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— In addition to penalties under section 162, unless proceedings under section 238 come first, in which case the penalty under section 162 cannot be added later [ssec. 238(3)]. — Paragraph 239(1)(d ): wilful evasion (fine of 50% to 200% of tax evaded or fine plus up to 2 years in prison on summary conviction). — If proceedings by indictment, the minimum fine would be 100% of tax evaded, and the period of imprisonment can be up to five years. Both a fine and imprisonment are possible [ssec. 239(2)]. — In addition to penalties under section 162 or 163, unless section 239 proceedings come first [ssec. 239(3)]. (B) Appeal procedure: — File Notice of Objection within 90 days of mailing a Notice of Assessment for the corporation and the later of one year after the filing-due date for the year and 90 days after the mailing of the Notice of Assessment for the individual. — Notice of Assessment has not been mailed yet, so watch for date. — Might try informal discussion before Notice of Objection to volunteer to prepare the returns and pay the related tax, interest and penalties. (C) Net worth assessment: — Method of estimating income and, hence, tax for a period when no returns filed. — Closing net worth less opening net worth less windfalls plus personal or living expenses. — Based on estimates. — Arguments based on estimates of assets and liabilities at the beginning and the end of the period as well as estimates of windfalls and personal or living expenses.

Exercise 13 (1) (i) A corporation must file tax returns within siX months after the end of its taxation year [par. 150(1)(a)]. (ii) Individuals must file tax returns on or before April 30 of the following calendar year, or on or before June 15 if they (or their spouse or common-law partner) are carrying on business [par. 150(1)(d )]. (2) A Notice of Objection must be filed by the later of (i) 90 days of the mailing of the Notice of Assessment to which the objection is being made — in this case by August 22, 2024; and (ii) one year after the original due date of the tax return, i.e., April 30, 2025 [ssec. 165(1)]. (3) Mr. Pan must pay quarterly instalments as follows in 2023: March 15 . . . . . . . . . . . . . . . . . . . . . . . . $ 2,250 June 15.......................................................... 2,250 September 15 ................................................... 3,250 December 15 ................................................. 3,250 Any remaining balance of tax must be paid by April 30, 2024 ]ssec. 156(1)]. (4) Taxed Ltd. should pay the following instalments in 2023: ● One instalment on March 31 of $5,000, and ●

Three instalments, one each on June 30, September 30 and December 31, respectively, of 1 /3 × [$26,000 -- $5,000] = $7,000 each

The balance of tax is due on the last day of March 2024 where a small business deduction was deducted in either of 2022 or 2023, and taxable income for 2022 (the preceding taxation year) did not exceed the $500,000 business limit for the year. Otherwise, the balance is due on the last day of February 2024 [ssec. 157(1)].

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— Burden of proof that assessment is wrong is on the taxpayer.

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Introduction to Federal Income Taxation in Canada

Exercise 14 Filing deadlines: (a) Individuals — on or before April 30 of the following calendar year. (June 15 if the individual or spouse has business income.) (b) Unfiled returns for deceased taxpayer — the later of the normal filing due date of April 30 (or June 15, if the deceased individual or his or her spouse carried on a business in the year of death) of the calendar year following the year in which the income was earned or si X months from the date of death. (c) Corporations — within siX months after the corporation’s year end. (d) Trust returns — within 90 days from the end of the year. (e) Notices of objection — within 90 days of the date of mailing of the Notice of Assessment or Reassessment for which the objection is being filed. (f) Section 85 elections — on or before the earliest day any taxpayer making the election is required to file a return for the taxation year in which the transaction to which the election relates occurred [ssec. 85(6)]. (g) Elections with respect to unpaid amounts — on or before the day the taxpayer who deducted the expense is required to file his tax return for the third taxation year following the year the amount was expensed [ssec. 78(1)].

Purchase and Sale of a Business — Share Transactions

397

CHAPTER 15

Chapter 15

Introduction to Federal Income Taxation in Canada

398

CHAPTER 15 — LEARNING CHART Problem Descriptions Textbook Example Problems 15-1 Small business corporation 15-2 QSBC 15-3 QSBC — modified asset test 154 Capital gains deduction 15-5 Corporate attribution 156 Acquisition of control 15-7 Acquisition of control 15-8 Acquisition of control with subsection 111(4) elections 159 Acquisition of control — use of losses 15-10 Acquisition of control — use of losses Exercises 1 2 3 4

Small business corporation Capital gains deduction

5 6 7 8

Corporate attribution Capital gains deduction, personal tax credits, donations — charitable and political QSBC shares QSBC shares Acquisition of control Acquisition of control

Acquisition of control

Assignment Problems 1 QSBC shares 2 3 4 5 6 7 8 9

QSBC shares Capital gains deduction Corporate attribution Acquisition of control Acquisition of control Acquisition of control Acquisition of control Integrative Case — Share sale and acquisition of control

Ch. 15/Study Guide — Learning Chart

399

CHAPTER 15

Introduction to Federal Income Taxation in Canada

400

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REVIEW QUESTIONS

(1) Ms. Simpson owned 10% of the shares of a small business corporation that went out of business. SiX months after it ceased business she sold her shares to an arm’s length person, Mr. X, for $1. When she went to claim a loss on her investment she did not know how much she could write off. In order to have the loss treated as an ABIL, the company needed to be a small business corporation at the time of sale and at that time it did not have any assets used in an active business. She has not used any of her capital gains exemption before. Can you clarify this situation for her? (2) What does the phrase ‘‘all or substantially all’’ mean? (3) A corporation that has had 40% of its assets invested in term deposits for the last two years, and the balance in active business assets, qualifies as a ‘‘small business corporation’’ but not a ‘‘qualified small business corporation’’. Do you agree or disagree? EXplain. (4) Mr. Smith, who is 61 years of age, incorporated his company 20 years ago for $100 of share capital. He has worked full time for the business since then and has prospered. The company now has some excess capital. He has decided to have his wife set up an investment holding company and his company will lend her company $100,000 of cash for her to invest and thereby split income. Will the corporate attribution rules apply? (5) Mr. Magee bought all the shares of Profitco Ltd. on July 1 of this year and is expecting to combine the profitable operations of Profitco with the loss operations of his current corporation. However, for Profitco’s deemed year end of June 30, he hopes to offset the si X months of profitable operations with a full year of CCA in order to minimize the tax liability. Profitco’s normal year end was December 31. Comment on his plan. (6) In 2023, Mr. Sargent, a Canadian resident, sold shares of his operating company that he inherited from his father in 2022. His father had started the business and incorporated in 2005. All of the capital assets of the company are business assets used in its Kitchener-Waterloo operations. The company also has $200,000 of excess cash invested in money market accounts. $60,000 of the cash was used periodically during the past 12 months for business operations on top of the $30,000 the company generally maintains in its operating bank account. Mr. Sargent would like to be able to use his capital gains exemption against his $1.2 million gain on the share sale. Please comment. (7) What action triggers a loss restriction event?

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Ch. 15/Study Guide — Exercises

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401

EXERCISES

Exercise 1

ITA: 248(1)

A Active business assets ..................................................... 85% Marketable securities ...................................................... 15% Shares of a connected small business corporation — 100%

B 50% — 50% 100%

C — 20% 80% 100%

CHAPTER 15

Consider each of the following independent proportions of assets at fair market value. Assume the assets are owned by a Canadian-controlled private corporation. Active business assets refer to assets used principally in an active business carried on primarily in Canada. D 40% 20% 40% 100%

— REQUIRED Determine whether each of the above proportions meets the test of a small business corporation as defined in the Act.

Exercise 2

ITA: 110.6

Bobby Mills has provided you with the following information: 2021 Taxable capital gains on sale of qualified small business corporation shares ............................................. $75,000 Business investment loss (before ssec. 39(9) adjustment) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — Grossed-up taxable dividends . . . . . . . . . . . . . . . . . . . — Net rental income (loss) . . . . . . . . . . . . . . . . . . . . . . . — Carrying charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . —

2022

2023

—

$300,000

— 600 140 (1,100) 1,075

160,000 1,200 — (220) —

The 2021 taxable capital gain was fully offset by a capital gains deduction in that year. — REQUIRED Determine Bobby’s capital gains deduction for 2023 supported by all the necessary calculations. Assume that there were no other capital transactions before 2021.

Exercise 3

ITA: 74.4

Mrs. Albert, age 45, owns all of the outstanding common shares of a corporation, Prince Albert Inc., which operates a small retail store in Saskatoon. Her wife, Sully age 48, owns the building with a fair market value of $2,000,000, in which the store is located. She is planning to transfer it to Prince Albert Inc. in exchange for $600,000 of cash, a 5% demand note for $200,000 and non-voting preference shares for $1,200,000. The fair market value of the business assets (which are all of the assets excluding cash used to pay for the building) in the company immediately before the transfer is $6,000,000. Of the total space in the building, 20% is used in the retail business. The net rental income that Sully earned in the previous year was $50,000. — REQUIRED Determine the tax consequences, if any, to Sully for 2023, assuming the prescribed interest rate is a constant 3% and that the sale took place on January 1, 2023. The corporation’s year end is September 30. Dividends of $10,000 were paid on the preference shares in 2023.

ITR: 4301(c)

Exercise 4 Mrs. Blue sold qualified small business corporation shares in April 2023 for proceeds of $523,000. She inherited the shares in 2008 when her father died. At that time, their value was $138,000. The only other capital gain Mrs. Blue has had was in 2006 when she sold some securities on which she recognized a capital gain of $33,000. She sheltered the $33,000 gain entirely with the capital gains deduction. She has not claimed any net capital losses in the past. She had a cumulative net investment loss balance of $4,850 at the end of 2023 consisting of the following items of investment income in 2022 and 2023:

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Interest expense to purchase investment portfolio . . . . Non-eligible dividends (grossed up at 15%) . . . . . . . . . Rental income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total cumulative net investment loss balance December 31, 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . .

2022 $9,000 6,900 2,000

2023 $13,000 5,750 2,500

Total $ 22,000 (12,650) (4,500) $ 4,850

— REQUIRED Calculate the maximum capital gains deduction available to be claimed by Mrs. Blue when preparing her 2023 tax return.

Exercise 5 Determine which of the following CCPCs are ‘‘small business corporations’’ and state the reason for your conclusion. Assets (@ FMV): Term deposits . . . . . . . . . . . . . . . . . . Land . . . . . . . . . . . . . . . . . . . . . . . . . Building . . . . . . . . . . . . . . . . . . . . . . Equipment . . . . . . . . . . . . . . . . . . . . Shares of X Ltd. . . . . . . . . . . . . . . . . Shares of Y Ltd. . . . . . . . . . . . . . . . . Liabilities (@ FMV): Accounts payable . . . . . . . . . . . . . . . Bank loan . . . . . . . . . . . . . . . . . . . . .

A Co.

B Co.

C Co.

D Co.

— 50,000 35,000 – — 15,000

— — — 80,000 20,000 —

$15,000 — — — — 15,000

— 40,000 60,000 — — —

10,000 10,000

2,000 —

— —

Additional Information (a) In each of the above situations, the land, building and equipment are used by the owner in an active business carried on in Canada with the exception of D Co. In the case of D Co., the land and building are leased to Spouse Co., a CCPC, and are used by Spouse Co. in its active business, which it carries on in Canada. D Co. is owned 100% by the spouse of the sole shareholder of Spouse Co. (b) X Ltd. is a public company. (c) Y Ltd. is a small business corporation. A Co. and C Co. each own 50% of Y Ltd.

Exercise 6 In each of the scenarios below, an individual who wants to use his/her capital gains exemption owns shares in a holding company (Holdco). Holdco owns active business assets, non-active assets and an interest in a connected subsidiary (Subco).

For each of (a), (b), (c), and (d), determine whether Holdco would meet the 24-month ‘‘asset test’’ as it relates to qualified small business corporations. The assets of Holdco and Subco, as shown below, are stated at their fair market value. The assets and their values have remained constant for the past three years.

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Investment in Subco $25,000 –

Other Non-Active Assets $15,000 80,000

Total FMV $100,000 100,000

(b) Holdco . . . . . . Subco . . . . . .

30,000 95,000

50,000 –

20,000 5,000

100,000 100,000

45,000 70,000

15,000 –

40,000 30,000

100,000 100,000

(d) Holdco . . . . . . Subco . . . . . .

– 92,000

75,000 –

25,000 8,000

100,000 100,000

ITA: 3, 110.1, 111(1), 111(1.1), 112

CHAPTER 15

(a) Holdco . . . . . . Subco . . . . . .

Assets Used in an Active Business* $60,000 20,000

*In each case, the active business is carried on in Canada.

Exercise 7 In 2021, a chain of bakeries, called Buscat Ltd., commenced operation. The industry is highly competitive and because of Mr. Buscat’s lack of marketing skills, the corporation incurred losses in the first three taxation years of operations as follows:

Taxation year end December 31, 2021 . . . . . . . . . . . . . . . . . . . . . . . . December 31, 2022 . . . . . . . . . . . . . . . . . . . . . . . . December 31, 2023 . . . . . . . . . . . . . . . . . . . . . . . .

Non-capital losses (business) $ 60,000 45,000 25,000 $130,000

ITA: 111(4), 111(5), 111(5.1), 249(4)

Capital losses $12,000 8,000 4,000 $24,000

On July 1, 2024, Mr. Buscat plans to sell 75% of his common shares to Mr. Tran, owner of Buns Plus Ltd. Mr. Tran has been in the business of supplying bread dough, pastry dough and bun bags for 10 years and has been very successful. Buns Plus Ltd. has two divisions: a bakery and a coffee shop, which it intends to transfer to Buscat Ltd. after the purchase. The following projected income tax data relates to Buscat Ltd.’s operations from January 1, 2024, to June 30, 2024: (a) Business loss (before inventory valuation/post CCA) . . . . . . . (b) Allowable capital loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (c) Property loss (assets sold in April) . . . . . . . . . . . . . . . . . . . (d) Assets at June 30, 2024:

Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Building (Class 1: 4%) . . . . . . . . . . . . . . . . . . Bakery equipment . . . . . . . . . . . . . . . . . . . . . Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Cost/ACB $ 85,000 270,000 720,000 100,000 —

$ 10,000 2,000 5,500 UCC June 30, 2024 — — $700,000 86,000 —

FMV $ 65,000 310,000 730,000 70,000 10,000

During the latter part of the 2024 calendar year, the bakery/coffee shop of Buns Plus Ltd. will be transferred to Buscat Ltd. For the si X-month period ending on December 31, 2024, Buscat Ltd. is projected to have net income of $90,000 from all its businesses. The breakdown of the net income projection is as follows: Buscat bakery ......................................................................................... $(55,000) Buns Plus bakery ..................................................................................... 130,000 Coffee shop . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,000 $ 90,000

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In the 2025 taxation year, Buscat Ltd. expects to earn $250,000, of which $65,000 will be from the original Buscat bakery business and $20,000 from the coffee shop business. Mr. Tran has approached your CPA firm for advice in regard to the acquisition of the shares of Buscat Ltd. and loss utilization. — REQUIRED The partner has asked you before your next meeting with Mr. Tran to: (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend. As part of your analysis, the partner has asked that you analyze the impact of both the partial and maximum election options on the future corporate tax filings for Buscat Ltd and recommend the best option that could be proposed to Buscat Ltd.’s accountant for the pre-acquisition corporate tax filings.

Exercise 8 Computer Rental Ltd., a computer rental business, commenced operations in 2021 with a December 31 year end. A highly competitive market and an unstable corporate sales force resulted in losses being incurred for 2021 and 2022 as follows: 2021 $75,000 40,000

Non-capital/business losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net capital/allowable capital losses . . . . . . . . . . . . . . . . . . . . . . . .

2022 $90,000 80,000

On January 1, 2023, Processing Ltd., a company carrying on a workstation rental business, purchased 55% of the shares of Computer Rental Ltd. The President and Vice-president of Computer Rental Ltd. were replaced by personnel from Processing Ltd. and extensive training programs, which had been highly successful in Processing Ltd., were given to the sales force of Computer Rental Ltd. In June 2023, Processing Ltd. transferred a profitable division of its workstation operation to Computer Rental Ltd. which continued to carry on the computer rental business. At the time of the acquisition of the shares, Computer Rental Ltd. had the following assets: Marketable securities . . . . . . . . . . . . . . . . . . . . . . Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Furniture & fiXtures . . . . . . . . . . . . . . . . . . . . . . . Computers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Cost $ 120,000 150,000 600,000 200,000 1,200,000 —

UCC/CEC FMV — $ 70,000 — 450,000 $400,000 400,000 160,000 165,000 480,000 200,000 54,000

In 2023, Computer Rental Ltd. earned net income of $65,000, as follows: Computer rental operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Workstation rental operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$25,000 40,000 $65,000

The computer rental operation was discontinued by Computer Rental Ltd. in 2024 as the workstation rental operation was more profitable. The computer rental operation had a loss of $40,000 in 2024. Income of $25,000 was earned from the workstation rental operation in that year. — REQUIRED (A) What are the income tax implications of the acquisition of shares of Computer Rental Ltd. by Processing Ltd. on the corporate tax filings for the company. Consider an election option under 111(4)(e) that is optimal under the assumption that Processing Ltd. is confident that non-capital losses of Computer Rental Ltd. can be utilized in future years? (B) To what extent are the non-capital losses of Computer Rental Ltd. deductible in the computation of its taxable income for 2023, 2024, and future years? (Ignore the assumption in part (A)).

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ITA: 127

Ch. 15/Study Guide — Exercises

405

Exercise 9

CHAPTER 15

As the auditor of Mother Ltd. (Mother), you have been asked to draft a memorandum to the president to explain the future deductibility of loss carryovers of its wholly-owned subsidiary, Childco Ltd. (Childco). Mother acquired Childco on January 1, 2023, when Childco was experiencing financial difficulties. Childco manufactures paper products, whereas Mother is a wholesaler of office supplies and equipment. Both companies are Canadian-controlled private corporations and have December 31 year ends. The loss carryovers of Childco are: 2018 . . . . . . . . . . . . . . . . . . . . . . . . . . 2019 . . . . . . . . . . . . . . . . . . . . . . . . . . 2020 . . . . . . . . . . . . . . . . . . . . . . . . . . 2021 . . . . . . . . . . . . . . . . . . . . . . . . . . 2022 (business loss) . . . . . . . . . . . . . .

Non-Capital Losses $300,000 250,000 200,000 150,000 50,000

Net Capital Losses $ 50,000 — — 100,000 —

On December 31, 2022, Childco had the following assets, which are still on hand:

Land . . . . . . . . . . . . . . . . . . . . . Building . . . . . . . . . . . . . . . . . . . Manufacturing Equipment . . . . . . Patent (Class 14) . . . . . . . . . . . . Goodwill (Class 14.1) . . . . . . . . .

Cost or Capital Cost $ 700,000 600,000 1,000,000 125,000 15,000

UCC–Dec. 31 2022 N/A $ 500,000 0 100,000 8,000

FMV–Dec. 31, 2022 $1,000,000 400,000 300,000 20,000 25,000

— REQUIRED Draft a memorandum to the president explaining the deductibility and the amount of the loss carryovers which are available in the 2023 year.

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ASSIGNMENT PROBLEMS

Problem 1 Karen, a resident of White Rock, B.C., owns all the common shares of Cyber Corp., which was incorporated in 2006. Karen invested $1,000 into the share capital of Cyber Corp. Cyber Corp is located in White Rock and distributes computer equipment and games to retail stores in southern B.C. The following is the balance sheet. Cyber Corp. Balance Sheet as at December 31, 2023 Assets FMV Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,500 $ 4,500 Marketable securities . . . . . . . . . . . . . . . . . . . . . . . . . . 300,000 800,000 Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . 800,000 780,000 Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 920,000 920,000 Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000 1,000 Investment in Cyber Sub Inc. . . . . . . . . . . . . . . . . . . . . 1,000 80,000 FiXed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140,000 150,000 Goodwill — Class 14.1 . . . . . . . . . . . . . . . . . . . . . . . . . — 200,000 $2,166,500 Liabilities & Shareholders’ Equity Accounts payable and accrued liabilities . . . . . . . . . . . . Loans payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Future income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . Share capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$2,935,500

$ 600,000 400,000 100,000 1,000 1,065,500 $2,166,500

The investment in Cyber Sub Inc., a CCPC, was made two years ago to distribute a new line of games. It is 25% owned by Cyber Corp and uses all of its assets in a Canadian active business. The relative values of Cyber Corp’s assets have remained stable over the past three years. The marketable securities comprise Cyber Corp’s investment portfolio which is not held as part of the corporation’s business activities. Karen was recently offered $1,700,000 for the shares of Cyber Corp. Karen would like to know whether, if she sold her shares of Cyber Corp, she would be able to claim the capital gains exemption on the sale. If they do not qualify for the CGE then she wants to know if there is anything that can be done to qualify. The partner has asked you to look into determining the company’s capital dividend account. He explains to you that a capital dividend can be paid out to a shareholder tax free (Refer to Chapter 16). Assuming a $300,000 capital dividend can be paid out before the shares are sold, he would like you to consider the impact on the cash available to Karen from the share sale. For the next meeting you agree that you will: (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

Problem 2 Rogo Dan owns all of the common shares of Julie Inc. which in turn owns all of the shares of two other companies, Opco Inc. and RE Inc. Opco Inc. carries on an active business in Sudbury. RE Inc. owns real estate, of which 100% is used by Opco Inc. in its business. All three corporations are CCPCs. The following are further details:

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ITA: 110.6

Ch. 15/Study Guide — Assignment Problems

407

CHAPTER 15

Julie Inc. assets: Shares of Opco Inc. at FMV ...............................................................................$850,000 Shares of RE Inc. at FMV ................................................................................... 800,000 Portfolio investments at FMV . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75,000 Opco Inc. assets and liabilities: Active business assets at FMV ..........................................................................$900,000 Term deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,000 Liabilities ............................................................................................................. 100,000 RE Inc. assets and liabilities: Land and building at FMV .................................................................................$800,000 Portfolio investments at FMV ............................................................................. 200,000 Mortgage ........................................................................................................ 200,000 The proportion of assets in each of the companies has been constant over the past three years. Rogo has owned the shares of Julie Inc. for the past five years. Rogo would like your advice on the following: (A) Does Julie Inc. meet each of the three tests necessary for its shares to be qualifying small business corporation shares? (B) If the shares of Julie Inc. are not QSBC shares, then suggest ways of purifying Julie Inc. and indicate the tax consequences of your recommendations.

Problem 3

ITA: 110.6

Phil Zamboni realized taxable capital gains of $12,000 in 2018. This gain was offset by a capital gains deduction of $12,000 in that year. This was the only time he had ever used his capital gains exemption. Phil has a cumulative net investment loss balance of $29,800 consisting of the following amounts: Cumulative net investment loss Investment expenses: Cumulative net rental losses . . . . . . . . . . . . . . . . . . . . . Cumulative interest expense and carrying charges . . . . Investment Income: Cumulative investment income . . . . . . . . . . . . . . . . . . . Cumulative taxable dividends . . . . . . . . . . . . . . . . . . . .

2021

2022

2023

Total

$15,000 1,475

$13,000 2,000

$1,000

$29,000 3,475

(1,650)

(2,475) (200)

(825)

(200)

$29,800 Phil had also realized a business investment loss of $26,000 in December 2020. In 2023, Phil sold the shares of Maps Unlimited Ltd., a qualified small business corporation, for a capital gain of $185,000 and he realized a capital loss of $21,000 on the sale of public company shares. He also has a $12,000 net capital loss carryforward that he would like to use to minimize tax in 2023 (the disallowed portion of the ABIL from 2020). Phil had no other previous capital transactions, investment income, or investment expenses. Phil has asked you to calculate his capital gains deduction for 2023 supported by all the necessary calculations.

Problem 4 Bob Smith, age 50, incorporated Smith Inc. 20 years ago when he purchased all of the 100 shares from the company for $100. Smith Inc. is a ‘‘small business corporation’’ which carries on an active business in Victoria, B.C. Bob works full time in the business. Thirteen years ago, Bob felt that he would like to involve his wife Betty in the share ownership and, on the advice of his accountant, Holdco Inc. was incorporated with Bob and Betty each owning 50 common shares which they bought for $1 each with their own funds. Bob then transferred his common shares of Smith Inc., which were worth $600,000, to Holdco Inc. and elected under s. 85 to defer the tax. As consideration for the transfer, Bob received preference shares with a non-cumulative dividend rate of up to 6% and a fair market value of $600,000. Betty has had no involvement in the Smith Inc. business.

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On July 1, 2023, Smith Inc. sold some property that was used in the active business for net proceeds of $150,000. This amount was then paid as a dividend from Smith Inc. to Holdco Inc. on the same day. Bob and Betty plan to have the corporation invest this amount and use it as capital for their retirement. After the sale of the property and the payment of the dividend to Holdco Inc., Smith Inc. has a fair market value of $800,000 and is still a ‘‘small business corporation’’. Bob received $6,000 in dividends on his preferred shares of Holdco Inc. in December 2023. Assume that the prescribed rate for 2023 was 4%. Bob is in the top tax bracket. Betty has a parttime retail sales job and no other source of income. Bob and Betty have just emailed you about this transaction and immediately a concern about the corporate attribution rules comes to your mind. You also wonder if dividends paid from Holdco Inc. would be subject to tax on split income. — REQUIRED (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

Problem 5 The president of Purchaser Inc. (Purchaser) is planning to have the company acquire all the shares of Target Inc. (Target) on September 1, 2023. He has asked you to calculate what losses will be available in Target after he acquires it and explain the future deductibility of those losses after the purchase. Target manufactures paper products, whereas Purchaser is a wholesaler of office supplies and equipment. Both companies are Canadian-controlled private corporations and have December 31 year ends. Purchaser co. will choose a December 31, year end for Target following the acquisition. The loss carryovers of Target are as follows: Non-Capital Losses

Net Capital Losses

$300,000 250,000 200,000 150,000

$ 50,000 — — 100,000

2019 . . . . . . . . . . . . . . 2020 . . . . . . . . . . . . . . 2021 . . . . . . . . . . . . . . 2022 . . . . . . . . . . . . . .

Target has estimated a loss for business operations of $50,000 from January 1, 2023, to August 31, 2023. On August 31, 2023, Target will have the following assets which are still on hand: Cost or Capital Cost Accounts Receivable . . . . . . . . Inventory . . . . . . . . . . . . . . . . . Goodwill . . . . . . . . . . . . . . . . . Manufacturing Equipment . . . .

$ $

40,000 20,000 — $1,000,000

UCC

FMV

— — — —

$ 20,000 $ 5,000 $100,000 $300,000

— REQUIRED (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

Problem 6 All of the voting shares of Lofty Limited, a manufacturer of automobile parts, have been acquired by Holdco Ltd., an investment holding company. Lofty Limited has a December 31 year end. At the time of the acquisition on March 10, 2023, Lofty Limited had non-capital business losses of $600,000 generated in 2022. Lofty Limited also had $20,000 of net capital losses carried forward from 2017. The corporation had business losses of $3,000 from January 1 to March 9, 2023. This amount includes the normal

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ITA: 111(4), 111(5), 111(5.1), 111(5.2)

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calculation of cost of goods sold. Holdco Ltd. plans to inject added capital and augment the management of Lofty Limited in an attempt to turn Lofty’s manufacturing business around. At the time of the acquisition, the following was discovered:

●

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●

The UCC balance in Class 8 was $70,000 while the fair market value of the assets in that class was only $40,000. The UCC balance in Class 14.1 (being from the acquisition on January 5, 2022, of an exclusive customer list for $60,000) was $53,700 while the fair market value of the customer list was $63,000. The book value of the corporation’s receivables was $240,000, while its realizable value was estimated at $225,000. The corporation’s only non-depreciable capital property, land, had accrued gains of $56,000 over its cost of $200,000.

— REQUIRED (A) What are the tax implications of the acquisition of the shares of Lofty Limited by Holdco Ltd., assuming the maximum election under paragraph 111(4)(e) is made? (B) Determine the minimum amount of elected proceeds under paragraph 111(4)(e) to offset expiring losses, if the accrued gains on the land were $100,000 instead of the $56,000 and Lofty Limited had an additional loss arising from property of $10,000.

Problem 7 On November 1, 2023, Chris purchased all the issued shares of Transtek Inc. from an acquaintance, Tom. Transtek has a December year end. Transtek carries on a transmission repair business and has done so since its incorporation on January 1, 2022. In addition to the transmission repair business, Transtek rents out a small building it owns. Neither the transmission repair business nor the rental endeavour has been successful. When Chris purchased Transtek, his financial projections indicated that Transtek would have significant income within two years. Chris credited Transtek’s failure to Tom’s brash personality and laziness. Chris, on the other hand, has a strong work ethic and has many contacts in the automotive industry to refer work to him. The values of the capital assets owned by Transtek at the time of purchase by Chris are as follows:

FMV . . . . . . . . . . . . . . . . . . Cost/ACB . . . . . . . . . . . . . . UCC . . . . . . . . . . . . . . . . . .

Repair shop Land Building $140,000 $730,000 80,000 650,000 — 647,000

Rental property Land Building $170,000 $1,120,000 190,000 1,120,000 — 1,120,000

Chris selected June 30, 2024, as the first fiscal year end for Transtek after his purchase. The following is a schedule of Transtek’s income (and losses) from its inception, January 1, 2022, through June 30, 2025. Period Before the acquisition: Jan. 1/2022–Dec. 31/2022 . . . . Jan. 1/2023–Oct. 31/2023 . . . . After the acquisition: Nov. 1/2023–June 30/2024 . . . . July 1/2024–June 30/2025 . . . .

Transmission repair business

Rental income (loss)

Capital Loss

$ (40,000) (60,000)

$ (2,000) (4,900)

$(10,000) —

(25,000) 54,000

6,000 11,000

— —

Part A You have been asked to discuss the tax implications of the acquisition of Transtek Inc. on November 1, 2023, ignoring all possible elections/options.

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Introduction to Federal Income Taxation in Canada

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In addition, you have been asked to determine the tax consequences of the acquisition of Transtek Inc. under the assumption that: (i) the maximum amount of all elections/options is utilized; and (ii) the partial amount of all elections/options is utilized so that only enough income is generated to offset most or all of the losses which would otherwise expire on the acquisition of control.

Problem 8 You are a new CPA working for Lin, Robson & Associates tax specialty practice. It is March, 2024 and you and the partner just met with a new client, John Forstill, in regard to his company Pro Ltd. John lives in Breslau and has owned and operated Pro Ltd. since he started the company in the early 2000s. Pro Ltd. has been in the business of retailing ladies’ fashion shoes for a number of years and has been very successful. A number of years ago, Pro Ltd. had the opportunity to acquire a warehousing operation, which it did. This has also been a very lucrative business. In 2022 alone, Pro Ltd.’s income from these two businesses was in excess of $1,000,000. On April 1, 2023, 80% of the shares of Style Ltd. were acquired by Pro Ltd. from the prior owner, a business colleague of John’s. The prior owner continued to hold a 20% interest in the common shares of the company. Style Ltd. is a retailer of ladies fashion athletic shoes, which commenced operations in 2021. It has a December 31 year end. The market for athletic shoes is highly competitive. John believed that the acquisition of Style Ltd was a good opportunity to expand his operations into the athletic market. The previous owner of Style Ltd. lacked funds to spend on advertising and had difficulty breaking into the fashion shoes market. As a result, the corporation incurred losses in its first years of operations as follows: 2021 Non-capital losses ........................................................................ $175,000 Net capital losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0

2022 $225,000 9,500

Pro Ltd. injected additional capital into the company after it was acquired. John believed that with this investment and his management team’s expertise they would be able to turn Style Ltd.’s business around and make it profitable within 12 months. An interim financial statement was prepared for Style Ltd. for the period January 1, 2023, through March 31, 2023. From this, it was determined that Style Ltd. had incurred a business loss of $5,500 for the three months. The values of the assets owned by Style Ltd. on March 31, 2023, were as follows: Land . . . . . . . . . . . . . . . . . . . . Building . . . . . . . . . . . . . . . . . Store fiXtures/equipment . . . . . Inventory . . . . . . . . . . . . . . . . . Marketable securities . . . . . . . . Goodwill . . . . . . . . . . . . . . . . .

Cost $500,000 690,000 30,000 45,000 9,000 —

UCC — $685,000 26,000 — — —

FMV $700,000 705,000 23,000 40,000 3,000 $ 25,000

On September 1, 2023, Pro Ltd. transferred its warehousing business division to Style Ltd., which also continued to carry on its retailing business. John indicated that at its year ending December 31, 2023, Style Ltd. had net income of $375,000, all of which was earned during the period April 1, 2023, to December 31, 2023. The income was derived from the following sources: Warehousing business (Sept 1 to Dec 31) .......................................................... $390,000 Retailing of ladies’ athletic shoes (loss) ................................................................... (20,000) Taxable capital gain on marketable securities ............................................................. 5,000 $375,000 Although the business of retailing ladies’ athletic shoes was projected to earn a small profit for 2024, John is considering discontinuing the business to enable management to spend more time on the warehousing operation which has been growing faster than expected. The profit from retailing ladies’

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athletic shoes for the first 2 months of operations in 2024 was $7,000. In 2024, the warehousing operation was projected to generate income of $950,000.

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John wants to understand the 2022 tax filings for Style Ltd. and maximize the use of the Style Ltd. losses. — REQUIRED The partner has asked you before your next meeting with John to: (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

Integrative Case Problem 9 You are a new CPA working for Lin & Robson Associates CPA firm. You and the tax partner met with Janece Davenport, a Canadian resident and long-time client of the firm, on November 1, 2023, to discuss a sale of her company, Davenport Inc. (DI). Janece has owned all of the shares of DI since her husband’s death in 2014. She is also the president of the corporation which carries on a high-end residential and industrial cabinetry manufacturing and installation business in Vaughan, Ontario. Janece would like to retire and pursue other interests and has asked for advice on the sale of the shares of DI. Janece has never used her capital gains exemption in the past and is wondering if she will be able to use it for the sale of the shares. The partner has asked you to look into this following the meeting and identify information the firm will need to collect and document to support the use of the exemption. Ms. Davenport’s husband, Joe, acquired the common shares of DI in 2009 from a third party for $1,000,000. When Joe died in 2014, the shares were inherited by Janece at a tax cost of $1,500,000. Alfonso Freeland, a long-time family friend who lives in Toronto, has offered Janece $8,200,000 for the shares of the company. Alfonso’s holding company will acquire the shares and the proposed date of the share transaction is January 1, 2024. DI’s balance sheet as of September 30, 2023, is provided in Appendi X A. Alfonso had a valuation of the company, and an appraisal of all of the assets of the business is included in the appendi X. The valuation determined the corporation’s customer lists and goodwill to be worth $900,000 due to the company’s location and management. According to Janece, the term deposits and marketable securities represent a build-up of surplus funds that have not been used in DI’s business over the last several years. In March 2023, Janece approved the sale of some of the marketable securities because of her concerns in regard to the volatility of financial markets. The sale resulted in a capital loss of $200,000. The company did not and will not have any other capital dispositions in 2023. Janece has indicated that DI’s asset mi X has been quite stable for the past three years. The shares owned by DI in DSL (an interior architectural design company) are an 18% interest in the common shares of the company. DSL only owns assets used in its business. The remaining 82% interest in the common shares of DSL are owned by Alfonso Freeland’s wholly-owned holding company. DI uses the services of DSL to design kitchens for its customers. Janece would like to maximize the funds available for her retirement and is wondering how much after-tax cash she would have available after the sale of the shares. She would like advice on how to minimize tax to the extent possible on the sale. Janece earns salary and investment income that will result in any additional income or gains being taxed in the highest tax bracket.

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After your meeting with Janece, you reviewed the draft corporate tax return for September 30, 2023, that has been prepared by your firm (see Appendi X B). You noted that DI had a challenging year in 2023 and incurred a $250,000 loss for tax purposes for its year ended September 30, 2023. Janece informed you that Alfonso is planning to amalgamate DSL and DI sometime in 2024 following the acquisition of the DI shares and use DI’s losses against future profits of the combined business. Janece’s controller has budgeted a recovery in profits to $120,000 for DI for the 12 months ending September 30, 2024. The partner would like you to consider any potential planning opportunities to minimize corporate and personal tax on the sale of the shares and minimize the risk of a CRA reassessment related to the share sale. Alfonso is using his own advisors to assist but indicated to Janece that he may be interested in retaining your firm to provide tax compliance following the share purchase. The tax partner has asked you to determine the filing requirements for DI assuming that the share sale proceeds as planned. He has also asked you to consider Alfonso’s intention to utilize DI’s losses following the share purchase and related tax planning in regard to DI’s 2023 tax filings.

— REQUIRED (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend. Appendix A Balance Sheet September 30, 2023

Assets Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Balance Sheet $

36,000

Accounts receivable (net of $15,000 allowance)

134,000

127,000

Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,900,000

2,000,000

Term deposits/marketable securities . . . . . . . . . .

1,800,000

Shares in Design Solutions Ltd. (DSL) . . . . . . . .

230,000

187,000

Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,400,000

2,150,000

Building, fiXtures and equipment (net of amortization) . . . . . . . . . . . . . . . . . . . . . . . . . . .

3,150,000

4,920,000

$8,650,000

$11,220,000

Liabilities Accounts payable . . . . . . . . . . . . . . . . . . . . . . . .

180,000

Future income taxes . . . . . . . . . . . . . . . . . . . . . .

450,000

Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . .

3,250,000 3,880,000

Capital Common shares . . . . . . . . . . . . . . . . . . . . . . . . .

10,000

Retained earnings . . . . . . . . . . . . . . . . . . . . . . .

4,760,000 $8,650,000

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FMV

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Balances from draft September 30, 2023 tax return: Fixed Assets (September 30, 2023) UCC Class 1 – MB ...................................................2,500,000 Class 8 . . . . . . . . . . . . . . . . . . . . . . . . . 50,000 Class 10 . . . . . . . . . . . . . . . . . . . . . . . . . 80,000 Class 53 ............................................................. 120,000 Accumulated Depreciation . . . . . . . . . . . . . . . . . . . .

Original Cost 4,000,000 80,000 90,000 400,000 4,570,000 (1,420,000) 3,150,000

Net capital loss balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-capital loss balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital dividend account balance . . . . . . . . . . . . . . . . . . . . . . . . Non-eligible RDTOH balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eligible RDTOH balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . GRIP balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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Appendix B Tax Balances Draft T2 Return September 30, 2023 Fair Market Value 4,500,000 60,000 60,000 300,000 4,920,000

100,000 350,000 400,000 50,000 0 0

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Introduction to Federal Income Taxation in Canada

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CHAPTER 15 — DISCUSSION NOTES FOR REVIEW QUESTIONS (1) It is true that in order to claim an ABIL the shares need to be shares in a small business corporation. However, the definition of small business corporation allows the status as a small business corporation to continue for 12 months for purposes of the ABIL provisions. Since she sold the shares within siX months, she should be able to claim the loss as an ABIL.

ITA: 248(1) ITA: 39(1)(c)

(2) In several Income Tax Folios and Interpretation Bulletins, the CRA states that the phrase means at least 90%. It should be noted that this phrase has not been specifically determined by the courts and it is unclear whether the courts would allow 85% or require 95% as the percentage necessary to meet this test. Practitioners generally use 90%. (3) This corporation is neither, since in order to meet the definition of ‘‘small business corporation’’ it has to meet the 90% test at the determination time. Since the corporation does not meet this test it is neither an SBC nor a QSBC. It would be possible to purify the corporation to ensure the company was an SBC at the time of the share sale. The company meets the basic asset test as more than 50% of the assets of the corporation are active business assets for the 24 months prior to sale. The holding period test would need to be verified as well for the shares to be QSBC shares. (4) The preamble to the corporate attribution rule refers only to situations where ‘‘individuals have transferred or loaned property.’’ In this case his corporation has loaned the funds to her corporation. It could not even be said that he did it indirectly since he has not loaned or transferred any money to his own corporation. Therefore, even though her corporation is not an SBC, the corporate attribution rules should not apply. TOSI should be considered. Dividend income earned by the spouse (a specified individual) from her private corporation is split income unless it is not derived directly or indirectly from a related business. A related business is a business carried on by a corporation in which a related person (Mr. Smith) is either: ●

actively engaged on a regular basis in its activities, or

●

in which he owns 10% of the fair market value of the shares.

Mr. Smith meets both of these conditions. If the dividends are considered to be derived indirectly from the business in Mr. Smith’s corporation because of the loan to Mrs. Smith’s company, the dividends would be considered split income. However, refer to Tax Window 2019-0771861E5. The CRA’s position appears to be that second-generation income is not subject to TOSI. If a portion of the $100,000 loan itself were paid out to Mrs. Smith, the dividend would be considered to be derived from a related business. However, the payment of a dividend from the after-tax investment income earned in the corporation would not be considered to be derived from a related business. This result seems logical. TOSI is generally applicable to dividends that result in splitting business income with family members or splitting property income that is derived from that business income. The investment income earned by Mrs. Smith’s company would be subject to the high rate of tax applicable to investment income and refundable tax treatment. The benefits of splitting the investment income through dividends to Mrs. Smith are reduced as a result. However, GAAR should be considered. (5) The deemed year end applies whenever there is an acquisition of control even if the company acquired is not a loss company. Profitco Ltd. will have a June 30 year end. A new year end of December 31 can be chosen (any year end within 365 days). Mr. Magee will not be able to claim a full year of CCA on either of the June 30 or December 31 year end returns since CCA is prorated for a short fiscal year. Also, to be able to use the losses of his other corporation against profits in Profitco Ltd. the two companies will need to be amalgamated into one legal entity. Alternatively, strategies involving intercompany transactions to create income in the loss company could be considered. (6) For Mr. Sargent to use his capital gains exemption on the sale, he must have been a Canadian resident throughout the year and he must not have used any capital gains exemp-

ITA: 74.4(2)

Ch. 15/Study Guide — Discussion Notes for Review Questions

415

(7) A loss restriction event is triggered when de jure control of a corporation is acquired by a person or a group of persons. However, it is important to note that control is deemed not to have been acquired solely because of the acquisition of shares by a related person. De jure control refers to legal control and results when a person or group of persons acquires voting control providing the power to elect the majority of the board of directors of the corporation. It differs from de facto control (relevant to the associated corporation rules) that is a broader concept that considers the direct or indirect influence over a corporation.

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tion in the past. We should also check to ensure that he does not have a cumulative net investment loss balance or has claimed deductions for allowable business investment losses in the past which could limit his available deduction. The shares must have met the definition of ‘‘qualified small business corporation shares’’ at the time of the share sale. Three tests must be met: 1) the small business corporation test, 2) the holding period test, and 3) the active business asset test. The company is a CCPC and will be a small business corporation as long as all or substantially all of the fair market value of the assets of the corporation are attributable to assets used principally in an active business carried on in Canada at the time of sale (determination time). $90,000 of cash appears to be necessary for business operations and would be considered an active business asset. It will be necessary to determine whether the $140,000 of cash that is not used in the business operations represents less than 10% of the fair market value of the assets of the business. The holding period test requires the shares to have been held throughout the preceding 24 months by the individual or a person related to the individual. Mr. Sargent’s father is a related person. Therefore, the holding period test is met. The basic asset test requires that throughout the 24 months prior to sale, more than 50% of the fair market value of the assets of the business are attributable to assets using principally in an active business carried on primarily in Canada. It would be necessary to verify that this was the case for the 24 months prior to the sale. ITA: 256(7)

Introduction to Federal Income Taxation in Canada

416

CHAPTER 15 — SOLUTIONS TO EXERCISES Exercise 1 In each of the cases, the test to be applied to the facts is whether all or substantially all (i.e., at least 90%) of the fair market value of the assets are: (a) used principally in an active business carried on primarily in Canada by the corporation (or a related corporation); (b) shares or debt of a connected SBC; or (c) a combination of (a) and (b). (A) This situation depends on whether the marketable securities are used in the active business or are passive investments not necessary to the active business. If the marketable securities are used in the active business, then the 90% test is met. This would be the case, for example, if the marketable securities represented a short-term investment of cash surpluses, awaiting the purchase of inventory for the next season. (B) In this situation, the 90% test is met with a combination of active business assets and shares in a connected SBC. (C) In this case, the marketable securities cannot be considered to be used in an active business, because the corporation has no other active business assets to carry on such a business. Since the shares of a connected SBC represent only 80% of the total fair market value of the corporation’s assets, the 90% test is not met. (D) Again, this case fits the definition of an SBC if the marketable securities are considered to be used in an active business. If the facts of this case so indicate, then the 90% test is met by a combination of active business assets (including the marketable securities) and the shares of a connected SBC.

Exercise 2 (A) Unused lifetime deduction in 2023: Lifetime cumulative deduction limit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: prior years’ deductions: Capital gains deduction claimed in 2021 . . . . . . . . . . . . . . . . . . . . . . . . . . Capital gains deduction available for 2023 . . . . . . . . . . . . . . . . . . . . . . . . (B) Cumulative gains limit for 2023: Cumulative net taxable capital gains ($75,000 + $225,000) . . . . . . . . . . . . Minus: Cumulative net capital losses deducted . . . . . . . . . . . . . — Cumulative ABILs realized . . . . . . . . . . . . . . . . . . . . . . . $ 5,000 Cumulative capital gains deductions . . . . . . . . . . . . . . . 75,000 Cumulative net investment loss: Investment expenses — Cumulative carrying charges . . . . . . . . . . $ 1,075 Cumulative net rental losses ($1,100 + $220) . . . . . . . . . . . . . . . . . . 1,320 $ 2,395 Investment income — Cumulative interest income ($600 + $1,200) . . . . . . . . . . . . . . . . . . (1,800) Cumulative grossed-up dividends . . . . . . (140) (1,940) 455 Cumulative gains limit for 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (C) Annual gains limit for 2023: Net taxable capital gains for 2023 (Note 3) . . . . . . . . . . . . . . . . . . . . . . . . Minus: Net capital losses deducted in 2023 . . . . . . . . . . . . . . . . — ABILs realized in 2023 (Note 1) . . . . . . . . . . . . . . . . . . . 5,000 Annual gains limit for 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (D) Least of (A), (B), (C) . . . . . . . . . . . . . . . . . . . . .

$ 485,595 75,000 $ 410,595 $ 300,000

80,455 $ 219,545 $ 225,000 5,000 $ 220,000 $ 219,545

Ch. 15/Study Guide — Solutions to Exercises

417

Note 1 Allowable business investment loss (ABIL):

Note 2 Net Taxable Capital Gain for 2023: Taxable capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Allowable capital loss (Note 3) . . . . . . . . . . . . . . . . . . . . . . Net Capital taxable gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 300,000 ($ 75,000) $ 225,000

Note 3 Allowable capital loss (ACL): Disallowed portion of BIL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ACL (1/2 × $150,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 150,000 $ 75,000

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BIL before ssec. 39(9) reduction . . . . . . . . . . . . . . . . . . . . . . . . . $ 160,000 Disallowed portion — Lesser of: (a) BIL .................................................................... $160,000(a) (b) Adjustment factor × cumulative CG deductions of previous years (2 × $75,000) . . . $ 150,000 Minus: Cumulative disallowed BIL of prior years . . . . . . . . . . — $150,000(b) Lesser of (a) and (b) ....................................................................... (150,000) BIL after adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 10,000 ABIL (1/2 × $10,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,000

Exercise 3 The disposition of the real estate is a transfer for tax purposes in 2023. The facts do not provide enough details on the cost base to determine the tax effect of the disposition. In this case it can likely be established that one of the main purposes of the transfer of the building may reasonably be considered to be to reduce the income of Sully and to benefit Mrs. Albert who is a designated person and a specified shareholder. Had Sully kept the building herself she would have earned $50,000 of rental income on which she would have been taxable. Instead, she will receive $10,000 of interest and $10,000 of dividends. Mrs. Albert benefits from the rental income since this will accrue to the common shares of the corporation. Therefore, it may be argued that the purpose test will have been met. Furthermore, the corporation will no longer be a ‘‘small business corporation’’, since the fair market value of the assets of the corporation will be as follows: Retail assets, 75%........................................................................................................... $6,000,000 Building, 25%....................................................................................................................2,000,000 Total .......................................................................................................................... $8,000,000

Even if 20% of the building (FMV $400,000) is classified as an active business asset, the corporation will still not be a small business corporation since all or substantially all of the fair market value of the assets are not used principally in an active business carried on primarily in Canada. Sully’s attributed amount: FMV of the building transferred ............................................................................ $2,000,000 Less: cash received .................................................................................................... (600,000) Outstanding amount ............................................................................................... $1,400,000 Interest imputed at 3% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: interest received (5% of $200,000) . . . . . . . . . . . . . . . . . . . . . . . . . . 1.15 × dividends received . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Attributed amount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$42,000 (10,000) (11,500) $20,500

ITA: 248(1)

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Sully would also have: Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable dividends ($10,000 × 1.15) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

10,000 11,500

Total income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$42,000

Note that TOSI should be considered in regard to the interest income and taxable dividends received by Sully. The income and dividends are derived from a related business because a related person, Mrs. Albert (a source individual), carries on the business from which the income/dividends are derived. She also owns 10% of the fair market value of the shares of the corporation through her common share ownership. The interest and dividends are split income subject to TOSI unless they meet the definition of an excluded amount. It appears that Sully is not actively engaged in the corporation’s business and the income would not be considered to be from an ‘‘excluded business’’. Further, her shares do not provide 10% of the votes and value of the corporation and thus are not ‘‘excluded shares’’. However, if the interest and dividends represent a ‘‘reasonable return’’ in regard to the property Sully contributed to the corporation (i.e., the building, the income and dividends would be excluded amounts and as such would not be subject to TOSI). Whether an amount is considered to be a reasonable return is a question of fact.

Exercise 4 This exercise demonstrates the impact of the CNIL balance on the availability of the capital gains deduction. Capital Gains Deduction (A) Unused lifetime deduction in 2023: Lifetime cumulative deduction limit . . . . . . . . . . . . . . . . . . . . . . . . . Less: prior years’ deductions: Capital gains deduction claimed in 2006 ($33,000 × 1/2) . . . . . . . . . .

$485,595

Capital gains deduction available for 2023 . . . . . . . . . . . . . . . . . . . .

$469,095

(B) Cumulative gains limit for 2023: Cumulative net taxable capital gains ($33,000 × 1/2 + $192,500) . . . . Minus: Cumulative net capital losses claimed . . . . . . . . . . — Cumulative ABILs realized . . . . . . . . . . . . . . . . . . — Cumulative capital gains deductions . . . . . . . . . . . 16,500 Cumulative net investment loss: . . . . . . . . . . . . . . 4,850 Cumulative gains limit for 2023 . . . . . . . . .

16,500

$209,000

21,350 187,650

(C) Annual gains limit for 2023: Net taxable capital gains for 2023 (Note 1) . . . . . . . . . . . . . . . . . . . Minus: Net capital losses deducted in 2023 . . . . . . . . . . . . . . . . . . . .

$192,500 $ 0

Annual gains limit for 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$192,500

Least of (A), (B), (C) . . . . . . . . . . . . . . . . . . . . . .

187,650

Note 1 Net Taxable Capital Gain for 2023 Proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ACB 69(1)(c) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

523,000 (138,000)

Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Allowable capital loss . . . . . . . . . . . . . . . . . . . . . . . . . . . .

385,000 192,500 —

Net Taxable capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

192,500

The maximum capital gains deduction available is the least of (A), (B), and (C), above, $187,650.

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Exercise 5

B Co. is not a small business corporation. Only 80% of the FMV of its assets are used in an active business. Therefore, it does not meet the ‘‘all’’ or ‘‘substantially all’’ test, interpreted to be 90% by the CRA. C Co. is not a small business corporation. Only 50% of the FMV of its assets are qualifying assets, being shares of a connected small business corporation. D Co. is a small business corporation. 100% of its assets are used in an active business carried on in Canada by a corporation related to it (Spouse Co.).

Exercise 6 To meet the basic asset test, the corporation must: At all times in the previous 24 months, where the corporation existed, be a Canadian-controlled private corporation with more than 50% of the value of its assets being assets used in an active business carried on primarily in Canada. Shares of connected corporations do not need to be considered (i.e., the modified asset test) if this test is met. If the corporation cannot meet the basic asset test as described above, then the basic asset test is modified. To meet the modified ‘‘asset test’’, the corporation must: At all times in the previous 24 months, where the corporation existed, be a Canadian-controlled private corporation with more than 50% of the value of its assets being: (i) assets used in an active business carried on primarily in Canada, (ii) shares of connected ‘‘small business corporations’’, or (iii) a combination of (i) and (ii). Alternatively, the modified asset test will be met if: At all times in the previous 24 months, where the corporation existed, the CCPC had more than 90% of the value of its assets being: (i) assets used in an active business carried on primarily in Canada, (ii) shares of connected corporations that at all times in the previous 24 months had more than 50% of the value of their assets being assets used in an active business carried on primarily in Canada, or (iii) a combination of (i) and (ii). (a) In this case, more than 50% of the FMV of the assets of Holdco are invested in assets used in an active business. Therefore, Holdco will meet the basic asset test. The modified asset test need not be considered. (b) In this case, the modified asset test must be considered because Holdco does not meet the basic asset test. Holdco has more than 50% of the FMV of its assets invested in a combination of (i) assets used in an active business carried on in Canada and (ii) shares of a connected corporation with more than 90% of the FMV of its assets used in an active business carried on in Canada (i.e., a SBC). Therefore, Holdco will meet the asset test. It is not necessary to consider the second alternative under the modified asset test.

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A Co. is a small business corporation. 100% of the FMV of its assets are used in an active business carried on by it in Canada or invested in a connected small business corporation, Y Ltd.

420

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(c) In this case, the modified asset test must be considered because Holdco does not meet the basic asset test. Holdco does not have more than 50% of the FMV of its assets invested in a combination of (i) assets used in an active business carried on in Canada and (ii) shares of connected small business corporations. Holdco also does not have 90% of its assets invested in a combination of (i) assets used in an active business carried on in Canada and (ii) shares of connected companies which meet the 50% test. Therefore, Holdco will not meet the basic asset test. (d) In this case, the modified asset test must be considered because Holdco does not meet the basic asset test. Holdco does not have any assets used in an active business. Holdco does have more than 50% of the FMV of its assets invested in a combination of (i) assets used in an active business carried on in Canada (0%) and (ii) shares of connected small business corporations (75%). Holdco will therefore meet the basic asset test. Note that Holdco does not have 90% of its assets invested in active business assets or shares of connected companies which meet the 50% test, or a combination thereof. However, it is not necessary to consider this alternative as the first alternative under the modified asset test is met.

Exercise 7 (A) Assess the Situation Diagram

Relationships: Mr. Tran/Buscat & Mr. Tran/Buns Plus — related/affiliated through control Mr. Buscat — not related (following the acquisition of control) Buscat Ltd./Buns Plus — related, affiliated, associated (controlled by same person) Profile: Buscat Ltd. — CCPC, bakery chains, non-capital losses of $130,000, capital losses of $24,000, December year end Buns Plus Ltd. — CCPC, supplies bread & pastry doughs, bun bags — bakery & coffee shop divisions

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Timeline: 2013 — Buns Plus Ltd. started business operations

2021, 2022, 2023 — Buscat Ltd. has losses 2024 January 1, 2024, to June 30, 2024 — Buscat Ltd. projected to have a business loss, property loss, and allowable capital loss July 1, 2024 — 75% of common shares of Buscat Ltd. sold by Mr. Buscat to Mr. Tran July 1, 2024, to December 31, 2024 — bakery/coffee shop divisions of Buns Plus Ltd. transferred to Buscat Ltd., Buscat Ltd. projected to have $90,000 of net income. 2025 Buscat Ltd. projected to have $250,000 of net income Client: Mr. Tran Objectives: (1) Understand the income tax implications of the acquisition of the shares and potential for loss utilization. (2) Partner has asked you to consider the partial and maximum election options and make recommendation to Buscat Ltd’s accountant.

(B) Issue Identification Issue 1 — Tax implications re: July 1, 2024, acquisition of common shares of Buscat Ltd. (a) Year end/filing requirements a. EXplain impact of the acquisition of control (AOC) on the tax filings for Buscat Ltd. for 2024 (b) Realization of losses in short year end. a. EXplain the impact of the AOC on losses included on the 2024 short year end return for Buscat Ltd. (i) Calculate losses to be realized (Quantitative) (ii) Calculate Division B/Taxable income for short year end (Quantitative) (c) Election to realize gains/income in short year end. a. EXplain purpose of election and options available for short year end return. (i) Calculate two potential election options, i.e., partial vs. max (Quantitative) Issue 2 — Loss utilization following loss restriction event. (a) EXplain the conditions required to utilize losses after the loss restriction event. (b) EXplain the impact of the election options on the utilization of losses after the loss restriction event. a. Calculate non-capital losses subject to restriction/available for future use (Quantitative)

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2021 — Buscat Ltd. started operations

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422 (C) Analysis of the Issues

Issue 1 — Tax implications re: July 1, 2024, acquisition of common shares of Buscat Ltd. (a) Year end/filing requirements — Buscat Ltd. is deemed to have a taxation year ending June 30, 2024, immediately before the acquisition of control by Buns Plus Ltd. on July 1, 2024. Tax returns will have to be filed for this short taxation year (i.e., siX months) and amounts such as CCA will have to be prorated. In addition, the short taxation year will cause the counting of a carryforward year for the non-capital losses from 2021, 2022, and 2023. — The tax return for the short year end will be due December 31, 2024. — A December 31, 2024, year end was chosen (within first year). The tax return will be due June 30, 2025, with the tax due March 31, 2025 (assuming conditions are met). (b) Realization of losses in the short year end. — The business loss on the inventory of $20,000 ($65,000 FMV--$85,000 Cost) must be realized. As well, the capital cost allowance of $16,000 ($86,000 UCC - $70,000 FMV) on the bakery equipment must be deducted. Quantitative analysis: Loss from Non-Capital Sources Losses from non-capital sources for the deemed taxation year ended June 30, 2024, before any elections and options are computed as follows: Loss from business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Add: Inventory loss [ssec 10(1)] ($85,000 - $65,000) Bakery equipment — Deemed CCA ($86,000 -- $70,000) . . . . . . . . . . . . . . . Total business losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Add: Property loss (will expire unless utilized by June 30, 2024) Total losses from non-capital sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$10,000 20,000 16,000 $46,000 5,500 $51,500

If no election is made, there is no income to offset the current business loss of $46,000 or the noncapital loss carryforward of $130,000. Therefore, the non-capital loss available to carry forward from June 30, 2024, would be $176,000 (i.e., $46,000 + $130,000). The $2,000 of allowable capital losses, $5,500 of property losses and $12,000 of net capital losses will expire (totalling $19,500). (c) Election to realize gains/income in short year end. — It is possible to elect to realize up to a $40,000 capital gain on the land ($310,000 FMV-$270,000 ACB) up to a $10,000 capital gain on the building which will result in recapture of $20,000 and up to a $10,000 capital gain on the goodwill. — The purpose of an election is to use up the $2,000 allowable capital loss, the $12,000 net capital losses and $5,500 property loss that will expire because of the AOC if the return is filed as above. — An election will also use up some of the current year business loss that may have restricted use after the AOC. — Another benefit of the election is through the resulting higher adjusted cost base/capital cost and undepreciated capital cost balances for the land, goodwill and building. The two election options to consider are the maximum election and the partial election. Maximum Election The maximum election will ensure all of the $19,500 expiring losses are used and will result in a portion of the use of the short year end business loss. The non-capital loss carryforward balance from 2023 will be preserved. If the maximum election is made on land, building, goodwill, the $20,000 of recapture on the building offsets the business loss, leaving $26,000 (i.e., $46,000 -- $20,000) of net business loss. The $30,000 of taxable capital gains uses up the $19,500 of expiring losses, leaving $10,500 (i.e., $30,000 -- $19,500) against which the remaining $26,000 of business loss is applied, leaving $15,500 of that business loss to be added to the non capital loss carryforward balance. As a result, the non-capital loss available for carry forward from June 30, 2024, is $145,500 (i.e., $15,500 + $130,000).

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The maximum election results in a bump in the tax cost amounts for the land and building as calculated below.

Maximum Election

Net Taxable Capital Gains (TCGs): Election on Land 111(4)(e) . . . . . . . . . . . Election on Building . . . . . . . . . . . . . . . . . Election on Goodwill . . . . . . . . . . . . . . . . Allowable capital loss – Securities . . . . . .

$ 20,000 5,000 5,000 (2,000)

Net TCGs . . . . . . . . . . . . . . . . . . . . . . . . .

$ 28,000

Business & Property Loss: January to June business loss . . . . . . . . . . Election on Building (Recapture) . . . . . . . Property loss . . . . . . . . . . . . . . . . . . . . . . Inventory loss . . . . . . . . . . . . . . . . . . . . . Equipment Capital Cost Allowance (CCA)

(10,000) 20,000 (5,500) (20,000) (16,000)

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$(31,500)

Division B Income . . . . . . . . . . . . . . . . . . . .

—

Division C Deductions Net capital loss . . . . . . . . . . . . . . . . . . . . Non-capital loss . . . . . . . . . . . . . . . . . . . .

(12,000)

Taxable Income . . . . . . . . . . . . . . . . . . . . . .

Non-Capital Loss Carryforwards:

31-Dec-23 Used in 2024 Added in 2024 July 1, 2024

Tax Attributes Post AOC: ACB land . . . . . . . . . . . . . . . . . . . . . . . . . . . ACB Building . . . . . . . . . . . . . . . . . . . . . . . . CC/UCC Building . . . . . . . . . . . . . . . . . . . . . ACB/CC Equipment . . . . . . . . . . . . . . . . . . . UCC Store Equipment . . . . . . . . . . . . . . . . . UCC Goodwill . . . . . . . . . . . . . . . . . . . . . . . ACB Goodwill . . . . . . . . . . . . . . . . . . . . . . . .

($310,000 -- $270,000) × 1/2 ($730,000 -- $720,000) × 1/2 ($10,000 -- $0) × 1/2

($720,000 LCP -- $700,000 UCC) 85,000 Cost -- 65,000 FMV 86,000 UCC -- 70,000 FMV

Choose to utilize net CLs

$130,000 2021 to 2023 — 15,500 $31,500 -- $16,000 net TCGs $145,500 $310,000 $730,000 $725,000 ($720,000 + $5,000) 13(7)(f ) $100,000 111(5.1) $70,000 111(5.1) $5,000 ($0 + $5,000) 13(7)(f ) $10,000

The adjusted cost base/capital cost of the properties, which were deemed to be sold at their fair market values. (d) Partial Election The objective of the partial election is to utilize all of the expiring losses. It is best to elect on either the land or goodwill to realize taxable capital gains. Electing on the building will result in both a taxable capital gain and the full amount of recapture being realized. The minimum amount to be elected upon under paragraph 111(4)(e) (i.e., proceeds of disposition) should result in taxable capital gains that are equal to the sum of: (a) the allowable capital loss of $2,000 which is about to expire, (b) the net capital losses of $12,000 which would otherwise expire, and (c) the property loss of $5,500 which otherwise expires. If the land was chosen as the asset to trigger all of the taxable capital gain, then the deemed proceeds would be determined as: [2 × ($2,000 + $5,500 + $12,000) + $270,000 ACB] or $309,000. The deemed proceeds of $309,000 which would result in a taxable capital gain of $19,500 ($309,000 -$270,000) × 1/2.

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Quantitative analysis: Buscat Ltd. June 30, 2024 Taxation Year End

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Alternatively, the goodwill could be chosen with deemed proceeds of $10,000 and then the deemed proceeds on the land would be $299,000. Together the result would be a taxable capital gain of $19,500. If a partial election is made to offset the $19,500 of expiring losses, the current business loss of $46,000 is not offset and, hence, is available to carry forward, along with the $130,000 of non-capital losses, from June 30, 2024, for a total of $176,000. If the election is made on the land only, the ACB of the land can be increased. If the election is made on both the goodwill and land, the ACB of both properties will be increased. Future CCA deductions will be higher if goodwill is elected on as the UCC balance of Class 14.1 will be $5,000 ($0 + 1 /2 × $10,000). Quantitative analysis: Buscat Ltd. June 30, 2024 Taxation Year End

Partial Election (Land Only)

Net Taxable Capital Gains (TCGs): Election on Land 111(4)(e) Designate at $309,000 . . . . . . . . . . . . . . . . . . . $ 19,500 Allowable capital loss – Securities .............. (2,000) Net TCGs ...................................................... $ 17,500

($309,000--$270,000) × 1/2

Business & Property Loss: January to June business loss . . . . . . . (10,000) Property loss . . . . . . . . . . . . . . . . . . . (5,500) Inventory loss . . . . . . . . . . . . . . . . . . . (20,000) Equipment Capital Cost Allowance (CCA) . . . . . . . . . . . . . . . . . . . . . . . (16,000) Total............................................................... $(51,500)

85,000 Cost-65,000 FMV

Division B Income . . . . . . . . . . . . . . . . .

—

Division C Deductions Net capital loss . . . . . . . . . . . . . . . . . . (12,000) Non-capital loss .......................................... Taxable Income . . . . . . . . . . . . . . . . . . . $ 0 Non-Capital Loss Carryforwards:

31-Dec-23 Used in 2024 Added in 2024 July 1, 2024

86,000 UCC-70,000 FMV

Choose to utilize net CLs

$130,000 2021 to 2023 — 46,000 $51,500 -- $5,500 net TCGs $176,000

Tax Attributes Post AOC: ACB land ............................................................... $309,000 ACB Building ........................................................ $720,000 UCC Building ............................................................ $700,000 ACB/CC Bakery Equipment . . . . . . . . . . . . . $100,000 111(5.1) UCC Bakery Equipment . . . . . . . . . . . . . . . . $70,000 111(5.1) Conclusion: Both the maximum and partial election will use up the expiring property loss. An election to realize taxable capital gains should be considered to use up the expiring net capital losses of $12,000, the expiring property loss of $5,500, and to ensure that the current period allowable capital loss is used. The loss carryforward balance subject to restriction following the acquisition of control will be higher with a partial election. As well, tax cost balances will be lower with the partial election relative to a maximum election. The non-capital losses will expire in 20 taxation years, including the deemed taxation year, from the year of the loss as follows, assuming that Buscat Ltd.’s fiscal year end after the acquisition of control returns to December 31. — 2021 non-CL — on December 31, 2040 — 2022 non-CL — on December 31, 2041 — 2023 non-CL — on December 31, 2042 — 2024 deemed taxation year — on December 31, 2043

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Issue 2 — Loss utilization following the loss restriction event, i.e., December 31, 2024, 2025 (a) The net capital losses of $14,000 (including the current period allowable capital loss) will expire and the property loss of $5,500 will expire without a 111(4)(e) election.

●

The business that generated the loss must be carried on and for a profit or a reasonable expectation of profit throughout the year in which the loss is to be used AND Only to extent of income from that business or a business with income derived from the sale of similar properties. Condition 1 — Buscat Ltd. bakeries are continuing to operate after the AOC. It is a question of fact whether the bakeries have a reasonable expectation of profit in the December 31, 2024, and December 31, 2025, taxation year ends. The bakery business had a loss of $55,000 in the December 31, 2024, year end and a profit is expected in the December 31, 2025 year end of $65,000. Perhaps Mr. Tran has the expertise, funding, etc. to turnaround the business.

●

Condition 2 — It is a question of fact as to whether the Buns Plus Bakery transferred into Buscat Ltd is selling similar products to the original Buscat Ltd. business. It will be necessary to consider whether supplying bread dough and pastry dough is a vertically integrated business to the bakery chains — Buns Plus Bakery had $130,000 of business income in the December 31, 2024 year end and is expected to have $165,000 in business income in the December 31, 2025 year end.

Conclusion: Non-capital losses can likely be used following the acquisition of control. The Buscat bakeries business has continued and it appears that the taxpayer could support that it has a reasonable expectation of profit. As a result, the losses could be available to be used against income from that business in 2025. There is also a potentially supportable position that the losses could be used against income from the Buns Plus Bakery business in 2024 and 2025. Information needs: Review supporting case law to document a position that Buns Plus Bakery business is earning income from the sale of similar products (vertically integrated businesses meet that criteria). Document support that the Buscat bakery businesses has a reasonable expectation of profit following the acquisition of control.

(D) Advise/Recommend: ●

●

We recommend that the taxpayer file a partial 111(4)(e) election or either the land or the goodwill to realize sufficient taxable capital gains to utilize the expiring net capital losses and property losses. The non-capital losses available following the partial election that would be subject to the restrictions following the acquisition of control would be $176,000. Utilize the pre-AOC non-capital losses in the December 31, 2024, taxation year end. If Buns Plus Bakery can be supported to be selling similar products to the Buscat Ltd bakery, $90,000 of the non-capital loss balance could be used.

Lesser of: (a) Net income for year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 90,000

(b) Income from: the loss business . . . . . . . . . . . . . . . . . . . . . . . . . the sale of similar products . . . . . . . . . . . . . . . . .

$130,000

$ 0 $130,000

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(b) The non-capital loss balance at the acquisition of control date will be subject to restriction in subsequent years and can only be used if both of the following conditions are met in 111(5)(a)(i);

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●

Utilize the pre-AOC non-capital losses in the December 31, 2025, taxation year end. $65,000 of losses can be used against bakery business income. The remaining $21,000 of losses could be used against the Buns Plus Bakery profits if supportable.

Conclusion: If the Buns Plus Bakery is earning income from the sale of similar products to the Buscat bakeries, all of the pre-AOC losses will be used in 2024 and 2025. As losses will be used in a short timeframe, the partial election could be chosen over the maximum election to maximize the available loss carryover balance.

Exercise 8 (A) Since control of Computer Rental Ltd. (Computer) was acquired on January 1, 2023, by Processing Ltd. (Processing), Computer is subject to a loss restriction event. Deemed Year End ●

Subsection 249(4), which deems Computer to have a taxation year end on December 31, 2022, will not cause the corporation to have an additional taxation year, because that date is the normal year end of the corporation.

Therefore, the 2022 loss amounts are a 2022 business loss and a 2022 allowable capital loss. Accrued Losses The $50,000 accrued capital loss on the marketable securities will be deemed to be an allowable capital loss of $25,000 for the year ended December 31, 2022 [par. 111(4)(d )] and the adjusted cost base of the securities will be reduced to their fair market value [par. 111(4)(c)]. The UCC of the computers is reduced to $200,000 [ssec.111(5.1)]. The $280,000 reduction (i.e., $480,000 -- $200,000) is deducted as CCA in the deemed year end and increases the business loss for the December 31, 2022 year end. Expiring Losses Unless capital gains are generated in the year ending December 31, 2022, the net capital losses and allowable capital losses of $145,000 (i.e., $40,000 + $80,000 + $25,000) will not be available for deduction after December 31, 2022. 111(4)(e) Election Computer may elect to realize a capital gain of up to $300,000 on the land, $54,000 on the goodwill and recapture of up to $5,000 on the furniture and fiXtures [par. 111(4)(e)]. ●

●

If Computer elects on the maximum amount available on the land, it will generate a taxable capital gain of $150,000; this will cause the adjusted cost base of the land to become $450,000 (i.e., $150,000 + $300,000). If Computer elects on the maximum amount available for the goodwill, it will generate a taxable capital gain of $27,000; this will cause the adjusted cost base to become $54,000 and the CC/UCC of the goodwill to become $27,000 ($0 + 1/2 × $54,000). If Computer elects an amount on the furniture and fi Xtures, recapture will be created that will offset its business loss for the deemed year end. This will cause the UCC of the class to become $165,000; however, Processing does not want this to be done because of the assumption in the required that the non-capital losses can be used in the future. Therefore, Computer should elect only on the land or land and goodwill and only to the extent that this election generates a taxable capital gains equal to the expiring losses of $145,000. The proceeds of disposition necessary to create a capital gain to offset the expiring loss is: ACB of the land $150,000 + (2 × $145,000) = $440,000 ● ●

If Computer makes the election, the new ACB for the land will be $440,000. Alternatively, Computer can elect on both the land and goodwill in which case the ACB of the goodwill will be $54,000 and the ACB of the land will be $386,000. This option will result in higher ongoing CCA deductions on the Class 14.1 UCC balance of $27,000.

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— Division B income for 2022 — Partial election on land only Income from non-capital sources (non-negative) . . . . . . . . . . . . $ 0 Net taxable capital gains: Taxable capital gain elected on land (1/2 × ($440,000 -- $150,000)) . . . . . . . . . . . . . . $ 145,000 Allowable capital losses in 2022 .................. $80,000 Allowable capital loss on securities deemed realized (1/2 × ($120,000 -- $70,000)) 25,000 (105,000) $ 40,000 Par. 3(c): Par. 3(a) + par. 3(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,000 Par. 3(d ): Losses from non-capital sources: Business loss for 2022 . . . . . . . . . . . . . . . . . . . . . $ 90,000 Loss on computers (CCA deduction) . . . . . . . . . . . 280,000 (370,000) Division B Net income (technically cannot be negative) (330,000) Division C deductions: Net capital losses from 2021, limited to net taxable capital gains in par. 3(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (40,000) Taxable Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (0) Non-capital loss for year ended December 31, 2022 added to non capital losses is $370,000. Computer has total non-capital losses of $75,000 + $370,000 = $445,000 at December 31, 2022 that would be subject to restriction following the AOC. This is the same with or without the election under par. 111(4)(e). The advantage of the election is that the expiring losses have been utilized. As well, the ACB of the land is bumped up to $440,000. Deductibility of non-capital losses in 2023: ●

●

Spar. 111(5)(a)(i) requires that the computer rental business be carried on throughout the year ended December 31, 2023, and with a reasonable expectation of profit. Spar. 111(5)(a)(ii) allows a deduction of non-capital losses to the extent of: Computer’s income from the computer rental business . . . . . . . . . . . . . . . . . . . . . . Computer’s income from the rental of similar properties, i.e., rental of workstations* Deductible non-capital loss in 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Available for carry over to 2024 ($445,000 -- $65,000) . . . . . . . . . . . . . . . . . . . . . .

$ 25,000 40,000 $ 65,000 $380,000

— Taxable income for 2023 will be $0: Income from rental operations (Division B income) .............................................................. $ 65,000 Less: non-capital loss (Division C deduction) ......................................................................... (65,000) Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0

Deductibility of non-capital losses in 2024: ●

● ●

●

Since the computer rental operations were discontinued in 2024, the computer rental business was not carried on throughout 2024 and the test in subpar. 111(5)(a)(i) is not met. Therefore, the $380,000 of non-capital losses cannot be deducted in 2024 or future years. The $40,000 loss from the computer rental operation in 2024 would offset the income from the workstation rental operation of $25,000. There would be a $15,000 non-capital loss. This noncapital loss could be used in 2025 and future years without any restriction applicable It is worth noting that if this business is commenced again in a future year and carried on throughout any such year, the losses can then be deducted, subject to the 20-year carryover period being met.

*Assuming that the rental of workstations is similar to the rental of computers.

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Par. 3(a): Par. 3(b):

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Exercise 9 The deemed year end, by virtue of ssec. 249(4) as a result of the loss restriction event, coincides with the normal year end of Childco. As a result of the loss restriction event, the following losses are restricted on January 1, 2023: ●

●

2018 net capital loss of $50,000 and 2021 net capital loss of $100,000 expire on December 31, 2022, as a result of the loss restriction event, unless an election is made under par. 111(4)(e) to realize the accrued gain on the land to offset the net capital losses (i.e., $50,000 + $100,000). The non-capital losses available under par. 111(1)(a) for carryover on December 31, 2022, are: 2018 non-capital loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2019 non-capital loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2020 non-capital loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2021 non-capital loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2022 non-capital loss (see below) . . . . . . . . . . . . . . . . . . . . . . . .

●

$300,000 250,000 200,000 150,000 230,000

$1,130,000

The losses from non-capital sources for the 2022 taxation year are: Business loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 50,000 Accrued losses — business Building (CCA deduction) ....................................................................... 100,000 Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 Patent (CCA deduction) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80,000

$230,000

Par. 111(4)(e) Election In order to offset the $150,000 of net capital losses that would otherwise expire on the loss restriction event, a minimum total gain of $300,000 must be elected under par. 111(4)(e) on the land. Electing on the land at $1,000,000 will trigger the $300,000 of accrued capital gains resulting in a taxable capital gain of $150,000 and raising the ACB of the land to $1,000,000. Electing on the goodwill at $25,000 will trigger $10,000 of accrued capital gain and result in a taxable capital gain of $5,000 and recapture of $7,000. The following would result: Par. 3(a): Income from non-capital sources . . . . . . . . . . . . . . . . . . . . . . Par. 3(b): Net TCG Deemed TCG on land (1/2 × ($1M - 700K)) . . . . . . . . . . . . . Deemed TCG on goodwill (1/2 × ($25K - $15K)) . . . . . . . . . . Par. 3(c): Par. 3(a) + par. 3(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Par. 3(d ): Losses from non-capital sources . . . . . . . . . . . . . . . . . . . . . . Division B Income (technically cannot be negative) . . . . . . . . . . . . . . . . Less Division C deductions: Par.111(1)(b) Net Capital losses . . . . . . . . . . . . . . . . . . . . . . . . . . . Par.111(1)(a) Non-capital losses . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-capital loss for year ended Dec. 31, 2022 . . . . . . . . . . . . . . . . . . . . Non-capital loss - 2022 Par. 111(8)(b) - Proof Business loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + net capital loss claimed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- 3(c) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-capital loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

150,000 5,000 $ 155,000 (230,000) $ (75,000) $150,000 0

(150,000) $ (0) $ 225,000 $ 230,000 150,000 (155,000) $ 225,000

Deductibility of restricted non-capital losses Conditions of deductibility (both must be met for losses to be used in a year post-AOC): Condition 1 (i) the loss business must be carried on for a profit or reasonable expectation of profit; (ii) loss business must be carried on throughout each year that a non-capital loss is to be deducted.

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Condition 2 Sources of income from which non-CL’s from a loss business may be deducted only against: (ii) income from a business where substantially all of the income is derived from the sale of similar properties or the rendering of similar services. Comments on above rules: Condition 1 Is Childco being operated with a reasonable expectation of profit? — Losses are declining. — Is there any other evidence of an attempt to turn Childco around? Condition 2 The losses are only available in Childco — if another source of income is put into Childco (it may be possible to offset Childco’s losses against that source of income, as long as that source is from the sale of similar products or services); — if Parentco transferred some of its business to Childco (the transferred business would only be considered similar if it were considered vertically integrated with Childco’s business (IT206R)). Both conditions must be met for the loss to be used in a post-AOC year.

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(i) income from the loss business, or

Chapter 16 Corporate Distributions, Asset Sales and Winding-Up

CHAPTER 16

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CHAPTER 16 — LEARNING CHART Problem Descriptions Textbook Example Problems 16-1 Related party transfer involving share consideration 16-2

Capital dividend account

16-3

Share attributes — tax consequences

16-4 16-5

Capital dividend Wind-up calculations

16-6

Assets vs. shares

Exercises 1 2 3 4

Capital dividend account Capital dividend account Withdrawing cash from a corporation Stock dividend

5 6 7 8 9 10

Independent situations — tax consequences Winding-up Winding-up Winding-up Capital dividend account Financial reporting and tax treatment of related party/non-arm’s length transaction

Assignment Problems 1 Capital dividend account 2 Capital dividend account 3 Deemed dividends 4 Redeem vs. sell shares 5 6 7 8 9

Withdrawing funds from investment corporation Wind up of a corporation Sale of assets with wind-up Sale of assets with wind-up Corporate distribution

10 11 12

Assets vs. shares Purchase of assets vs. shares Refundable dividend tax on hand; capital dividend account

Ch. 16/Study Guide — Learning Chart

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REVIEW QUESTIONS

(1) Under Canadian corporate law (CBCA and OBCA), how is the paid-up capital of a share determined? (2) What are ‘‘high-low’’ shares? (3) What are the four basic components of the capital dividend account? (4) Calculate the effect on the capital dividend account as a result of the sale of internally generated goodwill and all other intangibles on the sale of a business this year for $100,000. The only other transaction in Class 14.1 took place three years ago when a customer list was purchased for $10,000. The UCC balance is now approXimately $6,000. (5) Smith Co. has total PUC of $10,000. It decided to make a distribution of capital in the amount of $9,000, but when it actually paid out the $9,000, the PUC was only reduced by $8,000. What are the tax consequences? (6) What are the three components of a distribution on the winding-up of a corporation where the only shareholder is an individual? (7) Glee Co. is a CCPC that is in the process of being wound up under the general winding-up rule. One of its assets is a building that has an accrued terminal loss. The lawyer has suggested that subsection 13(21.2) will apply to deny the terminal loss to the corporation on winding-up. What do you think?

ITA: 88(2)

(8) Technically, on the winding-up of a corporation under the general winding-up rule, how are the proceeds of disposition of the shares calculated?

ITA: 88(2)

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Ch. 16/Study Guide — Exercises

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EXERCISES

Exercise 1

ITA: 89(1)

The following capital properties have been sold by a Canadian-controlled private corporation during the year ended December 31: A

Proceeds of disposition .......................................................... $4,000 $1,000 Cost......................................................................................... 2,000 2,000 Selling expenses........................................................................ 400 100

$2,000 2,000 200

— REQUIRED Compute the effects of the dispositions on the capital dividend account.

Exercise 2

ITA: 89(1)

Action Ltd., a Canadian-controlled private corporation, sold the following two capital properties during the fiscal year ending December 31:

Property 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . Property 2 . . . . . . . . . . . . . . . . . . . . . . . . . . .

Cost

Proceeds

Selling costs

$75,000 40,000

$110,000 11,000

$11,000 5,500

— REQUIRED Compute the effects of these sales on:

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(A) the net income for tax purposes, and (B) the balance in the capital dividend account.

Exercise 3

ITA: 83, 84

Mr. Duong, the sole shareholder of Investment Limited, a Canadian-controlled private corporation, requires some cash for other personal investment transactions. Investment Limited’s share capital is composed of 100 common shares with an ACB and PUC of $1 per share and 1,000 6% preferred shares with an ACB and PUC per share of $15 and a retractable value of $75 per share. Mr. Duong is considering the following alternatives: (a) Mr. Duong would cause Investment Limited to redeem 800 preferred shares at $75 per share. (b) Mr. Duong would cause Investment Limited to pay a cash dividend of $60,000 on the common shares. Investment Limited has a capital dividend account of $75,000. (c) Mr. Duong would cause Investment Limited to make a non-dividend cash distribution of $60,000 on the preferred shares. — REQUIRED Discuss the tax implication of the above transactions.

Exercise 4

ITA: 54, 84(3), 248(1)

A Canadian-controlled private corporation with no GRIP balance has paid a dividend this year in the form of 10 preferred shares, each having a redemption value of $10,000 and a paid-up capital value of $100.

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Introduction to Federal Income Taxation in Canada

436 — REQUIRED

(A) What are the tax consequences of the receipt of the dividend by an individual shareholder? (B) What are the tax consequences to the corporation? (C) What are the tax consequences to the individual shareholder of a sale at their fair market value of the shares received? (D) What are the tax consequences to the individual shareholder of a redemption of the shares received?

Exercise 5 The following situations deal with Canadian-controlled private corporations and their non-arm’s length shareholders. However, each transaction, described below, is separate and distinct from the other transactions unless the contrary is stated.

ITA: 53(1)(b), 53(2)(a), 84(1), 84(3), 84(4)

(a) X Ltd. issued to the daughter of its only shareholder retractable special shares (preferred shares) with a PUC of $1,500 and a redemption value of $10,000 for $1,000 cash. (b) Y, the controlling shareholder of Y Ltd., converted debt of $20,000 for preferred shares with a PUC and redemption value of $2,000 plus cash of $20,000. (c) Z, the sole common shareholder of Z Ltd., is considering causing the corporation to make a payment as a return of capital (PUC). The shares have a FMV of $50,000, PUC of $10,000 and ACB of $20,000: (i) payment is for $5,000; (ii) payment is for $18,000.

— REQUIRED Discuss the tax consequences of the above transactions.

Exercise 6 Flare Limited is a Canadian-controlled private corporation, founded 20 years ago by Mr. Siewert who holds all of the outstanding shares. The shares have a paid-up capital of $625,000. After selling all assets and paying all liabilities, the company has a cash balance of $950,000. The company has a non-eligible RDTOH balance of $50,000 and a capital dividend account balance of $150,000 on December 31, 2023. The company does not have any GRIP.

— REQUIRED (A) Determine the components of the distribution to Mr. Siewert on a winding up of the company. (B) Compute the taxable capital gain or allowable capital loss on the disposition of Mr. Siewert’s shares on January 1, 2024, assuming that their adjusted cost base was $350,000.

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ITA: 54, 83(2), 84(2), 88(2), 89(1)

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Exercise 7 Twilight Ltd., a CCPC with no GRIP balance, has been wound up this year and its only shareholder has surrendered her shares. She received $30,000 in total from the corporation for her shares which had a cost to her equal to their paid-up capital of $2,000. The company had a capital dividend account balance of $4,500. All business income of the CCPC has been taxed only at the low rate and therefore, the company does not have a GRIP balance.

ITA: 54, 83(2), 84(2), 88(2), 89(1)

— REQUIRED What are the tax consequences to the shareholder if she will be taxed on any income from the winding-up at a combined (33%) federal and (17%) provincial marginal rate of 50%?

Exercise 8 Dwight Limited is a Canadian-controlled private corporation which will be wound up by its only shareholder, Mr. Warren. Mr. Warren purchased the shares of the corporation for $1,000. The shares have a paid up capital value of $2,000.

ITA: 54, 83(2), 84(2), 88(2), 89(1)

As at December 31, 2023, the company’s balance sheet appears as follows: Dwight Limited BALANCE SHEET as at December 31, 2023

Total . . . . . . . . . .

Liabilities Bank loan . . . . . . . . . . $ 47,000 Wages payable . . . . . . 3,000 Total . . . . . . . . . . . $ 50,000 Shareholder’s Equity Share capital . . . . . . . $ 2,000 Retained earnings . . . 308,000 Total . . . . . . . . . . . $360,000

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Assets Cash . . . . . . . . . . . . $ 20,000 Inventories at cost (FMV: $220,000) 200,000 Land at cost (FMV: $70,000) 40,000 Buildings at UCC (cost: $200,000; FMV: $300,000) 60,000 Equipment at UCC (Cost: $100,000; FMV: $80,000) . . . 40,000 $360,000

The balance in the corporation’s non-eligible RDTOH was $10,000 and its GRIP and capital dividend account balances were $0 as at the above balance sheet date. The assets are to be sold to an unrelated purchaser corporation, including internally generated goodwill valued at $55,000 and the liabilities paid effective January 1, 2024. The corporation pays a combined federal and provincial corporate tax at the rate of 13% on the first $500,000 of active business income, 27% on active business income not eligible for the small business deduction, and 40% initially on any other income. Mr. Warren is wondering how much after-tax cash will be available in the corporation after the asset sale and would like advice on the HST implications of the asset sale. He is considering winding up the company and would like to know how much tax he would pay if he dissolves the corporation immediately following the asset sale. For the next meeting you agree that you will: (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

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Exercise 9 The following non-depreciable capital properties have been sold late in the year by a Canadiancontrolled private corporation during the taxation year ended December 31, 2023:

Proceeds of Disposition

Property

Cost

Selling Costs

$ 4,000

8,000

700

$ 4,000

2,000

100

$ 4,000

4,000

300

— REQUIRED Compute the effects of the dispositions on the capital dividend account.

Exercise 10 A, the sole shareholder of A Ltd., gave the corporation land with an ACB of $120,000 and FMV of $150,000. A holds 100 common shares of the corporation. The shares were issued to him on incorporation for $2,000.

— REQUIRED Discuss the financial reporting treatment of the transaction in the financial statements of A Ltd. Discuss the tax treatment of the transfer on A’s personal tax return. As well, consider the impact from a tax perspective of the transfer on A’s common shares of A Ltd. and the tax cost of the land to the corporation.

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439

ASSIGNMENT PROBLEMS

Problem 1

ITA: 89(1)

Sabres Limited, a Canadian-controlled private corporation whose fiscal year end is December 31, provides you with the following data concerning its tax accounts and capital transactions for 2023. The balance in its capital dividend account was $0 on January 1, 2023. Ms. Tsakiris, a Canadian resident, is the sole shareholder. Sabres Limited is considering winding up the corporation and wishes to determine the impact of the sale of all its capital assets on its tax surplus accounts. The following capital assets are recorded in the books of account:

Assets Investments . . . . . . . . . . . . . Land . . . . . . . . . . . . . . . . . . . Building . . . . . . . . . . . . . . . . Equipment . . . . . . . . . . . . . . Customer lists (Class 14.1) (Note 1) . . . . . . . . . . . . . . . .

UCC

Estimated proceeds

Estimated selling costs

$ 60,000 400,000 700,000 35,000

$450,000 0

$ 22,000 1,000,000 1,250,000 8,000

$ 500 50,000 60,000 400

40,000

34,000

60,000

—

Cost

Notes: (1) The balance in Class 14.1 reflects the purchase of the customer lists for $40,000 (purchased after January 1, 2017). (2) In addition to the above assets, there is $35,000 of goodwill which will also be sold. You have been asked to determine the effect on income and the capital dividend account balance immediately after the above transactions.

Problem 2

ITA: 53(1)(b), 84

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The following situations deal with a Canadian-controlled private corporation and its shareholders. Each transaction described below is separate and distinct from the other transactions. (a) Capital Inc. issued 1,350 preferred shares with PUC equal to $110 each for $110,500 cash and assets with a FMV of $38,000. The Canada Revenue Agency’s valuation team has determined the fair market value of the assets transferred to be $28,000. (b) Plastics Ltd. has shares with a FMV of $35,000 and a PUC of $5,500. Plastics Ltd. is considering making the following paid-up capital reductions on these shares. The sole shareholder has an ACB of $16,000 on her shares: (i) Payment of $4,000; and (ii) Payment of $8,000. (c) Festivals Ltd. has 4,500 common shares with a PUC and ACB of $22,500. In March of this year the corporation declared and distributed a 15% stock dividend in common shares with a PUC of $3,375. (d)(i) The sole shareholder of Baker Corp. Ltd. contributed machinery worth $38,400 to the corporation in return for cash of $15,400 and common shares. The assets had a cost of $50,000 and a UCC balance of $23,000. The machinery was not transferred on a tax deferred basis i.e. a Section 85 election was not filed. (ii) A year later, the company repurchased the common shares from the sole shareholder for $30,000. EXplain paid-up capital and how it is calculated. Discuss the tax consequences of each of the above transactions.

ITA: 84

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Problem 3

ITA: 54, 84(3), 84(6)

Ms. Chiu owns the following common shares of four different CCPCs: # of shares . . . . . . . . . . . . . FMV . . . . . . . . . . . . . . . . . . ACB . . . . . . . . . . . . . . . . . . PUC . . . . . . . . . . . . . . . . . .

Corp A 1,000 $50,000 20,000 20,000

Corp B 1,000 $50,000 40,000 20,000

Corp C 1,000 $50,000 20,000 40,000

Corp D 1,000 $50,000 80,000 100,000

Assume: (1) Ms. Chiu does not own any other shares of these corporations. (2) She is not related to any of the other shareholders. (3) She is in the top marginal tax bracket. (4) The shares are not QSBC shares. (5) None of the companies have a GRIP balance. Ms. Chiu has asked you to explain the tax consequences if her shares in each of the companies are redeemed by the companies for their fair market value or she sells her shares in each of the companies for their fair market value. (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

Problem 4 J. Tilkenhurst Limited (JTL) is a Canadian-controlled private corporation which was started 10 years ago by Mr. Santosh Prasad with an initial investment in common shares of $18,000. Mr. Prasad has decided that it’s time to retire and move to his retirement home in Saskatoon, Saskatchewan. Therefore, in January 2024 Mr. Prasad wishes to have JTL sell the assets to a corporate purchaser at their fair market value and then wind up JTL. He would like your advice on how much capital he would have to invest personally if he wound up JTL, and he would like your advice on whether he should instead retain JTL. The following is a projected tax balance sheet prior to the sale of the assets and the distribution of the resulting net cash as at the intended date of the winding-up:

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J. Tilkenhurst Limited BALANCE SHEET as at December 31, 2023 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 15,000

Accounts receivable ................................................... $60,000 Less: reserve for doubtful accounts . . . . . . . . . 5,000

55,000

Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Marketable securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Building — UCC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Equipment — UCC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Customer list — UCC . . . . . . . . . . . . . . . . . . . . . . . . . . . .

110,000 26,000 385,000 223,000 110,000 20,600 $944,600

Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Future income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . Common shares (PUC) . . . . . . . . . . . . . . . . . . . . . . . . . . Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$645,000 41,000 18,000 240,600 $944,600

ITA: 54, 83(2), 84(2), 88(2)

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Additional Information (1) Assets Accounts receivable . . . . . . . . . . . . . . . . . . . Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . Marketable securities . . . . . . . . . . . . . . . . . . Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Building . . . . . . . . . . . . . . . . . . . . . . . . . . . Equipment . . . . . . . . . . . . . . . . . . . . . . . . . Customer lists . . . . . . . . . . . . . . . . . . . . . . .

Cost $ 60,000 $110,000 $ 26,000 $385,000 $566,000 $300,000 $ 42,453

FMV $ 52,000 $ 127,000 $ 26,000 $ 950,000 $1,197,000 $ 60,000 $ 70,000

The books of account do not reflect unrecorded goodwill with an estimated fair market value of $60,000. This is in addition to the customer lists. The accounts receivable are to be sold separately to a factoring company. Santosh is in the top personal tax bracket in 2023 and expects to be in that bracket in 2024 as well. After that he expects his retirement income to be approXimately $100,000 per year. The customer lists were purchased in 2018. The company has a non-eligible RDTOH balance of $6,000, a capital dividend account balance of $12,000, and no GRIP. The provincial corporate tax rate for income eligible for the small business deduction is 4% and 12% for income above the small business deduction limit. For the next meeting you agree that you will: (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

Problem 5

The pro forma balance sheet of Batterup Ltd. as at December 31, 2023, is as follows: Cost Assets Cash . . . . . . . . . . . . . . . . . . . . Accounts receivable (net) . . . . Inventory . . . . . . . . . . . . . . . . . Land . . . . . . . . . . . . . . . . . . . . Building . . . . . . . . . . . . . . . . . Equipment . . . . . . . . . . . . . . . Marketable securities . . . . . . . . Liabilities Current liabilities . . . . . . . . . . . Future income taxes . . . . . . . . Shareholder’s Equity Share capital (PUC) . . . . . . . . Retained earnings . . . . . . . . . . Total liabilities and equity . . . .

25,000 87,500 222,500 110,000 350,000 450,000 142,500 $1,387,500

UCC

FMV

$ — $ 75,000 220,000 —

75,000 155,000 450,000 950,000 100,000 320,000 $2,050,000

$ 540,000 50,000 100,000 697,500 $1,387,500

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CHAPTER 16

Ms. Bast owns all the common shares of Batterup Ltd., a Canadian-controlled private corporation, which started operations in 2009. Batterup Ltd. has been quite profitable in recent years. As a result, Three-Strikes Ltd., a Canadian public corporation, has offered Ms. Bast $2,525,000 for the assets, excluding cash, as at December 31, 2023. The offer price reflects unrecorded goodwill of $475,000. Ms. Bast wants to wind up the company after the sale of the assets.

ITA: 54, 83(2), 84(2), 84(2.1), 89(1)

Introduction to Federal Income Taxation in Canada

442 Additional Information

(1) Batterup Ltd. pays corporate tax at an overall combined rate of 13% on active business income eligible for the small business deduction, 27% on active business income not eligible for the small business deduction, and an initial 40% rate for investment income, plus the 102/3% additional refundable tax on investment income. The corporation has a GRIP balance of zero. (2) The reserve for doubtful accounts at December 31, 2023 was $15,000. (3) Batterup Ltd. and Three-Strikes Ltd. elected under section 22. (4) The company has a capital dividend account balance of $40,000. You have agreed to do the following for Ms. Bast: (A) Compute the amount available for distribution to the shareholder. (B) Determine the components of the distribution to the shareholder. (C) Compute the taxable capital gain or allowable capital loss on the disposition of Ms. Bast’s shares on the winding-up. (Assume the adjusted cost base of Ms. Bast’s common shares is $100,000.) (D) EXplain the conditions for and advantages of using a section 22 election.

Problem 6 You have been approached by Mr. Sidney Chow, a Canadian resident, for advice on the sale of his business. He is considering an offer from a corporate purchaser who will buy the business assets from Chow Enterprises Ltd. (CEL) and continue the business. The purchase will take place on December 31, 2023 and the selling price of the assets will be their fair market value at that time (see information below). He wants to understand how much tax he will pay on the sale and how much he would have available to invest after the sale of the business. Sidney is also wondering about the HST implications of the asset sale (optional). Mr. Chow purchased all the common shares of CEL from the company on incorporation in 2015 for $20,000. The corporation has a GRIP balance of $0. The company has a non-eligible RDTOH balance of $5,000 and a capital dividend account balance of $8,000. The following information on Chow Enterprises Ltd. has been prepared: Chow Enterprises Ltd. BALANCE SHEET as at December 31, 2023 Tax Value Cash . . . . . . . . . . . . . . . . . . . . . . . . . Accounts receivable . . . . . . . . . . . . . . Less: reserve for doubtful debts . . . . . Land . . . . . . . . . . . . . . . . . . . . . . . . . Building (Class 1) — UCC . . . . . . . . . Equipment (Class 8) — UCC . . . . . . . . Goodwill (Class 14.1) — UCC . . . . . . . Liabilities . . . . . . . . . . . . . . . . . . . . . . Future income taxes . . . . . . . . . . . . . Common shares — PUC . . . . . . . . . . . Retained earnings . . . . . . . . . . . . . . .

$ $ 30,000 (5,000)

10,000

FMV $

Cost

10,000 18,000

25,000 550,000 950,000 12,000 38,000

1,500,000 3,200,000 3,000 120,000

$1,585,000

$4,851,000

$ 550,000 1,800,000 30,000 50,000

$1,385,000 12,000 20,000 168,000 $1,585,000

In 2018, CEL acquired a business along with the goodwill noted above. The fair market value reflects the goodwill for the combined businesses. Sidney would like to know whether he should keep his corporation after the sale. He is also wondering if he should instead sell the shares of the corporation and wants to know what share price he should sell the shares for.

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ITA: 54, 83(2), 84(2), 88(2), 89(1)

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443

The corporate tax rate for income eligible for the small business deduction is 4%. For income in excess of the small business limit the provincial tax rate is 12%. Sidney is in the top personal tax bracket. For the next meeting you agree that you will: (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend. ITA: 14, 38, 82, 83(2), 117, 121, 123, 124, 129

Problem 7 Ms. Debbie, the sole shareholder and president of Shining Limited, a CCPC, has been considering selling her common shares to Let’s-Make-a-Deal (LMD) Ltd., a CCPC. However, Ms. Debbie recalls reading somewhere that one should compare a share sale with an asset sale to determine which would result in higher after-tax cash flow. The shares of LMD are not qualified small business corporation shares.

ITA: 54, 83(2), 84(2), 84(2.1), 89(1)

Ms. Debbie provides you with the following information: (1) The cost of Ms. Debbie’s common shares in Shining Limited is $120,000. (2) Shining Limited pays tax at the overall rate of 13% on the first $500,000 of active business income, 27% on additional active business income, and 40% on all other income, plus the 10 2/3% additional refundable tax on investment income. The corporation has GRIP and RDTOH balances of $0. (3) Ms. Debbie’s combined federal and provincial personal tax rate is 50%, including a personal provincial tax on income rate of 17%. (4) Financial information concerning Shining Limited on December 31, 2023 is as follows: Book cost

Liabilities Current liabilities . . . . . . . . . . . . . Future income taxes . . . . . . . . . . . Shared capital (PUC) . . . . . . . . . . Retained earnings . . . . . . . . . . . . .

UCC

FMV

$195,000

$ 54,000 50,000 210,000 440,000 85,000 $839,000

CHAPTER 16

Assets Cash (required as working capital) Marketable securities (required as working capital) . . . . . . . . . . . . Inventory . . . . . . . . . . . . . . . . . . . Land . . . . . . . . . . . . . . . . . . . . . . . Building . . . . . . . . . . . . . . . . . . . . Goodwill . . . . . . . . . . . . . . . . . . . .

$ 23,000 58,000 41,000 154,000 213,700 0 $489,700 $ 45,400 2,400 120,000 321,900 $489,700

(5) The original cost of the building in Class 1 was $410,000. Book cost of $213,700 is net book value after accumulated amortization. (6) The company has a capital dividend account of $48,000. You have agreed to prepare the following quantitative analysis: (A) If Ms. Debbie sells all of the assets, except cash, to LMD, pays the outstanding liabilities, and then winds up Shining Limited, determine the net amount available for distribution to her, showing all computations. (B) Determine the components of the distribution to Ms. Debbie.

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444

Introduction to Federal Income Taxation in Canada

(C) Determine the amount, including principal, Ms. Debbie would retain from this distribution. (D) Determine a selling price for the Shining Limited shares that results in the same after-tax net cash retained as the net cash from sale of assets followed by a wind-up, as determined in Part (C). (E) Consider the impact of a payment of a capital dividend before the sale of the shares on the selling price of the shares determined in (D). (F) Based on the indicated fair market value of the net assets, determine the maximum price a Canadian-controlled private corporation should be willing to pay for the shares of Shining Limited. Assume that the CCPC pays tax at the low rate of 13% on all of its business income, that it uses an after-tax discount rate of 5%, and that it does not expect to sell the fiXed assets of Shining Limited for a very long time. Also, assume that if the purchaser bought the assets, it would have to invest $23,000 in cash to meet working capital requirements.

Problem 8 Glenda, a Canadian resident is considering the purchase of a family-run catering business, called Palace Catering Ltd. (PCL). PCL was incorporated by Samuel Molton in Canada in 2008. The corporation specializes in the planning, preparation, and hosting of professional dinners, parties, and activities. The corporation had a proven record of profits until two years ago, when the death of the chef, along with the retirement of two employees resulted in a loss of business. Although Glenda is qualified to operate and manage the business, there is a high probability that profits from operating this business will not begin for a couple of years. She is wondering if she should purchase the net assets from the corporation or 100% of the shares presently held by the vendor family. The accumulated non-capital loss carryforward balance for PCL is $84,000 according to the most recent corporate tax return and relates to losses from the past 3 years. Glenda’s plan is to continue the catering business. She is also considering a new bakery business that will produce baked goods for sale to hotels and restaurants. Over the next two years she is projecting profits on the sale of cakes of $14,000 and $21,000 respectively. Thereafter, she estimates profit from the cakes of approXimately $25,000 annually. Glenda plans to borrow from her bank to purchase the business. The bank has approved a small business loan with a 6% interest rate. If the business realizes early operating losses, she will use the proceeds from a bond investment that she holds to finance the business until the business becomes profitable. From January 1 to August 31 of the current year, Glenda earned $13,000 as senior hostess at a high end golf and country club on the outskirts of Saskatoon, and $12,000 in interest income on her investments. Glenda plans to continue to work at the golf club after purchasing the business until she is certain it will be successful. Glenda would like your advice on the factors to consider when deciding on a purchase of the shares of PCL or a personal purchase of the assets of the catering business. For the next meeting you agree that you will: (A) Assess the Situation (B) Identify the issues (C) Analyze the issues (D) Advise/recommend

Problem 9 It is now December 31, 2023. Recently, Mr. X received an offer from a U.S. multinational to purchase the shares of his company, XYZ Limited. It is planned that the sale will close on March 1, 2024, the day after the corporation’s normal year end. XYZ Limited is 100% owned by Mr. X and is a CCPC. Prior to the sale, Mr. X would like to pay himself the maximum available capital dividend. The corporation previously paid out a capital dividend in the amount of $50,000 on March 31, 2020, after receiving a capital dividend of the same amount from a related corporation.

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The company has disposed of the following capital assets since its inception: Date January 31, 2020 February 14, 2020 February 1, 2023 February 28, 2023

Description Land Equipment Licence Securities

Cost $115,000 $ 15,000 $ 10,000 $ 31,500

Proceeds $ 175,000 $ 4,500 $ 310,000 $ 22,500

XYZ Limited has also accepted an offer to sell vacant land for $590,000. The transaction is expected to close on January 31, 2024. The original cost of the land was $785,000. The land is capital property. Mr. X would like to ensure that the company pays out a taxable dividend sufficient to clear the balance in the company’s refundable dividend tax on hand (RDTOH) accounts before the sale. During the 2023 tax year, XYZ Limited received $10,000 in eligible dividends from taxable Canadian corporations (not connected corporations) and $15,500 in Canadian-sourced interest income. XYZ Limited also had active business income of $500,000 for 2023. Mr. X has determined Part I tax payable for the year to be $50,993. —

REQUIRED Part A Calculate the balance expected to be in the company’s capital dividend account on February 28, 2024. Show all calculations. On what date should the company pay out the capital dividend? EXplain. Part B Calculate XYZ Limited’s eligible and non-eligible RDTOH balances at the end of the year. (Assume the opening RDTOH balances are $0.) What amount and type of taxable dividends should be paid in order to reduce the RDTOH balances to $0?

Problem 10 — Integrative Case

ITA: 89(1)

Bob Stein 50 years old and owns all the shares of Stein Ltd., a Canadian-controlled private corporation incorporated in 2007. Bob invested $10,000 into his corporation for 100 common shares of the company when it was incorporated. Bob lives in Vancouver where the company is located.

CHAPTER 16

Bob would like to withdraw sufficient funds from this company to provide him with $200,000 of after-tax funds to contribute to his TFSA and to help his 25-year-old son purchase his first home. He has come to you for advice on possible options. Bob has never contributed to a TFSA in the past. Bob expects he will pay himself a salary of $90,000 from the company in 2024 to cover his personal living expenses and this will be his only other source of income for the year. In preparation for the meeting with Bob you have reviewed the tax returns for the corporation and made the following notes: 2009 Disposed of bonds resulting in a capital gain of $10,000. 2010 Received taxable dividend of $2,000 and capital dividend of $5,000. 2011 Disposed of shares resulting in a capital loss of $4,000. 2014 Disposed of equipment resulting in a capital gain of $6,000 and recapture of $3,000. 2015 Received life insurance proceeds of $100,000 on a life insurance policy on the life of the company president purchased in 2011 by the corporation. As at January 1, 2015, the company’s interest in the policy had an adjusted cost basis of $20,000. 2016 Sold vacant land and reported capital gain of $100,000. 2017 2016 capital gain on sale of vacant land was reassessed by the CRA as income. Stein Ltd. did not fight the reassessment. 2018 Sold shares resulting in a capital gain of $20,000. 2019 A customer list was purchased for $40,000. 2020 Paid capital dividends of $50,000. 2023 Sold the customer list purchased in 2019 for $100,000. The company’s Class 14.1 balance at the time of the sale was $33,000.

ITA: 89(1)

2023 Sold shares resulting in a capital gain of $37,500.

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On the December 31, 2023 corporate tax return, you also note that the corporation has $0 of GRIP and a non-eligible RDTOH balance of $30,000. Bob is expecting to have Stein Ltd. sell some investments with a $140,000 capital loss in 2024. (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

Problem 11 — Integrative Case It is October 2023 and you have just come out of a meeting with your tax partner, Ashley, and her clients, Mark and Hilary Miller. Ashley has asked you to assess the situation to identify the issues and develop a research plan. She would then like to meet with you to review your work. After that meeting she wants you to analyze the major issues, reach a conclusion and propose the advice she should give to Mark and Hilary. Mark and Hilary have been married for 35 years. They have lived in Wellesley, Ontario for many years and work in the technology sector in Waterloo. They have two children who are both married and living in Waterloo. Both Mark and Hilary plan to retire in about five years and expect to have retirement income of $130,000 each at that time. They set up Hilmar Investments Inc. (‘‘HII’’) 15 years ago to manage their investment capital. The company earns Canadian interest income, realizes capital gains and losses and earns dividend income from publicly-traded companies. Based on their salaries, they are both in the top marginal tax bracket and expect to remain there until they retire. Since they have enough personal cash from their salaries they have left any income earned by HII in the corporation. Since the company earns dividends from publicly-traded companies it has a GRIP balance of $60,000 as at August 31, 2023. At this point in their lives they would like your advice on how much money they can take out of the corporation without paying any corporate or personal tax. Then they would like to know if it makes sense for them to take more money out of the corporation as salary or dividend. Hilary would also like advice on the $40,000 she borrowed from HII given that she will repay it in October. They both agree that they want to minimize their risk of reassessment by the CRA. The following is the balance sheet of HII. Hilmar Investments Inc. BALANCE SHEET Year ended August 31, 2023

Current Assets Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Term deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Due from shareholder . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Long-term Investments Investments (at cost) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 20,000 155,000 40,000

Notes: (1) (2)

215,000 400,000

(3)

$615,000 Current Liabilities Income tax payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Shareholders’ Equity Share capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 8,000 8,000 100,000 507,000

(4) (6)

$615,000 Notes: (1) The term deposits are due on October 6, 2023. (2) The loan to the shareholder represents $40,000 borrowed by Hilary on July 1, 2022 to buy a car. She signed a note payable at the time she borrowed the money. The note does not specify any

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447

repayment terms or interest rate. Hilary plans to repay the loan in October when she receives her bonus at work. (3) The long-term investments have a fair market value of $760,000. (4) Hilary and Mark each paid $50,000 for 50 common shares of the company on incorporation 15 years ago. (5) The company has a non-eligible RDTOH balance of $25,000 and an eligible RDTOH balance of $23,000. It also has a capital dividend account balance of $30,000, which all relates to prior year net capital gains and a net capital loss carry forward balance of $10,000. (6) The provincial corporate tax rates for income eligible for the small business deduction and income above the small business limit are 4% and 12% respectively. (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

CHAPTER 16 ¶16,850

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448

CHAPTER 16 — DISCUSSION NOTES FOR REVIEW QUESTIONS (1) Under the Canada Business Corporations Act and the corporate laws of most other provinces and territories, the paid-up capital is the ‘‘stated capital’’ as determined by the directors of the corporation under corporate law. Generally, this stated capital will be the fair market value of the consideration for which the shares were issued. However, these statutes provide that, in connection with certain non-arm’s length transactions, the corporation may establish an amount which is less than the consideration for which the shares were issued as the stated capital and such amount as so determined will then be the amount of PUC for tax purposes. (2) In certain non-arm’s length situations, the stated capital (PUC) can be set at less than the fair market value of the consideration received by the corporation. In these situations, the PUC may be kept low to avoid certain negative tax consequences under the Act. This will result in the redemption value of the shares being high to represent the value of the assets transferred and the PUC being low to avoid undesirable tax consequences. (3) The four basic components of the capital dividend account are: (a) the non-taxable portion of net capital gains; (b) capital dividends received from other corporations; (c) proceeds from life insurance policies net of their adjusted cost base; and (d) capital dividends paid, which reduce the account. (4)

UCC balance (Class 14.1) . . . . . . . . . . . . . . . . . . . . . . . . . . .

$6,000

LCP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(10,000)

Recapture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$(4,000)

Capital gain ($100,000 -- $10,000) . . . . . . . . . . . . . . . . . . . .

90,000

Taxable capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $45,000 Capital dividend account . . . . . . . . . . . . . . . . . . . . . . . . . . .

$45,000

The $45,000 added to the CDA is one-half of the economic gain of $90,000 (i.e., 1/2($100,000 -- $10,000)).

(5) The $8,000 reduction in capital will not cause a deemed dividend. However, the extra $1,000 of payment will be a deemed dividend since it is considered to be a distribution out of taxable surplus.

ITA: 84(4)

Ch. 16/Study Guide — Discussion Notes for Review Questions (6)

The three components of a distribution are:

449 ITA: 88(2)

(a) paid-up capital which is returned tax-free; (b) a capital dividend to the extent of the capital dividend account and the election of a capital dividend; and

ITA: 83(2)

(c) a taxable dividend to the extent of the balance. (7) On the winding-up of the corporation, subsection 13(21.2) does not apply. Therefore, the terminal loss will be allowed as a deduction to the corporation.

ITA: 69(5)(d)

(8) The Act provides the definition of ‘‘proceeds of disposition’’ for purposes of the calculation of capital gain or loss. The proceeds do not include the deemed dividend on the winding-up distribution. Therefore, the proceeds are calculated as the amount distributed less the deemed dividend.

ITA: 54 ITA: 84(2)

CHAPTER 16

Introduction to Federal Income Taxation in Canada

450

CHAPTER 16 — SOLUTIONS TO EXERCISES Exercise 1 Proceeds of disposition . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: adjusted cost base . . . . . . . . . . . . . . . . . . . . . . . . . . . . selling expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital gain (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

A B C $ 4,000 $ 1,000 $ 2,000 (2,000) (2,000) (2,000) (400) (100) (200) $ 1,600 $(1,100) $ (200)

Adjustment to CDA (1/2 × capital gain (loss)) . . . . . . . . . . . .

800

$ (550)

$ (100)

Exercise 2 (A) Net income for tax purposes Proceeds of disposition . . . . . . . . . . . . . . Less: ACB . . . . . . . . . . . . . . . . . . . . . . . . selling costs . . . . . . . . . . . . . . . . . . Capital gain (loss) . . . . . . . . . . . . . . . . . .

Property 1 $75,000 11,000

$110,000 86,000 $ 24,000

Property 2 $40,000 5,500

$ 11,000 45,500 $(34,500)

Taxable capital gain (allowable capital loss) . . . . . . . . . . . . . . . . . . . . . . . . .

$ 12,000

$(17,250)

(B) Adjustment to CDA (1/2 × capital gain (loss)) . . . . . . . . . . . . . . . . . . . . . . .

$ 12,000

$(17,250)

Exercise 3 (A) Where Investment Limited redeems the preferred shares, Mr. Duong will have a deemed dividend equal to: Redemption amount ............................................................................................................ $60,000 Less: PUC (800 × $15) ......................................................................................................... 12,000 Deemed dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $48,000

ITA: 84(3)

Mr. Duong will not have a capital gain on the transactions because the adjusted proceeds of disposition equals the ACB of shares as demonstrated below: Proceeds of disposition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Deemed dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$60,000 48,000

Adjusted proceeds of disposition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: ACB (800 shares × $15) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$12,000 12,000 $ 0

ITA: 84(3) ITA: 54 ‘‘proceeds of disposition’’ (j )

(B) The dividend payment of $60,000 will be a taxable dividend unless Investment Limited makes an election to treat the cash dividend as a distribution from the capital dividend account. Where this election is made, the dividend will be tax-free to Mr. Duong.

ITA: 83(2)

(C) A non-dividend distribution to Mr. Duong in excess of the PUC of the preferred shares will result in a deemed dividend of $45,000 (i.e., $60,000 -- $15,000). The PUC and the ACB of the preferred shares will be $0 following the distribution. The ACB of the shares will be reduced by the non-taxed portion of the payment of $15,000. The PUC of the shares must be reduced by the $15,000 in this case to reflect the tax-free distribution of PUC. If PUC is not reduced by $15,000 in this transaction, the full $60,000 will be treated as a deemed dividend and will be taxable as a non-eligible dividend unless the company has a GRIP balance and designates the dividend from GRIP.

ITA: 84(4) ITA: 53(2)(a)(ii) ITA: 84(4)(a)

Ch. 16/Study Guide — Solutions to Exercises

451

Exercise 4 (A) The amount of the stock dividend is $100 per share or $1,000 in total and must be grossed up and included in income of the shareholder. Thus, income would total $1,150 (1.15 × $100 × 10 shares). The dividend tax credit would be available on the $1,000 amount of the stock dividend or about $150 total (including the provincial tax effect). The adjusted cost base of the shares on the acquisition date would be $1,000 in total (i.e., $100 per share). (B) The corporation will be deemed to have paid a dividend of $1,000 for determining its dividend refund and other amounts dependent on dividends paid. (C) Proceeds of disposition (10 shares @ $10,000 FMV) . . . . . . . . . . . . . . . . . . ACB (see (A), above) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$100,000 (1,000)

Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 99,000

Taxable capital gain (potentially eligible for capital gains deduction) . . . . . . (D) (i) Redemption amount (10 shares @ $10,000) . . . . . . . . . . . . . . . . . . . . . PUC (10 shares @ $1.00) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 49,500 $100,000 (1,000)

Deemed dividend on redemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 99,000

(ii) Proceeds of disposition (above) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$100,000

Less: deemed dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Adjusted proceeds of disposition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ACB . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(99,000) $ 1,000 (1,000)

Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ITA: 84(3) ITA: 54 ‘‘proceed disposition’’ (j ) s of

Exercise 5 ITA: 84(1)

Deemed dividend PUC increase .................................................................................................................. $1,500 PUC decrease . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ( 0) $1,500 Increase in net assets .................................................................................................... (1,000) Deemed dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 500

ITA: 84(1)

This $500 deemed dividend would be added to the ACB of the preferred shares acquired by the daughter. In addition, there would be a subsection 84(3) deemed dividend on the ultimate redemption of the preferred shares as calculated below: Redemption of shares Redemption amount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . PUC — Special share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deemed dividend on redemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds of disposition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: deemed dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Adjusted P of D . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ACB — original cost ..................................................................................... $1,000 — ssec. 84(1) deemed dividend ....................................................... 500 Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$10,000 (1,500) $ 8,500 $10,000 8,500 $ 1,500

(1,500) 0

Economic consequences Redemption amount .................................................................................................... $10,000 Actual price paid.......................................................................................................... (1,000) Economic gain on issuance/redemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 9,000

ITA: 84(3) ITA: 54 ‘‘proceeds of disposition’’ (j )

ITA: 53(1)(b)

CHAPTER 16

(a) This transaction would cause an immediate deemed dividend of $500 since the daughter could immediately retract the shares and receive $1,500 tax free whereas the price paid for the shares was only $1,000.

Introduction to Federal Income Taxation in Canada

452

Tax results: Deemed dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deemed dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total gain taxed ($10,000 -- $1,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 500 8,500 $ 9,000

ITA: 84(1) ITA: 84(3)

(b) Y has received $2,000 more in consideration than the cancelled debt (i.e., $2,000 + $20,000 versus $20,000); therefore, Y will have an income inclusion of: PUC increase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net asset increase ($20,000 -- $20,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deemed dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$2,000 $ 0 $2,000

The cost of the shares is $0 since the $20,000 cash cancelled the debt; however, there will be an increase in ACB equal to the deemed dividend of $2,000. Following the transaction and the deemed dividend, the PUC and the ACB of the shares will be $2,000.

ITA: 84(1)

ITA: 53(1)(b)

(c) (i) Since the payment of $5,000 is less than the PUC of the outstanding share(s) (i.e., $10,000), there are no immediate tax consequences because this payment is a return of the original investment in the corporation with tax-paid funds. However, the adjusted cost base of the shares is reduced to $15,000 (i.e., $20,000 -- $5,000) by the amount of the return of capital which would result in a potential higher capital gain on the ultimate disposition of the shares.

ITA: 53(2)(a)(ii)

Deemed dividend $10,000 PUC before distribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . PUC after distribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,000) PUC decrease (not an increase) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,000 Adjusted cost base ACB prior to distribution ..................................................................................... $20,000 Distribution amount ............................................................................................. (5,000) New ACB ............................................................................................................... $15,000

ITA: 84(1)

(ii) Since the payment of $18,000 exceeds the PUC of the outstanding share(s), there will be a deemed dividend of $8,000. However, the ACB of the share(s) will only be reduced by the nontaxed portion of the payment to $10,000. Following the transaction and the deemed dividend, the PUC of the shares will be $0 and the ACB of the shares will be $10,000.

ITA: 84(4)

Exercise 6 (A) Funds available for distribution to shareholder (including non-eligible RDTOH) Less: paid-up capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deemed dividend on winding-up . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$1,000,000 (625,000) $ 375,000

Less: capital dividend elected . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable dividend (sufficient to clear non-eligible RDTOH) . . . . . . . . . . . . . (B) Taxable capital gain (allowable capital loss) to Mr. Siewert: Proceeds on winding-up . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(150,000) $ 225,000

Less: deemed dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds of disposition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ACB . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable capital gain (1/2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(375,000) $ 625,000 (350,000) $ 275,000 $ 137,500

ITA: 84(2) ITA: 83(2), 88(2)(b)(i)

$1,000,000

If the shares are qualified small business corporation shares at the time of disposition, Mr. Siewart could use any available capital gains deduction to shelter the taxable capital gain from tax.

ITA: 54 ‘‘proceeds of disposition’’ (j )

Ch. 16/Study Guide — Solutions to Exercises

453

Exercise 7 Deemed taxable dividend to shareholder: Funds available for distribution ................................................................................... 30,000 Less: paid-up capital ...................................................................................................... (2,000) Deemed dividend on winding up ................................................................................. 28,000 Less: capital dividend elected ....................................................................................... (4,500) Deemed taxable dividend (sufficient to clear non eligible RDTOH) ......................... 23,500 Taxable capital gain to shareholder: Proceeds on winding-up ............................................................................................... 30,000 Less: Deemed dividend ................................................................................................ (28,000) Proceeds of disposition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,000 Cost .......................................................................................................................... (2,000) Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — Taxable capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

—

Net Cash Retained: Cash distribution......................................................................................................... $30,000 Tax on non-eligible dividend (23,500 @ 42.5%*) .................................................... (9,988) After-tax cash ................................................................................................................ 20,013 * (1 + .15) × 50% -- .15 = 42.5%

Exercise 8 Assess the Situation 1. Draw a diagram identifying all stakeholders and their relationships, e.g., corporate org charts

— Mr. Warren owns 100% of the company so they are related and affiliated — Purchaser is not related 3. Identify the profile of each stakeholder, e.g., tax features, risk profile — Mr. Warren — An individual resident in Canada (since Dwight Limited (DL) is a CCPC) — Planning to sell the assets of DL in January 2024 and wind up the company — ACB in DL shares is $1K — Dwight Limited — CCPC (given) — PUC of shares is $2K, non-eligible RDTOH $10K, no capital dividend account or general rate income pool — Purchaser — A corporation

CHAPTER 16

2. Identify the relationships among the stakeholders, e.g., related, affiliated, associated, connected

Introduction to Federal Income Taxation in Canada

454 4. Understand the decision maker and their objectives

— Mr. Warren wants to sell the assets in DL and pay off the liabilities — He wants to know how much after-tax cash will be in the company after the sale — He wants to know how much tax he will pay on a wind up of DL — He wants to know if there are HST implications on the asset sale 5. Identify the relevant past transaction/events or planned future transactions/events and create a timeline — DL will sell its assets, pay off its liabilities on January 1, 2024 — Planning transaction to potentially wind up the company following the asset sale.

Identify the Issues 1. Identify all of the major tax issues and any non-tax issues Issue 1 Discuss the tax treatment (income tax and HST) of an asset sale and impact on tax accounts of the corporation Quantitative: After-tax cash in DL after selling the assets and paying off the liabilities? Issue 2 Discuss the tax treatment of a wind up of DL to the corporation and to Mr. Warren Quantitative: After-tax cash available to Mr. Warren on winding up the company? 2. Identify missing information or assumptions made Assume that Mr. Warren will have other income in 2024 so that any income from the wind up of DL will fall into the highest tax bracket.

Analyze the Issues 1. Identify and perform the qualitative analysis of the transactions and plans including an analysis of the applicable provisions of the Act Issue 1 Discuss the tax treatment (income tax and HST) of an asset sale and impact on tax accounts of the corporation ●

●

There is a disposition of the properties sold for tax purposes which will result in taxable income in DL. The taxable capital gains/losses on disposition will result in additions to the capital dividend account and the non-eligible RDTOH balances for the company. The proceeds will be used to pay the company’s liabilities including the tax on the disposition of the assets. What remains will be available for distribution to Mr. Warren. The distribution of net proceeds as a taxable dividend will result in a refund of RDTOH to the corporation which can also be distributed to Mr. Warren. Where a corporation sells assets, the sale would be a sale of taxable supplies subject to GST/HST. GST/HST is payable on any taxable supplies of property. All of DL’s assets would be taxable supplies with the exception of the cash. However, a s. 167 election may be available, in which case the payment of GST/HST is not required. In order to qualify, a business established or carried on by the corporation (DL), must be acquired by a recipient who is a registrant. The recipient must acquire ownership or use of all or substantially all of the property needed for the recipient to carry on the business. The purchase of the assets by the unrelated purchaser appear to meet those requirements. A joint GST 44 election must be filed by the recipient by the due date of the HST return for the period of the supply.

Ch. 16/Study Guide — Solutions to Exercises

455

Issue 2 Discuss the tax treatment of a wind up of DL to the corporation and to Mr. Warren ●

●

If DL is to be ‘‘wound up’’ s. 84(2) applies. While s. 88(2) does apply, the assets have already been sold so there are no assets remaining to be deemed to be disposed of; the only asset is cash. 88(2) applies to a Canadian corporation where all or substantially of the property owned of a corporation is distributed to the shareholders on wind up. The shares will disappear along with the company. As a result, the wind up is treated like a redemption since the funds are coming from the company to Mr. Warren. As a result, there will be a deemed dividend [84(2)] and a capital gain or loss [84(9)] on the wind up.

Income ABI $ 20,000 40,000 140,000 $200,000 13% 26,000

AII

CDA —

$ 10,000

$ 15,000 27,500

$15,000 27,500

50,000 $ 92,500 502/3% 46,867

50,000

$92,500

28,367 $ 38,367 / 381/3% $100,087(7)

Calculate the components of the distribution Deemed Dividend (B) Funds available for distribution ................................................................................ $660,500 Less: paid-up capital .................................................................................................. (2,000) Deemed dividend on winding-up .............................................................................. $658,500 Less: capital dividend elected ................................................................................... (92,500) Deemed taxable dividend (sufficient to clear non-eligible RDTOH) ...................... $566,000 Taxable capital gain to shareholder: (C) Proceeds on winding-up ............................................................................................ $660,500 Less: deemed dividend .............................................................................................. (658,500) Proceeds of disposition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,000 Cost....................................................................................................................... (1,000) Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,000 Taxable capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 500 Calculate the tax cost and after-tax cash to Mr. Warren personally (D) Cash distribution ....................................................................................................... $660,500 Tax on non-eligible dividend ($566,000 @ 42.5%*).............................................. (240,550) Tax on taxable capital gain 50.0% ............................................... (250) After-tax cash ............................................................................................................. $419,700 *(1 + .15) × 50% -- .15 = 42.5%

CHAPTER 16

Proceeds Opening balance . . . . . $ 20,000 Cash . . . . . . . . . . . . . . Inventories . . . . . . . . . 220,000 Land(1) . . . . . . . . . . . . 70,000 Goodwill(2) . . . . . . . . . 55,000 Equipment(3) . . . . . . . . 80,000 Building(4) .................................. 300,000 $745,000 Liabilities . . . . . . . . . . . (50,000) Income taxes(6) . . . . . . (72,867) $622,133 Dividend Refund Available(6) . . . . . . . . . 38,367 $660,500

Non-eligible RDTOH

Introduction to Federal Income Taxation in Canada

456

3. Identify any risks including missing information, assumptions and uncertain research positions No additional items noted. 4. Reach a conclusion on each issue If Mr. Warren sells the assets for the amounts specified and subsequently winds up the company he will have personal after-tax cash of $419,700 to invest personally. If he does not wind up the company, he will still be able to withdraw the PUC ($2,000) and CDA ($92,500) tax free. He will also be able to access the $38,367 of non-eligible RDTOH on the payment of a dividend of $100,087 ($38,367/381/3%). Since his personal tax rate on this non eligible dividend of 42.5% is greater than the dividend refund rate of 38 1/3% he could wait until he is in a lower personal tax bracket before paying this dividend. If he doesn’t wind up, he will be able to defer the personal tax of $240,550 on the winding-up dividend and $250 of personal tax on the taxable capital gain. 5. Evaluate the strengths/weaknesses/risks of your conclusions — No weaknesses identified.

Advise/Recommend Advise the decision maker, integrating your conclusions on each of the issues with their objectives, giving priority to the most important issues Mr. Warren could consider deferring the wind up of the corporation until he is taxed in a lower tax bracket. In the meantime he could pay out tax free distributions of $94,500 and taxable dividends of $100,087 with a low overall tax cost after the refund of non-eligible RDTOH to the corporation. — NOTES TO SOLUTION (1)

Proceeds on sale of land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 70,000 Cost .........................................................................................................................(40,000) Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 30,000

Taxable capital gain ( /2 × $30K) (aggregate investment income) . . . . . . . . .

$ 15,000

Capital dividend account ( /2 × $30K) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 15,000

Proceeds on sale of goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 55,000 $ 0

Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 55,000

Taxable capital gain (1/2 × $55K) (aggregate investment income) . . . . . . . . .

$ 27,500

(2)

Capital dividend account ( /2 × $55K) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 27,500

(3)

Recapture (UCC $40K less LCP $80K) — fully accounts for gain (business income)

$ 40,000

(4)

Recapture (UCC $60K less LCP $200K) (business income) ................................ $140,000

Taxable capital gain (1/2 × ($300K -- $200K)) (investment income) . . . . . . .

$ 50,000

Capital dividend account ( /2 × ($300K -- $200K)) . . . . . . . . . . . . . . . . . . . .

$ 50,000

(5)

The $500,000 business limit for the small business deduction must be prorated for the number of days in the taxation year. Since the winding-up may take some time to complete, this solution assumes that the corporation maintains its eligibility for the small business deduction in the year in which the sale of assets occurs. In this case, there would be no need to bonus down to the business limit for the small business deduction, given active business income of $200,000. (6)

Income taxes 13% × ABI ($200,000) ............................................................................. $26,000 502/3% × investment income ($92,500) . . . . . . . . . . . . . . . . . . . . . 46,867

$ 72,867

Refundable Part I tax (30 /3% of $92,500) . . . . . . . . . . . . . . . . . . .

$ 28,367

(7)

Assumes a minimum $100,087 (i.e., $38,367/381/3%) is to be distributed as a taxable dividend to produce a refund of the non-eligible RDTOH.

IT-73R6, par. 9

Ch. 16/Study Guide — Solutions to Exercises

457

Exercise 9 Capital dividend account: 1 P of D . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 8,000 Less: ACB ............................................................................. $(4,000) Selling costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (700) Capital gain (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,300

2 $ 2,000 $(4,000) $ (100) $(2,100)

3 $ 4,000 $(4,000) $ (300) $ (300)

Adjustment to capital dividend account (1/2 × capital gain (loss)) . . . . . . . . . . . . . . . . . . . . . . . $ 1,650

$(1,050) $ (150)

Exercise 10 Tax Treatment to Mr. A There is a deemed disposition at the FMV of the land when gifted to the corporation. A capital gain of $30,000 would be triggered on the transfer to be reported as a $15,000 taxable capital gain on A’s personal tax return. Tax Treatment to A Ltd. The corporation would acquire the land with an adjusted cost base of $150,000. The withdrawal of this contributed surplus can only be in the form of a taxable dividend subject to the gross-up and tax credit mechanism. The Act permits the capitalization of contributed surplus into PUC as long as the ITA: 69(1), 84(1)(c.3) amount did not arise under one of the corporate tax-free rollover provisions, discussed in the next few chapters. The contributed surplus must have arisen on the acquisition of property by the corporation for no consideration from a person who held any of the issued shares for the corporation. Legal documentation to convert the contributed surplus to stated capital of a class of shares of the corporation would need to be prepared. Following the capitalization, the amount could be withdrawn tax free as a paid up capital distribution. Financial Reporting in A Ltd’s Financial Statements

Note that the tax cost of the land to the corporation will be $150,000 and the accounting cost will be $120,000. If the company is using the future taxes method of accounting for income taxes, the difference will be a temporary deductible difference and result in a future tax asset of $7,600 ($30,000 × 50.67% × 1/2 capital gains inclusion rate).

CHAPTER 16

This is a non-monetary transaction that is scoped out of ASPE 3831 (non-monetary transactions) as a related party transaction. A is a related party under ASPE 3840 as A is the sole shareholder who controls the company and this is a related party transaction that does not involve a financial instrument (just land) under ASPE 3840. The transaction is not in the normal course of operations supported by ASPE 3840.27. There is no substantive change in ownership interest as the shareholder owns the land both before the transaction and afterwards through a corporation A controls. The transaction should be measured at the carrying amount. Debit land and credit contributed surplus for $120,000.

Chapter 17 Tax Deferred Transactions: Section 85 Rollover on a Transfer to a Corporation, Section 86, Estate Freeze Transactions, Amalgamations and Wind Ups

CHAPTER 17

459

460

Introduction to Federal Income Taxation in Canada

Ch. 17/Study Guide — Learning Chart

461

CHAPTER 17 — LEARNING CHART Problem Descriptions Textbook Example Problems 17-1 Elected amounts — 85(1) 17-2 Consideration received — 85(1) 17-3 PUC of shares received — 85(1) 174 Comprehensive — 85(1) 17-5 Reorganization of capital 17-6 Reorganization of capital 177 Section 84.1 Exercises 1 2 3 4 5 6 7 8 9 10 11

Elected amount, income, non-share consideration 85(1) Cost and PUC of consideration 85(1) Comprehensive 85(1) Comprehensive 85(1) Non-arm’s length sale of shares 84.1 Sale of shares by a corporation 55(2) Section 85: Transfer of a business to a corporation Section 55(2) Reorganization of capital Amalgamation wind-up Section 86 Reorganization of capital

CHAPTER 17

Assignment Problems 1 Section 85 elected amounts 2 Transfer of assets to a corporation 85(1) 3 Transfer of assets to a corporation, sell or redeem shares 85(1) 4 Financial reporting (ASPE) for Problem 4 5 Transfer of assets to a corporation 85(1) 6 Transfer of assets to a corporation 85(1) 7 Transfer of shares to a corporation 84.1 8 Capital reorganization — Section 86 9 Amalgamation vs wind up 10 Estate planning — Sections 85, 86, 84.1 11 Estate planning — Extension of Problem 10 12 Sale of shares by corporation

462

Introduction to Federal Income Taxation in Canada

Ch. 17/Study Guide — Review Questions

¶17,800

463

REVIEW QUESTIONS

(1) In tax terms, what does the word ‘‘rollover’’ mean and how does it impact on both the transferor and the transferee? (2) When using section 85, the elected price is very important since it is used in the determination of four things that arise on the transfer. What are they? (3) Since the tax value and the fair market value are usually fiXed, what is the one decision variable that you can use that will have an effect on the limits of the elected transfer price range? (4) When using section 85, what is the maximum amount of boot that should be taken in order to maximize the deferral? (5) How is the cost of the consideration taken back by the transferor in a section 85 transfer determined?

ITR: 1100(2)

(6) Using section 85, what is the amount that determines how much the transferor can withdraw from the company on a tax-free basis? (7) Ms. Wong has decided to transfer some portfolio shares to her wholly owned company in exchange for more shares of the company. The shares have a cost of $5,000 and a fair market value of $9,000. She plans to elect at $8,000 and take back shares with a PUC and redemption amount of $9,000. What are the tax consequences to Ms. Wong and her company? (8) If the optimal value of the boot is equal to the tax value of the property transferred under section 85, what will the ACB and PUC of the shares taken back be? (9) Given that FMV is often not easily arrived at when transferring assets under section 85, what protection can you use to avoid a one-sided adjustment by the CRA if their value is different than yours? (10) What legal documents need to be filed in order to accomplish a reorganization of capital rollover? (11) What are some of the occasions in which a reorganization of capital rollover might be used? (12) When does a deemed dividend arise and what adjustments are the result of a deemed dividend arising on a reorganization of capital? (13) Legally, what happens to two corporations that are amalgamated? (14) At the time of amalgamation there is a deemed year end for tax purposes. What are some of the other tax rules that are impacted by this deemed year end? (15) In order for the subsidiary wind-up rollover to apply, what ownership criteria need to be met? (16) Ms. Sweeney purchased 1,000 convertible preferred shares at a total cost of $10,000. These shares gave her the right to convert each preferred share into two common shares. She exercised her conversion right at a time when the common shares were trading at $10 each. What is the ACB of her new common shares? (17) What is the primary purpose of an estate freeze?

CHAPTER 17

(18) What might be some of the secondary objectives of an estate freeze? (19) What are the three principal methods of freezing the value of growth assets? (20) What are the basic steps involved in a Holdco freeze? (21) What is the purpose behind section 84.1? (22) Mr. Blythe got a good deal a few years ago on the shares of a company that he just bought. He paid $10,000 for the shares even though the PUC of the shares is $100,000. Today the company is worth $100,000 again thanks to his hard work. Mr. Blythe has never used his QSBC share capital gains exemption. How can he get money out of the company without paying any personal tax?

¶17,800

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464

¶17,825

EXERCISES

Exercise 1

ITA: 85(1), 85(5.1)

Consider the following cases involving the transfer of capital assets to a corporation for consideration including both common shares and boot.

Fair market value . . . . . . . . . . . Adjusted cost base . . . . . . . . . . Capital cost . . . . . . . . . . . . . . . UCC of class . . . . . . . . . . . . . . . FMV of class . . . . . . . . . . . . . . . Boot . . . . . . . . . . . . . . . . . . . . .

$120 N/A 100 200 170 150

$100 75 N/A N/A N/A 200

$ 80 N/A 100 50 110 80

$100 75 N/A N/A N/A 50

$110 N/A 100 150 140 80

$100 75 N/A N/A N/A 90

$ 80 N/A 100 50 110 20

— REQUIRED (A) Compute the minimum elected amount possible given these data. (B) Compute the effects on income given these data. (C) Indicate the maximum boot that should be taken in each case to maximize the deferral of taxation.

Exercise 2

ITA: 85(1), 85(2.1)

Dee transferred capital property to Dee Ltd. The capital property had an adjusted cost base of $5,000 and a fair market value of $10,000. Dee could receive any of the following packages of consideration:

Notes at fair market value . . . . . . . . . . . . . . . Preferred shares at fair market value and LSC Common shares (LSC) . . . . . . . . . . . . . . . . . .

$5,000 4,500 500

$2,500 7,500 —

$4,000 — 6,000

— REQUIRED (A) Given an elected amount of $5,000, what would be the cost of each item of consideration under each possible package of consideration? (B) What will be the PUC for tax purposes under each possible package of consideration?

Exercise 3 Last year Mr. Good, age 50, purchased a business location including land for $350,000 and a brick building for $909,341. He operated the business as a sole proprietorship for a year taking maximum capital cost allowance on the building. On your advice, this year he incorporated the business using section 85 to transfer the land and building to the corporation without triggering any of the gain that had accrued on these assets during the year. The following is a summary of the transfer under section 85. Consideration

Land . . . . . . . . . . Building (UCC)

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Tax value

FMV

Elected amount

Assumed mortgage

New debt

Common shares

$ 350,000 827,500

$ 575,000 925,000

$ 350,000 827,500

$350,000 497,500

$ 0 330,000

$225,000 97,500

$1,177,500

$1,500,000

$1,177,500

$847,500

$330,000

$322,500

ITA: 13(7)(e), 84(3), 85(1), 85(2.1), 110.6

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— REQUIRED (A) What are the tax consequences of electing a transfer price of $1,177,500 as indicated? (B) (i) Compute the cost of the consideration received from the corporation. (ii) Compute the PUC for tax purposes of the common shares. (C) (i) What are the tax consequences to Mr. Good if the corporation redeems the debt issued by the corporation for $330,000 and he sells his common shares in the corporation for $425,000? (ii) What are the tax consequences to Mr. Good if the corporation redeems the common shares for $425,000?

Exercise 4

ITA: 22, 85

Mrs. Designer has provided you with the following balance sheet and additional information relative to her unincorporated ladies’ fashion business. Mrs. Designer (A Proprietorship) BALANCE SHEET May 31, 2023 Current Assets Current Liabilities Cash . . . . . . . . . . . . . . . . . . $ 4,000 Accounts payable . . . . . . . . $ 14,000 Investments . . . . . . . . . . . . 10,000 Mortgage payable (current) 16,000 Accounts Receivable................ $ 12,000 Total Current Liabilities $ 30,000 Allowance for Doubtful Mortgage payable . . . . . . . . $360,000 Account . . . . . . . . . . . . . -2,000 10,000 Net current . . . . . . . . . . . . -16,000 344,000 Inventory . . . . . . . . . . . . . . 5,000 Proprietor’s Equity . . . . . . . 47,500 Prepaids . . . . . . . . . . . . . . . 500 Total Liabilities & Total Current Assets . . . . $ 29,500 Equity . . . . . . . . . . . . . . . . $421,500 Building . . . . . . . . . . . . . . . 580,000 Accumulated Depreciation -418,000 162,000 Land . . . . . . . . . . . . . . . . . 230,000 Total Assets . . . . . . . . . . . $421,500 Additional Information (1) Income for tax and financial accounting purposes have always been the same. (2) The UCC of the building is equal to the net book value of $562,000. (3) The proprietorship began to carry on business about seven years ago. (4) The May 31, 2023 fair market value of various assets owned by the proprietorship are: Short-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,000 Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,000 Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25,000 Prepaid insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500 Building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 560,000 Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 226,500 Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144,000 970,000

CHAPTER 17

Effective June 1, 2023, Mrs. Designer wants to transfer her business assets to a corporation (HiFashion Co. Ltd.) in which her husband owns 100% of the common shares. She has indicated that, provided the company assumes the business debts, she would receive the balance in debt and preferred shares (stated value $100) as full consideration. — REQUIRED (A) Determine which assets should not be transferred to the corporation under section 85 and those that should not be transferred at all and give reasons. (B) Determine the amounts to be elected on the various assets to avoid any taxes. (C) Determine the consideration to be received without any tax consequences. (D) Determine the adjusted cost base of the consideration in part (C), above.

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466 (E) Determine the tax PUC of the preferred shares received. Ltd.

(F) Determine the cost/capital cost of the transferred assets for the corporation, Hi-Fashion Co.

Exercise 5

ITA: 84(3), 84.1, 85

Mr. Newberry, age 45 and a Canadian resident, owned all of the common shares with a paid-up capital value and cost of $75,000 in an operating company, Opco Ltd. Mr. Newberry started Opco Ltd. in 2004 and has been actively involved in operating the business since inception. He transferred these shares under section 85 to a company, Broco Ltd., owned by his brother at a time when the value of the Opco Ltd. shares was $800,000. As consideration for the shares transferred he received a note with a principal amount of $500,000 and non-voting preferred shares with a paid-up capital and fair market value of $300,000 such that an elected amount of $500,000 was possible under section 85. Mr. Newberry offset all of the resultant $425,000 of capital gain with his available QSBC share capital gains exemption. Both Opco Ltd. and Broco Ltd. are Canadian-controlled private corporations. — REQUIRED (A) What are the tax consequences of the transfer to Mr. Newberry? (B) What are the tax consequences if the preferred shares received from his brother’s corporation are redeemed by that corporation for their fair market value? (C) What are the tax consequences if the preferred shares are sold in an arm’s length transaction for their fair market value?

Exercise 6

ITA: 55(1)–(6)

Vendco Ltd. owns all of the shares of Preyco Ltd. The shares of Preyco have a total adjusted cost base of $100,000 and a fair market value of $1,000,000. Since its incorporation in 2009, Preyco has realized and retained $700,000 of income and has no refundable taxes. Vendco wishes to sell its shares in Preyco to Purchco. It causes Preyco to borrow $900,000 from the bank and to pay a dividend on its shares of $900,000. This reduces the fair market value of Preyco’s shares to $100,000 and Purchco buys the shares for this amount. — REQUIRED What are the tax consequences of these transactions?

Exercise 7 Beamen Laiken Retail Emporium has been operated as a sole proprietorship since 2009. The following are the balance sheet items for the retailing operations as at August 31, 2023, its fiscal year end:

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Marketable securities . . . . . . . . . . . . . . . . . . . . . . Accounts receivable (net of $5,000 reserve) . . . . . Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . . Land at cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . Building, at UCC (capital cost: $650,000) . . . . . . . FiXtures, at UCC (capital cost: $113,000) . . . . . . . Intangible assets (Class 14.1) (cost: $25,000) . . . .

Tax value $ 4,000 23,000 32,000 75,000 2,000 360,000 590,000 68,000 6,000 1,160,000 $

Fair market value $ 4,000 15,000 35,000 72,000 2,000 435,000 680,000 30,000 24,000 1,297,000 $

Beamen wishes to incorporate this business and have the corporation assume $65,000 in liabilities of the business. He will be the only shareholder of the corporation. — REQUIRED (a) Indicate, with a brief explanation: (i) which assets cannot or should not be transferred to the corporation under ss. 85(1), and (ii) which assets should not be transferred at all to the corporation. (b) Determine the amounts to be elected on the various assets to avoid any taxes.

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(c) Determine the consideration (rounded to the nearest $100) to be received without any tax consequences. (d) Determine the adjusted cost base of the consideration received. (e) Determine the tax PUC of the shares received.

Exercise 8 Aaron Chui owned some Class A preferred shares of a corporation that reorganized its capital structure. He exchanged all these shares which had an adjusted cost base and paid-up capital of $20,000 and a fair market value of $30,000 for the following consideration: Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6,750 Fair market value of Class B preferred shares (LSC: $10,000) .......................... 17,550 Fair market value of common shares (LSC: $3,250) . . . . . . . . . . . . . . . . 5,700 — REQUIRED What are the tax consequences to Mr. Chui as a result of this exchange?

Exercise 9 M&M Limited owns all of the shares of Acme Limited. The cost of the shares to M&M was $750,000 and they now have a fair market value of $1,000,000. Acme’s only asset is land which cost it $500,000. The land had a fair market value of $700,000 when the shares of Acme were purchased by M&M and the land now has a fair market value of $1,000,000. — REQUIRED Determine the income tax consequences to M&M Limited and Acme Limited of using either an amalgamation or a winding-up of a subsidiary to combine.

Exercise 10 Ichbin Verblonget owns the common shares of Verblonget Ltd. The shares have a PUC and adjusted cost base of $1,000 and a fair market value of $10,000. Mr. Verblonget wants to effect a reduction in the value of the common shares and has caused the corporation to undertake a capital reorganization. The corporation will exchange the common shares for the following package of consideration: Cash (at FMV) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 100 Preferred shares (at FMV) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,900 Common shares (at FMV) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,000 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 10,000 — REQUIRED Determine the tax consequences to Ichbin Verblonget as a result of the capital reorganization.

Exercise 11 Sell Ltd., a CCPC, owns 100% of the shares of Target Ltd. (a CCPC). The shares of Target Ltd. have appreciated greatly in value since Target Ltd. was incorporated by Sell Ltd. A large part of the share appreciation is attributed to land that has tripled in value since Target Ltd. acquired it. An arm’s length company, Acquisition Corporation, has offered to purchase 100% of the shares of Target Ltd. from Sell Ltd. for a purchase price equal to fair market value.

CHAPTER 17

In the course of these acquisition discussions, Sell Ltd. causes Target Ltd. to pay Sell Ltd. a dividend equal to the accrued capital gain on Target Ltd.’s shares. Acquisition Ltd. then buys 100% of the Target Ltd. shares for a price equal to Sell Ltd.’s adjusted cost base of the Target Ltd. shares. — REQUIRED Part A

What tax advantage was Sell Ltd. attempting to realize by causing Target Ltd. to pay the dividend?

Part B

EXplain how ss. 55(2) could act to minimize the tax advantages of the above transactions and what additional information you would require to determine the tax consequences to Sell Ltd. resulting from the above series of transactions?

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ASSIGNMENT PROBLEMS

Problem 1

ITA: 85(1)

The following assets are to be transferred under section 85 for consideration including common shares plus boot as indicated below. Fair market value

ACB/ Capital cost

UCC

Land . . . . . . . . . . . . . . . .

$175,000

$160,000

—

Marketable securities . . . .

65,000

55,000

—

Building* . . . . . . . . . . . . .

495,000

485,000

$470,000

Equipment . . . . . . . . . . . .

50,000

65,000

40,000

Furniture and fiXtures . . .

10,000

15,000

7,000

Licence** . . . . . . . . . . . . .

100,000

82,500

60,000

* Only asset in class. ** Indefinite life.

For each of the assets transferred: A. Assess whether they qualify for transfer under section 85. B. Determine the minimum possible elected amounts. C. Compute the effects on income. D. Indicate the maximum non-share consideration (boot) that can be taken and not create any income. E. Determine what would happen if the non-share consideration on the land was $170,000 and on the equipment was $45,000. Use the following format:

Consideration

Asset

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Tax Value

FMV

Elected Amt

New Debt

Pref Shares

Income

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Problem 2

ITA: 85(1)

Peter Henry is a Canadian resident who owns all the shares of The Resurface Shop Inc. (Resurface). He has been operating successfully for the past ten years but is finding that increasingly there are more lawsuits against contractors in his industry. While they do have product liability insurance to cover claims, Peter is concerned that, as the amount of the awards increase, a lawsuit might threaten the equity he has built up in the assets, particularly the land and building, and may even put him out of business. A friend told him that he should transfer the business assets and liabilities, other than the land, building and mortgage, to a new subsidiary corporation, Paintshop Inc. (Paintshop), and then use Resurface as a holding company to accumulate assets. Peter would like your advice on this proposal or other ideas you might have. Resurface has the following assets and liabilities: Book Value

Tax Value

Fair Market Value

Cash . . . . . . . . . . . . . . . . . . . . . . . .

$220,000

$ 220,000

Inventory . . . . . . . . . . . . . . . . . . . . .

440,000

395,000

Furniture and fiXtures . . . . . . . . . . .

120,000

60,000

80,000

Building . . . . . . . . . . . . . . . . . . . . . .

750,000

450,000

1,550,000

Land . . . . . . . . . . . . . . . . . . . . . . . .

80,000

1,300,000

Goodwill . . . . . . . . . . . . . . . . . . . . .

800,000

Accounts payable . . . . . . . . . . . . . . .

(250,000)

Bank loan . . . . . . . . . . . . . . . . . . . .

(300,000)

Mortgage payable . . . . . . . . . . . . . . .

(180,000)

Before your next meeting with Peter you want to: (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend. (E) Discuss the GST/HST implications on the transfer, including any elections that may be used to reduce the GST/HST implications (Optional). ITA: 84(3), 85

Ms. Hart, age 45, has just met with you to talk about incorporating her business and having her husband participate in its future growth in value. She is a Canadian resident and has provided you with the balance sheet and additional information concerning her unincorporated active technology accessories business. She has picked November 10, 2023 as the date when she wishes to transfer all of her business assets and liabilities to a newly incorporated corporation (Hart Ltd.) in which her husband owns 100% of the common shares. She wants your advice on how to do this with the minimum amount of personal tax and would like to understand her GST/HST obligations (optional). Mr. Hart is also a Canadian resident.

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CHAPTER 17

Problem 3

Introduction to Federal Income Taxation in Canada

470

The following financial information concerning the business as of November 10, 2023, has been provided: Tax value

Fair market value

Shares in public companies (note 1) . . . . . . . . . .

$ 11,000

Accounts receivable (net allowance) (note 2) . . .

13,000

10,000

Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

38,000

59,000

Land (held as inventory) . . . . . . . . . . . . . . . . . . .

400,000

520,000

Prepaid property insurance . . . . . . . . . . . . . . . . .

600

Building (Class 1, cost $690,000) . . . . . . . . . . . . .

670,000

1,150,000

Land (capital property) . . . . . . . . . . . . . . . . . . . .

340,000

660,000

Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

180,000

6,000

Additional Information: 1. The shares are capital property to Ms. Hart. She owns less than 1% of each public company. 2. The tax reserve for doubtful debts taken in the previous year was $1,000. The original cost of the accounts receivable before deducting the reserve was $14,000. 3. The unincorporated business has liabilities of $360,000 which are to be assumed by Hart Ltd. Ms. Hart has specifically asked you to provide her with a tax-effective plan to achieve her objectives. She has heard that she will have to receive some preference shares as consideration so she wants to know the tax consequences if she sells these shares or has the company buy them back at a later date. For the next meeting you agree that you will: (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

Problem 4 (Continuation of Problem 3) Referring back to Problem 3, assume the following. The cost of the building is $690,000 and the UCC is $670,000 according to Ms. Hart’s personal tax return at December 31, 2022. The accumulated depreciation for the building reported in her financial statements for the proprietorship for December 31, 2022 is $314,400. Mr. Hart is electing to use the Future Income Taxes method of accounting for income taxes for Hart Ltd. The combined corporate tax rate for Hart Ltd. will be 13% for income eligible for the small business deduction, and 27% for income above the small business deduction limit. Part A For the assets to be transferred by Ms. Hart to Hart Ltd. on November 10, 2023, prepare the financial reporting entries to report the acquisition of the property transferred to the corporation and the issuance of her preferred shares. Part B If a $10,000 dividend is paid on the preferred shares during the corporation’s first taxation year end, prepare the accounting entry for the dividend. What impact will the financial reporting for this dividend have on the corporate tax return for the year and how will it be taxed on Ms. Hart’s personal return for the year.

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Ch. 17/Study Guide — Assignment Problems

471

Part C Prepare the accounting entry for the corporation to report a future redemption of the preferred shares.

Problem 5 Tse Enterprises Ltd. (TEL) has carried on a retail business for about 20 years. Joe Tse, age 55, acquired all 100 common shares of TEL on incorporation and paid $1 each for these shares. On November 30, 2023 Joe intends to have TEL transfer its business assets and liabilities to a new corporation, TSE Inc. (TSE), in which he wants to have control. Three of his four children, all in their 20s, are active in the business and have each already subscribed for 100 common shares of TSE at $1 per share. Joe wants to make sure he can still earn income for his retirement, even if the business doesn’t prosper under the management of his children. In particular, he wants to keep the land and building in TEL so he can earn rental income and reduce the amount that TSE owes TEL. TEL has $3,000 of net capital losses that he would like to use on the transfer. The following is the projected balance sheet of TEL and certain additional information: Projected Balance Sheet Nov 30, 2023

Assets

Projected Fair Market Value Nov 30, 2023

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 12,000

Accounts receivable (Net of $10,000 allowance) . . . . .

110,000

102,000

Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

90,000

100,000

Shares of Supplyco Ltd.(1)

.................... .

36,000

40,000

Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

196,000

203,000

Buildings(2)

348,000

844,000

72,000

60,000

—

90,000

................................

Equipment(2)

...............................

Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 864,000

12,000

$1,451,000

Liabilities(3) Bank loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 30,000

Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . .

31,000

Accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6,000

Mortgage on land and building . . . . . . . . . . . . . . . . . .

384,000

CHAPTER 17

$ 451,000 Common Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

100

Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . .

412,900 $ 864,000

Notes to Balance Sheet (1) These shares represent a 2% ownership in the common shares of Supplyco Ltd. which is a small business corporation.

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472 (2)

FiXed assets are recorded at original cost less accumulated financial accounting depreciation. No single piece of equipment is worth more than its cost. Tax data follow: Original cost

UCC

$395,000 110,000

$342,000 57,000

Buildings . . . . . . . . . . . . . . . . . . . . . . . . . Equipment . . . . . . . . . . . . . . . . . . . . . . . .

(3) Liabilities are to be assumed by the corporation. In addition, TEL will receive as consideration for the transfer of assets the maximum in notes payable that it can receive without negative tax consequences plus voting retractable preferred shares.

Joe would like your advice on the transfer of the assets of TEL to TSE, including the consideration he should receive. His controller also wants to know what the tax values of the assets will be in TSE. Before you meet with Joe you want to: (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

Problem 6

ITA: 85

Mr. Schminkie, age 45, the sole proprietor of a small manufacturing business wishes to have his wife involved in the business on an equal basis. Mr. Schminkie’s barber advised him that this is possible by incorporating a company and having Mr. and Mrs. Schminkie, age 44, subscribe for all the common shares equally. Then, Mr. Schminkie could transfer all the assets of the business to the newly formed company, taking back Class A and Class B non-voting preference shares as consideration. Mr. Schminkie thought this was a wonderful idea and proceeded with incorporating the company. The assets and liabilities of the proprietorship and certain additional information are provided as follows:

Assets

Balance sheet Dec. 31, 2023

Fair market value Dec. 31, 2023

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 20,000

Accounts receivable(1)

.....................

90,000

85,000

Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

86,000

Shares in Public Co. . . . . . . . . . . . . . . . . . . . . . . .

50,000

20,000

Land — Parcel I(3)

........................

200,000

339,000

Building(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

150,000

750,000

Land — Parcel II(4)

.......................

220,000

445,000

Equipment(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . .

35,000

5,000

Auto(2)

10,000

12,000

—

60,000

................................

Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$861,000 Liabilities(5) Bank loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$169,000

Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . .

43,000

Mortgage on building . . . . . . . . . . . . . . . . . . . . . .

30,000 $242,000

Proprietor’s equity . . . . . . . . . . . . . . . . . . . . . . . .

619,000 $861,000

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473

Notes to Balance Sheet (1) The accounts receivable are net of a $6,000 reserve for doubtful accounts which represents the closing reserve for the previous fiscal period. (2)

FiXed assets are recorded at original cost less accumulated financial accounting depreciation.

Tax data is as follows:

(3)

Original cost

UCC

Building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$600,000

$150,000

Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

80,000

35,000

Auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

16,000

11,000

Parcel I of land is the property upon which the building used in the business is situated.

(4)

Parcel II of land was acquired in 2023. Mr. Schminkie purchased it with the intention to sell as soon as the fair market value exceeded $450,000. Mr. Schminkie speculates this will occur by April 19, 2024, at which point he will sell for the quick profit. (5)

Liabilities are to be assumed by the corporation.

You have been asked to do the following: (A) Indicate which assets should not be transferred to the corporation at all. (B) Indicate which assets should be transferred to the corporation, but cannot or should not be transferred under section 85 and briefly explain why. (C) For the assets which can be transferred under section 85 to the corporation, indicate the maximum amount of debt in addition to the shares that can be taken as consideration to defer all possible capital gains, losses, other income and other available adverse tax consequences given the consideration to be taken. The corporation will issue a maximum of $200,000 Class A retractable nonvoting preference shares with a dividend rate of 5% and the remainder of the share consideration will be Class B retractable, non-voting preference shares with no dividend entitlement. (D) Determine Mr. Schminkie’s cost of the consideration and the PUC for tax purposes of the preferred shares that he receives for the transfer of assets. (E) Compute the tax consequences of a redemption of the preferred shares of the corporation at their fair market value after the transfer of assets to the corporation.

Problem 7

ITA: 84.1, 85(1)

Mrs. Andrews, a Canadian resident, has just told you about a proposed transaction she is planning to undertake shortly. She would like your advice on her plan. She recently set up Von Trapp Holdings Limited (Holdings) with 100 common shares, which she owns and are worth $1 each. The plan is for her to sell her shares in Plummer Enterprises Inc. (Plummer) to Holdings in order to crystallize her capital gains exemption and for her to have a holding company to accumulate capital away from the risks of the business. She has never claimed the capital gains exemption in the past.

CHAPTER 17

Mrs. Andrews currently owns 100% of the outstanding common shares of Plummer. Plummer is a small business corporation and meets all the tests for the shares to be qualified small business corporation shares. Plummer and Holdings are both Canadian resident corporations. She purchased the Plummer shares ten years ago from an unrelated third party for their then fair market value of $200,000. The fair market value of the Plummer shares today is $4 million. The paid-up capital of these shares is $1,000. Mrs. Andrews plans to transfer her shares of Plummer to Holdings on December 3rd and has been advised by someone else to jointly elect under section 85 with Holdings and take back the following consideration: (a) Non-interest bearing note for $200,000, and (b) Voting preference shares that are retractable for $3.8 million and have a dividend rate of 6%.

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She has asked you if she could instead take back a $400,000 note and $3.6 million in shares. You realize early in the discussion that you will need to consider, among other things, the impact of s. 84.1 on this transaction. Before you meet with Mrs. Andrews you want to: (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

Problem 8

ITA: 85, 85.1

Matt, a resident of Toronto, owns all the common shares of Beam Inc., a company he owns and operates. Matt is a custom home builder. He incorporated his business in 2004 and has operated the custom home building business which now has 12 employees from a facility in Milverton, Ontario. Matt’s son has been employed full-time by the business for the past 5 years since graduating from college. The adjusted cost base and paid-up capital of these common shares is $300,000 and the FMV is $900,000. In the course of a reorganization of capital in Beam Inc., the following two packages of consideration have been offered to Matt by Beam Inc. in exchange for his common shares: Package (a) Cash ..................................................................... $10,000 Bond....................................................................... 80,000 FMV and LSC of Class A preferred shares — Redeemable and retractable at FMV ................. 810,000 Package (b) Cash ..................................................................... $500,000 FMV and LSC of Class A preferred shares — Redeemable and retractable at FMV ................... 400,000 Matt would like your advice on which option is better for him and whether there is a better option. After the reorganization, common shares of the company will be issued to Matt’s 30-year-old son for a nominal amount. Before you meet with Matt you want to: (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

Problem 9 Norm Bass has just met with you to ask your advice on the possible merger of his two companies. Norm, a Canadian resident, owns 100% of Normpar Inc. which in turn owns 100% of Jonsub Inc. Both are Canadian companies located in Saskatchewan and both have December 31 year ends. Normpar purchased the shares of Jonsub in 2018 at a cost of $4 million. The first few years were profitable and in 2020 Jonsub paid a dividend of $500,000 to Normpar. But the last two years have not been good as Jonsub has realized non- and net capital losses. It is unlikely that Jonsub will generate sufficient income to absorb the losses in the foreseeable future. However, Normpar expects to generate sufficient business income and taxable capital gains to absorb all of Jonsub’s losses. Norm has heard that he could amalgamate the two companies or wind up Jonsub into Normpar so Normpar could offset its income with the losses.

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ITA: 86(2)

Ch. 17/Study Guide — Assignment Problems

475

Norm would like your advice on when Normpar can gain access to the losses of Jonsub if the two companies merge on June 30, 2023, either by amalgamating or by winding up Jonsub into Normpar. After the transaction they want to retain the December 31 year end. Norm is also concerned about what will happen to the $4 million ACB that Normpar has in the shares of Jonsub after an amalgamation or wind-up. The balance sheet of Jonsub Ltd. immediately before the merger is as follows: Assets:

FMV

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

80,000

Accounts receivable (net of $30,000 reserve) . . . . . .

800,000

Inventory at cost . . . . . . . . . . . . . . . . . . . . . . . . . . .

920,000

$ 920,000

Land at cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,200.000

2,000,000

Building at UCC . . . . . . . . . . . . . . . . . . . . . . . . . . . .

300,000

500,000

Equipment at UCC . . . . . . . . . . . . . . . . . . . . . . . . . .

200,000

150,000

Goodwill (FMV $500,000) . . . . . . . . . . . . . . . . . . . . .

—

500,000

Total current assets . . . . . . . . . . . . . . . . . . . . . . . . .

3,500,000

Liabilities and shareholder’s equity: Accounts payable and accrued liabilities . . . . . . . . . .

$ 709,000

Loans payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

700,000

Share capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,000

Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . .

2,090,000 3,500,000

Other Information (1) The fair market value of the land and building at the time Normpar Ltd. acquired control were $1.9 million and $400,000, respectively. (2) The fair market value of goodwill developed by Jonsub Ltd. (i.e., not purchased) was $300,000 at the time Normpar Ltd. acquired control. (3) Jonsub has the following losses: Taxation year of loss

Non-capital loss $ 43,000

2021 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

7,000

14,000 10,000

CHAPTER 17

2022 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Net capital loss

— REQUIRED Before you meet with Matt you want to: (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

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Introduction to Federal Income Taxation in Canada

Problem 10 Alison owns all of the common shares of Knight Manufacturing Limited (KML) which operates an active business in Belleville, Ontario. Over the past few months, she has been thinking about doing an estate freeze on her shares of KML in anticipation of her retirement in a few years. She has received a proposed plan from an advisor, and she would like your thoughts on whether it will accomplish what she wants in a tax-efficient manner. The taxable capital of KML is less than $10 million. The following is information provided in the proposed plan: (1) Alison is 55 years old and a widow. She is a Canadian citizen and resident. (2) She acquired the shares of KML 20 years ago from an arm’s-length person for $400,000. The KML shares have a paid-up capital of $100,000. (3) She has three children. Sandra (32) works in a big bank in Toronto. Tom (30) is a CPA working for one of the large accounting firms in Vancouver. Helen (28) is an engineer with an MBA and she works in KML with Alison. (4) KML has a current fair market value of $2.7 million and it is expected that this value will continue to grow rapidly, particularly with Helen’s energy and skill leading the way. (5) Alison is concerned about the issue of control of KML after a freeze. Since Helen is showing significant skills and is rapidly taking over the leadership of the company, Alison wants her to have operating control in the long term. However, she wants to maintain control of KML while she has a significant investment in the company. (6) Alison is delighted with Helen’s role in KML, since she would like to retire in three to five years and travel. She has been too busy with the business over the last 10 years to travel as much as she would like. (7) Alison would like to freeze the value of KML and have her adult children benefit from the current value that she has built up over the years. (8) Since Helen is responsible for building the increase in value of the business, she would like Helen to benefit from the future growth in value. (9) She does not want to do anything that would lead to conflict among her children over the business in future years. She has heard too many stories where the children fight over control of the business after the parent is gone, especially where they are not all active in the business. (10) Alison does not have significant assets outside of KML so she will be relying on her interest in KML for her retirement. (11) Alison has not used any of her capital gains exemption to date. (12) All of KML’s assets are used in a Canadian active business and have been since incorporation. (13) Alison does not have a cumulative net investment loss and has never claimed an ABIL. (14) Alison does not want her children involved in her financial affairs while she is alive.

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477

Proposed plan The following is the plan proposed by Alison’s advisor: Alison will complete a Holdco Freeze with her children owning the common shares of Holdco.

Proposed Sequence of Transactions (1) The three children will incorporate Holdco Inc. (Holdco) by paying $1 per share for the common shares. Each child would purchase 100 shares from Holdco using money they have earned themselves. (2) Holdco will have two classes of shares authorized: (a) Common shares that are fully participating and voting. (b) Class A preference shares that are voting as well as redeemable and retractable for $1,000 each. They have a non-cumulative dividend of 6% annually. (3) The common shares of KML owned by Alison should qualify as QSBC shares since the three tests are met: (a) KML is a small business corporation. (b) She has held the shares for more than two years. (c) The asset miX has not changed in the past five years. (4) Alison will sell her common shares of KML to Holdco in exchange for 2,700 Class A preference shares valued at $2,700,000. She will elect under s. 85 as follows: TV KML common

$400,000

FMV

$2,700,000 $1,371,190

Debt —

Pref

Income

$2,700,000 $971,190

Under section 85 the elected amount would be $1,371,190, which is enough to trigger a capital gain equal to the available exemption of $971,190.

CHAPTER 17

ACB of Holdco Class A preferred shares Elected amount ............................................................................................. $1,371,190 Allocated to debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Cost of preferred shares (Holdco) ........................................................... $1,371,190 Paid-up capital of Holdco preferred shares PUC reduction [par. 84.1(1)(a)]: (a) increase in LSC of holding company (Holdco) ................................. $2,700,000 (A)

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Introduction to Federal Income Taxation in Canada

478 less: (b) greater of: (i) PUC of KML shares ................... $100,000

$400,000 (ii) modified ACB of KML shares

$400,000

less: FMV of boot . . . . . . . . . . . . . . . . . . . . . . .

excess, if any . . . . . . . . . . . . . . . . . . . . . . . . . .

(400,000) (B)

PUC reduction . . . . . . . . . . . . . . . . . . . . . . . . . . .

(A) $2,300,000

PUC of Holdco shares after reduction . . . . . . . . . .

$ 400,000

84.1

Deemed dividend [par. 84.1(1)(b )]:

Sum of: (a) increase in LSC of holding company (Holdco) ..................................... $2,700,000 (A) (b) FMV of boot . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

0 (D)

(A + D) $2,700,000 less sum of: (c) greater of: (i) PUC of KML shares ...................... $100,000 $400,000 (E) (ii) modified ACB of KML shares

$400,000

(d) PUC reduction [par. 84.1(1)(a)] . . .

2,300,000 (F) (E + F)

Deemed dividend . . . . . . . . . . . . . . . . .

(A + D) -- (E + F) $

2,700,000 0

Capital gain/loss: Elected amount under ss. 85(1) for KML shares .................................... $1,371,190 Less: s. 54 exclusion for par. 84.1(1)(b) deemed dividend . . . . . . .

Proceeds of disposition for KML shares .................................................. $1,371,190 Less: adjusted cost base ................................................................................ 400,000 Capital gain/loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 971,190 Stated Results Alison has frozen the value of her common shares in KML. As Holdco increases in value this incremental value will accrue to the common shares held by the children. Alison has used up her $971,190 capital gains exemption. As Alison needs money in retirement she can: — Have some or all of the preference shares redeemed. — Have KML pay a dividend to Holdco with Holdco then declaring a dividend on the preference shares. You have agreed with Alison that you will evaluate the proposed plan on its technical merit and whether it accomplishes her goals.

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479

Before you meet with her you want to: (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

Problem 11 EXtension of Problem 10 The following alternative structure has been suggested to accomplish Alison’s objectives.

The Class A shares have the following characteristics: (1) Redeemable and retractable for $2.6 million; (2) Non-voting; (3) Dividend rate of up to 6% per annum. You have agreed with Alison that you will: (1) Assess whether this structure can achieve her objectives. (2) Propose the technical steps needed to move from the current ownership structure to this one.

ITA: 84(3); 84.1; 85

CHAPTER 17

Problem 12 Holden Limited has received an offer from an unrelated corporation, Corporate Raider Inc., to purchase all of Holden’s common shares in a wholly owned subsidiary, Profits Galore Ltd. All three corporations are Canadian-controlled private corporations and have December 31 year ends. The common shares of Profits Galore Ltd. have an adjusted cost base and paid-up capital of $500,000 and a fair market value of $2.4 million. Profits Galore Ltd. has realized and retained income for tax purposes of $900,000 since its incorporation in 2005. All of this realized income was derived from active business assets. Holden Limited has come to you for your comments on two acquisition alternatives proposed by Corporate Raider Inc. Plan A would first have Profits Galore Ltd. borrow from the bank $1.9 million and, then, immediately pay a dividend to its parent corporation, Holden Limited, for the same amount. Corporate Raider Inc. would then purchase the common shares of Profits Galore Ltd. from Holden Limited for the residual fair market value of $500,000. Then, Corporate Raider would inject $1.9 million into Profits Galore Ltd. through a common share subscription so that the bank loan could be repaid. Plan B would have Holden Limited transfer its common shares in Profits Galore Inc. to Corporate Raider Inc. on a tax-free basis by jointly electing under section 85 at a transfer price of $500,000. Holden Limited would accept as consideration only special shares of Corporate Raider Inc. with a paid-up capital of $500,000 and a redemption/retraction value of $2.4 million. These shares would represent 15% of all the voting rights and fair market value of Corporate Raider Inc. Holden Limited would, then, retract the special shares which it holds in Corporate Raider. Holden Limited has asked you to describe the tax implications of the above acquisition alternatives supported by any relevant calculations.

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CHAPTER 17 — DISCUSSION NOTES FOR REVIEW QUESTIONS (1) In general, a rollover allows for a partial or complete deferral of the recognition of income/gains on the transfer of property from one person to another. The transferor, in return for the property transferred, should receive a package of consideration, the total fair market value of which should be equal to the fair market value of the property transferred. The transferor is the one who is deferring the recognition of income. The transferee usually steps into the position of the transferor in terms of the tax value of the asset received. Therefore, on the ultimate disposition of the asset by the transferee, the income/gain will be recognized. EXamples of rollovers include subsections 73(1), 85(1), 88(1) and sections 51 and 86. (2) The following are the four uses of the elected price: (a) it is the proceeds of disposition to the transferor; (b) it is the cost of the property to the corporation; (c) it is used to determine the ACB of the package of consideration taken by the transferor from the corporation in return for the assets transferred to the corporation; and (d) it is used to calculate the paid-up capital of the shares taken as consideration by the transferor from the corporation. (3) On the transfer, the only decision variable you have is the non-share consideration or boot. If the boot is higher than the tax cost (lower limit) for the particular asset transferred, then the elected amount is increased. The boot cannot, however, raise the elected amount above fair market value.

ITA: 85(1)(b), 85(1)(c)

(4) The maximum ‘‘boot’’ that should be taken in order to maximize the deferral is the tax value of the asset transferred. If, however, the asset being transferred is shares, section 84.1 applies (and the transfer doesn’t meet the conditions for an exemption from 84.1 for an intergenerational transfer), the maximum boot should be the greater of the PUC and the modified ACB (removing any CGE element) of the shares transferred. (5) The elected transfer price is equal to the total cost of the consideration taken back. This elected amount is allocated among the different types of consideration in the following manner:

ITR: 1100(2), 1100(2.2); ITA: 84.1(2)(e)

First: to non-share consideration (boot) up to the FMV of that property as long as that FMV does not exceed the FMV of the assets transferred to the corporation;

ITA: 85(1)(f)

Second: to preferred shares up to the FMV of those shares after the transfer but only to the extent that there is a balance left after the boot has been deducted from the elected amount; and

ITA: 85(1)(g)

Third: to common shares to the extent that the elected amount exceeds the FMV of the boot and the cost allocated to the preferred shares.

ITA: 85(1)(h)

(6) The ‘‘elected amount’’ determines how much can be withdrawn tax-free since this is the starting point for determining the ACB and the PUC of the shares. In addition, it is the amount that is used to determine how much boot to take back on the transaction to fully defer the accrued income (except when section 84.1 applies). (7) The elected amount is correct since the upper limit is the FMV of $9,000. Ms. Wong will realize a capital gain of $3,000. The company will have a cost in the portfolio shares of $8,000 which is the elected amount (no boot is received). There will be a paid-up capital reduction to reduce the PUC to $8,000. Thus, on redemption, she will have a deemed dividend for $2,000 (i.e., $10,000 of redemption value -- $8,000 of PUC). If boot is equal to the elected amount and equal to the tax value of the property being transferred, then the ACB and PUC of the shares will be $0.

ITA: 85(1)(b) ITA: 85(2.1)

Ch. 17/Study Guide — Discussion Notes for Review Questions (8) Price adjustment clauses are often used to provide for an adjustment to the consideration taken back in the event that the assessed value is different than what was originally used. The courts have determined that the price adjustment clause will only be recognized if the parties have reasonably and in good faith attempted to determine fair market value. The CRA’s position on them is outlined in an Income Tax Folio.

481

Income Tax Folio S4-F3-C1

(9) Either articles of amendment or supplementary letters patent need to be filed with the incorporating jurisdiction in order to reorganize the capital of the corporation. Nothing needs to be filed with the CRA. (10) Some of the uses of a reorganization of capital rollover include: (a) an estate freeze to allow the children to benefit from future capital appreciation; (b) freeze the value of the common shares to allow a purchaser to buy common shares for a nominal amount; and (c) freeze the value of the common shares to allow employees to buy shares at a reduced value. (d) exchange of common shares for a new separate class of common shares to allow dividend payments on separate classes of shares for tax planning, e.g., to minimize the impact of TOSI. (11) A deemed dividend may arise under the reorganization of capital rollover where the non-share consideration received exceeds the PUC of the old shares that are being exchanged for new shares. Technically, the redemption proceeds (the reduced PUC of the new shares plus the non-share consideration) exceeds the paid-up capital of the old shares and results in a deemed dividend. The deemed dividend results in an adjustment to reduce the proceeds of disposition on the disposition of the shares for capital gains purposes. (12) For corporate law purposes, the two predecessor corporations are deemed to continue to exist as an amalgamated corporation. The amalgamated corporation is deemed to have existed previously as the predecessor corporations. Property owned by the predecessor corporations continues to be the property of the new amalgamated corporation. Liabilities enforceable against the predecessor corporations are now enforceable against the new amalgamated corporation. (13) The deemed year end as a result of an amalgamation has an impact on: (a) unpaid amounts the deemed year end will count for purposes of section 78; (b) CCA will have to be prorated; (c) the small business deduction business limit ($500,000) will have to be prorated for a short taxation year; (d) the short taxation year will count as one of the carryforward years available; and (e) the immediate expensing limit of $1.5 million available to eligible persons or partnerships will have to be prorated for a short taxation year.

(15) In order for the rollover on winding up a subsidiary to apply, not less than 90% of the issued shares of each class of the capital stock of the subsidiary need to be owned by the parent, which is a taxable Canadian corporation. Also, all of the shares of the subsidiary that were not owned by the parent immediately before the winding-up need to be owned at that time by persons with whom the parent was dealing at arm’s length. (16) Her new ACB is the total ACB she had on her preferred shares divided by the total number of new common shares. In this case her new ACB on the common shares would be $10,000 divided by 2,000 or $5 per share.

CHAPTER 17

(14) The CRA has indicated that, if an amalgamation is undertaken with a shell corporation solely to effect a year-end change, the GAAR would be applied. Therefore, this is considered to be an offensive transaction as far as the CRA is concerned.

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482

(17) The primary purpose of an estate freeze is to freeze all or part of the value of growing assets at their current fair market value in preferred shares held by a taxpayer. Future growth in these assets accrues to someone else, usually the next generation of family members through ownership of common shares. The result will be that this future growth will not be taxed in the hands of the taxpayer on a disposition or at his or her death. (18) Some secondary objectives of an estate freeze would be to: (a) defer any immediate tax cost on the freeze transaction and establish the amount of the tax liability on death; (b) maintain control over the asset(s) that have been frozen (i.e., an operating company); (c) maintain a source of income from the asset(s) being frozen (i.e., dividends on freeze shares); (d) split income with low tax-rate family members (considering TOSI); (e) use up the QSBC share capital gains exemption on shares being frozen, if possible (i.e., shares of an operating company); and (f) multiply the future use of the capital gains exemption by family members holding common shares in the operating company either directly or through a family trust. (19) The three principal methods of freezing the value of growth assets are: (a) holdco freeze; (b) internal freeze; and (c) reverse or asset freeze between corporations. Refer to the text for details of these methods. (20) The basic steps involved in a Holdco freeze are: (a) incorporate the holding company; (b) transfer the shares of an operating corporation to the holding corporation using section 85 to avoid incurring an immediate tax cost; and (c) have the transferor take back, as consideration for the growth asset (i.e., shares of the operating company), debt, and preferred shares of the holding company. The preferred shares will have certain characteristics to achieve the freeze objectives including a fi Xed retraction value that will freeze the value of the common shares in the preferred shares received as consideration. Other features would revolve around desired voting control, income and security. (21) The provision is designed to prevent an individual from stripping the fair market value in excess of the greater of the modified ACB or the PUC of the shares out of a company through boot consideration (that can be received tax free). It applies where the transaction is non-arm’s length and the individual retains an (indirect) interest in the corporation. Without the non-arm’s length transaction, the individual would not have been able to remove the funds from the corporation other than through the payment of a dividend that would be subject to tax. Only intergenerational transfers which meet specific conditions would be exempt from 84.1. (22) He can reduce the PUC of the shares by $100,000 (a PUC distribution). However, this will cause his ACB in the shares to become negative $90,000 which will give rise to an immediate capital gain. Alternatively, he can transfer his shares to a holding company under section 85 with an elected amount of $100,000 and take back a note for $100,000 and one share with a value of, say, $1. Section 84.1 will not give rise to a deemed dividend, since the boot does not exceed the greater of the modified ACB of $10,000 and the PUC of $100,000. In either case, he can use his capital gains exemption to shelter the gain if the shares are QSBC shares.

ITA: 40(3), 53(2)(a)(ii), 84(4)

Ch. 17/Study Guide — Solutions to Exercises

483

CHAPTER 17 — SOLUTIONS TO EXERCISES Exercise 1 A (A) Minimum elected amount or deemed proceeds . . . . . . . . . . . . . . . . . . . . . . . . .

$120 $100 $ 80 $ 75 $100 $ 90 $ 50

(B) Proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . $120 $100 $ 80 $ 75 $100 $ 90 $ 50 Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

100

Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . $ 20 $ 25 $ 0* $ 0 $ 0 $ 15 $ 0 Taxable capital gain (1/2) . . . . . . . . . . . . . . . $ 10 $ 13 $ 0 $ 0 $ 0 $ 8 $ 0 Lesser of cost or proceeds . . . . . . . . . . . . . .

100

UCC of class . . . . . . . . . . . . . . . . . . . . . . . .

200

150

Recapture . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0

$ 30

$ 0

Income from shareholder benefit . . . . . . . . . $ 30 $100 $ 0 $ 0 $ 0 $ 0 $ 0

ITA: 15(1)

* No capital loss on depreciable property.

Exercise 2 (A) Cost of consideration received:

Elected transfer price . . . . . . . . . . . . . . . . . . . . . . . . .

$5,000

Allocated to note up to FMV . . . . . . . . . . . . . . . . . . . .

5,000

2,500

4,000

Allocated to preferred shares up to FMV . . . . . . . . . . .

$2,500

Allocated to common shares . . . . . . . . . . . . . . . . . . . .

$1,000

(B) LSC before reduction . . . . . .

$5,000

$7,500

$6,000

Reduction in PUC

ITA: 85(2.1)

$5,000 (A)

$7,500 (A)

$6,000 (A)

(b) Elected amount . . . . . . .

$5,000

Less: boot . . . . . . . . . . . . .

5,000

2,500

4,000

EXcess, if any . . . . . . . . . . Total reduction in PUC (A -- B) . . . . . . . . .

0 (B) $5,000

2,500 (B)

1,000 (B)

$5,000

CHAPTER 17

(a) Increase in LSC of all shares . . . . . . . . . . . . . . .

Introduction to Federal Income Taxation in Canada

484 A

$4,500 = $5,000

$4,500

Common shares $5,000 ×

$500 = $5,000

$ 500

Tax PUC Preferred shares . . . . . .

Common shares . . . . . .

$2,500 $1,000

Note how the PUC after reduction is equal to the amount of the $5,000 ACB of the original capital property that has not been recovered through the notes (boot) received as consideration. For example, in the first scenario, the note is $5,000, and therefore the PUC after the reduction is $0 ($5,000 ACB less $5,000 note).

Exercise 3 (A) The elected amount becomes the proceeds of disposition of the assets transferred by Mr. Good. Since his adjusted cost base on the land and his undepreciated capital cost on the building are equal to these proceeds, there will be no capital gain on that land and no recapture on the building. The corporation is deemed to acquire these assets at a cost equal to the elected amount. On the building, the corporation is deemed to have a capital cost of $909,341 and to have taken capital cost allowance of $81,841 ($909,341 -- $827,500) making it liable for future recapture and for a potential future capital gain if ultimate proceeds exceed $909,341. This places the corporation in the same position as Mr. Good was in with respect to the building prior to the transfer. (B) (i) As boot up to the elected amount has been received by Mr. Good, the tax cost (ACB and PUC) of the share consideration is $0. As boot up to the elected amount has been received by Mr. Good, the tax cost (ACB and PUC) of the share consideration is $0. The cost of the shares received by Mr. Good as consideration would be computed as follows: Elected transfer price ................................................................................... $ 1,177,500 Allocated to debt: — mortgage assumed ..................................................... $847,500 — new debt issued . . . . . . . . . . . . . . . . . . . . . . . .

330,000

Allocated to shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,177,500 $

(ii) LSC before reduction .......................................................................................... $322,500 ITA: 85(2.1) Formula

Reduction in PUC (1) Increase in LSC of all shares ....................................... $322,500 (A) (2) Elected amount ...................................... $ 1,177,500 less: boot ($247,500 + $330,000) ........... 1,177,500 EXcess, if any . . . . . . . . . . . . . . . . . . . . . . . . . . .

0 (B)

Total PUC reduction (A -- B) .......................................................... (322,500) Tax PUC after reduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Ch. 17/Study Guide — Solutions to Exercises

485

(C) (i) If the new debt is redeemed for $330,000, given its adjusted cost base in Mr. Good’s hands of $330,000, there would be no gain or loss. However, on the disposition of the shares, the following would result: Proceeds of disposition ............................................................................... $425,000 Adjusted cost base . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Capital gain ...................................................................................................... $425,000 Taxable capital gain ........................................................................................ $212,500 (ii)

Redemption amount......................................................................................... $425,000 Less: PUC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Deemed dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$425,000

ITA: 84(3)

Redemption amount......................................................................................... $425,000 Less: deemed dividend ...................................................................................... 425,000 Proceeds of disposition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Less: adjusted cost base . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ITA: 54 ‘‘proceeds of disposition’’ (j )

The TOSI rules apply to include taxable capital gains from the disposition of shares of a private corporation in split income other than excluded amounts. Split income also includes taxable dividends from a private corporation (including a deemed dividend on a redemption of shares) other than excluded amounts. As Mr. Good owns all of the common shares of the company, and the gain/dividends would not be derived from a related business as defined, the gains/dividends would be excluded amounts. A related business is a business carried on by a source individual in respect of the specified individual or a business of a corporation if a source individual owns shares of not less than 10% of the fair market value of the corporation. In this situation, Mr. Good is the individual carrying on the business. As a result, TOSI will not apply.

Exercise 4 (A) Items not transferred under subsection 85(1): (not capital property and therefore not eligible property)

$ 4,000

Short-term investments . . . . .

5,000

(capital loss denied)

Accounts receivable . . . . . . . .

9,000

(use section 22(1))

Prepaid insurance . . . . . . . . .

500

(not capital property and therefore not eligible property)

Building . . . . . . . . . . . . . . . .

560,000

(terminal loss of $2,000 denied)

Land . . . . . . . . . . . . . . . . . . .

226,500

(capital loss denied)

Total . . . . . . . . . . . . . . .

$805,000

CHAPTER 17

Cash . . . . . . . . . . . . . . . . . . .

The above assets will be transferred at fair market value as they are not included in the Section 85 election. The total fair market value consideration of $805,000 will be received by Mrs. Designer in assumed debt of $374,000 (see F/Ss) and new debt of $431,000. The inventory and goodwill will be transferred using a Section 85 election per below. The building may not be transferred using the rules in section 85 because of the unrealized terminal loss. A stop-loss rule applies to deny the loss. Mrs. Designer can continue to claim CCA on the $2,000 terminal loss on her return until the building is disposed of by Hi Fashion Co. Ltd to an arm’s length person.

ITA: 13(21.2)

Introduction to Federal Income Taxation in Canada

486

If the short-term investments are considered assets used in the active business of the corporation, they can be transferred to the corporation for use in the business. Section 85 need not be used where there is no unrealized gain to defer. The capital loss will be considered to be a superficial loss because the corporation is affiliated with the transferor, Mrs. Designer. Therefore, a stop-loss rule will deny the loss to Mrs. Designer. The denied loss will be added to the ACB of the investments held in the corporation and will instead be realized when the corporation sells the investments.

ITA: 54 ITA: 40(2)(g), 53(1)(f)

Section 85 need not be used when there is no accrued income to defer. If the short-term investments cannot be considered as assets used in an active business, then they should not be transferred to the corporation, because it could jeopardize the qualification of the shares of the corporation as QSBCSs. The land need not be transferred under section 85 for the same reasons as the short-term investments, because of the unrealized capital loss. The loss will be denied to Mrs. Designer, and would be added to the ACB of the land held in the corporation after the transfer. As a result, the loss will be realized instead when the corporation disposes of the land. (B) and (C) Items transferred under subsection 85(1) and consideration of additional new debt and preferred shares as required under ss. 85(1): Consideration Tax value

FMV

Elected Assumed amount debt(2)

Inventory . . . . . . $ 5,000 $ 25,000 $ 5,000 Goodwill . . . . . . .

144,000

$ 5,000 $169,000 $ 5,001

New debt

Pref. shs. Income/TCG

0 $ 5,000 $ 20,000 0

144,000

0.50

0 $ 5,000 $164,000

Since the corporation will qualify as a small business corporation, the Act will not apply to attribute income or capital gains back to Mrs. Designer.

ITA: 74.4, 248(1)

(D) The ACB and the PUC of the share consideration will be $1. It represents the amount of tax-paid cost that has not been recovered through boot received from the corporation. The $1 of income resulting from the transfer of the goodwill is a tax-paid cost. A total of $5,000 of total tax-paid cost was recovered through boot. Supporting calculations: Elected transfer price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 5,001

Allocated to debt consideration: debt assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

new debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5,000

Allocated to ACB of preferred shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5,000 $

(E) LSC before reduction .........................................................................................................$164,000

Reduction in PUC

ITA: 85(2.1)

(i) Increase in LSC of all shares ........................................................ $164,000 (A) (ii) Elected amount . . . . . . . . . . . . . . . . . . . . . . . .

$ 5,001

Less: boot .................................................................. 5,000 EXcess, if any . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1 (B)

Total PUC reduction (A -- B) ............................................................................... (163,999) Tax PUC after reduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Ch. 17/Study Guide — Solutions to Exercises

487

(F) For those assets not transferred under subsection 85(1) and not subject to the specific provisions discussed below, the cost amount for tax purposes to the corporation would be equal to the fair market value of the consideration:

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . $ Prepaid insurance . . . . . . . . . . . . . . . . .

4,000 500

Building (UCC to transferee) .......................560,000 $564,500 = debt consideration

Under section 22, the purchaser, Hi-Fashion, would record the accounts receivable at their face value of $12,000. Under the conditions of section 22, the corporation must include in its income the business loss of $3,000 recognized by the transferor (i.e., difference between the face value ($12,000) and the fair market value ($9,000)). Hi-Fashion is now entitled to set up a reserve to offset any potential doubtful debts (i.e., $3,000), plus an amount equal to any further decline in value. In addition, the corporation is now eligible to write off any realized bad debts since it has included an amount in income in respect of these receivables. The ACB of the short-term investments and the land to the corporation will be their fair market value plus the denied superficial loss. Therefore, the ACB of the short-term investments will be $10,000 ($5,000 FMV + $5,000 denied loss) and that of the land will be $230,000 ($226,500 FMV + $3,500 denied loss). This puts the corporation in the same tax position on these assets as Mrs. Designer was in before the transfer. Note that the corporation will hold investments with an ACB of $10,000 and land with an ACB of $230,000. The transferee will have received debt consideration of $5,000 and $226,500 respectively for the properties.

The capital cost and, therefore, the ACB of the building in the corporation is $580,000 for purposes of calculating future recapture and capital gains on the disposition of the property.

ITA 13(21.2)

For the inventory that has been transferred under subsection 85(1), the cost base would be the elected amount (i.e., inventory — $5,000). The goodwill, which is a Class 14.1 property, would have a cost base equal to the elected amount of $1 ACB for capital gains purposes and a capital cost/UCC of .50 for CCA purposes.

— NOTES TO SOLUTION (1)

Reserve of $2,000 from last year must be brought into income this year. There will be a full business loss of $3,000 (i.e., face value of $12,000 less fair market value of $9,000) using section 22. (2) The $805,000 of debt consideration for the assets not transferred under subsection 85(1) includes all assumed liabilities of $374,000, leaving none to be assumed in the subsection 85(1) transfer.

Part (A) Section 84.1 applies because Mr. Newberry is a Canadian resident and is not at arm’s length with his brother who controls the corporation to which the Opco shares were transferred. Therefore, Mr. Newberry is not at arm’s length with Broco Ltd. In addition, Opco Ltd. is connected with Broco Ltd., since Broco owns all of its outstanding common shares. The PUC after the PUC reduction is $0 because all of the $75,000 hard cost in the operating company shares has been recovered in boot from the brother’s corporation. A deemed dividend of $425,000 will result because the boot of $500,000 received from the brother’s corporation exceeded the hard cost of the shares of the operating corporation transferred (the greater of PUC and modified ACB of the shares).

ITA: 251(2)(b)(iii) ITA: 186(2)

CHAPTER 17

Exercise 5

Introduction to Federal Income Taxation in Canada

488 Supporting Calculations:

ITA: 84.1(1)(a)

PUC reduction: (a) Increase in LSC of brother’s corporation .......................................... $ 300,000 (A) Less: (b) Greater of: (i) PUC of operating company shares ..................................................$75,000

}

(ii) Modified ACB* of operating $ 75,000 company shares ................................. $75,000 Less: FMV of boot......................................................... 500,000 EXcess, if any . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

0 (B)

PUC reduction (A -- B) ............................................... $ 300,000 PUC after reduction ($300,000 -- $300,000) . . . . . .

Deemed dividend:

ITA: 84.1(1)(b)

Sum of: (a) Increase in LSC of brother’s corporation .............................................. $ 300,000 (A) (b) FMV of boot . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

500,000 (D)

(A + D) ................................................................................................. $ 800,000 Less sum of: (c) Greater of: (i) PUC of operating company shares . . . . . . . . . . . .

(ii) Modified ACB* of operating company shares . . . . . . . . . . . .

$ 75,000

(d) PUC reduction . . . . . . . . . . . . . . . . . . . . . . . . .

}

$ 75,000 (E)

300,000 (F)

(E + F) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ITA: 84.1(1)(a)

375,000

Deemed dividend (A + D) -- (E + F) .............................................................. $ 425,000 * Adjusted actual cost.

TOSI applies the highest marginal rate of tax to split income. Split income includes taxable dividends from a private corporation (including deemed dividends) unless the income meets the definition of an excluded amount. An excluded amount includes an amount that is not derived from a related business. A related business is defined to include a business carried on by a source individual in respect of the specified individual or a business if the source individual owns not less than 10% of the fair market value of the shares of the corporation. A source individual is a Canadian resident who is related to the specified individual. As the dividend would not be considered to be derived directly or indirectly from a related business carried on by Mr. Newberry’s brother, it would be an excluded amount. The dividend in this case is derived from the Opco business that was carried on by Mr. Newberry.

Ch. 17/Study Guide — Solutions to Exercises

489

Capital gain or loss on disposition of Opco Ltd. shares: Elected amount and proceeds of disposition for operating company shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 500,000

Less: deemed dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

425,000

Adjusted proceeds of disposition for operating company shares . . . Less: ACB of operating company shares . . . . . . . . . . . . . . . . . . . .

$ 75,000 75,000

Capital gain (loss) if any, (not denied*) . . . . . . . . . . . . . . . . . . . .

ITA: 40(2)(g)

The capital gains exemption cannot be used for the transfer as a result of 84.1. ACB of Broco Ltd. preferred shares received: Cost of shares of Broco Ltd. after allocation of $500,000 elected amount to ‘‘boot’’ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ITA: 85(1)(g)

ITA: 85(1) ITA: 54 ‘‘proceeds of disposition’’ (k)

* He is not affiliated with Broco Ltd. by the definition of ‘‘affiliated person’’ in section 251.1, since he does not control, directly or indirectly, Broco Ltd.

Part (B) Ultimate redemption of preferred shares of brother’s corporation Redemption amount .................................................................................. $ 300,000 Less: PUC ............................................................................................ 0 Deemed dividend on redemption . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 300,000

ITA: 84(3)

Proceeds of disposition......................................................................... $ 300,000 Less: deemed dividend on redemption . . . . . . . . . . . . . . . . . . . . . . 300,000

ITA: 84(3)

Adjusted proceeds of disposition . . . . . . . . . . . . . . . . . . . . . . . . . . Less: adjusted cost base ....................................................................... Capital gain (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

0 0 $

ITA: 54 ‘‘proceeds of disposition’’ (j )

Summary of income effects: Sec. 84.1 deemed dividend ................................................................ $ 425,000 Redemption deemed dividend . . . . . . . . . . . . . . . . . . . . . . . . . 300,000 Capital gain (loss) on transfer . . . . . . . . . . . . . . . . . . . . . . . . 0 Capital gain (loss) on redemption ................................................ 0

ITA: 84(3) ITA: 85(1)

Net economic effect ....................................................................... $ 725,000 Note that $725,000 represents the accrued gain on the Opco Ltd. shares at the time of the transfer. Part (C) Ultimate arm’s length sale of shares of brother’s corporation Proceeds of disposition......................................................................... $ 300,000 Less: adjusted cost base ....................................................................... 0 Capital gain ............................................................................................... $ 300,000

$ 425,000 0 300,000

Net economic effect . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 725,000

Again, the $725,000 represents the accrued gain in the Opco Ltd. shares at the time of the transfer. TOSI applies the highest marginal rate of tax to split income. Split income includes taxable capital gains from the disposition of shares of a private corporation unless it meets the definition of an excluded amount. Split income also includes taxable dividends from a private corporation (including a deemed

ITA: 85(1)

CHAPTER 17

The capital gains exemption could be utilized if the shares were QSBC shares when sold. Summary of income effects: Sec. 84.1 deemed dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital loss on transfer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital gain on arm’s length sale . . . . . . . . . . . . . . . . . . . . . .

Introduction to Federal Income Taxation in Canada

490

dividend on a redemption of shares) unless it meets the definition of an excluded amount. As noted in (A) above, the amounts would not be considered to be derived from a related business as they relate to the Opco business. As a result, TOSI would not apply.

Exercise 6 Of the $900,000 dividend received by Vendco, $700,000 can be attributed to post-1971 earnings of Preyco and, therefore, can be received by Vendco without tax consequences under Part I and Part IV of the Act. The other $200,000 of the total dividend received will be deemed to be a gain of the dividend recipient. These results are equivalent to Vendco’s receiving a dividend from Preyco, of $700,000 without tax consequences and then selling the shares of Preyco to Purchco for their fair market value of $300,000 (i.e., $1,000,000 -- $700,000). With an adjusted cost base of $100,000 for the shares, a capital gain of $200,000 would result.

Exercise 7 (a) (i) Items not transferred under S. 85(1): Cash . . . . . . . . . . . . . . . . . . .

$ 4,000 (not eligible)

Accounts receivable ....................... 35,000 (use Section 22 election*) Inventory ..................................... 72,000 (no gain to defer — $3,000 business loss) Prepaid expenses . . . . . . . . .

2,000 (not eligible)

FiXtures ....................................... 30,000 (no gain to defer — terminal loss denied by Section 13(21.2))* Liabilities assumed ........................ (65,000) FMV of debt consideration .......... $78,000 Treatment of Accounts Receivable with a Section 22 election: Proprietor (Disposition)

Corporation (Purchase)

Income (Reserve) . . . .

$ 5,000

Consideration rec’d . . .

35,000

Business loss ($37K -$35K) . . . . . . . . . . . . .

2,000

A/R . . . . . . . . . . . . . . .

$37,000

Consideration pd . . . . .

$35,000

Income (s. 22) . . . . . . .

$ 2,000

(equal to proprietor’s loss) — can claim reserve at year end — can write off bad debts

* Beamen will maintain the denied terminal loss of $38,000 in Class 8 (F&F). He can continue to claim CCA on this balance until the company disposes of the assets or ceases to use them in the business.

Ch. 17/Study Guide — Solutions to Exercises

491

(ii) Items not transferred at all to the corporation: Marketable securities should be held personally. If they are transferred to the corporation, the accrued capital loss of $8,000 will be denied as a superficial loss whether or not an election is made under subsection 85(1). A denied loss is added to the cost of the securities in the corporation. If the securities are held personally, the loss can be realized on an arm’s length sale when the corporation needs additional funds. After the sale, the cash can be transferred to the corporation for debt consideration. In addition, these are not active business assets and may cause the corporation to cease being a small business corporation for purposes of the capital gains exemption. (b) Items transferred under subsection 85(1) and (c) Consideration: Consideration Tax Value Land . . . . . . . . . . . Building . . . . . . . . Intangible . . . . . . .

(d)

FMV

Elected Amount

Assumed Debt

Debt

$360,000 $ 435,000 $360,000 590,000 680,000 590,000 6,000 24,000 6,000

$ 0 0 0

$360,000 $ 75,000 590,000 90,000 6,000 18,000

$956,000

$ 0

$956,000 $183,000

$1,139,000 $956,000

Income $ 0 0 0

The ACB of the share consideration received is $0 because boot up to the elected amount was received by the transferor. Supporting calculation: ACB of consideration received: Elected amount . . . . . . . . . . . . . . . . . . . . $956,000 Allocated to debt consideration: Assumed debt . . . . . . . . . . . . . . . . . . $ 0 New debt . . . . . . . . . . . . . . . . . . . . . 956,000 956,000 Allocated to ACB of shares . . . . . . . . . . . .

(e)

The PUC of the share consideration received by the transferor will be $0 as all of the tax cost of the properties transferred was received in boot consideration. Tax PUC of shares: Increase in PUC of corporation on transfer . . . . . . . . . . . . $183,000 Reduced by (Subsection 85(2.1)): (A) Increase in legal PUC . . . . . . . . . . . . . $183,000 (B) Elected amount . . . . . . . . . . . . . . . . . $956,000 FMV of boot . . . . . . . . . . . . . . . . . . . 956,000 EXcess, if any . . . . . . . . . . . . . . . . . .

(A - B) . . . . . . . . . . . . . . . . . . . . . . . . . .

$183,000

Tax PUC of shares . . . . . . . . . . . . . . . . . .

Exercise 8 There is no deemed dividend because the non-share consideration does not exceed the PUC of the original shares. The redemption amount paid, consisting of cash for $6,750 and total reduced PUC of the new shares for $13,250 (as calculated below), does not exceed the PUC of the old shares of $20,000. (1) Reduced PUC: LSC increase for all new shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $23,250 Less: PUC of old Class A preferred shares ............................................... $20,000 Less: Boot....................................................................................... (6,750) $13,250 PUC reduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

10,000

Total reduced PUC (Class B Preferreds, $10,000; Commons, $3,250) . . . . . . .

$13,250

Class B PUC reduction = $17,550/$23,250 × $10,000 = $7,548 Common PUC reduction = $5,700/$23,250 × $10,000 = $2,450

ITA: 86(2.1)(a)

CHAPTER 17

Issuance of New Shares

Introduction to Federal Income Taxation in Canada

492

(2) Cost of Class B preferred and Common shares received: Adjusted cost base of old shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: FMV of non-share consideration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$20,000 6,750

Adjusted cost base of Class B preferred and Common shares received . . . . . .

$13,250

Cost of non-share consideration (boot) received (equal to FMV) . . . . . . . . . . .

$ 6,750

ITA: 86(1)(c)

Allocation of adjusted cost base of new shares: Class B preferred shares: FMV of Class B Preferred shares FMV of all shares =

$17,550 $17,550 + $5,700

× cost of new shares

× $13,250 = $10,000

Common shares: FMV of Common shares FMV of all shares =

× cost of new shares

$5,700 $17,550 + $5,700

× $13,250 = $3,250

Redemption of Old Shares (1) Proceeds on redemption of old shares: Boot or non-share consideration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Reduced PUC of the new shares — see above . . . . . . . . . . . . . . . . . . . . . . . . .

$ 6,750 13,250

Redemption proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

20,000

Deemed dividend on redemption: Redemption proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: PUC of old shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

20,000 20,000

Deemed dividend on redemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ITA: 84(5)(d )

ITA: 84(3)

(2) Proceeds of disposition of old shares: Adjusted cost base of all new shares (above) ........................................ $13,250 Plus: cost of all non-share consideration (equal to FMV) ........................ 6,750 $20,000 Less: deemed dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Adjusted proceeds of disposition of old shares . . . . . . . . . . . . . . . . . . . . . . . .

$20,000

Capital gain or loss on disposition of old shares: Proceeds of disposition of old shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Adjusted cost base of old shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital gain (loss)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

20,000 20,000 $ 0

Net economic effect: Deemed dividends on redemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 Capital gain (loss) on disposition of old shares . . . . . . . . . . . . . . . . . . . . . . . . $ 0 Accrued capital gain on new shares: FMV ($17,550 + $5,700) ........................................................................ $23,250 ACB ....................................................................................................... (13,250) $10,000 Net economic effect . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ITA: 84(5)(d )

$10,000

This $10,000 reflects the accrued gain (i.e., $30,000 -- $20,000) on the old shares before the reorganization.

ITA: 84(3) ITA: 86(1)(c)

ITA: 84(3)

Ch. 17/Study Guide — Solutions to Exercises

493

NOTE TO SOLUTION (1) Capital losses on a redemption are denied where the corporation is still affiliated with the shareholder (e.g., where the shareholder or the shareholder’s spouse still controls the corporation after the exchange).

Exercise 9 If the conditions of section 87 or subsection 88(1) are met: (A) Acme Limited will be deemed to have proceeds of disposition on the land of $500,000, so the capital gain will be deferred. (B) M&M will be able to ‘‘bump’’ the cost base of the land on its books — the potential ‘‘bump’’ would be computed as follows: M&M’s ACB of Acme’s shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less the sum of: (I) cost amount of Acme’s net assets ....................................$500,000 (II) dividends paid by Acme to M&M .................................. 0 Potential Bump . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ITA: 88(1)(d )

$750,000

500,000 $250,000

Without the bump designation, $250,000 of tax cost is lost. The corporation loses $750K in ACB in the Acme Limited shares and only gains net assets with a tax cost of $500,000. — this ‘‘bump’’ cannot exceed: fair market value of the land at the time control was acquired . . . . . . . . less: ACB of the land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$700,000 500,000

maximum ‘‘bump’’ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$200,000

— therefore, the ACB of the land to M&M will be $700,000 after a maximum ‘‘bump’’ of $200,000. M&M will have recouped $200,000 of the lost $250,000 of tax cost (ACB) in the shares of Acme resulting from the amalgamation. The bump designation must be made in the tax return of M&M for the year of amalgamation/wind up.

Exercise 10 Tax Consequences of section 86 Reorganization of Capital Section 86 provides for an automatic tax-deferred exchange of Ichbin’s common shares because he is disposing of all of his common shares of the class that he owned in the corporation, the shares are capital property, and he is receiving other shares of the capital stock of the corporation in the course of a reorganization of capital. The following tax consequences result: (1) Issuance of New Shares (a) Reduced PUC LSC increase for all new shares .................................................................................. $9,900 Less: PUC of old shares .......................................................................... $1,000 Less: boot . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (100) 900 PUC reduction in total ................................................................................................. $9,000

Preferred Shares

Common Shares

LSC increase by class of share . . . . . . . . . . . . . . . . . . . . . . . . . Less: PUC reduction by class of share . . . . . . . . . . . . . . . . . . . .

$5,900 (5,364)

$4,000 (3,636)

Reduced PUC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 536

$ 364

CHAPTER 17

Proration of PUC reduction: (a) preferred shares: $9,000 × $5,900/$9,900 = $5,364 (b) common shares: $9,000 × $4,000/$9,900 = $3,636

Introduction to Federal Income Taxation in Canada

494

(b) Cost of new shares ACB of old shares ......................................................... $1,000 — cost of boot .............................................................. (100) Cost of new . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 900

Allocation based on FMV 900 × 5,900/9,900 = 536 Preferred 900 × 4,000/9,900 = 364 Common (2) Redemption of Old Shares (a) Subsection 84(3) on Redemption of Old Shares Proceeds PUC of new shares par. 84(5)(d ) . . . . . . . . . . . . . . . . . . . . . $ 900 FMV of boot ................................................................................... 100 1,000 — PUC of old ......................................................................................(1,000) Subsection 84(3) dividend . . . . . . . . . . . . . . . . . . . . . . . . . .

(no deemed dividend since boot is not greater than old PUC) Subsection 86(2) Gifting: None since consideration received equals value transferred. (b) CG (CL) on Old Shares Proceeds Cost of new (above) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 900 + boot . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100 — Subsection 84(3) dividend ..................................................................... ( —) Proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000 ACB ......................................................................................................... (1,000) CG (CL) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Exercise 11 Part A Tax advantage Sell Ltd. was attempting to realize: ●

Avoiding taxable capital gain

●

Receiving a tax-free intercorporate dividend

Part B Impact of S. 55(2): ●

The dividend, or a portion thereof, will be deemed to be proceeds of disposition

●

A capital gain will result

Additional information required: ● The portion of the dividend received by Sell Ltd. that was subject to Part IV tax in Sell Ltd.; and ●

The post-71 income (‘‘safe income’’) of Target Ltd.

Environmental, Social, and Governance (ESG) Landscape and Tax

Note: There is no content for this chapter.

495

CHAPTER 18

Chapter 18

Chapter 19 Partnerships, Trusts and Death of a Taxpayer

CHAPTER 19

497

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544

CHAPTER 19 — LEARNING CHART Problem Descriptions Textbook Example Problems 19-1 Partnership income allocation 192 Partnership income flow through 19-3 Tax treatment of distributions of income from a trust 19-4 Attribution 19-5 Use of the capital gains exemption on death 19-6 Comprehensive death of a taxpayer Exercises 1 2 3 4 5 6 7 8 9 10

Partnership income flow through Disposal of partnership interest Taxable income of trust and beneficiary Partnerships Trusts Inter vivos trust Graduated rate estate Death of a taxpayer Death of a taxpayer Death of a taxpayer

Assignment Problems 1 Partnership income, ACB 2 Incorporation of partnership interest 3 Partnerships 4 Partnership income, ACB, disposition 5 Trusts 6 Establish a trust, income allocation, personal tax 7 Estate freeze 8 Merging t wo businesses 9 Advice on estate plan 10 Death of a taxpayer 11 Integrated Case — Death of a taxpayer

Ch. 19/Study Guide — Learning Chart

499

CHAPTER 19

Introduction to Federal Income Taxation in Canada

500

¶19,800

REVIEW QUESTIONS

(1) What does the term ‘‘partnership’’ mean and where would you find the definition? (2) A limited partner can fully deduct losses allocated to that partner by the partnership. True or false? EXplain. (3) An older man, Dadd, and his son, Ladd, wish to carry on a business as a partnership. Dadd is going to contribute land, building and equipment and cash while Ladd is going to contribute energy. They have agreed that they will split the profit from the business on a 50/50 basis; however, they would allocate any capital gain on the land and building fully to Dadd. In addition, any losses in the first five years are to be fully allocated to Dadd. What are your comments on the allocation of the gains and losses? (4) Assume that you are a partner in a partnership and you are entitled to 25% of the income. How would your income allocation and adjusted cost base be affected by a $1,200 capital gain realized by the partnership? (5) Assume that you are a partner in a partnership and you are entitled to 25% of the income. How would your income allocation and adjusted cost base be affected by a $100,000 receipt from a life insurance policy on the death of one of your partners? (6) Ms. Jones is about to become a partner in a partnership and she wants to contribute some property on a rollover basis. There are 13 other partners involved although one of them has just moved to the United States for a four-year assignment. Should Ms. Jones have any concerns about the availability of the rollover?

ITA: 97(2)

(7) What is a trust? (8) Comment on this statement: ‘‘Trusts are taxed in much the same way as partnerships; they are both conduits of income and neither is liable to pay tax’’. (9) How is a testamentary and an inter vivos trust created? (10) What is a discretionary trust and how does it work? (11) One method of transferring the tax liability from the trust to the beneficiary is to either pay out the income or make it payable to the beneficiaries. What types of income retain their source for purposes of calculating the taxable income and tax payable of the beneficiary? (12) Ms. Betty is the sole beneficiary of a trust that arose on the death of her father. He died on March 15, 2023. When does the trust file its first tax return? When does Ms. Betty report the income that is allocated to her by the trust in its first tax year end? (13) Describe the different tax returns that can be filed for a deceased individual and describe the income that would be included on each return.

¶19,800

ITA: 104(6)

Ch. 19/Study Guide — Exercises

¶19,825

501

EXERCISES

Exercise 1

ITA: 96, 110.1, 118.1, 121

The following income statement was prepared for Bob and Stan Tax Services, a partnership of two individuals who share income equally: Bob and Stan Tax Services Income Statement for the year ended December 31, 2023

Dividends received from a CCPC that has no GRIP balance . . . . . . . . . . . . . . . . . Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$400,000

CHAPTER 19

Gross revenue from operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Amortization on office furniture . . . . . . . . . . . . . . . . . . . . . . . . $ 3,750 Donations to charities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,500 Dues to Canadian Tax Foundation . . . . . . . . . . . . . . . . . . . . . . 550 Employees’ salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67,220 Fringe benefits for employees . . . . . . . . . . . . . . . . . . . . . . . . . 11,500 Heat, light and water . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,400 Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 725 Membership in fitness club . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,250 Office rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,000 Office supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,250 Repairs and maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 575

104,720 $295,280 4,000 5,000 $304,280

Additional Information (1) Maximum capital cost allowance on the furniture for the year is $4,300. (2) The partners each took drawings of $54,000 in the year. (3) The dividends were received from a CCPC, all of whose income was eligible for the small business deduction. — REQUIRED Bob is your client. He has received personal investment income consisting of $3,500 in dividends from Canadian public companies and $1,200 in interest income. Determine his taxable income for 2023 and analyze the nature of his income.

Exercise 2

ITA: 53(1)(e), 53(2)(c)

Five years ago, a partnership was formed between David and Katie to carry on a professional accounting practice. Both partners made an initial contribution of $50,000 at that time agreeing to make equal drawings and to share equally in the profits and losses of the practice. The following data pertains to the partnership business during the period from its inception to the end of 2022: Income of the partnership during the period . . . . . . . . . . . . . . . . . . . . . . . . Losses of the partnership during the period . . . . . . . . . . . . . . . . . . . . . . . . Net taxable capital gains included in the above income . . . . . . . . . . . . . . . . Drawings by the partners in the period . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital dividends received by the partnership . . . . . . . . . . . . . . . . . . . . . . . Charitable donations made by the partnership . . . . . . . . . . . . . . . . . . . . . . . In 2023, Katie will retire from the partnership and will receive in full settlement of her partnership interest . . . . . . . . . . . . . . . . . . . . . . . . . . .

$450,000 15,000 20,000 176,000 4,000 27,000 250,000

— REQUIRED Assuming Katie retires on January 1, 2023, what are the tax consequences to Katie of the disposition of her partnership interest in 2023?

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Exercise 3

ITA: 104

On January 1, 2023, Mr. Ruester settled a trust for the benefit of his two children, Rebecca and Robert, both over the age of 18, neither of whom has other income. Robert attends, for eight months a year, a university in Canada where tuition is $9,500 per year. All tuition for 2023 was paid in respect of that year. Under the terms of the trust, the trustees have complete discretion to allocate the accumulated income to the beneficiaries in any manner they wish. The trust earned income from cash transferred to the trust by Mr. Ruester. For the 2023 taxation year, the trust received the following income: Interest ....................................................................... $11,500 Dividends from public corporations . . . . . . . . . . . . 9,000 Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,000 The trustees paid the income, and made the appropriate designations as follows:

Rebecca . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Robert . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Interest $5,500 1,500 $7,000

Dividend $3,000 3,000 $6,000

Capital gain $3,000 3,000 $6,000

Total income accumulated in trust . . . . . . . . . . . . .

$4,500

$3,000

— REQUIRED Compute the taxable income and the taxes payable of the trust and each beneficiary.

Exercise 4 Two of your university friends, who became lawyers, left the firms where they were employed and set up their own practice on January 1, 2023. They started the practice by contributing $10,000 working capital each and decided to split the profits equally and pay themselves equal salaries. They have chosen a December 31 year end for the practice. Their accountant has prepared the following financial statements: YOLO Law Practice Balance Sheet As at December 31, 2023 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Work in progress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Computer hardware, at cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Computer software, at cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 2,000 30,000 25,000 10,000 8,000 $75,000

Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Initial Partner Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income for the period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$15,000 20,000 40,000 $75,000

YOLO Law Practice Income Statement For the Period Ending December 31, 2023 Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Meals and entertainment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Office supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Partner’s salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Secretary’s salary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income for the period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$230,000 6,000 4,000 130,000 24,000 26,000 190,000 $ 40,000

The work in progress represents work done by the lawyers at their standard charge rate that has not been billed to clients at this time.

¶19,825

Ch. 19/Study Guide — Exercises — REQUIRED Part A Part B Part C

503

Your friends have come to you to determine the amount that they must include in their 2023 tax returns from the practice. They would also like to know if there are any partnership-related expenses which they may have incurred personally which they may be able to deduct on their 2023 tax return. Compute the adjusted cost base of each partner’s partnership interest at January 1, 2024.

Exercise 5 Several years ago, Mr. Snider established an inter vivos trust for his daughter, who is now 20 years old. The terms of the trust provided that the trustees had complete discretion to distribute any portion of the annual income of the trust to the beneficiary. The following income was earned in the trust for its taxation year ended December 31, 2023: $15,000 21,000 16,000 5,000

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$57,000

CHAPTER 19

Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash dividends from taxable Canadian public corporation . . . . . . . . . . . . . . . Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rental income (after deduction of $1,500 of CCA) . . . . . . . . . . . . . . . . . . . . .

In 2023, 75% of each type of income was paid to the beneficiary and the other 25% was retained by the trust. The daughter had no other source of income in 2023 and has used all of her capital gains exemption. She paid tuition fees of $9,500 in the year for eight months of full-time attendance at university. — REQUIRED Compute the taxable income and the taxes of the trust and the daughter.

Exercise 6 The Estate of Mr. Frank Wellsay is a graduated rate estate with a November 6 year end. The beneficiaries of the estate are Mr. Wellsay’s two grandchildren, Keith Wellsay and Karen Wellsay, and his niece, Marie Barr. This is the second year of the estate. It is now November 1 and the executors of the estate have told you that the estate has earned the following income: Cash dividends received from Canadian public corporations . . . . . . . . . . . . . . Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign income (in Canadian dollars) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$15,000 6,000 4,000 1,300

(Foreign tax withheld — Cdn $195) Business income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,000

The terms of the will indicate that the executors can distribute the income of the estate to the beneficiaries at their discretion (timing and amounts to each beneficiary). The executors are required to distribute the capital of the estate equally to the beneficiaries. — REQUIRED Discuss how this income can be taxed (no calculations are required) and when the trust return must be filed.

Exercise 7 On July 1, 2023, Russell created a trust for the benefit of his two children who are 12 and 22 years of age. Russell gifted 500 shares of X Ltd., a taxable Canadian public corporation, to the trust. At the time of the gift, the 500 shares were valued at $240,000. Russell had purchased the shares in 2009 for $90,000. Russell also loaned $100,000 to the trust, interest-free.

¶19,825

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During the period July 1, 2023 to December 31, 2023, the trust earned interest income of $6,000 and received $8,000 dividends on the X Ltd. shares. The trust earned exactly the same income during the period January 1, 2024 to June 30, 2024. In addition, the trust sold the 500 shares of X Ltd. on July 15, 2024 for $360,000. Under the terms of the trust, the trustees, at their discretion, can accumulate the income earned in the trust or pay it out annually to the beneficiaries. — REQUIRED Part A

What are the tax consequences to Russell of the gift of the shares of X Ltd. to the trust?

Part B

What date should be the day of the first taxation year end of the trust? Briefly explain the reason for the date you select.

Part C

Based on the year end you selected in Part B, what is the due date for the tax return of the trust?

Part D

If all of the income is taxed in the trust, calculate the taxable income for the trust for its first taxation year and calculate the tax payable for the trust using assumed provincial tax rates.

Part E

Describe the tax implications to the trust and to the beneficiaries if all the income of the trust was paid equally to the two beneficiaries prior to the year end of the trust.

Exercise 8 Sam Elder died on September 10, 2023. Discuss how the following are to be reported: (A) $200, accrued but unpaid, interest on his bank account. (B) $100 dividend declared on September 15, 2023 and paid on September 30 (the previous dividend was paid on March 30). (C) Canada Pension Plan of $600 for August 2023, received on September 3 and $200 for the period September 1 to 10, received on October 4. (D) Charitable donations for the period January 1 to September 10, 2023. (E) Capital losses incurred in 2022 of $4,000, of which no amount was deducted in 2022. (F) Income of $900 from a graduated rate estate established on his wife’s death, of which Sam was a beneficiary, for the year ended December 31, 2022. (G) $50,000 in life insurance payable on Sam’s death.

Exercise 9 After the 2022 personal tax season, the brother (Mr. Kaye) of one of your clients (Ms. Kaye) contacted you with respect to his sister. He indicated that his sister had passed away on May 2, 2023, at the age of 50. Mr. Kaye indicated that his sister, who was not married, had the following income from January 1 to May 2, 2023: (a) Salary — $22,000, (b) $2,000 of vacation pay that had not been paid at the time of her death. (c) Bond interest payable of $950 that had not been received at the time of death. (d) Interest in her savings/chequing account of $150. (e) Interest of $140 on a 60-day GIC that matured on May 15, 2023. (f) Grossed-up dividend income of $1,380 on 100 Flying High shares, payable on April 30, 2023, but had not been paid at the time of her death. (g) The fair market value of Flying High shares on May 2, 2023, was $25/share. These shares had been purchased for $10/share in 2016.

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(h) Her RRSP had a value of $34,000 at the date of her death. In March 2023, Ms. Kaye made an RRSP contribution, in respect of 2023, of $9,000. Her earned income for 2022 was $80,000.

— REQUIRED Discuss the tax implications and filing requirements as a consequence of Ms. Kaye’s death.

Exercise 10 Mr. James has just found out that he is the executor of the estate of his late aunt, Ms. Ray. Ms. Ray died on July 15, 2023. Mr. James would like to know the tax treatment that results in the least tax to the estate for the following items:

Land

Building

Original cost in 2008 . . . . . . . . . . . . . . . . . . . . . . . . .

$138,000

$165,000

UCC — December 31, 2022 . . . . . . . . . . . . . . . . . . . . .

N/A

135,000

FMV — July 15, 2023 . . . . . . . . . . . . . . . . . . . . . . . . .

218,000

265,000

CHAPTER 19

(a) A rental property which was left to Ms. Ray’s daughter:

(b) Net rental income before CCA of $25,200 earned from January 1, 2023 to July 15, 2023. (c) 1,000 shares purchased in 2014 for $17,000, which have a fair market value of $38,000 on July 15, 2023 and were left to Ms. Ray’s husband. (d) Non-eligible dividend income: Amount

Declared

Paid

$300

January 3, 2023

January 31, 2023

$325

April 6, 2023

April 30, 2023

$325

July 5, 2023

July 31, 2023

(e) Net income from Ms. Ray’s legal practice which had a December 31 year end: January 1, 2023 to July 15, 2023 ................................................................ $63,000 (f)

Term life insurance of $100,000, which was paid to Ms. Ray’s estate on her death.

(g) Unmatured RRSP’s with a fair market value of $72,000 payable to her estate. Ms. Ray had not designated a beneficiary in her RRSP contract. Her will leaves all of her property on death except for the above-noted rental property to her husband.

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¶19,850

ASSIGNMENT PROBLEMS

Problem 1

ITA: 53(1)(e), 53(2)(c)

Mr. Clancy, a lawyer, has come to you to prepare his 2023 personal tax return. He is a partner in the law firm Ludlum, Clancy, Follet & Associates (LCF&A). Mr. Clancy is one of four equal partners in the partnership. He has provided you with the following income statement information: Ludlum, Clancy, Follet & Associates PROJECTED INCOME STATEMENT for the year ended December 31, 2023 Gross revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$980,250

EXpenses: Professional staff employee salaries ......................................................$329,000 Office salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

74,000

Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

42,000

Office supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

17,000

Client entertainment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5,075

Capital cost allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

16,222

Donations to charities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

25,000

508,297 $471,953

Dividends from Canadian public companies (eligible) . . . . . . . . . . . .

18,000 $489,953

Mr. Clancy withdrew $97,500 from the partnership for his personal living expenses during the year. Mr. Clancy is not married and does not have any children. He is 31 years old. His only income is from the partnership. Both he and the partnership are located in Saskatoon, Saskatchewan. He would like to know how much tax he will owe for 2023. He also wonders what personal deductions or credits he could claim on his tax return to minimize tax and if he is required to contribute to CPP. He recently received an offer to join another law firm that he turned down but he would like to better understand what would happen from a tax perspective if he were to sell his partnership interest in the law firm. You have reviewed his prior year’s tax returns and determined that the adjusted cost base of Mr. Clancy’s partnership interest was $55,792 at the beginning of 2023. If Mr. Clancy were to sell his partnership interest in 2024 for $300,000, what would he need to report on his 2024 personal tax return for the sale? — REQUIRED For your next meeting, you agree that you will: (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

Problem 2 Refer back to Problem 1. Mr. Clancy wonders whether it would be to his advantage to incorporate his partnership interest. He has asked you to advise him on the following:

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1. How the partnership income would be taxed if his partnership interest was owned by a corporation that he personally owned.

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2. Whether he should incorporate his partnership income. If he incorporates, assume that he pays his drawings out as a salary. Ignore CPP. The provincial corporate tax rate is 4% on active business income eligible for the small business deduction and 12% on any other income. For the next meeting you agree that you will: (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

Problem 3 Jim, Bob, and Stan formed the ‘‘Taxman Associates’’ partnership on February 1, 2021. Each partner contributed $30,000 in return for an equal share of the profits of the partnership. At the end of the 2023 fiscal year of the partnership on December 31, Bob retired. He received $240,000 for his partnership interest on January 1, 2024. The following income statement was prepared for Taxman Associates: TAXMAN ASSOCIATES INCOME STATEMENT For the Year Ended December 31, 2023 Gross revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$878,210

Less: Office salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 85,500

Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

40,500

Office supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

17,500

Capital cost allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

20,110

Donations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

247,500

Capital gain on sale of land (capital property) . . . . . . . . . . . . . . . . .

$135,000

(411,110)

Dividend income: Non-eligible dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

36,000

Capital dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

14,400

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

185,400 $652,500

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The financial statements of the partnership revealed the following for the first two fiscal years ended December 31: 2021

2022

Income (loss) before capital gains (below) . . . . . . . . . . . .

$121,500

$(67,500)

Capital gains on partnership property (November) . . . . . .

19,800

Charitable donations of partnership . . . . . . . . . . . . . . . . .

1,350

Jim . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

28,800

14,400

Bob . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

28,800

18,000

Stan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

28,800

14,400

Partners’ drawings:

Additional Information (1) Each partner drew $120,000 from the partnership in fiscal 2023. (2) The following data pertains to Bob: (a) he has no other income for 2023; and (b) he has a net capital loss of $150,000 (arising in 2009) that is available to be carried forward. — REQUIRED (A) Compute Bob’s income for tax purposes for 2023 as a result of his participation in the partnership. (B) Compute Bob’s taxable income for 2023. (C) Compute Bob’s capital gain on the disposition of the partnership interest.

Problem 4

ITA: 53(1)(e), 53(2)(c)

About five years ago, Isabelle, Eden, Samara, and Joy formed a partnership to carry on a snow removal and landscape business. All the partners, except Isabelle, made an initial contribution of $50,000. Isabelle made an initial contribution of $90,000. Each agreed to share in the profits and losses of the business as follows: 20% to each of Samara, Joy & Eden and 40% to Isabelle based on contributions of capital and labour to the partnership. At the end of the 2023 fiscal year of the partnership, Isabelle and Samara decided to go their separate ways. On January 1, 2024, Samara received $125,000 for her partnership interest, while Isabelle received $250,000. The tax records for the five years ended December 31, 2022 reflected the following cumulative amounts: Income (before capital gains) from operations for tax purposes ........................... $750,000 Losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

80,000

Capital gains (to 2022) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

10,000

Drawings by the partners ........................................................................................... 730,000* Charitable donations (added back to Division B income for tax purposes)

15,000

* Isabelle, $170,000; Eden, $150,000; Samara, $250,000; and Joy, $160,000.

Financial results for the year ended December 31, 2023, are as follows: Net income per financial statements ......................................................................... $65,000 Charitable donations (deducted from accounting income) . . . . . . . . . . . . . . .

¶19,850

2,000

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Drawings: Isabelle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

10,000

Samara . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5,000

Eden . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5,000

Joy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4,000

Other Information (1) Isabelle is single, and has interest income of $2,500 for the year 2023. (2) Samara has interest income of $6,600, and has made an RRSP contribution in 2023 of $2,700 (her 2022 earned income was $15,000). You have agreed to do the following: (1) Compute the partnership income for the year ended December 31, 2023, and the income to be allocated to the partners.

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(2) Advise on the tax consequences to Samara and Isabelle as a result of the disposition of their partnership interests in 2024. Compute Samara’s and Isabelle’s capital gain on the disposition of their partnership interests on January 1, 2024. (3) Compute Samara’s and Isabelle’s taxable income and tax payable for 2023 using the hypothetical provincial tax rate table presented in Chapter 10, ¶10,250.

Problem 5 Part A For each of the following trusts settled by Mrs. A explain: – The tax consequences of the transfer of property by Mrs. A to the trust; – The rate of tax payable by the trust; – The tax consequences of the transfer of property from the trust to the beneficiary (a) On June 1, 2023, Mrs. A settled a painting on her daughters, B and C, in trust for her grandchildren. The painting has a cost to Mrs. A of $500 and a fair market value of $7,000. (b) Mrs. A provides in her will that her shares of ABC Co. are to be held in trust for her grandchildren. These shares have a cost to Mrs. A of $10,000 and a fair market value of $35,000. Part B Mr. B died on March 15, 2023. Mr. B’s will provides that the residue of his estate is to be transferred to a trust for the benefit of his wife, Mrs. B, a resident of Canada. The will provides that the income of the trust is to be paid to Mrs. B. The will also allows the executors to pay out capital for the benefit of Mrs. B. On Mrs. B’s death, the trust’s assets are to be distributed to the Bs’ children. Mr. B’s assets include shares of XYZ Inc., a public company, which were purchased about 25 years ago for $1,000 and have a fair market value at his death of $100,000. You have agreed to advise the executor as follows: (A) EXplain the tax consequences to Mr. B arising out of the transfer of the ABC Inc. shares to the trust for Mrs. B. (B) EXplain the tax consequences to the trust of holding the shares and earning dividend income. (C) EXplain the tax consequences if the shares are transferred to Mrs. B. (D) EXplain the tax consequences if the shares are still held by the trust at the time Mrs. B dies. (E) EXplain how your answer to (A) would be different if Mr. B’s will provided the trustees with the power to encroach on capital for the benefit of the Bs’ children. Part C Ms. C, a lawyer, died on June 1, 2023. Ms. C was divorced at the time of her death. Under the terms of her will, her estate is to be distributed equally to her 2 adult children. At the time of death, Ms. C owned investments in publicly traded securities, RRSPs, a house and cottage, artwork and personal

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Introduction to Federal Income Taxation in Canada

properties as well as an interest in her professional partnership. The executor of her estate is her longtime partner Ms. J. You have agreed to advise the executor as follows: (A) EXplain the tax consequences to Ms. C at the time of her death related to the properties she owned at that time. (B) EXplain the tax treatment of the estate arising on Ms. C’s death. (C) EXplain the tax consequences of the distribution of properties from Ms. C’s estate to her children.

Problem 6

ITA: 104

On January 1, 2022, Mr. Bilodeau settled a trust for his daughter Jane, who became age 17 in 2022. The trust was documented by a written agreement. There are three trustees, Mr. Bilodeau, Mrs Bilodeau, and a long-time family friend. The trust provided that the trustees had complete discretion to distribute any portion of the capital or annual income of the trust to the beneficiary. Mr. Bilodeau transferred the following assets into the trust on January 1, 2022: (a) $250,000 cash; and (b) 1,500 shares of Successful Retailers Ltd. (Retailers), a corporation that is incorporated in Canada and is a CCPC with no GRIP balance. The original cost of the shares about 23 years ago when they were purchased by Mr. Bilodeau was $17 per share. At the date of transfer the fair market value was $500 per share. Mr. and Mrs. Bilodeau run the retail business from a location in downtown Toronto. The trust immediately purchased a 5% bond with the $250,000 cash. Interest of $12,500 is payable on December 31. The amount of dividends paid on the Retailers shares for each of 2022 and 2023 is $40,000. The dividends were received only from income eligible for the small business deduction. In each year, the trust is to ‘‘accumulate’’ 60% of the income earned and pay out the remainder to the beneficiary to meet her financial needs. Mr. Bilodeau is in the top tax bracket. Jane does not have any income other than from the trust. The trustees would like your advice on the tax consequences of the above transactions and the reporting of the income. Before you meet with the trustees you want to: (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

Problem 7 Gordon Willows is 60 years old. He is the president and sole shareholder of Amazing Results Inc. (‘‘Amazing’’). Amazing was incorporated about 25 years ago. At the time of incorporation, Gordon subscribed for 100 common shares without par value for subscription proceeds of $100. These are still the only shares that are issued and outstanding. Amazing has been involved in the lobbying business and achieves results for its clients which are considered to be simply amazing. Amazing has just been involved in a very successful high-profile lobbying effort and business is booming. Four years ago his daughter Wendy joined the company and has learned the business very well. She has taken on significant responsibility and has proven leadership ability. Amazing has been a very profitable company. It is estimated that the fair market value of the shares is $8 million today. Gordon believes that, under Wendy’s leadership, there is a reasonable chance that the value of the shares of Amazing will increase over the next five years to between $9 million and $13 million. This will require a lot of work from Wendy since Gordon plans to cut back on his work activity.

¶19,850

ITA: 84(1), 85, 86, 104, 129(6)

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Gordon is divorced with three children. – Wendy is 35 years old and very active in the business. Her intention is to make a career out of Amazing. – Wayne, who is 32 years old, is an artist with no interest in Amazing. – Winona, who is 28 years old, is in a PhD program in accounting. She has stated her intention is to become a researcher at a top university. Gordon would like to retire from active involvement in Amazing within the next 10 years. He estimates that he will continue to require an income of $200,000 per year thereafter. He wants to take action now so that, in the event of his death, he will not be taxed on the growth of Amazing beyond its current value. You have looked at Amazing recently and determined that the shares do meet the qualifications to be QSBC shares. Gordon has decided that a plan should be implemented to ensure that the future growth in value of Amazing will accrue to Wendy. He wants to maintain sufficient voting control over Amazing during his life in the event that Wendy does not fulfil his expectations of her involvement in the business. He has never claimed the capital gains exemption.

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He wants you to determine the amount of tax that would be payable in his estate on his death and suggest where the cash come from to pay the tax. On his death Gordon wants to leave his assets equally among his three children. The tax partner has suggested the following structure.

Before your next meeting with Gordon you have been asked to: (A) Assess the situation. (B) Identify the issues: (a) Determine the high-level technical steps needed to achieve the structure. (b) Determine if the proposed structure meets Gordon’s objectives. (C) Analyze the issues: (a) Complete the technical details. (D) Advise/recommend.

Problem 8 Kay Sega is a pharmacist and owner of a well-established and unincorporated pharmacy in a Saskatoon mall. Lamia Savitz is a nutritionist and owner of an unincorporated health food store that is located in the same neighbourhood shopping mall. Kay and Lamia both realize that they share many of the same products and customers. They are currently considering combining the two stores to not only save on costs but also to provide opportunities for growth and tax deferral. Kay heard, at a local investment seminar, that tax rates for corporations are much lower than for partnerships. Last year, each earned the following: ● Pharmacy net income from a business $160,000 ● Health food store net income from a business $110,000

Advise Kay and Lamia on the alternative methods that would permit the merger to take place. Which alternative will attract the least tax, over time?

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Problem 9 Cora Dusk owns 100% of the common shares of a corporation, Cee Ltd. These shares have an original cost of $1,000, a paid-up capital of $1,000 and a fair market value of $1.8 million. At the current time, the common shares are the only shares of Cee Ltd. that are issued and outstanding. Cora is a Canadian resident, 70 years old and a recent widow. She wants to freeze the value of her common shares of Cee Ltd. in favour of a trust for her children and grandchildren. Cora has a 40-yearold daughter, Jordan, and a 35-year-old daughter, Susanne. All of Cora’s grandchildren are under the age of 10. Her current will leaves these shares equally to Jordan and Susanne. Cee Ltd. carries on a real estate rental business and has nine full-time employees throughout the year, including Cora, Jordan and Susanne. The company qualifies as a small business corporation and the shares which Cora owns meet all the tests to be qualified small business corporation (QSBC) shares. Cora’s plan is to settle one trust for her daughters and grandchildren with $100. The trust would use the $100 to subscribe and pay for 100 common shares of a holding company (Holdco Inc.) at a cost of $1 each. The trustees of the trust will be Jordan, Susanne and the family’s lawyer and decisions would be made by a majority of trustees. The trust agreement would allow the trustees discretion as to the allocation of income to beneficiaries on an annual basis. The trust agreement would provide that, at the end of 21 years, the trust capital would be distributed equally to the children of Jordan and Susanne. Cora would then sell her common shares of Cee Ltd. to Holdco Inc. She wants to crystallize the $600,000 remaining of her lifetime QSBC capital gains exemption when she freezes the value of her shares. She plans to make an election under section 85 of the Act in the amount of $601,000 as a result. She will receive $601,000 of debt, with the balance of the consideration being Holdco Inc. shares with a fair market value and legal stated capital of $1,199,000 from Holdco Inc. in return for her common shares of Cee Ltd. Cora currently pays tax at the top marginal rate, but Jordan and Susanne do not because of child care expenses, RRSP contributions and other deductions and tax credits. Cora has asked you for your comments on her stated plans and whether you have any ideas for improvement or alternatives for her to consider.

Problem 10 In early March, you were preparing your client list with respect to the personal tax return preparation season. When you came across Mr. Rogozynski’s name you remembered that Mrs. Rogozynski had called you regarding her husband’s death. Mr. Rogozynski had passed away March 1, 2023, at age 62. Mrs. Rogozynski is the executriX. Mr. Rogozynski owned and operated a Canadian-controlled private corporation, Deeridge Ltd. Mr. Rogozynski’s 100 shares had an adjusted cost base and paid-up capital of $55,000. The fair market value of the shares at the date of death was $5,750,000. Mr. Rogozynski earned $12,000 per month in salary, which was paid by direct deposit on the last day of the month. A non-periodic bonus of $50,000 had been declared on February 15, 2023, but had not yet been paid at the time of his death. CPP of $3,500 has been, or will be, withheld on this income. He is not eligible for EI. In addition to his shares, Mr. Rogozynski owned bonds with accrued interest of $917 in 2023 to the date of his death. Further, Mr. Rogozynski had owned two rental properties. Net rental income before capital cost allowance was $5,000 for each of the months of January and February 2023. Other Information: (1) All assets of Deeridge Ltd. have been used in the active business of the corporation. (2) The shares of Deeridge Ltd. have been owned by Mr. Rogozynski since 2003. (3) Mr. Rogozynski had earned income in 2022 of $125,000. He contributed to his RRSP the maximum amount allowed as a deduction in 2022 but did not make the 2023 contribution. His RRSP was worth $795,000 at the time of his death. Mrs. Rogozynski is the designated beneficiary of his RRSP. (4) His 2022 personal tax return was prepared but not filed at the time of his death.

¶19,850

ITA: 60, 70, 118.93; IT-210R2, IT-212R3, IT-326R3

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(5) Mr. Rogozynski had not used any of his capital gains exemption. (6) All of Mr. Rogozynski’s assets have been left to his wife, except for the two rental properties that are bequeathed to his 20-year-old daughter. (7) The rental properties had the following details:

Unit #1 Land

Unit #2 Land

Building

Fair market value . . . . . . . . . . $600,000 $1,100,000

$620,000

$380,000

Capital cost . . . . . . . . . . . . . .

310,000

383,000

300,000

UCC . . . . . . . . . . . . . . . . . . . .

Building

472,000 350,000

352,000

The partner has asked you to prepare a memo to the tax file explaining the tax implications of the above information, the filing requirements for Mr. Rogozynski’s tax returns and any planning opportunities available.

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Before you meet with the partner you want to: (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

Problem 11 — Integrative Case You are a new CPA working for Lin, Robson & Associates LLP. A long-time client Josephine Franklin passed away on the evening of December 1, 2023 at the age of 66 years old. Josephine’s brother Harry is the executor of her estate. It is February 1, 2024 and Harry has contacted you for assistance and advice on his filing requirements and responsibilities as the executor of Josephine’s estate. He would like your firm to file the tax returns for Josephine and for her estate for 2023 and 2024. Harry has provided Josephine’s will. The terms of the will bequeath properties to Josephine’s husband Ali, age 67, their 30-year old son, Ernie, and their 25-year old daughter Natalia. Josephine was a practicing lawyer at the time of her death. She held a 50% partnership interest in the law practice partnership, Franklin & Jones LLP with another lawyer at the time of her death. Natalia is also a lawyer and currently works for the partnership. On Josephine’s death, the terms of the partnership agreement allowed for the transfer of Josephine’s partnership interest to Natalia. The valuation of the partnership at that time was $600,000, 50% attributable to Josephine’s partnership interest. For the 2023 calendar year, the Division B income of the partnership was $380,000. The adjusted cost base of Josephine’s partnership interest was $350,000 on January 1, 2023 and she withdrew $120,000 of drawings from the partnership in 2023 before she died. Harry has been told that the partnership agreement for Franklin & Jones LLP does not deem a year end for a partnership at the time of the death of a partner. As a result, the year end of the partnership for 2023 will be December 31, 2023. The partner would like you to calculate the adjusted cost base of the partnership interest at the time of Josephine’s death. Josephine and Ali live in a rented townhouse in Waterloo and also own a condominium rental in Waterloo. The condominium rental purchased in 2021 has the following attributes: Land

Building

Original cost in 2021 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$380,000

$650,000

UCC — December 31, 2022 . . . . . . . . . . . . . . . . . . . . . . . . . . . .

N/A

350,000

FMV — December 1, 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

680,000

950,000

The property earned net rental income before CCA of $14,600 per month.

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At the time of her death, Josephine also owned a cottage on Miller Lake that she inherited from her parents in 2015. The value of the cottage in 2015 was $350,000. It was worth $700,000 when Josephine died. Under the terms of her will the cottage is to be transferred to a trust for Ali. Harry is the trustee of the trust. Ernie and Natalia are the capital beneficiaries of the trust and will inherit the cottage on Ali’s death. Ali is the beneficiary of the trust while living, is required to maintain the cottage and can use the cottage while alive. The terms of the trust indicate that the cottage cannot be sold while Ali is living. At the time of Ali’s death, the trust will be wound up and the cottage distributed equally to Ernie and Natalia. Ali is still working as a lawyer and earns $300,000 of income from his law practice. He is a busy man and will likely rent the cottage for at least a month during the summer months. Josephine held 100% of the common shares in an investment holding company at the time of death. The company held $20,000 of cash and has a direct trading account with TD Waterhouse with the following investments at the time of her death. The shares in the investment holding company are bequeathed to Ernie under the terms of her will. Josephine’s only other investments when she died were held personally in her self-directed RRSP account. The company had a value of $74,200 at the time of her death.

Investment

ACB

FMV Dec. 1, 2023

BNS (Bank of Nova Scotia) . . . . . . . . . . . . . . . . . . . . .

185

$11,900

$10,500

BCE (BCE Inc.) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

195

$10,900

$11,200

CNQ (Canadian Natural Resources) . . . . . . . . . . . . . . .

580

$17,900

$15,100

CNR (Canadian National Railway) . . . . . . . . . . . . . . . .

$4,100

$10,500

BLO (CannibiX Technologies Inc.) . . . . . . . . . . . . . . . .

5,900

$8,100

$ 2,800

L (Loblaw Companies Ltd.) . . . . . . . . . . . . . . . . . . . . .

146

$6,800

$10,200

$59,700

$60,300

The investment holding company was incorporated in 2021. Josephine invested $30,000 in the common shares at that time to be invested in the corporate trading account. Josephine had declared a dividend of $5,000 on the shares of the investment holding company on November 25, 2023 that was paid to her estate December 31, 2023. Ernie has indicated to Harry that he doesn’t want to deal with the annual corporate tax filings for the company and wants the company to be wound up so he can hold the investments in his personal trading account. You had a look at the draft corporate tax return for the December 31, 2023 year-end for the investment holding company and determined that the $5,000 dividend had been designated as an eligible dividend from GRIP. After the dividend and resulting dividend refund, the company had a remaining eligible RDTOH and GRIP balance of $3,000 and $7,800 respectively at December 31, 2023. The company also had a capital dividend account balance of $10,000 as of December 31, 2023. The company has an outstanding bill owing to Josephine’s lawyer for $1,100 related to the preparation of the resolution for the above dividend that was owing at the time of her death. Harry and Ernie would like to understand the tax impact of winding up the company and want to know how much tax will need to be paid on a wind-up. Ernie has other sources of income that result in any additional income being taxed in the highest tax bracket. The most recent investment statements for the company’s trading account on January 31, 2024 show a fair market value of $81,000 for the above investments. Dividends of $1,560 were received on the share investments during January, 2024. You noted that there were no trading transactions in the account from the date of Josephine’s death to the end of January, 2024. Term life insurance of $100,000 was paid to Josephine’s estate on her death. Josephine had unmatured RRSPs with a fair market value of $472,000 at the time of her death. Josephine had forgotten to designate a beneficiary in her RRSP contract with TD Waterhouse and the RRSP proceeds were paid to the estate in January, 2024.

¶19,850

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All of Josephine’s properties except those specifically discussed above are bequeathed to Ali on Josephine’s death under the terms of the will. The partner has asked you to prepare a memo to the tax file to address Harry and Ali’s questions. In addition, he would like you to explain the tax returns that must be filed, identify the income and taxable capital gains to be included on each return and the filing due dates. He would like you to identify any tax saving opportunities available and any information that needs to be collected to prepare the returns. He would also like you to summarize the tax cost amounts of the properties received by the beneficiaries of Josephine’s estate. — REQUIRED (A) Assess the situation. (B) Identify the issues. (C) Analyze the issues. (D) Advise/recommend.

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Introduction to Federal Income Taxation in Canada

CHAPTER 19 — DISCUSSION NOTES FOR REVIEW QUESTIONS (1) The term ‘‘partnership’’ is not defined in the Income Tax Act. The term ‘‘partnership’’ is defined in the provincial Partnership Acts. The Ontario Partnership Act, for example, provides that a ‘‘partnership is a relationship that subsists between persons carrying on a business in common with a view to profit.’’ (2) False. The amount of losses a limited partner can deduct in computing income in respect of losses allocated by the limited partnership is limited. The losses can only be deducted to the extent of the limited partner’s ‘‘at-risk amount’’ as defined. Generally, the losses may be deducted by a limited partner only to the extent that the total of his or her investment in the partnership plus his or her share of the partnership profit exceeds any amount owing to the partnership by him or her and so on. To the extent that limited partnership losses are restricted, they can be carried forward indefinitely and deducted, but only against income from the limited partnership that gave rise to the loss.

ITA: 96(2.1)

(3) Because Dadd and Ladd do not deal at arm’s length, the anti-avoidance rule must be considered. The issue is whether the allocation is reasonable in the circumstances having regard to the capital invested in or work performed for the partnership by the members thereof, or such other factors as may be relevant. For example, the allocation of the capital gain to Dadd may be reasonable given that it was his property in the first place. Since Dadd is the only one with capital and cash invested in the partnership, any losses may be his losses, as the losses impair his capital in the partnership. Arguments can be made that the allocation is reasonable in the circumstances.

ITA: 103(1.1)

Because the decision has been made to allocate income on a 50/50 basis but to allocate all of the losses to Dadd, reference should also be made to another anti-avoidance rule. There should be no problem with this allocation on the basis that the principal reason for the allocation cannot reasonably be considered to be the reduction or postponement of the tax otherwise payable under the Act.

ITA: 103(1)

(4) Income is calculated at the partnership level and then allocated to the partners. A $600 taxable capital gain would be included in the income of the partnership, of which your share is $150 (25% × $600). Your adjusted cost base will be increased by $300, being your share of the taxable capital gain of $150 and your share of the non-taxable portion of $150. (5) Income is calculated at the partnership level and then allocated to the partners. A $100,000 receipt would not be included in the partnership’s income, since life insurance proceeds are not taxable. The adjusted cost base of your partnership interest will be increased by your share or $25,000. (6) A rollover is available only on a transfer to a Canadian partnership. This is defined to include only those partnerships where all the members are resident in Canada at the particular time. In this case, Ms. Jones will need to determine whether the partner in the United States is still considered a resident of Canada for purposes of the Act. If not, the rollover will not be available.

ITA: 96(2.2)

ITA: 111(1)(e)

ITA: 53(1)(e)

ITA: 97(2) ITA: 102

(7) A trust is a relationship whereby a person (who is called a trustee) is bound to deal with property (which is called the trust property) over which he or she has control for the benefit of persons (who are called the beneficiaries) any of whom may enforce the obligation according to the terms of the trust document. A trust is created when a person (called the settlor) transfers property to a trustee. (8) While it is true that trusts are conduits by allowing certain types of income to flow through to the beneficiaries and retain their character for tax purposes (for example, dividends, capital gains, foreign income), the income of a trust may be subject to tax. Trusts are taxed as an individual on any income that is not paid or payable to the beneficiaries. The rate of tax paid is calculated at the highest personal tax rate unless the trust is a testamentary trust that is designated as a graduated rate estate.

ITA: 104(2), 104(6)

Ch. 19/Study Guide — Discussion Notes for Review Questions

517

(9) A testamentary trust is created as a consequence of the death of an individual. An inter vivos trust is one that is created during the lifetime of an individual. An inter vivos trust may also be created for tax purposes where a person other than the deceased has contributed property to a testamentary trust. (10) A discretionary trust is a trust where the trustee is given the power of choice. The trustee may be given the power to determine the date of distribution of trust property, whether income or capital is to be paid to a beneficiary, how much is to be paid to a beneficiary and in what proportions among a group of beneficiaries it is to be paid. This feature gives the trust a great deal of flexibility and can be a very useful planning tool for income splitting (subject to TOSI) and estate equalization purposes. (11) The special treatment applies to the following types of income: (a) taxable dividends from a Canadian corporation which allows the beneficiary to use the dividend gross-up and tax credit;

ITA: 104(19)

(c) net taxable capital gains which are eligible for the capital gains deduction available in respect of qualified shares of a small business corporation and qualified farm property (note that net capital losses do not flow through to the beneficiary);

ITA: 104(21)–(21.3)

(d) non-taxable dividends which are excluded from the computation of taxable income;

ITA: 152(6)

(e) foreign income and related foreign tax paid to allow the beneficiary to claim the foreign tax credit; and

ITA: 104(22)

(f) superannuation and pension benefits.

ITA: 104(27), 104(28)

(12) The trust would file a tax return for the fiscal period ending on December 31, 2023 on or before March 31, 2024 (that is, 90 days after the end of the trust’s year). She would report the income allocated to her for the December 31, 2023 taxation year on her 2023 personal tax return, i.e., the calendar year in which the fiscal year end of the trust fell. A testamentary trust that is created by will is not an ‘‘estate’’ and so cannot be a graduated rate estate with an off-calendar year end.

ITA: 104(13), 104(14)

(13) The following are the returns that can be filed for an individual for the year of death and for the individual’s estate after death: (a) Terminal return — This return reports the income for the period in the year before the date of death and includes any gain or loss on the deemed disposition on death. Full personal credits may be claimed.

ITA: 70(1)

(b) Rights or things — ‘‘Rights or things’’ can be reported on a separate return to take advantage of the lower marginal tax brackets. A rights or thing is an amount that the deceased taxpayer had an enforceable right to receive at the time of death but had not received the amount. It does not include amounts that are payable periodically, e.g., remuneration included on the terminal return. The full personal tax credits may be claimed again on this return.

ITA: 70(2), 118(1), 118(2)

(c) Estate return – All of the properties of the individual will be part of the individual’s estate on death. The estate is a trust for tax purposes and may need to file a tax return for any income earned on the properties of the estate prior to distribution to the beneficiaries. The estate can be designated as a graduated rate estate in the first tax return filed.

CHAPTER 19

(b) net taxable capital gains which can allow the beneficiary to utilize allowable capital losses or net capital loss carryforwards;

Introduction to Federal Income Taxation in Canada

518

CHAPTER 19 — SOLUTIONS TO EXERCISES Exercise 1 Partnership’s net income for financial accounting purposes . . . . . . . . . . . . .

$304,280

Deduct: Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5,000 $299,280

Add: Amortization on office furniture . . . . . . . . . . . . . . . . . . . . .

$ 3,750

Donations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5,500

Membership in fitness club . . . . . . . . . . . . . . . . . . . . . . . .

1,250

Taxable capital gain ( /2 × $5,000) . . . . . . . . . . . . . . . . . . .

2,500

13,000 $312,280

Deduct: Capital cost allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4,300

Income to be allocated (Division B) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$307,980

Bob’s share of income from partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$153,990

Add: Gross-up of Bob’s share of partnership dividends (15% × $4,000 × 1/2) . . . . . . . . . . . . . . . . . . . . . .

300

Grossed-up personal dividends ($3,500 × 1.38) . . .

4,830

Personal interest income . . . . . . . . . . . . . . . . . . . .

1,200

6,330

Bob’s net income (Division B) and taxable income . . . . . . . . . .

$160,320

Analysis of Bob’s income: Personal

Partnership

Grossed-up dividends . . . . . . . . . . . . . . . . . . . .

$4,830

$ 2,300

$ 7,130

Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,200

—

1,200

Taxable capital gains . . . . . . . . . . . . . . . . . . . .

—

1,250

150,740

$154,290*

$160,320

Business income . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$6,030

Total

* $153,990 + $300 gross-up — NOTE TO SOLUTION (1)

Drawings taken by the members of a partnership do not constitute a business expense but are a method of distributing partnership income to members of the partnership.

(2)

Charitable donations are not deductions in computing the income of a partnership but are used as the basis for computing the charitable donations tax credit for an individual partner.

(3)

Fees paid to a fitness club are non-deductible expenses.

(4)

Dividend from partnership allocated to Bob; $4,000 × 50% × 1.15 = $2,300.

(5)

Bob will be eligible for the following federal dividend tax credit: — on share of partnership dividends (9/13 × $300) . . . . . . . . . . . . . . . . . . . . . . .

ITA: 18(1)(l)

— on personal dividends ( /11 × $1,330) ..................................................................... Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

208 725

933

Ch. 19/Study Guide — Solutions to Exercises

519

Exercise 2 Adjusted cost base of Katie’s partnership interest: Contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Add:

Share of profits excluding taxable capital gain (1/2 × ($450,000 -- $20,000)) . . . . . . . . . . . . . . . . . . .

$215,000

Share of capital gain (1/2 × $20,000 × 2) . . . . . . . . .

20,000

Share of capital dividends (1/2 × $4,000) . . . . . . . . .

2,000

$ 50,000

237,000 $287,000

$ 7,500

Drawings (1/2 × $176,000) . . . . . . . . . . . . . . . . . .

88,000

Share of donations (1/2 × $27,000) . . . . . . . . . . .

13,500

109,000

ACB of partnership interest January 1, 2023 . . . . . . . . . . . . . . . . . . . . .

$178,000

Capital gain on disposition of partnership interest: Proceeds of disposition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$250,000

ACB . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

178,000

Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 72,000

Taxable capital gain (1/2 of $72,000) . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 36,000

Exercise 3 Trusts Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

11,500

Eligible Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

9,000

Taxable capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . .

4,500

Trust’s total income . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deduct: Amounts Paid . . . . . . . . . . . . . . . . . . . . . . . . . .

25,000 (16,000)

9,000

Dividend gross up (3,000 × 38%) . . . . . . . . . . . . . . . . .

1,140

Trust’s Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . .

10,140

Tax 50% (federal & assumed provincial) . . . . . . . . . . . .

5,070

Dividend Tax Credit (assumed equal to gross up) . . . . .

(1,140)

Taxes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3,930

CHAPTER 19

Share of losses ( /2 × $15,000) . . . . . . . . . . . . . .

Deduct:

Introduction to Federal Income Taxation in Canada

520

Rebecca

Robert

$ 5,500

$ 1,500

Eligible dividend (grossed up 38%)

4,140

Taxable capital gain

1,500

Division B/Taxable Income

11,140

7,140

Interest

Tax 25% (federal & assumed provincial)

2,785

1,785

Basic personal credit 25% of 15,000

(3,750)

Dividend tax credit (assumed equal to gross up)

(1,140)

—

Taxes payable

Note: None of the tuition tax credit was claimed by Robert. Federal tuition tax credits of $525(1) are transferable to a parent, or the unused amount less any amount transferred to a supporting person may be carried forward. The definition of tax payable and the ordering rules require that the personal, tuition and education tax credits be deducted before the dividend tax credit which is lost in this case. Note: Tax would have been minimized if more income of the trust were allocated to the beneficiaries to fully utilize Rebecca and Robert’s personal tax credits. — NOTE TO SOLUTION (1)

Lesser of: (a) (15% × $9,500) = $1,425 (b) (15% X $5,000) = $750 (federal)

}

$ 750

Minus Part 1 tax payable by Robert (7,140 × 15% -- $15,000 × 15%) . . .

Net amount transferred to parent (designated) . . . . . . . . . . . . . . . . . . . .

$ 750

Exercise 4 Part A Partnership income for tax purposes: Income for the period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 40,000

Add:

Partners’ salaries . . . . . . . . . . . . . . . . . . . . . . . . . .

130,000

Meals and entertainment (50%) . . . . . . . . . . . . . . .

3,000

Deduct: Capital cost allowance: Class 50 $10,000 × 55% × 1.5 . . . . . . . . . . . . . . .

$8,250

Class 12 $8,000 × 100% . . . . . . . . . . . . . . . . . . . .

8,000

(16,250)

Taxable income of the partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$156,750

Therefore, each partner must include $78,375 of income from the partnership in their 2023 tax return. Note that all professionals must include work in progress at the end of the taxation year in income from business.

ITA: 118.9(1) ITA: 118.61 ITA: 118.81, 118.92

Ch. 19/Study Guide — Solutions to Exercises

521

Part B They may also be able to deduct the following expenses which they may have incurred personally: – any interest expense on money borrowed to make the capital contribution of $10,000; – the business portion of any car expenses; – any promotion expenses such as 50% of meals & entertainment, networking event costs, advertising etc.; – expenses for any office in the home (to a maximum of business income before the deduction), if the work space is used exclusively for business purposes and it is used on a regular and continuous basis for meeting clients (s. 18(12)). Part C Adjusted cost base of partnership January 1, 2024:

$ 10,000

Share of partnership income* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

78,375

Draws ($130,000 divided by 2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(65,000)

Adjusted cost base . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

23,375

* only added to partnership ACB on January 1, 2024

Exercise 5 Income Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Trust $

15,000

Rental Income (before CCA) . . . . . . . . . . . . . . . . . . . . .

6,500

Eligible Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

21,000

Taxable capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . .

8,000

Trust’s total income . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deduct: Amounts Paid to Beneficiaries . . . . . . . . . . . . .

50,500 (37,875)

12,625

Dividend gross up (21,000 × 25% × 38%) . . . . . . . . . . .

1,995

CCA on Rental Property . . . . . . . . . . . . . . . . . . . . . . . .

(1,500)

Trust’s Net Income Division B/Taxable Income . . . . . . . .

13,120

Tax 50% (federal & assumed provincial) . . . . . . . . . . . .

6,560

Dividend Tax Credit (assumed equal to gross up) . . . . .

(1,995)

Taxes Payable in the trust . . . . . . . . . . . . . . . . . . . . . . .

4,565

CHAPTER 19

Capital contribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Introduction to Federal Income Taxation in Canada

522 Income

Interest (75% of $15,000) . . . . . . . . . . . . . . . . . . . . . . .

Daughter $

11,250

Rental Income (75% of $6,500) . . . . . . . . . . . . . . . . . . .

4,875

Eligible dividend (75% of $21,000 grossed up 38%) . . . .

21,735

Taxable capital gain (75% of $8,000) . . . . . . . . . . . . . . .

6,000

Division B/Taxable Income . . . . . . . . . . . . . . . . . . . . . . .

43,860

Tax 25% (federal & assumed provincial) . . . . . . . . . . . .

10,965

Basic personal credit 25% of $15,000 . . . . . . . . . . . . . . .

(3,750)

Tuition tax credit (15% × $9,500) . . . . . . . . . . . . . . . . .

(1,425)

Dividend tax credit (assumed equal to gross up) . . . . . .

(5,985)

Taxes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

As the rental property is held in the trust, CCA would be deducted at the trust level. The CCA of $1,500 is less than 25% of the rental income of $1,625 and therefore is fully deductible. Assumed that there is no provincial tax credit for the tuition the daughter paid in 2023. None of the unused tuition credit would be available for carryforward or transfer to a parent because the dividend tax credit isn’t recognized when calculating the carryforward/available transfer.

Exercise 6 (1)

The income can be taxed either in the trust or in the income of any one of or combination of the beneficiaries in any proportion. The trust is discretionary; therefore, income can be paid out or not to any beneficiary.

Ch. 19/Study Guide — Solutions to Exercises

523

Income is computed in the trust as an individual, then the graduated rates of tax for individuals is applied to the taxable income of the trust for no more than 36 months after death, after which the estate becomes a testamentary trust subject to the highest personal rate of taxation.

(3)

If amounts are paid or made payable to the beneficiaries from the trust, then these amounts are deducted from the taxable income of the trust.

(4)

The income deducted from the trust’s net income is taxed in the hands of the beneficiary as income from property unless it falls within certain categories specified in the Income Tax Act, in which case it retains its source for the purposes of calculating the taxable income and tax payable of the beneficiary.

(5)

Dividends retained in the trust are grossed up and qualify for the dividend tax credit.

(6)

If dividends are actually paid, this income retains its nature. The amounts will be taxed on the beneficiaries’ returns as eligible taxable dividends from Canadian corporations. This enables the beneficiary to use his or her dividend tax credit. The dividends will be grossed up by 38% to determine the taxable amount.

(7)

If the capital gains are taxed in the trust, then 50% of the capital gain is taxable.

(8)

The trust does not get a capital gain exemption.

(9)

Capital gains designated to beneficiaries retain their nature. If the beneficiaries have allowable capital losses or net capital losses, the losses can be used against the taxable capital gains on the beneficiaries’ personal returns.

(10)

Net taxable capital gains on qualifying small business corporation (QSBC) shares (or qualified farm property) of a trust that are allocated to individual beneficiaries and designated by the trust are eligible for the capital gains deduction subject to the trust’s annual gains limit and cumulative gains limit. In order to qualify, the trust must be resident in Canada throughout the year.

(11)

Foreign income and its related foreign tax paid retain its nature when paid or deemed to have been paid to a beneficiary.

(12)

Interest income would be treated as property income if allocated to a beneficiary.

(13)

Business income would be treated as property income if allocated to a beneficiary.

(14)

Amounts that are paid/payable to beneficiaries are included in their income in the calendar year in which the trust’s year ends (i.e., if amounts are paid out of the trust in the period November 7, 2022 to November 6, 2023, then the beneficiary includes the amounts received in his or her 2023 tax return.

(15)

The trust return must be filed within 90 days of the year end, which is November 6. Therefore, the due date would be February 4.

Exercise 7 Part A Russell is deemed to have a disposition at fair market value on gifting the shares to the trust. Thus, he will have a taxable capital gain of $75,000 to report in 2023 (1/2 × ($240,000 -- $90,000)). Part B December 31, 2023. Inter vivos trusts are taxed on a calendar basis. Part C March 30, 2024. The tax return must be filed within 90 days after the trust’s taxation year end. Part D Trust income Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 6,000

Dividends ($8,000 × 1.38) . . . . . . . . . . . . . . . . . . . . . . . . .

11,040 $17,040

CHAPTER 19

(2)

Introduction to Federal Income Taxation in Canada

524

Federal & provincial tax ($17,040 × 50%) . . . . . . . . . . . . .

$ 8,520

Dividend tax credit [assumed equal to gross-up] . . . . . . . . .

(3,040)

Federal and provincial tax payable . . . . . . . . . . . . . . . . . . .

$ 5,480

Part E The trust is entitled to a deduction for the income paid to the beneficiaries in computing net income. The interest and dividend income paid to the 12-year-old will be subject to attribution and will be included in Russell’s income for tax purposes for 2023. The interest and dividend income paid to the 22-year-old will also be subject to attribution if it can reasonably be considered that one of the main reasons for Russell making the loan was to reduce tax. The dividend income will retain its character and thus be subject to the gross-up and dividend tax credit. The 2024 capital gains realized by the trust on the sale of the shares, if paid to the beneficiaries, will not be subject to attribution. The attribution rules do not apply with respect to capital gains of a minor and similarly, where applicable subsection 56(4.1) will only attribute income from the loaned property. The capital gains retain their character on the children’s returns.

Exercise 8 (A) The accrued interest is a periodic payment to be reported on the terminal T1 return, due April 30, 2024.

ITA: 70(1)

(B) Since the dividend is not payable until declared, it does not have to be accrued. Because it was declared after death, it is not a right or thing. Therefore, it is income of his estate. The March 30 dividend would be included on the terminal return.

ITA: 70(1), 70(2)

(C) The $800 of CPP would be reported on the terminal T1 return, since no amount was unpaid at the date of death that related to a completed pay period. CPP earned from September 1 to the date of death on September 10 is not considered to be a right or thing, since it is not legally receivable for a completed pay period on the date of death. (D) The donations are creditable, to the extent of 100% of net income reported, on all of the year of death returns combined or in the preceding year’s return. Only personal tax credits may be deducted on each of the separate returns for the year of death.

ITA: 118(1), 118(2) ITA: 118.93

(E) Net capital losses are deductible from any source of income in the year of death and the preceding year.

ITA: 111(2)

(F) Trust income of $900 for the year ended December 31, 2022 from Sam’s wife’s graduated rate estate would have been reported on Sam’s 2022 personal tax return due April 30, 2023. An election is permitted to report the trust income payable to Sam for the stub period, January 1, 2023 to September 10, 2023 on a separate return, due April 30, 2024. The personal tax credits can be deducted on both the terminal return and this separate return.

ITA: 104(23)(d) ITA: 118(1), 118(2)

(G) Life insurance proceeds received on death are not taxable.

Exercise 9 Ms. Kaye’s 2023 terminal personal tax return is required to be filed by April 30, 2024. In Ms. Kaye’s ITA: 150(1)(d) 2023 return all accrued income earned on a periodic basis during the period January 1 to May 1, 2023 ITA: 70(1) should be included. In addition, all capital property (such as her Flying High shares) is deemed to have ITA: 70(5) been disposed of at the fair market value. A claim for the full personal tax credits can be made on the terminal return even though Ms. Kaye died on May 2, 2023. The RRSP contribution of $9,000 is deductible on her 2023 terminal return, since it is less than the maximum amount (i.e., lesser of $30,780 and 18% of $80,000). Ms. Kaye’s 2023 terminal return will include the following: Salary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$24,000

Bond interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

950

Savings account interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

150

Ch. 19/Study Guide — Solutions to Exercises

525

GIC interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

140

Dividend income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,380

Taxable capital gain [ /2 ($25 -- $10) × 100] . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

750

RRSP accumulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

34,000

RRSP contribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(9,000)

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$52,370

Ms. Kaye’s legal representative can report amounts which were receivable but not received at the date of death, on a separate tax return, called a ‘‘rights or things’’ return, instead of on the terminal return.

ITA: 70(2)

The unpaid vacation pay of $2,000, interest payable of $950 (an amount owing at the date of death) and $1,380 of grossed-up dividend income (declared but unpaid) would qualify as income from ‘‘rights or things.’’Personal tax credits equal to the amounts claimed in the terminal return may be claimed again on the ‘‘rights or things’’ return. This return is due on the date that is the later of one year after death and 90 days after assessment of any return for the year of death.

Alternatively, the legal representative can assign the income from ‘‘rights or things’’ to a particular beneficiary.

Exercise 10 The estate will need to file a terminal tax return (and possibly a rights and things return) for Ms. Ray and pay the final tax liabilities from properties in the estate. Any income earned in the estate after Ms. Ray’s death would be reported on an estate return which could be designated as a graduated rate estate. (a) By virtue of par. 70(5)(a), the land will be deemed disposed of at fair market value at the time of Ms. Ray’s death. The disposition will be reported on the terminal tax return. A taxable capital gain on the land of $40,000 [($218,000 -- $138,000) × 1/2] will be included in Ms. Ray’s return. By virtue of par. 70(5)(b), Ms. Ray’s daughter will be deemed to have acquired the land at its fair market value and, therefore, she will have an adjusted cost base of $218,000. By virtue of par. 70(5)(a), the building will be deemed disposed of at fair market value. The proceeds will be $265,000 and, therefore, a taxable capital gain on the building of $50,000 [($265,000 -- $165,000) × 1/2] and recapture of $30,000 ($165,000 -- $135,000) will be included in Ms. Ray’s terminal return. Ms. Ray’s daughter will be deemed to have acquired the building at a cost equal to the deemed proceeds of $265,000. (b) The net rental income of $25,200 will be included in Ms. Ray’s terminal return. No CCA can be claimed as the rental property was deemed disposed of immediately before her death. Rental income earned after Ms. Ray’s death and before the property is distributed to the daughter from the estate will be taxable on the estate return. The estate can be designated as a graduated rate estate. (c) By virtue of par. 70(6)(a), the shares will be deemed disposed of at their adjusted cost base of $17,000 and no capital gain will be realized. Ms. Ray’s husband will be deemed to have acquired the shares for $17,000. Unless she had net capital losses to offset, or the shares were QSBC shares eligible for the capital gains exemption there would be no benefit in electing the transfer to be at FMV by ssec. 70(6.2). (d) The dividends paid on January 31, 2023 and April 30, 2023 will be included in Ms. Ray’s terminal return. The taxable amount would be $725 [($300 + $325) × 1.15]. The dividend declared on July 5, 2023, before Ms. Ray’s death, but not paid until July 31, 2023, after her death, may be included on a separate rights or things return by virtue of ssec. 70(2) with an additional personal credit.

ITA: 70(3)

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All of the GIC interest was included on the terminal tax return but could have been prorated to the date of death and the amount related to the time period after the date of death included on an estate return. We have assumed that properties were immediately distributed to beneficiaries and included all of the income on the terminal return.

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(e) The income of Ms. Ray’s legal practice of $63,000 must be included in Ms. Ray’s terminal return. If this amount is a right to a share of income of a partnership at the time of death, it could instead be included on the rights and things return. (f) The life insurance is not taxable on Ms. Ray’s terminal return or to the estate. (g) The full amount of Ms. Ray’s RRSPs must be included in her terminal return by virtue of ssec. 146(8.8) unless a joint election is filed. Ms. Ray’s estate and her spouse can jointly elect under ssec. 146(8.1) to instead include the RRSP proceeds in Mr. Ray’s income under ssec. 146(8). Mr. Ray can then transfer these funds to his RRSP and claim a deduction under ssec. 60(1) as long as the amount is contributed to Mr. Ray’s RRSP no later than 60 days after the year, i.e., March 1, 2024.

Chapter 20 International Taxation in Canada

CHAPTER 20

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Ch. 20/Study Guide — Learning Chart

529

CHAPTER 20 — LEARNING CHART Problem Descriptions Textbook Example Problems 20-1 Taxation in Canada of U.S. corporation 20-2

Branch tax

20-3

Sale of shares of CCPC

20-4

Going non-resident — RRSP

20-5

Canadian rent paid to non-resident

20-6

Part-year resident

20-7

Deemed acquisition on becoming resident

20-8

Deemed disposition on becoming non-resident

20-9

Transfer pricing

20-10

Dividends from non-foreign aff iliates

20-11

Dividends from non-foreign aff iliates

20-12

Investment income in foreign corporation

Exercises Deemed disposition on becoming non-resident

Foreign tax credit

Income earned in Canada by non-resident

Immigration — moving expenses 5

Dividends from foreign corporation

Rental property owned by non-residents

Assignment Problems 1 Canadian income of non-resident individual 2

Sale of property by non-resident individual

Canadian income of non-resident corporation

Canadian income of non-resident individual

Individual becoming a non-resident

Transfer pricing

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Problem Descriptions 7

8 9 10

Transfer pricing Foreign aff iliate, surplus balances Surplus balances Foreign aff iliate, surplus balances

Ch. 20/Study Guide — Learning Chart

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REVIEW QUESTIONS

(1) Describe two objectives that international tax treaties and tax information exchange agreements (TIEA) strive to achieve. What is the Multilateral Instrument (MLI) that Canada enacted in 2020? (2) Distinguish between a part-year resident and a non-resident. (3) Distinguish between a permanent resident, a part-year resident and a sojourner. (4) Briefly explain the intention behind the ‘‘transfer pricing’’ legislation. (5) Briefly explain the ‘‘thin capitalization rules’’ and the new interest deductibility limits regime and what the legislation is designed to prevent. (6) Is a non-resident who owns shares in a Canadian corporation taxable on the disposition of those shares? Does the purchaser have a withholding requirement? (7) Can a part-year resident claim the full amount of personal tax credits in the year of arrival/departure? (8) How would you calculate the gain on the disposition of a rental property that an immigrant to Canada owned in the country he/she emigrated from. Assume that property was owned for five years prior to coming to Canada and is disposed of after his or her move to Canada? If the rental property was located in Canada how would your answer change? (9) When is a non-resident employer required to withhold and remit Canadian tax from an employee’s employment income? (10) What withholding tax rate applies to dividends from a Canadian corporation to a shareholder resident in the United States? (11) When is it best for a non-resident to make a section 217 election for Canadian RRSP benefits received? (12) Would a non-interest-bearing loan by a Canadian corporation to its non-resident parent company result in a Canadian tax liability? (13) What is the purpose of deeming that an immigrant has disposed of and reacquired all of his or her capital property on entering Canada? (14) Under what circumstances might a non-resident be entitled to the same or similar total personal tax credits that are allowed to a resident? (15) When and how much of a foreign tax credit can be claimed by a Canadian resident for withholding taxes paid to a foreign jurisdiction on dividend income? (16) What is the purpose of the FAPI rules related to foreign passive income? (17) How would you describe exempt surplus and its treatment for Canadian tax purposes?

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Ch. 20/Study Guide — Exercises

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EXERCISES

Exercise 1 Alan Croupier is moving to Venezuela on August 1. In anticipation of this move, he has sold all of his assets except for 1,000 common shares in Tell Canada (a TSX listed company). The shares have a value of $40,000 and his adjusted cost base is $28,000. What is Alan’s tax position on these shares should they remain unsold at the time of his departure? — REQUIRED Are there any alternatives available to Alan in respect to the Tell Canada shares in the year of departure?

Exercise 2 A non-resident is liable for Canadian taxes where they are employed in Canada, carry on business in Canada, or dispose of taxable Canadian property. In most countries, the non-resident will also be subject to tax in his or her country of residence on this same income. Tax treaties will alleviate the double taxation burden by allowing for foreign tax credits. — REQUIRED As the income will be taxed in two countries, does the taxpayer claim a foreign tax credit in both countries? If not, in which country is a foreign tax credit claimed?

Exercise 3 Sam-son Industries Inc. is a small American company located in Minneapolis, Minnesota. Sam-son sells various items online, mostly promotional items such as pens, mouse pads, notepads, coffee travel mugs and other swag items, to Canadian businesses. Last year was the first year of business and profits on its Canadian sales amounted to $76,000. The company did not have sales representatives enter Canada during the year. The principals of Sam-son are worried about their liability for Canadian income tax and have come to you for advice. — REQUIRED

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Advise Sam-son on their Canadian tax liability. Include an explanation of your rationale.

Exercise 4 Mary Jane is a Canadian citizen and has been living and working in Singapore for the past 11 years. Mary Jane moved back to Canada on October 13, 2023 and incurred $8,000 in moving expenses. Mary Jane paid her own moving expenses and did not receive a reimbursement from her new employer. She earned $35,000 in employment income from October 13 to December 31, 2023. — REQUIRED Advise Mary Jane if she is entitled to claim her moving expenses.

Exercise 5 Canco is a Canadian-controlled private corporation with a manufacturing business. In 2021, Canco invested C$500,000 of excess cash in a newly incorporated Dutch company (Dutchco) and received an 80% common share interest in the entity. A U.S. company invested C$125,000 for the remaining 20% interest. All except C$200,000 was used to acquire a distribution business. The distribution business will distribute products manufactured in Canada and the United States to European customers. For its December 31, 2022 year end, Dutchco earned C$30,000 from the distribution business and C$12,000 in interest on a money market account holding the C$200,000 of excess cash. For its December 31, 2023 year end, Dutchco earned C$50,000 from the distribution business and C$12,000 in interest. The company paid a C$50,000 dividend to its shareholders in February 2023. Dutchco paid corporate tax of 20% on its income each year. Withholding tax of 5% applied to the dividend paid to Canco. — REQUIRED Determine the Canadian tax consequences of the investment in Dutchco and the dividend received in 2023.

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Exercise 6 Mr. and Ms. Doe are citizens and residents of China. They purchased a condominium in their names in Waterloo, Ontario, for their son, Joe. Joe moved to Waterloo in August 2023 to attend university and rented two rooms to his friends, Sam and Harry, who are both Canadian residents. Joe will live in Canada for at least four years while attending school. Sam and Harry each pay rent of $400 per month to Joe, who deposits the funds into his parents’ Canadian bank account. Joe pays the mortgage, utilities, and property taxes for the property from this account. His parents will occasionally withdraw excess funds from the account. — REQUIRED (A) Discuss the Canadian tax implications associated with the rental of the property and any options available to the non-residents. (B) What will happen if the condominium is sold in the future? (C) Would it have been better for Joe’s parents to give or lend Joe funds to purchase the condominium in his name?

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Ch. 20/Study Guide — Assignment Problems

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ASSIGNMENT PROBLEMS

Problem 1 Jaileah English has agreed to play professional soccer with the Toronto Metros of the Canadian Professional Women’s Soccer League starting March 1, 2024. Jaileah lives in England and will live in Canada temporarily for the five months of the soccer season. Her three-year contract calls for an annual salary of $55,000. At the time of signing this contract in England in the fall of 2023, the Metros gave Jaileah a signing bonus of $25,000. Jaileah’s agent was paid $5,000 to represent her in negotiating the contract. Jaileah will earn C$100,000 playing soccer in England during the other seven months. Determine Jaileah’s Canadian income tax obligations. What deductions/credits may she claim against Canadian income?

Problem 2 Kresna Dubchuk lives in Kenya and is in the process of selling her Canadian real property, situated in New Brunswick, which has been rented to various tenants over the last 10 years. The selling price of the property is $100,000 and her ACB is $35,000. She will incur $6,500 in real estate commissions and $500 in legal fees in connection with the sale. A few days after complying with the requirements concerning the proposed disposition of the property, Kresna receives a copy of a proposed assessment from the CRA from the agent collecting the rent on her behalf in Canada. The assessment is for income taxes, plus penalties and interest for the past three taxation years. (A) Describe and detail Kresna’s Canadian tax obligations arising on the sale of this property. (B) What is the probable cause of the proposed assessment? Can you offer Kresna and her agent any professional assistance with regard to the proposed assessment? If so, detail what you might advise her.

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Problem 3 A corporation resident in the United States (USCO) recently expanded its sales activities in Canada. Up until two years ago, the company had been selling small amounts of product directly to Canadian customers. The Canadian sales resulted from U.S. tradeshows, industry magazines, and the company’s website. USCO did not have a sales force in Canada or a direct advertising program. Starting last year, USCO hired three sales employees to work from an office rented by USCO in Toronto. The company uses an independent wholesaler and bonded warehouse in Mississauga to keep a supply of its products on hand. Shipping instructions are faxed to the warehouse. Invoicing is done in Dallas and payments are remitted to the U.S. head office. All purchase orders are subject to approval and acceptance by USCO’s home office. The Canadian balance sheet and income statement for USCO’s second year of operations ending December 31 was as follows: Balance Sheet (000s) Assets

Liabilities/Equity

Cash (Cdn currency)

$ 50

Accounts payable . . . . . . . . . . . . . . . . . .

$ 400

Accounts receivable

150

Bank loan (used to purchase fiXed assets)

150

Inventory . . . . . . . . .

400

Tax liability . . . . . . . . . . . . . . . . . . . . . . .

104

FiXed assets (UCC)

200

Home office account . . . . . . . . . . . . . . . .

146

Total assets . . . . .

$800

Total liabilities/equity . . . . . . . . . . . .

$800

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536 Income Statement (000s) Sales . . . . . . . . . . . . EXpenses Sales expenses . . . $ 120 Office expenses 30 Advertising . . . . . 90 Total expenses . . . . Pre-tax profit . . . . . . Tax provision . . . . . . After tax profit . . .

500

240 260 104 156

For its first year of operations ending December 31, the Canadian operations incurred a taxable loss of $4,000 and had an investment allowance, as defined in the Regulations, of $2,000. The aggregate FMV of the assets is $820,000 (Cash — $50,000, A/R — $150,000, Inventory — $410,000, FiXed Assets — $210,000). The $50,000 cash balance was the lowest balance outstanding for the year. Assume an Ontario income tax rate of 12%. (A) How will USCO be taxed under Canadian domestic tax law? (B) Without considering the Canada–U.S. Tax Convention, calculate USCO’s total federal and provincial Canadian tax liability under Parts I and XIV of the Act. Assume that pre-tax profit represents taxable income. (C) Would USCO be considered to have a permanent establishment under paragraphs 1, 2, or 5 of Article V of the Canada–U.S. Tax Convention? How does paragraph 6, Article X of the Canada–U.S. Tax Convention impact the Canadian tax return for the company? Perform calculations to reflect the impact.

Problem 4 Sally Juarez is retired and lives in Mexico, but virtually all of her investment assets, and her income, are Canadian. In 2023, Sally realized the following income (all Canadian except as identified): Dividends on shares in Canadian Public Co Ltd. . . . . . . . . . . . . . . . . Interest on deposit in bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gain on sale of raw land (assume business income) . . . . . . . . . . . . . Gain on sale of Canadian Public Co Ltd. shares . . . . . . . . . . . . . . . . . Gain on sale of real estate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Share of income from business partnership . . . . . . . . . . . . . . . . . . . . Mexican pension income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 5,000 8,000 60,000 15,000 30,000 7,000 20,000

Sally has paid $7,500 in Canadian section 116 withholding tax on the property gains. Without considering the implications of the Canada–Mexico Tax Convention, calculate Sally’s taxable income earned in Canada and tax owing (refund). Identify any other Canadian tax requirements. Assume any business income was earned in a province where the personal tax rates are the hypothetical rates shown in Chapter 10. Ignore any CPP/QPP implications.

Problem 5 Cal Murphy, a Canadian citizen, is emigrating from Canada to take up residence in Jakarta, Indonesia. At the time of his departure, Cal will have the following Canadian assets:

Principal residence . . . . . . . . . . . . . . . . RRSP . . . . . . . . . . . . . . . . . . . . . . . . . . 20% interest in CCPC (active) . . . . . . . . GIC at TrustCo . . . . . . . . . . . . . . . . . . .

FMV

Cost

$450,000 75,000 145,000 15,000

$335,000 N/A 1,000 15,000

Cal has not been impressed by the capital appreciation he has made on his residence, so he intends to keep it and rent it out for $2,500 monthly. He intends to sell it at some future opportune time but believes this will be many years from now. The expected expenses for the mortgage, taxes, repairs,

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insurance, and sundry for the house are expected to be about $2,200 a month. Cal’s brother, Joseph, will be collecting the rents for him and depositing them to Cal’s Canadian bank. This money will be kept at the bank in a savings account in case of any unanticipated expenses. His 20% shareholding in the CCPC is not easily liquidated, and so he is retaining it, for now, to earn about $5,000 in annual dividend income. He is anxious to dispose of the shares, but has not yet found a prospective purchaser, despite a fairly exhaustive attempt to do so. The $145,000 fair market value was determined by a chartered business valuator. Cal is not at all sure what to do with the RRSP. He can liquidate it either before or after his planned departure date. Cal intends to renew the GIC when it matures as he is uncertain as to the Indonesian banking system, and won’t transfer the money to an Indonesian bank until he’s done some research. Cal and his wife separated last year, and Cal has custody of their only child, who will be moving to Indonesia with Cal. Cal receives $500 in monthly child support and Mrs. Murphy will continue to pay the support to Cal in Indonesia. Cal has engaged you to advise him of his current (year of departure) and any future Canadian tax obligations. Identify and advise Cal of his current and future Canadian tax position. Ignore the Canada– Indonesia Tax Convention in your analysis. Include any options or alternatives he may have available and any planning advice you think appropriate.

Problem 6 Samsystems Inc. (SI) is a Canadian-controlled private corporation and a leading edge developer and manufacturer of furniture components with subsidiaries worldwide. You are the tax manager for SI. The controller of the corporation is very concerned that the corporation’s intercompany transactions do not meet the transfer pricing requirements of the Act. In a recent meeting, the controller provided you with the following information concerning the company’s transactions with foreign corporations.

ITA: 247

Transactions with Samsystems Netherlands Inc. (SNI) SI sells metal drawer slides to its newly acquired, wholly owned subsidiary and Netherlands resident, SNI. SNI was acquired by SI in July and has two divisions: a manufacturing division that manufactures ergonomically designed furniture components, and a distribution division that distributes curtain rod products purchased from Thailand and now the drawer slides purchased from SI. All products purchased by the distribution division are sold to arm’s length European distributors.

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Until the purchase of SNI, SI was selling drawer slides directly to European distributors for all European sales. Now all European sales are through SNI. Over the next two years, SNI plans to replace the use of distributors in the European market and sell SI’s slides directly to original equipment manufacturers. SNI does not own any trademarks related to the sale of SI products. SNI is responsible for collection of receivables from European distributors. However, SI is responsible for all warranty costs associated with the sale of its products by SNI. All patents for Canadian-manufactured products are owned by SI. For Canadian sales, SI sells drawer slides to arm’s length distributors in Canada. All international sales of the slides are sold by subsidiaries of SI (including SNI) in various countries. A subsidiary of SI, U.S. resident Samsystems United States Inc. (SUSI) (see below), manufactures a similar drawer slide to SI’s. These slides are sold by the U.S. company to arm’s length distributors in the U.S. market. For its taxation year ending December 31, SNI’s distributor division earned a gross margin of 30% and an operating profit of 5% of sales for its sales of SI product. For sales of curtain rods, the division earned a gross margin percentage of 35% and an operating profit of 8% of sales. Transactions with SUSI SUSI was acquired by SI through a share purchase in July. For several years prior to the acquisition, SUSI had purchased ergonomic furniture components from SI for distribution to original equipment manufacturers in the U.S. After the acquisition of SUSI, SI continued to sell these products to the company. SUSI does not own any trademarks for the sale of SI’s product and does not distribute products for any other entity. SI sells its ergonomic products in Canada through arm’s length Canadian distribution companies. Advise the controller on the possible transfer pricing methodologies that could be applied to the above transactions under section 247. Indicate why discarded methodologies would not be appropriate.

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Describe how you would apply these methodologies and indicate what additional information you will need from the client to help you determine the appropriate methodology.

Problem 7 Ergold Ltd. is a Canadian subsidiary of a Swedish company. The company is a distributor of automated milking machines to dairy farmers in Canada. Its sole supplier is the Swedish parent company. The current transfer pricing policy between Ergold Ltd. and its parent company has resulted in losses in Canada for its years of operation since incorporation as follows: Year Ended December 31 2021 . . . . . . . . . . 2022 . . . . . . . . . . 2023 . . . . . . . . . .

Tax Loss

Gross Revenue

$200,000 400,000 850,000

$3,000,000 6,500,000 9,500,000

The company does not appear to have any internal or external uncontrolled comparable transactions that would allow you to apply a traditional transaction method. In discussions with some of your colleagues in your Toronto office transfer pricing group, you have discovered that recent transfer pricing studies have concluded, using the transactional net margin method, that similar distributors operating in Canada earn an operating margin percentage of 5% of sales. You mention this to the controller. He indicates that he does not believe that there is much of a concern as he has heard that because of the company’s small size there would not be any penalties applicable if the CRA were to audit the company. Ergold’s effective tax rate is approXimately 27%. How would you respond to the controller? How can you convince the controller that he should consider having your firm prepare a transfer pricing report to provide it with documentation to support its transfer pricing?

Problem 8

A Co., B Co., and C Co. are Canadian resident Canadian-controlled private corporations. C Co. is not related to either A Co. or B Co. B Co.’s share capital consists of 1,000 common shares. The companies have a December 31 year end. A Co. and B Co. received dividends of C$36,000 and C$48,000, respectively, out of a total dividend of C$600,000 paid by U.S. Co. on December 31, 2023. U.S. Co.’s taxation year end is October 31. U.S. Co. was incorporated in the United States in 2021, issuing 100 common shares to its shareholders. The share structure of the corporation has not changed since incorporation. The company is operated and managed from the U.S. The company’s only business is the manufacturing of auto parts supplied to various customers, including A Co. U.S. Co. earned net income from its operations of C$900,000 from the time of incorporation up to its October 31, 2023 taxation year end. U.S. Co. paid U.S. federal and state tax of C$180,000 on those earnings. U.S. Co. has not paid any dividends and has not incurred capital gains or losses in previous years. The company does not own shares in any other company.

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No Treaty Co. is a cut-and-sew shop incorporated in a country with which Canada does not have a treaty or a TIEA. For its first taxation year ending December 31, 2023, the company earned C$500,000 net income from its operations. On this net income, the company paid a 20% tax to the government of the foreign country. The company does not own shares in any other company and did not incur any capital gains or losses in the year. No Treaty Co. paid a dividend to shareholders of C$222,000 on January 31, 2024; this is the first dividend payment made by the company. A Co. and C Co. received dividends of C$35,520 and C$19,980, respectively. A dividend withholding tax of 3% applied to the dividends. Part A Determine whether the corporation paying the dividend is a foreign affiliate of the Canadian company receiving the dividend.

ITA: 95(1)

Part B Depending on your response in Part A, determine whether a Division C deduction is available to the Canadian corporation in respect of the dividend. If not, how will the dividend be treated for tax purposes?

ITA: 113(1) ITA: 126(1)

Part C If a Division C deduction is available, follow these steps to calculate the deduction: (1) Compute the relevant surplus balances for the company showing all components.

ITR: 5907

(2) Compute the portion of the full amount of the dividend (whole dividend) paid out of each surplus balance.

ITR: 5901

(3) Compute the portion of the dividend received by the Canadian shareholder out of each surplus balance.

ITR: 5900

(4) If needed, compute the foreign tax applicable to the portion of the dividend received by the Canadian shareholder out of taxable surplus. (Refer to the definition of ‘‘underlying foreign tax’’).

ITR: 5900(1)(d) ITR: 5907

(5) Calculate the Division C deductions.

ITA: 113(1)

Part D What is the rationale for the double taxation elimination mechanism applied under Parts B and C? Part E

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How would the dividends be treated if they were paid to Canadian resident individuals instead of corporations? Ignore foreign exchange differences in your solution.

Problem 9 Mallot Co. is a Canadian-resident corporation owning 60% of the common shares of Trotter Inc., a U.S.-incorporated company operating and managed out of Chicago. Mallot Co. owns 60 common shares of the company that were issued to it for a capital contribution of US$60,000 at the time of incorporation. The other 40% of Trotter Inc. is owned by Mr. Tellus, a Canadian resident. Trotter Inc. has been operating a medical supplies business since its incorporation on January 1, 2019 and has an October 31 year end. Mr. Tellus owns 40 common shares of the company that were issued to him for a capital contribution of US$40,000. You are filing the December 31, 2023 tax return for Mallot Co. and have been provided with the following information: (1) Trotter Inc. had earnings (losses) from its active business operations in the United States and related tax liabilities (refunds) since incorporation as follows: Taxation Year End October 31, 2019 October 31, 2020 October 31, 2021 October 31, 2022 October 31, 2023

Earnings (Loss) (US$) $200,000 100,000 100,000 (200,000) 50,000

Tax Paid (Refunded) (US$) $50,000 25,000 25,000 (50,000) 12,500

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(2) In the October 31, 2020 taxation year end, Trotter Inc. sold some equipment used in its operations incurring a capital gain of US$100,000 on which it paid a tax of US$20,000. It also paid a dividend of US$100,000 to shareholders that year. On October 31, 2021, Trotter Inc. received a dividend for US$200,000 from a wholly owned subsidiary, N, located in a country that is not a designated treaty country. N has a December 31 year end and was acquired in an arm’s length transaction in 2021 for US$50,000. You have been told that the dividend represented all of N’s active business income for 2021 and that no underlying income tax on the income and no withholding tax on the dividend was paid to the government on that income. U.S. domestic tax of US$50,000 was paid by Trotter Inc. on the dividend. Assume that the Canadian dollar is on par with the US dollar. Compute the surplus balances for Trotter Inc. as of December 31, 2023.

Problem 10 Ragyun Co. (Ragyun) is incorporated and operates in Hungary. The structure of the corporation is as follows: All unrelated Canadian residents:

Ragyun was formed on January 1, 2023 and has an October 31 year end. The company was formed to hold a patented technology that the Canadian shareholders developed in Canada and transferred to the corporation at the time of incorporation. The technology was valued at $55,000 at the time of transfer. The foreign unrelated shareholders contributed cash of $45,000 at the time of incorporation for common shares. The company holds the patented technology, a small amount of cash, and investment properties. Ragyun’s income for 2023 included a $20,000 gain on the sale of shares in another foreign entity, Maya Inc. Ragyun owned 1% of the shares of Maya Inc. as a speculative investment. Also included in income was a $10,000 gain on the sale of shares of Tech Inc., a corporation that Ragyun owned in Hungary. Tech Inc. is an engineering firm (whose activities and assets relate only to the engineering business) that provided services to Ragyun in the final development phase of the technology. Because of a dispute with the firm, Ragyun sold the 60% share interest to another shareholder of Tech Inc. Ragyun’s income also included $5,000 of dividend and interest income from investments in mutual funds, and $25,000 in royalties from licensing the technology to unrelated foreign corporations. Ragyun has two employees. One is responsible for administration and accounting for the company, and the other is responsible for marketing and arranging licence agreements. Ragyun paid tax of $7,200 on its income to the Hungarian taxing authorities for the 2023 taxation year end. On January 31, 2024, Ragyun paid a dividend of $52,800 to its shareholders. A 15% withholding tax applied to dividends paid to the Canadian shareholders.

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Part A Is Ragyun a foreign affiliate or controlled foreign affiliate (CFA) of Ms. Ambrose? Part B Is Ragyun a foreign affiliate or controlled foreign affiliate (CFA) of Mr. Frank? Part C Calculate foreign accrual property income (FAPI) for Ragyun for 2023. Calculate the impact of the FAPI on Mr. Frank’s taxable income for 2023 and the adjusted cost base of his shares. Part D How will the January 31, 2024 dividend affect Mr. Frank’s taxable income for 2024 and the adjusted cost base of his shares? Part E How will the January 31, 2024 dividend affect Ms. Ambrose’s taxable income for 2024?

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CHAPTER 20 — DISCUSSION NOTES FOR REVIEW QUESTIONS (1) One objective of international tax treaties is to eliminate double taxation. This is accomplished by ensuring that income is not taxed in more than one country or by providing a foreign tax credit for the taxes paid in the other country. The second objective of the treaties and TIEAs is to prevent tax evasion and address harmful tax practices. This is accomplished through ‘‘sharing of information’’ provisions in the treaties and TIEAs. Treaties and TIEAs facilitate information exchange and promote resolution of disputes related to domestic tax laws of the two countries. The Multilateral Instrument that was developed as part of the OECD BEPS project will allow faster treaty updates with the objective of reducing opportunities for tax avoidance. The purpose of the instrument is to allow countries who have ratified the instrument to amend bilateral treaties between countries more quickly. The MLI provides rules that will replace or interpret articles in an existing treaty between the countries. (2) A part-year resident is a taxpayer who either becomes a permanent resident of Canada or relinquishes permanent resident status at some point in the year. This taxpayer is taxable in Canada on worldwide income only during the period of residency. Income that is not Canadian source income is not taxable in Canada for the period during the year that the taxpayer is not a resident of Canada. A non-resident is a person who is resident somewhere other than Canada and is taxable in Canada only on Canadian employment, business income, or taxable capital gains on taxable Canadian property. Part XIII withholding tax may apply to certain other types (passive sources) of Canadian-source income earned by a non-resident.

ITA: 2(3) ITA: 114

(3) An individual who is a permanent resident of Canada i.e. has residential ties in Canada is taxable on his/her taxable worldwide income. To become a non-resident, the individual must break residential ties with Canada. In the year that such ties are broken, the individual will become a non-resident at the time that ties are considered broken and will for that year be a part-year resident i.e. part year resident and part year non-resident. For the period of non-residence, the taxpayer will be taxable only on Canadian source income. A sojourner refers to an individual who does not have residential ties to Canada and therefore is considered a non-resident of Canada but has temporarily stayed in Canada (i.e. was physically present) for 183 days or more in a calendar year during the period of non-residence. A nonresident who meets the sojourning test is deemed to be a resident throughout the taxation year and would be taxable on worldwide income for the year in Canada. Treaties need to be consulted to establish whether a tie-breaker rule will override deemed residency resulting from the Canadian domestic law sojourning test. (4) The transfer pricing rules are intended to ensure that transactions between Canadian taxpayers or partnerships and non-arm’s length non-resident persons occur at an arm’s length price, i.e., the price that would be used between unrelated persons. The objective of the legislation is to protect Canada’s tax base by preventing a profit shift to other countries (often low tax jurisdictions).

ITA: 247(1)

(5) The thin capitalization rules are designed to prevent the erosion of Canada’s tax base resulting from deductible interest payments on loans to Canadian corporations by nonresidents. By under-capitalizing a Canadian subsidiary, a foreign parent could receive deductible interest that would otherwise be profits of the subsidiary that are taxable in Canada instead of the subsidiary repatriating the profits through non-deductible dividends. The thin capitalization rules place a limit on the interest that can be deducted and encourage capital investment in the Canadian company. New interest deductibility limits effective for taxation years beginning on or after October 1, 2024 serve a similar purpose. The legislation will limit excessive net interest and financing deductions to 40% (30% in later years) of adjusted taxable income (Tax EBITDA) for Canadian resident corporations, trusts or partnerships or non-residents earning taxable income in Canada. For CCPCs, the rules apply only if the CCPC (together with associated companies) has taxable capital employed in Canada of $50 million or greater. Taxpayers (with related/affiliated corporations) and net interest expense of

ITA: 18(4)

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greater than $1,000,000 are also exempt. Unlike the thin capitalization provision, the limits imposed consider both arm’s length and non-arm’s length debt. The purpose is similar, to prevent excessive debt being placed in Canada with the impact of eroding the Canadian tax base. (6) A non-resident is taxable on the disposition of taxable Canadian property (TCP). TCP is defined in the Act and includes shares of an unlisted corporation resident in Canada, if more than 50% of the fair market value of the shares is derived from real or immovable property situated in Canada, or Canadian or timber resource properties at any time in the prior five years. Listed shares of a Canadian resident corporation are TCP only if, at any time in the prior five years, the non-resident and non-arm’s length persons owned not less than 25% of the shares of the corporation and more than 50% of the fair market value of the shares were derived from real or immovable property situated in Canada, or Canadian or timber resource properties. The relevant tax treaty would need to be considered to determine whether a treaty article overrides the domestic law. Unless the shares are treaty-protected property, the purchaser of the shares is required to withhold and remit 25% of the purchase price unless the non-resident obtains a certificate of compliance and remits a tax payment of 25% of the gain on the property to the CRA no later than 10 days after the disposition.

ITA: 248(1)

ITA: 116(1)

(7) Some personal tax credits are prorated for the portion of the year the individual is resident in Canada, for example, the basic personal tax credit, age credit, etc. Other credits can be claimed in full, for example, the donation credit, medical expense credit, etc. ITA: 128.1(1)(c)

(9) A non-resident employer is required to withhold and remit tax from remuneration paid to an employee related to duties performed in Canada. The employee will file a Canadian tax return to include the Canadian employment income less any income exempt from tax under the relevant Canadian tax treaty. The tax withholdings will be applied against any taxes payable on the return. Employers resident in countries that have a tax treaty with Canada which exempts the employment income from Canadian tax can apply for a withholding tax waiver. The exemption to the income tax withholding requirement for nonresident employers applies to a qualifying non-resident employer for qualifying non-resident employees. A qualifying non-resident employer must be resident in a treaty country and needs to obtain certification to be eligible for the waiver. A qualifying non-resident employee is an employee who is resident in the treaty country, is exempt from Canadian tax under the treaty on the employment income and works in Canada for less than 45 days in the calendar year or is present in Canada for less than 90 days in any 12-month period during which the salary is paid.

ITA: 153(1), (6), (7); ITR: 102

(10) The withholding tax rate is 25%. However, under the Canada–U.S. Income Tax Convention this rate is reduced to 5% if the shareholder owns at least 10% of the voting stock of the corporation and is reduced to 15% in all other cases.

ITA: 212(1)

(11) There would only be a benefit to a section 217 election where the individual’s tax calculated under Part I on those benefits would be less than the 25% withholding tax rate (or the reduced rate under the relevant tax treaty).

ITA: 212(1)(l), 217

(12) If the loan is not repaid within one year of the end of the taxation year in which the loan was made, Part XIII tax will apply to a deemed dividend to the shareholder equal to the loan balance. Subsection 17(1) will not apply where Part XIII tax is paid (and not refunded on a repayment of the balance). A refund of the Part XIII tax may be requested

ITA: 15(2), 214(3)(a)

Article X Canada–U.S. Tax Convention

CHAPTER 20

(8) If the rental property were located in the country from which the individual was emigrating, the individual would be taxable only on the taxable capital gain resulting from the appreciation in value from the time he or she moved to Canada. The cost base used to calculate the gain would be the fair market value of the property at the date of the move to Canada. If the property were a rental property located in Canada, the property would be taxable Canadian property and would be exempt from the deemed disposition rules when the individual immigrated to Canada. As a result, on disposition of the property, the individual would be taxable on the taxable capital gain calculated using the original purchase price of the property as the adjusted cost base.

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within two years of the calendar year in which a repayment of the balance occurs (in which case, subsection 17(1) could apply).

(13) The purpose of the deemed disposition/acquisition rule is to provide a tax cost base from which future income/gains are determined for Canadian income tax purposes. Properties that are taxable in Canada irrespective of the residency status of the owner are exempt from the deemed disposition/acquisition rule, e.g., real property situated in Canada.

ITA: 128.1(1)

(14) Non-residents who are filing a Canadian income tax return for employment income, business income, or because they have disposed of taxable Canadian property, are entitled to claim the same personal tax credits available to a resident where their Canadian-source income represents 90% or more of their world income.

ITA: 118.94

(15) A Canadian resident individual may reduce Part I taxes payable by a foreign tax credit for tax withholdings up to a rate of 15%. Withholding taxes in excess of 15% are deductible in computing Division B income. A Canadian resident corporation may claim a foreign tax credit for withholdings unless the dividends are received from a foreign affiliate, in which case Division C deductions apply.

ITA: 113(1), 126(1)

(16) The FAPI rules prevent a Canadian resident from deferring tax on investment income by holding investments offshore in controlled foreign affiliates. The rules require the Canadian investor to pay tax on the foreign investment income as it is earned each year instead of when it is received as a dividend.

ITA: 91(1)

(17) EXempt surplus of a foreign affiliate represents income or gains for which Canada relinquishes its right to tax. Active business income earned in a designated treaty country (countries with which Canada has a treaty or tax information exchange agreement) as well as the non-taxable portion of capital gains become exempt surplus of a foreign affiliate [other than the non-taxable portion of gains included in hybrid surplus]. The taxable portion of gains on the disposition of properties used principally to gain or produce active business income in a designated treaty country is also included in exempt surplus.

ITR: 5907, ‘‘exempt earnings’’

ITA: 20(11)

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CHAPTER 20 — SOLUTIONS TO EXERCISES Exercise 1 Alan is deemed to have disposed of the shares on emigration at their fair market value of $40,000. Given his ACB of $28,000, he will have a capital gain of $12,000, and a taxable capital gain of $6,000. Alan can elect to defer paying the tax that results from the deemed disposition rule. The election must be made on or before the balance due date for the year in which emigration takes place. If the election is made, the payment of the tax can be deferred without interest until the properties are actually sold. Since security is not required for up to $100,000 of capital gains resulting from the deemed disposition rule, Alan will not be required to post security with the CRA.

ITA: 220(4.5), (4.51)

Exercise 2 No, a foreign tax credit is not claimed in both countries. To do so would eliminate the taxes on the income altogether. The country where the income is sourced (the source country) has the first right of taxation and consequently, a foreign tax credit is allowed only in the other country (the residence country).

A non-resident will pay the Canadian income taxes on income from duties of office and employment performed in Canada, income from business carried on in Canada, and on taxable capital gains on taxable Canadian property. These taxes will then be used as a foreign tax credit in the country of residence. Note that treaties can limit or eliminate a country’s jurisdiction to tax source income. The country of residence will provide a tax credit only if taxes are paid.

ITA: 2(3)

Exercise 3 ITA: 2(3), 253

CHAPTER 20

Canada levies tax on non-residents who carry on business in Canada. Carrying on business in Canada is distinguishable from carrying on business with Canada. While Sam-son solicits sales from Canadians, it does not solicit sales in Canada through an agent or servant. Given these facts, Sam-son is not carrying on business in Canada and is not liable for Canadian income taxes on the $76,000 profit originating from within Canada.

Exercise 4 The Act defines ‘‘moving expenses’’ as including any expenses incurred as, or on account of, travel costs in the course of moving the taxpayer from the old residence to the new residence, cost of transporting or storing household effects, cost of meals and lodging, etc. It appears Mary Jane’s expenses would qualify under this definition; however, the move must be an eligible relocation as defined by the Act. The definition of ‘‘eligible relocation’’ only includes relocations that are both from and to a residence in Canada unless the person is a student or person absent from but a resident of Canada.

ITA: 62(3)

ITA: 62(1); 248(1) ITA: 62(2)

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546

Exercise 5 Dutchco is a foreign affiliate of Canco as Canco owns not less than 10% of the shares of the company. Dutchco is a controlled foreign affiliate of Canco as it is controlled by a Canadian resident. Dutchco is earning income from an active business in a country with which Canada has a tax convention. This income would be treated as exempt surplus. The company is also earning income from property. This income would be treated as FAPI and would become part of Dutchco’s taxable surplus. For 2022 and 2023, Canco must include, in respect of each share it owns in Dutchco, the share’s participating percentage of FAPI less a deduction for the foreign accrual tax applicable to the FAPI income inclusion. Income Income Inclusion . . . . . . . . . . . . . . . . . . . . . . . . . Deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income Inclusion . . . . . . . . . . . . . . . . . . . . . . . . . ACB Addition . . . . . . . . . . . . . . . . . . . . . . . . . . .

2022 $9,600 ( 7,680) $1,920 $1,920

2023 $9,600 1 ( 7,680)2 $1,920 $1,920

ITA: 91(1) ITA: 91(4)

Notes: 80% of $12,000 2 20% of $9,600 multiplied by the relevant tax factor of 1/(38% -- 13%) 1

The net income inclusion for 2022 is added to the adjusted cost base of the shares of Dutchco held by Canco, i.e., $500,000 + $1,920 = $501,920. The net income inclusion for 2023 is added to the adjusted cost base of the shares of Dutchco held by Canco (i.e., $501,920 + $1,920 = $503,840). When the dividend is paid in 2023, it will be included in Canco’s Division B income. A deduction is available for the portion of the dividend prescribed to have been paid from exempt surplus. E Xempt surplus includes exempt earnings for any taxation year ending in the period that starts with the first day of the taxation year in which Dutchco became a foreign affiliate and ends at the time the dividend is paid. FAPI is included in taxable surplus in a similar manner. The exempt surplus and taxable surplus balances of Dutchco at the time of the dividend would be as follows:

Income for December 31, 2022 taxation year end of the affiliate Income/profits tax paid to Netherlands tax authorities . . . . . . . . Balance February 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Exempt Surplus $30,000 (6,000) $24,000

Taxable Surplus $12,000 (2,400) $ 9,600

Surplus balances are not impacted by 2023 income amounts because the dividend was paid within the first 90 days of 2023. The portion of the whole dividend of $50,000 deemed to have been paid out of exempt surplus would be $24,000. The portion of the whole dividend deemed to have been paid out of taxable surplus would be $9,600. The remainder, of $16,400, would be considered to have been paid from pre-acquisition surplus. The 2023 income inclusions less deductions for Canco related to the dividend would be as follows: Pre-acquisition surplus deduction (Note 3) . . . . . . . . . . . . . . . . . . . . . . . . . Dividend income (50,000 × 80%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . EXempt surplus par. 113(1)(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable surplus par. 113(1)(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable surplus par. 113(1)(c) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Reverse FAPI inclusion ss. 91(5) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Pre-acquisition surplus par. 113(1)(c) . . . . . . . . . . . . . . . . . . . . . . . . . . . .

($ 1,920) 40,000 (19,200)1 ( 5,760)2 ( 1,536)2 ( 1,920)3 (13,120)1 ( $1,536)

The subsection 91(5) deduction reduces the adjusted cost base of the shares of Dutchco held by Canco. The adjusted cost base of shares after the February 2023 dividend is $501,920.

ITA: 12(1), 90(1)

ITR: 5907(1)

ITR: 5901(2)(a)

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Notes: 1

— The portion of the dividend paid from exempt surplus, i.e., $19,200 ($24,000 × 80%) and pre-acquisition surplus, i.e., $13,120 ($16,400 × 80%), is not taxed in Canada. 2 — The portion of the dividend paid from FAPI, i.e., $7,680 ($40,000 -- $19,200 -- $13,120), is taxed in Canada after taking a deduction for $5,760 related to the underlying foreign tax on the income from which this portion of the dividend was paid and a deduction of $1,536 related to the withholding tax on that portion of the dividend. Lesser of: (1) $5,760 [$2,400 × 80% × (1/(38% -- 13%) -- 1)], and (2) $7,680 [$9,600 × 80%] Lesser of: (1) $1,536 [$9,600 × 80% × 5% × 1/(38% -- 13%)], and (2) $1,920 [$9,600 × 80% less: paragraph 113(1)(b) deduction of $5,760] 3

— There is a further deduction of $1,920 to reverse the prior year’s FAPI inclusion. This deduction prevents the double taxation of the passive income earned in the CFA by ensuring that the FAPI is not taxed a second time when the dividend is paid out. This deduction is limited to $1,920, which is calculated as the total amount of the taxable surplus dividend, i.e., $7,680 net of the deduction of $5,760 related to the underlying tax on the income from which this portion of the dividend was paid. Lesser of: (1) $1,920 [$9,600 × 80% less: paragraph 113(1)(b) deduction of $5,760], and (2) 2022 net FAPI inclusion of $1,920 added to the ACB of the shares

ITA: 113(1)(b)

ITA: 113(1)(c)

ITA: 91(5) ITA: 113(1)(d )

Exercise 6 (A) The rents paid by Sam and Harry to Joe’s parents are subject to a 25% withholding tax. Joe is acting as an agent for his parents in collecting the rents and would be required to deduct and withhold the tax from the rents received and submit it to the Receiver General. Failure to withhold can result in interest charges and a penalty of 10% to 20% of unremitted withholdings. Joe’s parents can file a Canadian tax return within two years of the end of the year to obtain a refund of any Part XIII tax paid in excess of the Part I tax payable (using graduated tax rates) on the net rental income (rents less mortgage interest, CCA, utilities, and property taxes). Alternatively, an undertaking (NR6) to file an income tax return can be filed prior to the first rental payment for the year indicating Joe’s parents’ intent to file a Canadian tax return within si X months of the end of the year. In that case, withholding tax can be reduced to 25% of the net rents received (i.e., rents less mortgage interest, utilities, and property taxes). The return must be filed within siX months of the end of the year or Joe will become liable for the excess of 25% of the rents received less the withholdings remitted to CRA. Mr. and Mrs. Doe are not excluded owners for purposes of the proposed new 1% underused housing tax as they are not Canadian citizens or permanent residents. They will be required to report in a declaration of property, information about the rental property and the exemptions available. A qualifying occupancy exemption would apply under the proposals because Joe is a child of the owner and is in Canada for purposes of authorized study and the occupancy relates to that purpose. However, the declaration would be required to be filed by Mr. and Mrs. Doe on an annual basis to claim the exemption. If not filed, the tax on the ‘‘specified value’’ of the property will apply, plus penalties and interest.

ITA: 212(1)(d), 215(3), 227(8), 227(8.3)

ITA: 216(1)

ITA: 216(4)

CHAPTER 20

Note that for taxation years beginning after April 7, 2022, a proposed amendment to subsection 95(1) will amend the definition of relevant tax factor and the RTF used for the above calculations will be 1.9 instead of 4 (1/(0.38 -- 0.13) because Canco is a CCPC. As well, the deductions for dividends received from taxable surplus will not increase the general rate income pool for the corporation and the capital dividend account will be increased by the paragraph 113(1)(b) and 113(1)(c) (net of the withholding tax) deductions and can then be distributed to the shareholder tax free as a capital dividend. The impact will be a higher FAPI inclusion in 2022 and 2023 which will be reversed in the year the income is paid out as a dividend (2023).

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(B) If the condominium is sold in the future, Joe’s parents will have disposed of taxable Canadian property. They will be required to file a personal tax return to report the taxable capital gain on the disposition of the property. They will also be required to file a separate personal tax return to report any recapture on the disposition of the property. The Canada–China Tax Convention would need to be reviewed to determine if the taxable capital gain on the disposition of the property is treaty exempt. Assuming not, the purchaser would be required to withhold 25% of the proceeds paid for the land and 50% of the proceeds paid for the building within 30 days of the end of the month of the purchase, unless Mr. and Mrs. Doe have obtained a clearance certificate and paid 25% of the estimated (or actual) capital gain on the disposition of the property plus an estimate of the tax on the recapture related to the disposition of the property.

ITA: 248(1)

(C) Assuming Joe is a permanent resident of Canada under common law or a sojourner, he will be taxed on his worldwide income. He would need to report the rental income net of deductions on his personal tax return each year. The rents paid to him by the roommates would not be subject to withholding tax. If Joe were to own the condominium in his name, it may be possible for him to treat the property as his principal residence on its sale. He would need to be able to argue that the incomeproducing use is ancillary to the main use of the property as a principal residence, and he would not be able to claim CCA on the property in order to do so. If Joe’s parents were to loan him the funds to purchase the property, the attribution rules would not apply, as the rules only apply to individuals who are residents of Canada. Any interest Joe were to pay on loans from his parents would be subject to withholding tax, as the interest would be paid to a non-arm’s length person. The Canada–China Tax Convention may reduce the withholding rate.

ITA: 212(1)(b)

ITA: 116(1), (5)

CHAPTER 21

Chapter 21 GST/HST

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550

CHAPTER 21 — LEARNING CHART Problem Descriptions Textbook Example Problems 21-1 GST/HST treatment of various expenses 21-2 Refundable GST/HST credit 21-3 Employee GST/HST rebate Exercises 1 2 3 4 5 6 7

GST/HST implications Ceasing to be a small supplier HST payable or receivable – taxable supplies HST payable or receivable – taxable and exempt supplies Schedule 1 reconciliation – HST Employee – HST rebate GST remittance – quick method and regular method

Assignment Problems 1 Schedule 1 reconciliation – HST 2 Employee – HST rebate 3 Employee – HST rebate 4 Capital asset – HST implications 5 Capital assets – GST implications 6 GST/HST implications of a windup 7 GST/HST – sale of assets 8 GST/HST – sale of assets 9 GST/HST – Section 85 10 GST/HST – Section 85 11 Ceasing to be a small supplier 12 GST remittance 13 GST remittance — quick method and regular method 14 Single vs. multiple supplies

Ch. 21/Study Guide — Learning Chart

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CHAPTER 21

Introduction to Federal Income Taxation in Canada

552

¶21,825

EXERCISES

Exercise 1 Mr. E. Evans has decided to open a small car-detailing company. The individual at the name registration office suggested that Mr. Evans walk down to the CRA office and pick up the information package with respect to tax filing, etc. Mr. Evans had anticipated that the package of information obtained at the CRA office would include information on the harmonized sales tax (‘‘HST’’). Unfortunately, this information was not included in the package obtained. Mr. Evans approached you to explain the obligations of a registrant under the Excise Tax Act (‘‘ETA’’). — REQUIRED Provide the appropriate explanations.

Exercise 2 Ms. Ima Creator began her retail business on March 1, 2022, in Edmonton, Alberta. The quarterly sale of taxable supplies are as follows: Calendar Quarter Sales March 2023 (one month) . . . . . . . . . . . . . . . . . . . . . $ 1,500 April to June, 2023 .............................................................. 5,000 July to September, 2023 ................................................... 12,500 October to December, 2023 ........................................... 14,000 January to March, 2024 .................................................... 35,000 — REQUIRED Determine the date that Ms. Creator is required to register and start collecting GST.

Exercise 3 Wai-Keat Ltd. is located in Halifax, Nova Scotia, which has an HST rate of 15%. Below is the abbreviated portion of WaiKeat’s monthly income statement for the period of December 1, 2023, to December 31, 2023. HST is not included in any of the amounts listed below. Sales:

Taxable supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable supplies (zero-rated) . . . . . . . . . . . . . . . . . . . . .

$7,200,000 900,000

Cost of goods sold – fully taxable supplies . . . . . . . . . . . . Cost of goods sold – zero-rated supplies . . . . . . . . . . . . . Depreciation expense . . . . . . . . . . . . . . . . . . . . . . . . . . . Salaries and wages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income before HST and income taxes . . . . . . . . . . . . . . . . . . . . .

4,680,000 585,000 675,000 1,200,000 375,000 75,000 $ 510,000

EXpenses:

Additional Information: (1) Other costs include: warehouse lease, office rent, utilities, cleaning services, legal and accounting fees. 75% of these costs relate to the taxable supplies sold, while the remaining balance relates to zero-rated supplies. (2) During December 2023, the company purchased a new office building for $2,500,000, net of HST. The office building was used 75% for fully taxable supplies and 25% for zero-rated supplies. — REQUIRED Based on the information above, determine the HST payable or receivable for the month of December, and outline when the HST return and any payment is due.

¶21,825

Ch. 21/Study Guide — Exercises

553

Exercise 4 Coral Ltd. is located in Waterloo, Ontario, which has an HST rate of 13%. Below is the abbreviated portion of Coral Ltd.’s monthly income statement for the month of November. HST is not included in any of the amounts listed below. Taxable supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . EXempt supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$7,200,000 900,000

Cost of goods sold – fully taxable supplies . . . . . . . . . . . . Cost of goods sold – exempt supplies . . . . . . . . . . . . . . . Depreciation expense . . . . . . . . . . . . . . . . . . . . . . . . . . . Salaries and wages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest costs on building mortgage . . . . . . . . . . . . . . . . . Net income before GST and income taxes . . . . . . . . . . . . . . . . . . . . .

4,680,000 585,000 675,000 1,200,000 375,000 75,000 $ 510,000

EXpenses:

CHAPTER 21

Sales:

NOTES: (1) Other costs include warehouse lease, office rent, utilities, cleaning services, legal and accounting fees. 75% of these costs relate to the taxable supplies sold, while the remaining balance relates to exempt supplies. (2) On November 1, 2023, the company purchased a new office building for $2,500,000, net of HST. The office building was used 75% for fully taxable supplies and 25% for exempt supplies. (3) Additional purchases in the year, not included in the cost of goods sold, were $750,000. All of these purchases relate to the taxable supplies. — REQUIRED Based on the information above, determine the HST payable or receivable for the month of November, and outline when the HST return and any payment is due.

Exercise 5 The following information concerning the financial statements of Incredible Incubators Incorporated for its fiscal year ended September 30, 2023, has been presented to you in order to prepare tax returns. (a) Net income after tax per financial statements..........................................................$150,000 (b) Provision for income taxes — current .................................................................... 25,000 — future .................................................................... 130,000 (c) Amortization expense .................................................................................................... 40,000 (d) Reserve for doubtful debts — deducted in 2022 .................................................... 10,000 — deducted in 2023 .................................................... 15,000 (e) Interest on income taxes paid after due date ................................................................ 2,500 (f) Bond interest expense (including annual discount amortization of re bonds issued this year) ...................................................................................................... 39,500 (g) Landscaping costs re: factory premises — debited to land account......................... 12,000 — REQUIRED Outline the proper HST treatment by the corporation of the items presented.

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Exercise 6 Patty, a single parent of two children (ages nine and seven), works part-time as a clerk in a law office. She has provided you with the following information for 2023:

Income: Workers’ Compensation payments . . . . . . . . . . . . . . . . . . . . . . . . .

$ 9,000

Employment income (Subdivision a) . . . . . . . . . . . . . . . . . . . . . . .

38,000

Cash dividend from Canadian-resident public corporations . . . . . .

480

University scholarship received . . . . . . . . . . . . . . . . . . . . . . . . . . .

600

Canada Pension Plan contributions . . . . . . . . . . . . . . . . . . . . . . . .

1,796

EXpenses: Employment Insurance contributions . . . . . . . . . . . . . . . . . . . . . .

553

Cost of subsidized day care for the children (three days a week) University tuition paid for a three-month evening course . . . . . . . .

2,400 600

Patty receives the Workers’ Compensation payment because of the accidental death of her husband two years ago. Her two minor children have no income. Patty had $700 of tax withheld from her employment income and has paid no income tax instalments.

— REQUIRED Based on the information above, determine if Patty is eligible for the refundable goods and service tax credit. EXplain.

Exercise 7 Loftus Inc., located in Edmonton, Alberta, sells office furniture to local businesses in Alberta. Loftus’s sales have never been in excess of $400,000 annually. Loftus has chosen to file its GST returns on a quarterly basis and has elected to use the quick method to file its GST returns. The following information relates to the first quarter (January to March, 2024):

Net of GST Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$65,000

Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

29,250

Actual inventory purchases in the quarter . . . . . . . . . . . . . . . . . . . .

31,250

Salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

15,000

Interest on loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . New fork lift (capital expenditure) . . . . . . . . . . . . . . . . . . . . . . . . . .

900 7,500

— REQUIRED 1. Based on the information provided, determine the GST owing (refundable) for the first quarter of 2024 using the quick method. 2. Based on the information provided, determine the GST owing (refundable) for the first quarter of 2024 assuming the company uses the regular method of calculating GST.

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555

ASSIGNMENT PROBLEMS

The unaudited income statement for Lomas & Sons Limited, a Canadian-controlled private corporation, for its year ended December 31, 2023 shows the following: Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cost of sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . General and administrative expenses . . . . . . . . . . . . . Research and development expenditures . . . . . . . . . .

$ 795,000 $350,000 225,000 65,000

(640,000)

Operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 155,000 20,000

Net income before taxes . . . . . . . . . . . . . . . . . . . . . . Provision for income taxes: — current . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — future . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 175,000

Net income after income taxes . . . . . . . . . . . . . . . . .

ETA: 123(1), 161, 164, 169(1), 170(1)(a), 232, 236, Sched. V, Part VII

$ 27,000 25,000

(52,000) $ 123,000

The information in the following notes has already been reflected in the above income statement 1. Payment made by company on April 1, 2024, to a defined contribution (money purchase) registered pension plan for the president of the company in respect of current employment service, allocated to 2023 expenses by the company’s accountant; in addition, the president had $7,500 withheld from his compensation of $74,000 for the RPP . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 7,000

2. Increase in warranty reserve on company’s product (net of expense incurred; based on self-insurance warranty program) . . . . . . . . . . . . . . . . . .

16,000

3. Amortization expense recorded in the financial statements . . . . . . . . . . . . . .

30,000

4. Landscaping costs re: factory premises . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2,500

5. Interest on bank loan obtained for the purpose of purchasing common shares in Advanco Ltd., a dividend-paying Canadian corporation . . . . . . . . . .

6,300

6. Legal costs of arranging an agreement among shareholders . . . . . . . . . . . . . .

8,500

7. Legal and accounting fees related to issue of shares . . . . . . . . . . . . . . . . . . .

12,700

8. Interest on municipal real estate taxes paid late in error . . . . . . . . . . . . . . . .

1,000

9. Golf club membership fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2,200

10. Donation to United Way . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3,000

11. Meals and entertainment for clients . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4,000

12. Appraisal fees to determine selling price of fiXed assets . . . . . . . . . . . . . . . .

6,200

13. Premium on term insurance on life of president with the corporation as beneficiary; policy was not required to be assigned as collateral for corporate borrowing from the bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2,800

14. Management bonuses ($20,000 of the bonuses expensed in 2023 and shown as ‘‘Bonus Payable’’ on the Balance Sheet as at December 31, 2023, has not been paid at the time of filing the corporate tax return on June 30, 2024) . . . . . . .

40,000

15. Amortization of bond discount on bonds issued in 2019 . . . . . . . . . . . . . . . .

3,400

16. Interest and penalties on income tax assessments, expensed for accounting purposes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,250

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Problem 1

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17. Items included in the financial accounting statements in arriving at net profits: ● Amount paid by an insurance company on its business interruption insurance to compensate for loss of profits when company was closed down for a month during the year due to fire . . . . . . . . . . . . . . . . . . . . . . 26,800 Dividends received . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,700 ● Volume rebates and discounts on purchases . . . . . . . . . . . . . . . . . . . . . . . 16,000

●

— REQUIRED (A) Outline the general HST requirements applicable in this corporate situation. for:

(B) Indicate which of the items listed in the additional information notes represent costs incurred ●

taxable supplies, eligible for an ITC, and

●

exempt supplies, not eligible for an ITC.

(C) Comment on the appropriate HST treatment of the other items listed in the additional information notes and on the income statement.

Problem 2 Author’s Note: This problem addresses the GST/HST implications for Problem 22, Chapter 3. The GST/HST solution may be used in conjunction with the solution in Chapter 3 or as a separate assignment. Anita Flare is a skilled tool and die worker. She has been working for Car Parts Inc., a large manufacturer of parts for the automobile industry for over 10 years. Car Parts Inc. is a Canadiancontrolled private corporation. Anita has become their ‘‘Jane on the Spot’’ as far as diagnosing and quickly retooling machinery that breaks down or needs to be updated to run a short order. Anita is single and she rents a home in north Toronto. Because Anita is required to travel for 75% of the year, Car Parts Inc. actually pays the $1,200 monthly rent on Anita’s home in Toronto. Anita reimburses the company for 25% of this amount ($300 per month) through payroll deduction as set out below. The head office of Car Parts Inc. is located in north Toronto. The company, however, has plants that are located throughout Ontario and Quebec, wherever there are large automobile manufacturing operations to be supplied with parts. When a plant requires emergency retooling or repair Anita is sent out to that location to supervise and organize the work. As stated above, this involves about 75% of Anita’s total employment hours for any given year. She stays at a particular location for a period of days or weeks depending on the nature of the job involved. She is never at a site for less than 36 hours. For the balance of the year, Anita works at the head office in the research department. Anita’s final 2022 pay stub showed the following totals for the year: Gross salary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$115,000

Payroll deductions: Income tax withheld . . . . . . . . . . . . . . . . . . . . . . . . . . . . $44,200

¶21,850

Canada Pension Plan contributions (incl. enhanced portion of $631) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3,754

Employment Insurance premiums paid . . . . . . . . . . . . . .

1,002

Contributions to company group RRSP . . . . . . . . . . . . . .

1,750

RPP contributions on account of current service . . . . . . .

5,000

Union dues to Canadian Union of Automobile Workers (HST exempt) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

800

Group accident income protection insurance premiums (matched by company) . . . . . . . . . . . . . . . . . . . . . . . . . . Monthly rent reimbursement (as described above) . . . . .

240 3,600

ITA: 6(8); ETA: 253(1)

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In discussion with Anita, you determined that the company also provides the following fringe benefits:

CHAPTER 21

Payment of board and lodging costs at special work sites as required — at cost to company.......................................................................................... $18,000 Bonus based on company profits for the year above budgeted targets ............. 12,500 Provision of safety boots and company uniform consisting of five shirts and five matching pairs of pants; the shirt is embroidered with her name on the front pocket and has the company name on the back . . . . . . . . . . 450 Registered pension plan contributions to defined benefit plan . . . . . . . . . 6,750 Monthly allowance of $150 to cover personal phone calls, laundry costs and other incidentals while travelling (She estimates that she spends $100 per month.) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,800 Fitness club membership dues to a club with locations across Ontario (including HST); Anita feels that it is important to her productivity to remain in top physical shape as her work can be physically demanding . . . . 805 Anita was injured on the job early in the year and received total payments of $11,500 out of the company group income protection plan for 2 months while she was recuperating. She had not previously received any payments under this plan and has paid total premiums of $2,880 into the plan since she began employment 12 years ago (this includes all of the year 2023 premiums paid through December 2023). Due to her extensive travel, Anita’s employer requires her to have an automobile for employment purposes. Anita has provided you with the following details of her automobile expenses. Owned car(1) Leasing costs(2) . . . . . . . . . . . . . . . . . . . . . . Gasoline and oil (including HST) . . . . . . . . . Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . Maintenance (including HST) . . . . . . . . . . . . Licence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CCA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

n/a $2,880 1,333 400 90 1,207

Leased car $3,680 1,440 667 240 30 n/a

NOTES: (1)

She owned an automobile until August 31, 2023, at which time she disposed of that vehicle and began leasing a new one. Assume that there are no tax consequences to Anita of the disposition of the automobile other than the fact that she can claim CCA in 2023 on this vehicle, as set out above, since it was a luXury vehicle. Anita received an automobile loan to purchase the owned automobile. She received the loan on April 1, 2018, for $40,000, but has been making principal repayments annually on April 1 each year. She made the last principal repayment of $8,000 on April 1, 2023. There was no interest payable on the loan. Assume that the prescribed interest rate for employee loans was 1% for all of 2023. During 2023, Anita drove the owned car a total of 40,000 kilometres, of which 35,000 kilometres were employment related. (2) Anita leased the car as of September 1, 2023, at a cost of $1,243 a month that includes $143 of HST. The lease is for a three-year period that will expire August 31, 2026. At the time that she leased the car, the manufacturer’s list price on the vehicle was $55,000 excluding all taxes.

During 2023, Anita drove the leased car a total of 20,000 kilometres, of which 18,000 kilometres were employment related. — REQUIRED Based on the facts above, determine the potential HST rebate and income tax consequences upon receipt of this amount.

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Problem 3 Author’s Note: This problem addresses the GST/HST implications for Problem 23, Chapter 3. The GST/HST solution may be used in conjunction with the solution in Chapter 3 or as a separate assignment. Mr. Ned Newell is employed by Snoopy-Snacks Ltd. (a Canadian-controlled private corporation). As of February 15, 2023, Ned was promoted to vice-president of sales due to his hard work negotiating puppy snack contracts on behalf of the company. This promotion required Ned to relocate from the Toronto office of Snoopy-Snacks Ltd. to its Victoria, British Columbia office. Ned has provided you with the following information regarding his 2023 income and expenses. He requests your assistance in determining his 2023 employment income for tax purposes. Payroll details: Gross salary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Canada Pension Plan contributions (incl. enhanced portion of $631) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Employment Insurance contributions . . . . . . . . . . . . . . . . . Registered pension plan contributions: defined benefit . . . . Group income protection premiums paid . . . . . . . . . . . . . . Group term life insurance premiums paid . . . . . . . . . . . . . .

$125,000 $45,000 3,754 953 6,750 120 180

56,803 $ 68,194

Employer-paid amounts and fringe benefits paid by Snoopy-Snacks Ltd.: Dental plan premiums — paid to Star Insurance Company . . . . . . . . . . Group term life insurance premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . B.C. provincial health care premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . Group income protection premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . Monthly allowance to cover travel and automobile expenses (based on a flat monthly amount of $400 for travel and $400 for auto) . . . . . . . . . . . . Travelling expenses for Ned and his wife to Bermuda for a sales conference. Ned’s time was spent attending the conference but his wife was on vacation the entire time. No HST was payable on the trip since it was outside of Canada. One-half of the expenses related to Ned and one-half to his wife . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A birthday gift (a watch) received while in Ontario (including HST). Snoopy-Snacks Ltd. deducted the cost of this gift as a business expense Outside financial counselling fees (including HST). The counselling firm indicated that 80% of its fees relate to counselling for future retirement while the remaining 20% of its fees relate to tax preparation . . . . . . . . .

$ 245 90 640 400 9,600

2,800 150

2,568

Other Information: 1. Snoopy-Snacks Ltd. provided Ned with some assistance that relates to his move from Toronto to Victoria. The details of that assistance are set out below. (a) Ned purchased a new home in Victoria just prior to his move. However, he could not take possession of that home until April 30, 2023. Snoopy-Snacks Ltd. paid Ned’s rent for a Victoria apartment for the months of February through April 2023. The rent paid was $1,200 per month. (b) Ned and Snoopy-Snacks Ltd. agreed that he would receive reimbursement from SnoopySnacks Ltd. for one-half of the loss realized by him on the sale of his Toronto home. Ned received $16,500 as a result of this agreement. (c) Ned received an allowance of $15,000 to cover his moving expenses.

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CHAPTER 21

In addition to the above, Ned’s employer agreed to reimburse him an amount equal to one-quarter of his annual mortgage interest payment for the first five years of his mortgage on his new Victoria home. This was intended to compensate for higher real estate prices in Victoria. For 2023, Ned received $2,000 under the terms of this agreement. 2. Ned had unlimited use of the company’s private swimming pool. All management level employees are permitted to utilize this pool. The local private swimming pool charges annual fees of $1,800 per year before HST. 3. Ned had the following expenditures during 2023. Automobile operating expenditures: Lease payments for 12 months ($850 a month including HST of 12%) (lease commenced July 1, 2022, for a period of three years; deducted lease costs for 2022 were $4,585) Gasoline and oil . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Licence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$10,200

1,300 1,050 180 120

Travelling expenditures: Meals (consumed while out of metropolitan area for greater than 12 hours) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accommodation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

7,200 12,000

During 2023, Ned travelled a total of 36,000 kilometres, of which 22,500 kilometres were employment-related. The manufacturer’s list price on his automobile was $33,000 before HST. — REQUIRED Consider the facts above. Ned would like you to compute the potential HST rebate in 2023 and the income tax consequences upon receipt of the HST rebate. While BC has both PST and GST, assume an HST rate of 12% for this purpose.

Problem 4 Author’s Note: This problem addresses the GST/HST implications for Problem 6, Chapter 6. The GST/HST solution may be used in conjunction with the solution in Chapter 6 or as a separate assignment. It is early January 2023 and the president of BDC Distributing Limited, a client of your firm, called recently to discuss the tax implications regarding the construction of a new building. BDC has been growing rapidly and needs new warehouse space. They have been unable to locate any suitable space in the existing buildings in town and, therefore, have decided that their only option is to build their own building. They have identified the site and have estimated the costs of the project. These projected costs (and dates of completion) are as follows:

ETA: 123(1), Sch. V, Parts VI, VII

The land that has been identified will be purchased on February 15, 2023, for $405,000. There is no significant site preparation required so construction of the building can commence immediately. The cost of the building is estimated to be $1,348,000 plus the costs noted below. It is anticipated that BDC will be able to occupy the building on October 31, 2023. BDC currently has an architect finalizing the drawings for the building. The architect fees, which will all be paid in 2023, will amount to $7,200. There will also be fees of $2,100 for an engineer to examine the drawings. BDC has arranged for the financing required for the project. The project will be financed with a mortgage of $875,000 and $1,000,000 of preferred shares issued on January 15, 2023. Interest on the mortgage is payable semi-annually on July 15 and January 15 at a rate of 8% per annum. The preferred shares pay dividends of 5% per annum, payable semi-annually on July 15 and January 15. There will be a number of costs incurred in order to issue the debt and shares. These costs are legal and accounting fees of $18,450, commissions of $58,300 and registration fees of $1,800 for amending the articles of incorporation to allow the issuance of the preferred shares. BDC had previously deducted $3,000 for its original incorporation costs.

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The balance of the costs related to the building is summarized below: Building insurance from April 15, 2023 @ $450 per month . . . . . . . . . . Property taxes from February 15, 2023 @ $770 per month . . . . . . . . . . Soil testing to determine location of footings for building . . . . . . . . . . . Relocation expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Utilities service connections estimated to be completed on May 20, 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mortgage insurance premium from March 1, 2023 of $325 per month . . . . Maintenance from October 31, 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . Utilities from October 31, 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Landscaping . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 3,825 8,085 1,825 34,100 3,800 3,250 2,500 6,300 15,500

— REQUIRED The president of BDC Distributing Limited has asked you to calculate the HST consequences of the transactions presented. Assume that HST was paid at 13%, where applicable, in addition to the amounts shown.

Problem 5 Author’s Note: This problem addresses the GST/HST implications for Problem 24, Chapter 7. The GST/HST solution may be used in conjunction with the solution in Chapter 7 or as a separate assignment. PITA Co. Ltd. is a nutritional consulting firm that advises manufacturers and distributors on consumers’ dietary needs and preferences. For its year ended December 31, 2023, it reported net income before taxes of $900,000 for financial statement purposes. This amount included a gain on the disposition of land held as capital property of $50,000 and of a building (not the only one in the class) of $95,000. The corporation also realized an accounting loss of $20,000 on securities and of $10,000 on a trademark. These assets were acquired for the following amounts: Land.................................. $120,000 in 2012 Building ............................ 100,000 in 2012 (UCC of the class is $125,000) Securities .......................... 50,000 in 2021 Trademark .......................... 80,000 in 2021 The proceeds of disposition of these assets were as follows: Land . . . . . . . . . . . . . . Building . . . . . . . . . . . . Securities . . . . . . . . . . Trademark . . . . . . . . . .

$150,000 120,000 30,000 75,000

The corporation has reported accounting amortization of $80,000 and wishes to claim the maximum available capital cost allowance of $100,000. During 2023, the corporation also made payments in respect of interest on unpaid income taxes ($1,500), charitable donations ($10,000), and an annual employee dinner-dance in December 2023 ($14,000). During 2023, the corporation established that an unsecured $5,000 note receivable in respect of the sale (as capital property) of a parcel of land in the prior year had become a bad debt. This was not reflected in the financial statements. — REQUIRED PITA has asked you to discuss in general terms the treatment of these items by the corporation for purposes of the HST.

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Problem 6

CHAPTER 21

Author’s Note: This problem addresses the GST/HST implications for Exercise 8, Chapter 16. The GST/HST solution may be used in conjunction with the solution in Chapter 16 or as a separate assignment. Dwight Limited is a Canadian-controlled private corporation which will be wound up by its only shareholder, Mr. Warren, who bought the shares at their paid-up capital value of $2,000. As at December 31, 2023, its balance sheet for tax purposes appears as follows: Dwight Limited Balance Sheet As at December 31, 2023

Assets

Liabilities

Cash . . . . . . . . . . . . . .

$ 20,000

RDTOH . . . . . . . . . . . .

10,000

Inventories at cost (FMV: $220,000) . . . .

Wages Payable . . . . . . .

3,000

Total . . . . . . . . . . . . . . $ 50,000 200,000

Land at cost (FMV: $70,000) . . . .

Bank Loan . . . . . . . . . . $ 47,000

Shareholders’ Equity 40,000

Building at UCC

Paid-up capital . . . . . . $ 2,000

(Cost: $200,000; FMV: $300,000) . . . .

60,000

Equipment at UCC

Surplus ............................ 318,000 Total ............................... $370,000

(Cost: $100,000; FMV: $80,000) . . . . .

40,000

Total . . . . . . . . . . . . . . $370,000

The balance in the corporation’s capital dividend account was nil as at the above balance sheet date. The assets are to be liquidated, the liabilities paid and the net proceeds distributed to Mr. Warren effective January 1, 2024.

— REQUIRED (A) Discuss the HST implications on the wind-up of Dwight Limited.

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Problem 7 J. Tilkenhurst Limited (JTL) is a Canadian-controlled private corporation which was started 10 years ago by Mr. Santosh Prasad with an initial investment in common shares of $18,000. Mr. Prasad has decided that it’s time to retire and move to his retirement home in Saskatoon, Saskatchewan. Therefore, in January 2024 Mr. Prasad wishes to have JTL sell the assets to a corporate purchaser at their fair market value and then wind up JTL. He would like your advice on how much capital he would have to invest if he wound up JTL, and he would like your advice on whether he should not wind up JTL but keep it. The following is a projected tax balance sheet prior to the sale of the assets and the distribution of the resulting net cash as at the intended date of the winding-up: J. Tilkenhurst Limited Balance Sheet As at December 31, 2023 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . RDTOH . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accounts receivable $60,000 Less reserve for doubtful debts 5,000 . . . . . . . . . . . . . . . . Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Marketable securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Building – UCC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Equipment – UCC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Customer List – UCC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$15,000 6,000 55,000 110,000 26,000 85,000 23,000 10,000 20,600 $350,600

Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Future income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Common shares (PUC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital dividend account (no unabsorbed negative amounts) Other surplus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$45,000 41,000 18,000 12,000 234,600 $350,600

Additional Information: Assets Accounts receivable . . . . . . . . . . . . . . . . . . . . . Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Marketable securities . . . . . . . . . . . . . . . . . . . . Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . Customer lists . . . . . . . . . . . . . . . . . . . . . . . . . ●

● ●

Cost

FMV

$ 60,000 $110,000 $ 26,000 $ 85,000 $ 66,000 $ 30,000 $ 42,453

$ 52,000 $127,000 $ 26,000 $150,000 $ 97,000 $ 6,000 $ 70,000

●

After that he expects his retirement income to be approXimately $100,000 per year.

●

The customer lists were purchased in 2018.

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563

The provincial corporate tax rate for income eligible for the small business deduction is 4% and 12% for income above the small business deduction limit.

CHAPTER 21

— REQUIRED Discuss the GST implications on the wind-up of J. Tilkenhurst Limited, including any elections that may be filed to reduce the GST implications.

Problem 8 You have been approached by Mr. Sidney Chow, a Canadian resident, for advice on the sale of his business. He would like to know whether he should keep his corporation after the sale. He wants to understand how much tax he will pay on the sale and how much he would have available to invest after the sale of the business. The business is located in Ontario and the corporation is HST registered. He is considering an offer from a corporate purchaser who will buy the business assets from Chow Enterprises Ltd. (CEL) and continue the business. The purchase will take place on December 31 and the selling price of the assets will be their fair market value at that time (see information below). Mr. Chow purchased all the common shares of CEL from the company on incorporation in 2010. The following information on Chow Enterprises Ltd. has been prepared: Chow Enterprises Ltd. BALANCE SHEET as at December 31, 2023

Cash . . . . . . . . . . . . . . . . . . . . . . . RDTOH . . . . . . . . . . . . . . . . . . . . . Accounts receivable . . . . . . . . . . . . Less: reserve for doubtful debts . . .

$30,000 5,000

Land . . . . . . . . . . . . . . . . . . . . . . . Building (Class 1) – UCC . . . . . . . . Equipment (Class 8) – UCC . . . . . . Goodwill (Class 14.1) – UCC . . . . .

Liabilities . . . . . . . . . . . . . . . . . . . . Future income taxes . . . . . . . . . . . Common shares – PUC . . . . . . . . . . Capital dividend account . . . . . . . . Other surplus . . . . . . . . . . . . . . . . .

Tax Value

FMV

$ 10,000 5,000

$ 25,000

18,000

55,000 95,000 12,000 15,150

150,000 320,000 3,000 120,000

$217,150

$626,000

Cost

$ 55,000 170,000 30,000 50,000

$ 35,000 12,000 20,000 8,000 142,120 $217,150

Additional Information: (1) Goodwill was acquired in 2013 in connection with a similar business which was purchased that year. The fair market value reflects the goodwill for the combined businesses. (2) The corporation has a GRIP balance of nil. (3) Sidney is in the top personal tax bracket. Sidney is wondering if he should instead sell the shares of the corporation and wants to know what share price he should sell the shares for. (4) The corporate tax rate for income eligible for the small business deduction is 4%. For income in excess of the small business limit the provincial tax rate is 12%. — REQUIRED Discuss the HST implications on the wind-up of Chow Enterprises Ltd, including any elections that may be used to reduce the HST implications.

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Problem 9 Peter Handy is a Canadian resident who owns all the shares of The Handyman Shop Inc. (Handyman). He has been operating successfully for the past ten years but is finding that increasingly there are more lawsuits against retailers for injuries sustained by hobbyists, particularly for the tools that Handyman develops internally. While they do have product liability insurance to cover claims, Peter is concerned that, as the amount of the awards increase, a lawsuit might threaten the equity he has built up in the assets, particularly the land and building, and may even put him out of business. A friend told him that he should transfer the business assets and liabilities, other than the land, building and mortgage, to a new subsidiary corporation, Tool Man Inc. (Tool Man), and then use Handyman as a holding company to accumulate assets. Peter would like your advice on this proposal or other ideas you might have. Handyman operates in Ontario and is an HST registrant. Handyman has the following assets and liabilities:

Book Value

Tax Value

Fair Market Value

Cash . . . . . . . . . . . . . . . . . . . . . . . . .

$220,000

$ 220,000

Inventory . . . . . . . . . . . . . . . . . . . . . .

440,000

395,000

Furniture and fiXtures . . . . . . . . . . . .

120,000

60,000

80,000

Building . . . . . . . . . . . . . . . . . . . . . . .

750,000

450,000

1,550,000

Land . . . . . . . . . . . . . . . . . . . . . . . . .

80,000

1,300,000

Goodwill . . . . . . . . . . . . . . . . . . . . . . .

nil

800,000

Accounts payable . . . . . . . . . . . . . . . .

(250,000)

Bank loan . . . . . . . . . . . . . . . . . . . . . .

(300,000)

Mortgage payable . . . . . . . . . . . . . . . .

(180,000)

— REQUIRED Discuss the HST implications on the above transaction, including any elections that may be used to reduce the HST implications.

Problem 10 Ms. Hart, age 45, has just met with you to talk about incorporating her business and having her husband participate in its future growth in value. She is a Canadian resident and has provided you with the balance sheet and additional information concerning her unincorporated active retail clothing business. Ms. Hart is an HST registrant. She has picked November 10, 2023, as the date when she wishes to transfer all of her business assets and liabilities to a corporation (Hart Ltd.) in which her husband owns 100% of the common shares. She wants your advice on how to do this with the minimum amount of personal tax. Mr. Hart is also a Canadian resident.

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The following financial information concerning the business as of November 10, 2022, has been provided: Fair Market Value

Shares in public companies (1) . . . . . . . . . . . . . . .

$ 11,000

$ 6,000

Accounts receivable (net allowance) (2) . . . . . . . .

13,000

10,000

Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

8,000

9,000

Land (held as inventory) . . . . . . . . . . . . . . . . . . .

100,000

220,000

Prepaid property insurance . . . . . . . . . . . . . . . . .

600

Building (Class 1, cost $90,000) . . . . . . . . . . . . . .

70,000

150,000

Land (capital property) . . . . . . . . . . . . . . . . . . . .

140,000

160,000

Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

nil

80,000

CHAPTER 21

Tax Value

Additional Information: (1) The shares are capital property to Ms. Hart. She owns less than 1% of each public company. (2) The tax reserve for doubtful debts taken in the previous year was $1,000. The original cost of the accounts receivable before deducting the reserve was $14,000. (3) The unincorporated business has liabilities of $60,000 which are to be assumed by Hart Ltd. — REQUIRED Discuss the HST implications of incorporating her business using a Section 85, including any elections that may be used to reduce the HST implications.

Problem 11 Below are two independent situations. For each situation, determine when each taxpayer ceases to be a small supplier and must register as a GST/HST registrant. 1. Jean-Claude Poitras began his business on January 1, 2022. His quarterly sales were as follows: Quarter

Sales

Jan – Mar, 2023 . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 7,500

Apr – Jun, 2023 . . . . . . . . . . . . . . . . . . . . . . . . . .

8,500

Jul – Sep, 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . .

16,000

Oct – Dec, 2023 . . . . . . . . . . . . . . . . . . . . . . . . . .

18,500

Jan – Mar, 2024 . . . . . . . . . . . . . . . . . . . . . . . . . .

28,000

2. TiCha Corporation began their business on July 1, 2022. The quarterly sales were as follows: Quarter

Sales

Jul – Sep, 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . .

$10,500

Oct – Dec, 2023 . . . . . . . . . . . . . . . . . . . . . . . . . .

22,500

Jan – Mar, 2024 . . . . . . . . . . . . . . . . . . . . . . . . . .

19,875

Apr – Jun, 2024 . . . . . . . . . . . . . . . . . . . . . . . . . .

22,300

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Problem 12 Mrs. Hardeep Kang, a marketing consultant, has sales of $176,000 (no HST included) during the current year. She has incurred the following expenses (HST is not included in the amounts below): Lease costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Wages and salaries . . . . . . . . . . . . . . . . . . . . . . . . Office supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital costs: Two new laptops . . . . . . . . . . . . . . . . . . . . . . New software . . . . . . . . . . . . . . . . . . . . . . . . New office furniture . . . . . . . . . . . . . . . . . . .

$24,180 87,250 1,275 5,950 1,250 12,500

— REQUIRED Assuming an HST rate of 13% and that Mrs. Kang files her HST return on an annual basis, determine the net HST payable or refund for the year. Round to the nearest dollar.

Problem 13 Jennifer Auto Glass (‘‘JAG’’) is a private corporation providing auto glass and auto body repair in Edmonton, Alberta. Below is the income statement for the current fiscal year ending December 31: Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 85,000 Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140,000 Cost of goods sold ....................................................................... ($95,000) Depreciation expense ........................................................................ (12,000) Salaries and wages ........................................................................... (80,000) Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,500) Other operating expenses ................................................................ (16,800) (209,300) Income (loss) before taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 15,700 (2,355)

Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 13,345

All of the amounts above do not include GST. JAG files their GST return annually and has a GST rate of 5%. Additional information: (1) Inventory purchases in the year totalled $115,000. All the inventory relates to the provision of taxable supplies. (2) All sales and services are considered fully taxable for GST purposes. (3) Other operating expenses related to fully taxable supplies. (4) Capital expenditures in November of the current year was $215,000, with GST being paid on the full amount. The capital expenditure was new shop supplies which will be depreciated over the estimated 25 year useful life. The capital asset will be used solely for the purpose of providing taxable supplies. — REQUIRED 1. Calculate JAG’s net GST remittance or refund for the current year assuming JAG does not use the quick method. 2. Calculate JAG’s net GST remittance or refund for the current year assuming JAG elects to use the quick method.

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Problem 14

CHAPTER 21

Elite Athlete Educational Institution is a private school located in Mississauga, Ontario. The school provides a combination education and hockey skills program for students in grades 3 through 12. Students are billed monthly tuition fees of $2,000 a month before HST. On the monthly invoice, the education portion of the fee is $1,500 and the hockey skills portion of the fee is $500 plus HST. Elite has claimed ITCs on 25% of the HST incurred on the school’s expenses on its HST return as well as the HST on fees paid to NHN Inc. NHN Inc. is a company that is owned by Don Kiwi, a retired NHL coach. The hockey program is operated by Don and his staff. CRA has issued a reassessment to Elite Athletes to reverse the ITCs claimed for the school’s expenses. The school principal has asked your firm to review the reassessment and suggest a course of action.

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CHAPTER 21 — SOLUTIONS TO EXERCISES Exercise 1 Sam should explain to his father that he would be required to register for HST purposes and to collect HST on his taxable supplies unless he qualifies as a small supplier if his annual sales are below $30,000; as a small supplier, he could voluntarily opt to become a registrant. As a registrant, he will be required to remit the ‘‘net tax’’ for each reporting period to the Receiver General. Generally, net tax is determined by adding the total amount of HST collected or collectible during the period less the total amount of input tax credits claimed for the period. Sam should explain that the reporting period is dependent on the size of the business. A small business whose revenue is $6 million or less in the preceding year and in the preceding quarters ending in the current year would be required to file an HST return on a quarterly basis. Where revenue in the preceding year does not exceed $1,500,000, a registrant may file on an annual basis rather than on a quarterly basis. However, quarterly instalments are required to be remitted within one month after the end of each fiscal quarter. The returns for quarterly filers must be filed within one month following the end of the reporting period. If Mr. Evans elects to report on an annual basis, the return is required to be filed within three months following the end of the fiscal year. Mr. Evans is required to maintain documentation to support input tax credits. Documentation could include invoices, receipts, credit card receipts, written contracts, etc. Depending on the value of the purchase, the information requirements will vary, but will generally require the vendor’s name, HST registration number, total amount of HST charged, and total consideration paid. As is the case for income tax purposes, adequate books and records are required to be maintained for the CRA’s audit purposes.

Exercise 2 The sale of taxable supplies in Ms. Creator’s retail business accumulated to more than the $30,000 threshold in the fourth calendar quarter (October to December, 2023). As a result, the business is no longer considered a small supplier and is required to collect the GST starting February 1, 2024, which is the first day of the second month after the end of the fourth quarter. Formal registration as a GST registrant is required by the 29th day after the day the entity is required to begin collecting GST. In this case, registration is required by February 29, 2024 (29 days after February 1, 2024).

Exercise 3 The HST receivable for Wai-Keat Ltd. for the period of December 1 to December 31, 2023 can be calculated as follows: ETA 220(2)(b)

HST collected ($7,200,000 × 15%) . . . . . . . . . . . . . . . . . . . . . . . . . $1,080,000 HST self-assessed on building (2,500,000 × 15%) . . . . . . . . . . . . . . 375,000 Input Tax Credits: Purchases [(4,680,000 + 585,000) × 15%] . . . . . . . . . . . . . . . . . . . .

(789,750)

Other costs (375,000 × 15%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Building (2,500,000 × 15%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(56,250) (375,000)

HST payable (Refundable) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 234,000 Since Wai-Keat has positive net income for tax purposes, the company has an amount of net tax payable. Pursuant to paragraph 220(2)(b) the supplier would not have collected the HST on the supply of the building; however, as a registered purchaser, Wai-Keat must self-assess HST on the purchase of the building. However, since the building is used entirely for commercial activities, all of the selfassessed HST would be eligible for an HST input tax credit, thus amounting to an effective nil payment in this respect. The situation would be different if the building was not used exclusively (i.e., less than 90%) to make taxable supplies. Interest costs are exempt from HST as these are a financial service. Salaries and Wages are also exempt. Wai-Keat must file the HST return by January 31, 2024.

ETA 220(2)(b)

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Exercise 4 The HST payable for Coral Ltd. can be calculated as follows:

CHAPTER 21

HST collected ($7,200,000 × 13%) . . . . . . . . . . . . . . . . . . . . . . . . . $ 936,000 HST self assessed on building purchase (2,500,000 × 13%) . . . . . . . 325,000 Input Tax Credits: Cost of goods sold (4,680,000 × 13%) . . . . . . . . . . . . . . . . . . . . . . . (608,400) Inventory purchases in November (750,000 × 13%) . . . . . . . . . . . . . (97,500) Other costs (375,000 × 75% × 13%) . . . . . . . . . . . . . . . . . . . . . . . . (36,563) Building (2,500,000 × 75% × 13%) . . . . . . . . . . . . . . . . . . . . . . . . . (243,750) HST payable (Refundable) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 274,787 Coral must file their HST return for November 2023 by December 31, 2023. The amount owing would need to be remitted at that time. Pursuant to paragraph 220(2)(b) the supplier would not have collected the HST on the supply of the building; however, as a registered purchaser, Coral must selfassess on the full value of the building. The HST paid related to the exempt supplies is not eligible for an input tax credit, including 25% of the HST self-assessed on the building. Inventory purchases made in November are eligible for an input tax credit provided these purchases relate to the taxable supplies. Interest costs are exempt from HST as these are a financial service. Salaries and Wages are also exempt.

Exercise 5 Since the corporation is carrying on business, it is engaged in a commercial activity. Therefore, the corporation is required to register and collect HST on its supplies, i.e., sales of goods, which are ‘‘taxable supplies.’’ As a registrant, the corporation is entitled to a full input tax credit (ITC) in respect of HST paid or payable on goods and services that it purchases exclusively for use in its commercial activity. If HST collected or collectible on its sales exceeds its ITCs, the corporation must remit the difference. On the other hand, if ITCs exceed HST collected or collectible, a refund of the excess is available. The following is the appropriate HST treatment of the items listed: (a) Net income per financial statements would have been increased by HST charged which is included in revenue and reduced by HST paid or payable which is included in costs. HST charged net of ITCs from HST paid or payable must be remitted. (b) There are no HST implications for the provision for income taxes. (c) HST paid on the purchase of depreciable property provides an ITC. When the cost of the asset is subsequently written off through depreciation or capital cost allowance, there are no further HST implications. (d) Landscaping goods and services would involve payment of GST/HST on taxable supplies and, hence, would give rise to an ITC, to the extent they are made in relation to taxable supplies. The following costs would not involve the payment of HST, since they are for exempt supplies: (a) interest paid on income tax due results from a financial service, (b) bond interest also results from a financial service, and (c) similarly, the reserve for doubtful debts has by itself no GST/HST implication as it is not a supply. This is different from the bad debt expense incurred when an account receivable is actually written off. In such cases, the registrant is entitled to recover the GST/HST portion of the write-off.

Exercise 6 Refundable Good and Services Tax Credit [sec. 122.5]: To qualify for this credit the taxpayer must be an ‘‘eligible individual’’ as defined in sec. 122.5(1). Patty meets that definition, since she has attained the age of 19 years (assumed) or she is a parent who resides with her child. Her two children meet the definition of ‘‘qualified dependant’’ since they are her children, they live with her and they are under 19 years of age. Patty’s net income of $45,262 ($38,000 + $9,000 + (480 X 1.38) -- 2,400) is more than the threshold income, so there will be a reduction in the credit based on income.

ETA: 123(1); 169(1)

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Exercise 7 (a) Quick Method Loftus has elected to use the quick method to file its GST returns and to file on a quarterly basis. For the quick method uses the sales are inclusive of GST collected; therefore, the first step would be to determine the total sales including GST. Sales — including GST Basic tax Credit on first $30,000 Input tax credit on capital expenditures in the period

($65,000 × 1.05) (68,250 × 1.8%) (1%) (7,500 × 5%)

GST owing — first quarter

$ 68,250 1,229 (300) (375) 554

Note that regardless of the method used to determine the GST remittance, the entity still receives a credit for the capital expenditures in the period. Since this is the first quarter of the calendar year, Loftus would receive the 1% credit on the first $30,000. In the future quarters, no credit would be provided since the entire $30,000 was used. (b) Regular Method The regular method of filing GST calculates the input tax credits individually as follows: Sales Input tax credits: Actual purchases in the year Capital expenditures GST owing — first quarter

($65,000 × 5%)

$ 3,250

(31,250 × 5%) (7,500 × 5%)

(1,563) (375) $ 1,313

It should be noted that while in this quarter, using the quick method is beneficial as it reduces the overall GST payable; however, this may not always be the case.

Chapter 22 Data Analytics and Information Systems in Tax

CHAPTER 22

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CHAPTER 22 — LEARNING CHART Problem Descriptions Assignment Problems 1 Applying data analytics to: Geographic allocation of income 2 Applying data analytics to: Analyze GST excess or deficiency 3 Applying data analytics to: Visualizations to assess r isks in a tax audit

Ch. 22/Study Guide — Learning Chart

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CHAPTER 22

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Problem 1 You are the accounting manager for a Canadian company, Friendly Patio Furniture Inc. (FPFI). The company is based in Ottawa, Ontario, and it sells patio furniture made from environmentally sustainable materials. The company has grown rapidly since its incorporation in 2012 and now has over 80 employees and production plants in British Columbia and New Brunswick. The head office and the research and development centre are all located in Ottawa. Both plants make all of the company’s products, with the majority of the products being shipped from the BC plant to western North American customers and most of the products shipped from the New Brunswick plant shipped to eastern North American customers. One plant may ship to the other plant’s normal geographic regions when there are capacity issues in meeting surges in demand. All shipments are made directly to customers from the plants. The retail price of the company’s products range from $1,000 to $5,000. FPFI sells to retailers across North America. It has over 100 customers in various markets. Each year, it has been successful in finding new retailers and markets for its products based on significant social media spending and strong ‘‘word of mouth’’ referrals from current customers. Generally, the retailers mark up the cost of the products purchased from FPFI by varying percentages depending on competitor pricing and product positioning. FPFI provides suggested retail pricing as shown in the ‘‘tProducts’’ data file. FPFI bills the wholesale price to customers. Products are shipped to customer sales locations. Some major customers have ‘‘master accounts’’ which allow them to negotiate better prices. These are referred to as ‘‘Chains’’ in the customer file, while non-chain customers are ‘‘Independents’’. Chain customers have all invoices sent to their central accounting departments while independents have their invoices sent to the delivery address. Sales are relatively consistent over the months of the year except for a spike in demand before the spring patio season. The four salespeople based in BC sell to customers in Western North America and they report to the Western sales manager in BC. Similarly, four salespeople based in NB report to the Eastern Canadian sales manager based in New Brunswick and sell to the Canadian Maritime provinces and the USA Northeast. The remaining nine salespeople are based in the Ontario head office and report to the director of sales and marketing who works out of the head office. They sell to customers in Ontario, Quebec and the central USA. All salespeople travel extensively. When they go to the USA, they visit customers and discuss product trends with customers and future products. All contracts for sales are negotiated and finalized by the appropriate sales managers/director of sales and marketing in Canada. The company’s IT, purchasing, finance, administration (including payroll) and executive functions are based at the company’s head office in Ontario. Salespeople visit their ‘‘home location’’ at least once every two weeks, and work from home the rest of the time that they are not traveling to visit customers. Salespeople do not have any products at their homes, no customers visit their homes and they do not have any company identifying information located at their home offices. The company has a December 31 year end. The company’s federal taxable income for 2023 has been correctly calculated as $480,000. You are now preparing the information needed to determine the allocation of salaries and wages and gross revenues to permanent establishments of the company (PE’s) for the company’s 2023 taxation year. Included with the electronic version of the study guide for this problem, you will find the following items necessary for completion of the problem: ●

The database schema of the company’s files needed for this problem with ‘‘FK’’ denoting ‘‘foreign key’’ which acts as a cross-reference between tables that references the primary key of another table)

●

tSales file (this file shows the company’s 2022 sales transactions)

●

tPayroll file (this file shows the salary and benefits of the employees in the year)

●

tCustomer file (this shows the customer billing and shipping addresses)

●

tEmployees file (this file shows extracts from employee master file)

●

tProducts file (this file shows the company’s products sold in the year and related prices)

●

tLocationsfile (this file shows the company’s production and head office locations)

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— REQUIRED (A) Use the CRSP-DM method discussed in the chapter and data analytics tools that you have available to prepare the company’s T2 Schedule 5 Tax Calculation Supplementary-Corporations for 2023. This schedule should show the allocation of salaries and wages and gross revenues to provinces with permanent establishments and the resulting allocation of the company’s taxable income to those provinces. (B) Where you find issues with data in the ‘‘tSales’’ or other data files during the data preparation stage of your work, please summarize those issues for follow up. For purposes of this project, you should assume that these issues are not errors and will not impact your calculations in Part A.

Notes: Your predecessor’s summarized notes on Income Tax Act Regulations 400-402 and related background documents on CRA’s interpretation of those regulations are shown below. These notes will help you prepare the Schedule 5. 1. Salaries and Wages (a) Use ‘‘gross employment income’’ without deductions (i.e., salaries, wages, bonuses, taxable benefits)

2. Gross Revenues (a) Ignore investment income (b) Look at gross revenues (ignore adjustments where they are not traceable to specific sales) (c) Allocate all non-investment income gross revenues to PE’s (d) Method of allocation of gross revenues depends on 3 factors (i) If sales are made to a province in Canada in which the company has a PE, sales should be allocated to that province (ii) If sales are made to a province in Canada in which the company does not have a PE, sales should be allocated to PE where the salesperson reports. (iii) If sales are made to a foreign country without a PE, then those sales should be allocated to the PE province where products were produced.

Problem 2 You are student at a medium-sized accounting firm in Etobicoke, Ontario. You are working on the audit of a Toronto-based client, New Wave Computers Inc. (NWC). The audit senior has assigned you with the responsibility to audit the GST/HST liability of NWC. The company has a December 31 year end. NWC sells high end personal computers online. These computers have received rave reviews from leading IT publications and web sites in the past few years. Sales started out slowly in the first years of operation but increased dramatically in 2022 after COVID-19 caused so many people to work and play at home and demand for computers increased dramatically. The company sells its products to customers throughout North America online by way of its website and ships its computers to the customers using third party couriers like FedEX and UPS. It does not charge customers extra for shipping. Given its customer base represents small businesses and consumers that often do not have IT support, customers frequently watch YouTube videos to deal with installation and ongoing computer operating and connectivity issues. However, the company also has a group of employees in the Etobicoke location that provide telephone, chat and internet support service for customers requiring more intensive assistance with installing and maintaining their computers and related network issues. Customers can call a 1-800 number to ask questions, they can email/chat their questions or, where necessary, they can have NWC staff remotely access their computer systems. Customers are billed an hourly rate for the assistance, and there is a minimum billing time of one hour. The rate charged is $150 per hour, and customers are billed a minimum one hour to start the service process. All product and service amounts are billed in Canadian dollars and paid for by credit card or occasionally by etransfer. It is now February 10, 2024 and you are working on the audit of NWC. You are currently focusing on the GST/HST amounts collected from customers to determine if it billed the correct tax amounts. The company files GST/HST returns monthly.

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(b) Allocate to PE’s based on where employee reports to work (i.e., where the employee is ‘‘attached’’ to the company) and not where an employee lives.

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Below, you will find the summary of GST/HST billed to customers in 2023 by region and shown as entries in the GST/HST liability account: Sales Recorded

GST/HST Billed

AB BC NB NS ON QC SK USA

$ 4,496,056.85 $ 4,657,887.44 $ 515,749.85 $ 680,417.66 $14,078,562.29 $ 5,925,507.88 $ 491,737.04 $ 7,610,054.63

$ 224,802.84 $ 232,894.37 $ 77,362.48 $ 102,062.65 $1,830,213.10 $ 296,275.39 $ 24,586.85 $ —

Total

$38,455,973.63

$2,788,197.68

Note 1 below details the content of the data files needed to complete this part of the audit. — REQUIRED (A) In preparation for the Data Understanding element of using the CRSP-DM method in (B) below, determine the type of supplies made by NWC. Once this is determined, research various Canada Revenue Agency (CRA) publications and summarize Canada’s Place of Supply (‘‘POS’’) rules for those supplies. This information will help determine the correct rate of tax to be charged on different types of sales made by NWC. (B) Use the CRSP-DM method discussed in the chapter and data analytics tools that you have available to determine the amount of excess or deficient GST/HST the company billed and collected from its customers for the 2023 fiscal year. You should show the results of your analysis as a summary by region consistent with the regions above. Another audit team member is auditing the GST/HST Input Tax Credits (ITC’s), so you are not required to consider that area of the company’s accounts. (C) Where you find issues with data in the ‘‘tSales’’ or other client data files during the data preparation stage of your work, please summarize those issues for follow up. For purposes of this project, you should assume that these issues are not errors and will not impact your calculations in Part B.

Note 1: Data Files for Assignment Sales for 2021 to 2023 are included in the file ‘‘tSales’’ that have been agreed to the general ledger and the GST/HST returns for the years. Customer type and account number are included with each transaction in the file. Customer file (‘‘tCustomer’’) provides information gathered by the company for all customers as part of its normal revenue generation process including up to three addresses. Customer specific information has been encrypted except for province/state and country information that is required to complete this analysis. Customers are shown as corporations or individuals and account numbers are assigned according to customer type. When a customer makes an order for computers or customer assistance over the phone or by way of email/chat, a customer profile is set up in the system depending on whether the customer is an individual or a corporate customer. For NWC, corporate customers must enter at least one address to make an order/receive tech support. Individual customers paying with certain types of credit cards and by etransfer do not need to enter an address. A customer can enter one, two or three addresses (home/business head office address, shipping address and ‘‘bill to’’ address). The company’s system populates all 3 addresses as the same except where the customer provides more than 1 address at the time of the order. Product file (‘‘tProducts’’) provides the company’s products for the 2021 to 2023 years, and this filet is used to generate the sales price charged to customers in each year GST/HST rates by province are included in the file ‘‘tRates_01’’ with the appropriate two-letter provincial abbreviation used in various files

Other Notes: NWC is not considered to be carrying on business in Quebec, so you do not separately address QST rules and tax. You can also ignore Provincial Sales Taxes (PST) for your analysis. You do not need to look at other areas of GST/HST for revenues like real property rules, personal service rules, professional consulting rules, or intangible personal property rules. When determining the location where a ‘‘contracting decision’’ is made in this case, you can use the ‘‘home address’’ in the customer file as this represents the ‘‘head office address’’ for corporations and ‘‘home address’’ for individuals.

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577

Problem 3 Zelda Inc. (‘‘Zelda’’) is a CCPC that commenced operations in July, 2018 after Shannon incorporated her successful sole proprietorship. The company manufactures and sells inflatable Halloween figures to Canadian retailers. It has a December 31 year end and is based in Vancouver, BC. You are CPA, a Finance Manager for the company. The CFO of the company just received a letter from CRA. You and the CFO are new to the company as the company has been improving its finance team to support its explosive growth. It is September 4, 2023 and CRA will commence an income tax audit on September 15, 2023. The CFO would like you to help prepare for the audit. She hopes to understand potential income tax audit risk areas based on the General Index of Financial Information (‘‘GIFI’’) reports submitted to CRA with the company’s previously filed T2 Corporate Income Tax Returns by the company’s previous Finance Manager. She has heard CRA uses data analytics of GIFI data extensively to assess risk in its audits. The CFO has the following questions: (a) What years will CRA be able to audit?

(c) From the visualization results in (b) above, how would you screen for risky expense accounts? (d) Based on your screening process discussed in (c) above, what are 5 specific expense accounts and which taxation year(s) for those specific accounts you believe may be audited by CRA? For each of those 5 accounts, provide the following: (i) A visualization of that account specifically that you believe supports your view more clearly that CRA will audit that account specifically during the audit period. (ii) A potential reason for CRA to review that account. That is, what is a potential tax adjustment CRA is looking to make and why? (iii) A potential reason that would explain the account situation such that CRA would be satisfied that the expense amounts were properly deducted in the year. (e) What would you do as a next step in this risk assessment process for each of the 5 expense account risk areas you have identified? (f) Are there any other significant expense accounts that you believe CRA may audit even though your visualization screening process did not flag these accounts? If yes, what is the issue CRA would be auditing? (g) Are there any revenue accounts that you believe may present an opportunity to reduce the company’s taxable income as reported in those years? Which account(s) and year(s) for those accounts may present such an opportunity, briefly explain the opportunity and how would you assess this opportunity? — REQUIRED Prepare a memo to the CFO which addresses her questions above.

Note 1: Data File for Problem GIFI information for the 2018 to 2022 tax years has been exported from the T2 Corporate Tax Returns to the file ‘‘zeldadatafile’’. Also included with this file is the date of the notice of assessment by CRA for each taxation year.

Note 2: Other Procedures Already Completed You have briefly reviewed the T2 Corporate Tax Returns for all the years from 2018 to 2022. You noted that Schedule T2SCH1 (‘‘Net Income (Loss) for Income Tax Purposes’’) had correct adjustments for depreciation and amortization, capital cost allowance (‘‘CCA’’) and recapture, gains/losses on fi Xed asset disposals and 50% of meals and entertainment expenses. There were no other adjustments on that T2SCH1 schedule for any tax years.

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(b) What visualization technique would you use to screen for expense accounts that appear to be risky from an audit point of view? Please show the results of the visualization technique you would use.

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COMPREHENSIVE SECTION — LEARNING CHART Problem Coverage and Chapter References Problem 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23

Coverage

Chapters

Income from business for tax purposes . . . . . Division B income of an individual from various sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income from business for tax purposes . . . . . Individual taxes payable . . . . . . . . . . . . . . . . . . . . Employment income . . . . . . . . . . . . . . . . . . . . . . . Income, taxable income, taxes payable for an individual . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income, taxable income, taxes payable for an individual . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable income of an individual . . . . . . . . . . . Taxable income of an individual; adjusted taxable income for AMT . . . . . . . . . . . . . . . . . . . Division B income and taxable income of a corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Division B income and taxable income of a corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable income (corporate) . . . . . . . . . . . . . . . . CCPC — T2S(1) & comprehensive federal tax payable calculation . . . . . . . . . . . . . . . . . . . . . Integration & investment income . . . . . . . . . . . Individual Division B income calculation Comprehensive personal tax calculation — capital gains exemption with CNIL calculation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sale of assets vs. shares . . . . . . . . . . . . . . . . . . . . Business income reconciliation; corp. tax calculation; CDA . . . . . . . . . . . . . . . . . . . . . . . . . . Corporate distribution . . . . . . . . . . . . . . . . . . . . . Integration of business income; s. 85 transfer of business to corp. . . . . . . . . . . . . . . . . Income from business for tax purposes; taxable income of a corporation; taxdeferred winding-up . . . . . . . . . . . . . . . . . . . . . . . . Acquisition of control; amalgamation; windup . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Case . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4, 5, 6, 7 3, 4, 5, 6, 7, 8 4, 5, 7 3, 4, 6, 7, 9, 10 3, 9, 10 3, 6, 7, 9, 10 3, 6, 7, 8, 9, 10 3, 6, 7, 8, 9, 10 3, 6, 7, 9, 10 4, 5, 6, 7, 11 4, 5, 6, 7, 11 4, 5, 6, 7, 8, 11 4, 5, 7, 11, 12 6, 7, 10, 11, 12, 13 3, 6, 7, 9, 10 3, 6, 7, 9, 10, 15 7, 11, 12, 15, 16 4, 5, 6, 7, 8, 11, 12, 16 11, 12, 13, 15, 16, 17 6, 8, 9, 10, 11, 12, 13, 16 4, 5, 6, 7, 11 7, 8, 15, 17 7

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582

¶23,850 COMPREHENSIVE CASE PROBLEMS Problem 1 The income statement for Holly Industries Limited (HIL) for its 2023 year ended December 31 shows the following. HIL is a Canadian-controlled private corporation. Holly Industries Limited Statement of Income Year ended December 31, 2023 Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cost of sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$47,821,700 (35,564,780) $12,256,920

EXpenses: Selling . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . General and administrative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest on long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

394,924 305,148 230,000 37,427 55,460

$ 1,022,959 Other income: Profit on sale of fiXed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Equity income of associated company . . . . . . . . . . . . . . . . . . . . . . . . . . . Income from other investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gain on sale of land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loss on sale of portfolio investments . . . . . . . . . . . . . . . . . . . . . . . . . . . .

100,000 92,096 17,329 189,800 (52,400) 346,825

Income before income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income taxes: Current . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$11,580,786

Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 8,688,286

(2,352,500) (540,000)

An analysis of various accounts revealed the following information: Note 1 Included in the cost of sales: (A) Dec. 31/22 Inventories: Raw materials ................................................................................ $ 210,000 Work-in-process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 370,000 Finished goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 595,000

Dec. 31/23

$1,175,000

$1,575,000

$ 295,000 565,000 715,000

(B) The Dec. 31, 2023 finished goods ending inventory is stated net of a reserve for a possible decline in market price of $57,000. Note 2 Included in general and administrative expenses are the following transactions: (A) Connection of a gas line on conversion of furnace . . . . . . (B) Cost associated with the valuation of land sold . . . . . . . .

$ 17,000 2,800

Comprehensive Section/Study Guide — Comprehensive Case Problems (C) Donations to registered charities . . . . . . . . . . . . . . . . . . (D) Premium for term life insurance policy on the president; the company is the beneficiary of the policy; the policy is required as collateral for a bank operating line of credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (E) Advertising targeted at the Canadian readers of an exclusive foreign magazine distributed in Canada . . . . . . (F) Membership in social clubs for senior executives . . . . . . (G) Cost of reorganizing the company’s share capital . . . . . . (H) Meals and entertainment with clients . . . . . . . . . . . . . . . (I) Cost of employee training seminar to teach employees about new provincial workplace safety laws . . . . . . . . . . (J) Cost of Christmas party to which all employees were invited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

583

64,000

22,200 13,375 3,200 16,000 12,000 7,200 17,700

Note 3 Included in interest on long-term debt and other interest are the following transactions: (A) Bond interest paid to November 30, 2023 . . . . . . . . . . . . $ 10,000 Bond interest accrued to December 31, 2023 . . . . . . . . . $ 950 Amortization of bond premium . . . . . . . . . . . . . . . . . . . . $ 375 (B) Interest on deficient federal income tax instalments . . . . $ 1,200 Interest on late municipal property taxes . . . . . . . . . . . . $ 500 Note 4 Income from other investments includes receipt of a cash dividend of $7,500 from an associated company. Note 5 The company had the following undepreciated capital cost amounts on January 1, 2023: $225,000 55,000 354,000 190,000

Note 6 The company is undergoing a major change to its operations, with financing from a new investor. During the year, it sold its warehouse and updated all of its office and manufacturing equipment. It purchased a fleet of new trucks to take over control of the delivery of its product. As a result, the following sales of capital property are included in other income:

Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Truck . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Equipment - Class 8 . . . . . . . . . . . . . . . . . . . . . Building (warehouse) - Class 1 . . . . . . . . . . . . Portfolio Investments . . . . . . . . . . . . . . . . . . . . Equipment - Class 53 . . . . . . . . . . . . . . . . . . . .

Cost $ 65,000 80,000 300,000 50,000 60,000 50,000

Proceeds $202,800 25,000 75,000 60,000 7,600 7,500

Book Value $13,000 10,000 20,000 15,000 60,000 22,500

The following purchases were made throughout the fiscal year. HIL is not associated with any other corporations. Office furniture and equipment . . . . . . . . . . . . . . . . . . $ 550,000 Manufacturing equipment . . . . . . . . . . . . . . . . . . . . . . 700,000 Trucks .................................................................................. 1,000,000

Comprehensive Section

Depreciable Property: Class 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Class 8 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Class 10 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Class 53 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Introduction to Federal Income Taxation in Canada

584 — REQUIRED

Prepare a reconciliation between net income per the income statement and net income for tax purposes under Division B, with supporting calculations. Briefly explain why any of the above items were omitted from the reconciliation.

Problem 2 Mr. Rich is president of a large public corporation located in Toronto. He has provided you with the following selected data concerning his 2023 receipts, benefits and expenditures.

(a) Receipts and benefits paid by his employer, inclusive of HST where applicable: Gross salary .................................................................................................. $ 350,000 Membership in a Toronto social club* . . . . . . . . . . . . . . . . . . . . . . . .

2,500

Housing loan; 2%, 10-year repayment term loan advanced on November 1, 2023. The principal will be repaid in equal annual instalments, principal and interest to be paid on each anniversary date. (Assume that the prescribed rate for the last quarter of 2023 is 5%)........................................................................................................... 500,000 Company car. Available for the whole year; leased at an annual cost of $15,000, inclusive of $1,000 for insurance for loss and damage

15,000

Operating costs for the above car. The car is used 20% for business. Total kilometres driven in 2023 = 20,000 . . . . . . . . . . . . . . . . . . . . .

3,000

Contributions to the employer’s registered pension plan . . . . . . . . . .

10,000

Private dental plan premium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2,000

(b) Investment receipts (losses) Rental Property 1 net income before CCA . . . . . . . . . . . . . . . . . . . . Rental Property 2 net loss after CCA . . . . . . . . . . . . . . . . . . . . . . . .

3,000 (16,000)

Rental Property 1 was sold during 2023 for $200,000. The real estate commission was $10,000. The capital cost and undepreciated cost at the date of sale were $70,000 and $60,000, respectively. For Rental Property 2, $8,000 of the loss is attributed to the maximum capital cost allowance claimed. Dividends from taxable public Canadian corporation . . . . . . . . . . . . .

8,000

Dividends from U.S. corporations, net of foreign withholding tax of 15% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3,400

(Cdn)

$ 11,400 * Mr. Rich only uses the membership at the Toronto social club for networking with current and future clients.

The above amounts do not include interest income received by his family on funds given to them by Mr. Rich.

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Wife.................................................................................. $20,000 Son - 21 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000 Son - 18 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000 Son - 16 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000 During 2023, Mr. Rich sold 100 shares of X Ltd., a Canadian public company for $10,000. The brokerage costs were $300. The following data relates to the cost of these shares: 2015 2016 2018 2020 2023

Acquired 200 shares for $8,000 Received a stock dividend of 10% which increased the corporation’s paid-up capital by $10 per share Acquired 500 shares for $11,400 Acquired 1,200 shares for $24,000 Received a stock dividend of 10% which increased the corporation’s paid-up capital by $10 per share

Also during 2023, Mr. Rich sold 1,000 shares of Y Ltd., a taxable Canadian public corporation. He sold 500 of these shares to his wife and 500 of these shares to his 21-year-old son. He sold the shares for $10 per share when the fair market value was $15 per share. Mr. Rich’s adjusted cost base was $5 per share. His wife and son each received $1,500 of cash dividends during the year, after purchasing the shares. No elections were filed on the sale of the shares to his wife. (c) Disposition of personal assets: Mr. X sold the following personal assets during 2023: Cost $ 1,200 350 1,000 25,000

Proceeds $ 500 800 1,600 32,000

Mr. X took back a promissory note of $20,000, due June 2024, in respect of the sale of the sailboat. — REQUIRED Calculate Mr. Rich’s income for 2023 from the following sources: (i) employment, (ii) property, and (iii) net taxable capital gains. Ignore the effects of a leap year in your answer.

Problem 3 The following is a condensed Income Statement for Thingamajig Manufacturing Ltd. for its fiscal year end on December 31, 2023. The company was incorporated in Ontario in 1997 and has been continuously in the same business since that date. The company is a public company. Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,750,000 Cost of manufacturing (see note (1), below).............................................. (1,050,000) Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 700,000 General and administrative expenses (see note (2), below) . . . . . . . . (294,000) $ 406,000 EXtraordinary income and expenses (see note (3), below) . . . . . . . . (77,000) Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 329,000 Provision for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (91,000) Net income after taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

238,000

Comprehensive Section

Antique Table . . . . . . . . . . . . . . . . . . Antique Clock . . . . . . . . . . . . . . . . . . Jewellery . . . . . . . . . . . . . . . . . . . . . Sailboat . . . . . . . . . . . . . . . . . . . . . .

Year of Purchase 2006 2012 2014 2015

Introduction to Federal Income Taxation in Canada

586 Note 1 Included in the cost of manufacturing: (a) Inventories: Raw materials . . . . . . . . . . . . . . . . . . . . . . . . . . . Work-in-process . . . . . . . . . . . . . . . . . . . . . . . . . . Finished goods . . . . . . . . . . . . . . . . . . . . . . . . . .

Dec. 31, 2022 $ 70,000 52,500 140,000 $262,500

Dec. 31, 2023 $ 94,500 45,500 175,000 $315,000

(b) The finished goods opening inventory is stated net of a reserve for a possible decline in market price of $35,000. (c) The raw materials inventories above have been stated on a LIFO basis. The equivalent amounts on a FIFO basis would be: December 31, 2022 — $115,500 December 31, 2023 — $157,500 Note 2 Included in the general and administrative expenses are the following selected transactions: (a) Damages of $14,000 paid to a competitor in an out-of-court settlement concerning a trademark infringement. (b) Contributions made in January 2024, and allocated by the accountant to the 2023 fiscal year, in respect of deferred income plans for senior executives: Money-purchase Registered Employment pension plan* compensation EXecutive A . . . . . . . . . . . . . . . . . . EXecutive B . . . . . . . . . . . . . . . . . . EXecutive C . . . . . . . . . . . . . . . . . .

$ 8,350 6,400 5,300

$130,000 70,000 50,000

* Contributions matched by employees

(c) Costs related to the acquisition of new machinery and equipment other than the actual purchase price of the equipment: Costs in issuing bonds to finance new machinery and equipment — accounting and legal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,500 — printing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 550 — commission paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 850 Bond interest paid to October 31, 2023 . . . . . . . . . . . . . . . . . . . . . . 4,550 Accrued bond interest to December 31, 2023 . . . . . . . . . . . . . . . . . 1,450 Amortization of bond discount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 700 (d) An analysis of the promotion account revealed the following selected expenditures: Membership in several social clubs for senior executives . . . . . . . . . . . . $ 2,800 Magazine advertising paid in 2023: — ads in magazines distributed only in South America . . . . . . . . . 21,000 — ad in a Canadian periodical to be run early in 2024 . . . . . . . . . . 17,500 Charitable donations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,200 Note 3 Included in the extraordinary income and expenses are the following selected amounts: (a) Sales of certain capital property: Marketable securities . . . . . . Equipment — Class 53 . . . . . Patent — Class 14 . . . . . . . . Licence — Class 14.1 . . . . . . Trucks* . . . . . . . . . . . . . . . .

Cost $ 10,500 42,000 45,000 8,000 19,600

Proceeds $ 7,000 11,200 70,000 35,000 1,300

Book value $10,500 15,000 3,500 700 4,200

* The company has decided to lease its trucks in the future and, therefore, disposed of all of its trucks, the only assets in this class.

Comprehensive Section/Study Guide — Comprehensive Case Problems

587

(b) Write-down of $52,500 of investment in a wholly-owned subsidiary. (c) A cash dividend of $45,000 from a wholly-owned subsidiary. (d) Cost of $12,600 to reorganize the company’s share capital. Additional Information: (1) The company has claimed $55,000 for amortization in the books of account. (2) The company had the following undepreciated capital cost (UCC) balances on January 1, 2023. Depreciable property: Class 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 49,000 Class 8 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,400 Class 10 (two-seat delivery van) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,500 Class 14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35,900 Class 14.1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29,650 Class 53 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,750 (3) The company made the following capital purchases during the year. Building constructed in 2001 used 100% for manufacturing activities Manufacturing machinery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tools (costing under $500 each) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$315,000 87,000 16,000

(4) During the year, the company made an improvement costing $7,000 to a leased warehouse. The 15-year lease commenced 10 years ago and has two successive options to renew for 5 years and 3 years, respectively. — REQUIRED Prepare a reconciliation between net income per the condensed income statement and income for tax purposes under Division B, with supporting schedules. Briefly explain why any of the above items were omitted from the reconciliation.

Problem 4 Mr. Debit, age 66, who resides in Toronto, has provided you with the following information concerning his 2023 tax return. All numbers are in Canadian dollars. $100,000 8,900 (11,000) 1,350 560 1,500 (200)

(4,500)

Other income for tax purposes: Old Age Security benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Pension annuity received . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deduction: Capital portion of above annuity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

8,251 1,490 (200)

Comprehensive Section

Employment income for tax purposes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Business income for tax purposes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Property income (loss) for tax purposes: Rental loss (before CCA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Canadian interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash dividends from taxable Canadian public corporations . . . . . . . . . . . . . . . . . . Dividends from U.S. corporations — gross amount $1,500, net amount $1,275 . . . . Less: carrying charges on bank loan to purchase Canadian securities which yield the above dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable capital gains (allowable capital losses): Shares of X Ltd., a Canadian public company . . . . . . . . . . . . . . . . . . . . $(6,000) Shares of ABC Ltd., a Canadian-controlled private corporation, all of the assets of which are used in earning active business income in Canada . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3,000) Shares of Y Ltd., a Canadian public company . . . . . . . . . . . . . . . . . . . . 500 Listed personal property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000 Personal-use property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000

588

Introduction to Federal Income Taxation in Canada

Additional Information: (1) During the year Mr. Debit married Ms. Credit, age 48. Ms. Credit received the following income in 2023: Before After marriage marriage Employment insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Annual pension from her deceased husband’s estate . . . . . . . . . . . . . . . . Interest — Canadian . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividends from taxable Canadian public corporations . . . . . . . . . . . . . . .

$2,000 3,000 200 —

$ 700 — 150 300

$5,200

$1,150

(2) Ms. Credit moved into Mr. Debit’s home immediately after the marriage along with her 72-yearold mother, whose only income is the Old Age Security Pension of $8,251. (3) Mr. Debit supported the following persons, in his home, during 2023: (a) Ms. Credit. (b) Ms. Credit’s mother (physically infirm, certified as impaired by a medical doctor). (c) Donald, age 19, a full-time second-year McGill University student. Donald had the following receipts and disbursements for 2023: Employment income for tax purposes — in Montreal while attending McGill ........................................................................ $1,050 — in Toronto while home from school for the summer ............................................... 6,000 Canadian bank interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200 Scholarship from McGill ......................................................................................................... 3,100 Tuition fees — allowable for tax purposes for eight months full-time attendance at McGill ....................................................................................................... 3,000 Eligible moving expenses to Toronto in April 2023............................................... $300 to McGill in August 2023 . . . . . . . . . . . . . . . . . . . 400 700 (d) David, age 15, who is a paraplegic and has been confined to bed or wheelchair since early childhood. He has been certified by a medical doctor as impaired. David has no income for tax purposes. (4) Mr. Debit made the following selected disbursements during 2023: Charitable donations (consistent with prior years) ............................................................ $1,000 Donation to Federal Political Party . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500 Private health and dental insurance premiums .................................................................... 1,600 (5) Mr. Debit paid $1,500 for surgery (essential, not cosmetic) for Donald, not reimbursed by any insurance plan or his provincial health plan .............................................. $1,500 (6) Mr. Debit has the following loss carryovers from 2022: Capital loss from sale of listed personal property .............................................................. $2,000 Net capital losses, arising in 2001 ......................................................................................... 6,000 (7) Maximum Employment Insurance (EI) and Canada Pension Plan (CPP) premiums were withheld from Mr. Debit’s employment income. The CPP premiums paid include enhanced CPP payments of $631. (8) Mr. Debit did not claim a capital gains deduction or any net capital losses in the period 1985 to 2022, inclusive, since he did not have any capital gains in that period. — REQUIRED (A) Compute Mr. Debit’s Division B income, according to the rules in section 3, and his taxable income, according to the rules in section 111.1. (B) Determine his federal tax using his maximum possible personal tax credits in accordance with the ordering rules in section 118.92. Also, set out clearly any alternative answers and the reason for your position supported by any necessary calculations.

Comprehensive Section/Study Guide — Comprehensive Case Problems

589

Problem 5 Ms. Janrayad was appointed as president of Massive Ltd., a public corporation, on January 1, 2023. She provides you with the following information concerning her receipts, benefits, and disbursements: Gross salary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income taxes withheld . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Canada Pension Plan (CPP) contribution (max. amount) . . . . . . . . . . . . Employment Insurance (EI) contribution (max. amount) . . . . . . . . . . . . Net salary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$100,000 $30,000 3,754 1,002

34,756 $ 65,244

Benefits paid by Massive Ltd.:

Comprehensive Section

(a) Private, group dental plan premium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 175 (b) Registered pension plan premium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6,000 (c) Membership fees in Businessperson’s Private Dining Club . . . . . . . . . . . . . . . . . . $ 1,100 (d) Company-provided car. Ms. Janrayad uses the car 70% for business and 30% for pleasure based on total kilometres driven for 2023 of 25,000. Insurance costs of $2,000 and gas and oil costs of $3,000 were paid by Ms. Janrayad. (e) Automobile operating costs. The company paid the following automobile expenses directly to third parties, including HST where applicable: (i) Repairs and maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,000 (ii) Lease costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,700 (f) Allowances (i) Ms. Janrayad receives 62 cents per employment kilometre as an automobile allowance. (ii) Ms. Janrayad, who travels regularly away from her employer’s place of business to negotiate contracts, receives a monthly allowance of $450 to cover her accommodation and meals while travelling. She is, however, required by her contract to pay for these expenses directly. Her actual expenses were $3,500 for meals (incurred in equal monthly amounts) and $6,000 for accommodation, all of which were reasonable in the circumstances. Moving Ms. Janrayad moved from Halifax to London on January 1, 2023 to accept the position at Massive Ltd. Massive Ltd. paid her a moving allowance of $17,000. Ms. Janrayad incurred the following expenses: Air fare for family . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,750 Moving cost of furniture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,400 Costs of disposing of Halifax home — legal fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800 — real estate commission ............................................................................................. 15,500 One day in London — meals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80 — accommodation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175 Costs of purchasing London home — prepaid realty taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 550 — legal fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,100 — land transfer tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 450 Security Options Ms. Janrayad received an option to purchase up to 6,000 previously unissued common shares from the company at $11 per share. The fair market value of the shares at the time of granting the right on January 1, 2023 was $11. On October 1, 2023, Ms. Janrayad decided to exercise part of her option and purchased 3,600 shares with a fair market value of $17 per share as at that date.

Introduction to Federal Income Taxation in Canada

590

Employer-provided Loans Massive Ltd. loaned Ms. Janrayad the following amounts in 2023. (i) $35,000 on October 1st at 2% interest per year with a five-year repayment term. Ms. Janrayad used this loan to exercise her stock option in October. Ms. Janrayad pays interest on the loan at the end of each quarter; (ii) $150,000 on January 1st at 3% interest per year with a five-year repayment term but amortized over a 25-year period, to purchase a house in London. On January 1, 2024, Ms. Janrayad repaid $15,000 principal in addition to the interest for the year. Assume that the prescribed rates for the year were: 1st quarter — 4% 3rd quarter — 5% 2nd quarter — 4% 4th quarter — 5% — REQUIRED (A) Calculate Ms. Janrayad’s employment income for tax purposes (as determined by Subdivision a of Division B of the Income Tax Act) supported by all necessary calculations and explanations where there are alternative methods. (B) EXplain why any amounts were excluded from the calculation in Part A of the required. (C) EXplain any other tax consequences of the amounts included in Part A.

Problem 6 The following information concerns a client, Mr. White, who brought you this information for preparation of his tax return. Gross salary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Canada Pension Plan (CPP) premium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Employment Insurance (EI) premium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Registered Pension Plan (RPP) contribution (employer contributes an equal amount) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income taxes withheld . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 70,000 (3,754) (1,002)

Net Pay . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Pension income received on a periodic basis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rental property loss excluding capital cost allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investment income: Dividends from taxable Canadian public corporations (grossed up) . . . . . $ 9,000 Canadian bank interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,000

$ 46,444 6,000 (10,000)

(800) (18,000)

15,000

Capital gains and capital losses: X Ltd — a Canadian-controlled private corporation (CCPC) that qualifies as a ‘‘small business corporation’’ . . . . . . . . . . . . . . . . . . . . . . . Y Ltd — a public company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Personal-use property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Listed personal property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(28,000) 11,250 4,500 6,000

(6,250) $ 51,597

Additional Information: (a) The following selected payments were made during the year: Brokerage fee on the acquisition of some shares . . . . . . . . . . . . . . Legal fees in respect of an appeal of income taxes paid . . . . . . . . . Contribution to a Registered Retirement Savings Plan (RRSP) . . . . Charitable donations (consistent with prior years) . . . . . . . . . . . . . Federal political donation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

200 1,000 8,500 1,000 100

Comprehensive Section/Study Guide — Comprehensive Case Problems (b)

591

Mr. White has the following carryovers as at January 1, 2023: Charitable donations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 500 Listed personal property losses . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000 Net capital loss balance (from 2001) . . . . . . . . . . . . . . . . . . . . . . . 12,000 Mr. White utilized a capital gains exemption of $11,250 in 1987. The cumulative disallowed portion of business investment losses in previous years is nil. In 2022, Mr. White had, essentially, the same income except that his salary was $55,000 and RPP contribution was $700. His pension adjustment for 2022 was $1,400. Included in his total CPP premiums paid in the year are enhanced CPP contributions of $631. Mr. White’s unused RRSP deduction room at the end of 2022 was $0.

— REQUIRED (A) (B)

Determine Mr. White’s 2023 taxable income, demonstrating clearly the ordering rules found in Division B and Division C, supported by any necessary calculations. EXplain the tax implications of any amount or any part thereof which was not included in your answer in Part A.

Problem 7 Buck Shot, age 59, has asked you for some assistance in preparing his 2023 tax return. He is married and has three children, ages 21, 19, and 15. He has provided the following financial information for himself and his family. (a)

Net salary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (b)

(c)

$90,000

37,281 $52,719

Other sources of income: Taxable capital gains (allowable capital losses) — Winchester Rifles Ltd. (public company) ............................................... $18,000 — Artwork (a painting) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600 — Shares of Bell Canada (public company) ..................................................(1,000) Monthly pension of $1,500 from previous employer ............................................. 18,000 Buck Shot’s wife, age 48, has the following property income: Dividends from Bell Canada (public company), cash amount . . . . . . . . . . $ 600 Interest on Canada Savings Bonds given to her by Buck Shot . . . . . . . . . . 600 Canadian Bank Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300 Interest on loan to her brother . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250 Dividends from U.S. corporations* (no foreign withholding tax) . . . . . . . . 3,600 * Mrs. Shot paid $1,540 in bank interest to purchase these shares.

(d)

Buck Shot has heard that it is possible for him to include on his tax return the dividends from taxable Canadian corporations received by his wife. He is unaware of whether this is advantageous to him from a tax perspective. He is also aware of the fact that he can split up to 50% of his pension income with his wife if it is to his advantage from a tax perspective. Agnes, the 21-year-old, attended Ryerson University for eight months as a full-time student during the year and has income for tax purposes of $2,500. She paid tuition fees of $6,000.

Comprehensive Section

Employment: Gross salary and taxable benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Income tax withheld ....................................................................................$28,425 Registered pension plan contributions (required contributions to a defined benefit plan) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,600 Contribution to United Way . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500 Canada Pension Plan (CPP) premium . . . . . . . . . . . . . . . . . . . . . . . 3,754 Employment Insurance (EI) premium . . . . . . . . . . . . . . . . . . . . . . . 1,002

Introduction to Federal Income Taxation in Canada

592 (e)

(f)

Robert, age 19, and Charles, age 15, are attending high school and have no income except for $300 of interest from GICs, given to them by Buck Shot. Charles attends a special school for the disabled and is confined to a wheelchair. Buck Shot paid $4,000 in tuition fees in respect of Charles’ school for 2023. The following additional disbursements were made by Buck Shot in 2023: Donation to Lakehead University . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $150 Premiums for private health insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 320 Donation to provincial political party . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150

(g) (h)

Buck Shot has a net capital loss balance of $25,770 which arose in 2001. Included in Buck Shot’s CPP premiums paid in the year is $631 in enhanced CPP payments.

— REQUIRED (A)

(B)

Prepare a statement of income, taxable income and basic federal tax according to the ordering rules for Division B, Division C, and Division E of the Federal Income Tax Act. Utilize any elections with respect to Buck Shot’s wife’s dividends or his pension income. EXplain your decisions and show your calculations. Give an explanation for each item omitted from your answer in Part A.

Problem 8 Marilyn is a marketing representative for a Canadian-controlled private corporation, Tax Books Inc. She has worked for this company since January 1, 2021. She is married to Jorge, who is working fulltime on his Masters of Sociology degree. Marilyn and Jorge have two children, ages 4 and 7. Marilyn has asked you to look at her 2023 tax information. Marilyn provides you with the following information: 1.

3. 4.

Marilyn received a salary of $70,000, a performance bonus of $15,000 and commissions of $5,000 (based on sales she generated). Her employer withheld the following amounts from her pay: Income tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $30,000 Canada Pension Plan (CPP) and Employment Insurance (EI) premiums . . . . . . . 4,756 (The CPP premiums include $631 of enhanced CPP payments.) Registered Retirement Savings Plan (RRSP) contributions . . . . . . . . . . . . . . . . . 3,000 (Marilyn’s employer matches her RRSP contributions) [The contributions of both parties were made equally throughout each month of 2023 ($250 per month by Marilyn and $250 per month by her employer). The January and February 2023 contributions were deducted on Marilyn’s 2022 tax return.] Group disability insurance premium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150 ($25 per month; Marilyn pays half and the employer pays half) Donations to United Way . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300 Her employer provides her with the following benefits: (a) An automobile, which cost her employer $20,000 plus HST @ 13%. The car was available to Marilyn for the entire year and she used the car 40% for employment during 2023. She drove approXimately 30,000 kilometres in total during 2023. Tax Books Inc. also pays for all of the operating costs of the car, as set out below. Gas, oil changes and repairs ....................... $2,000 (including applicable HST) Insurance .................................................. $1,200 (b) Annual membership fee of $700 in a local golf club so that she can meet potential clients. (c) Personal tax preparation costs, $400, inclusive of HST, in 2023 to have her 2022 tax return prepared. Marilyn was given a trip to St. Lucia worth $900 by one of Tax Books Inc.’s suppliers who appreciated the work done by Marilyn. She bought another ticket for Jorge and they went during December of 2023. Marilyn owns 50% of the shares of Microcosm of Life Limited, a Canadian-controlled private corporation. In 2022, she had $15,000 included in her income for loans made to her by the company. During 2023, she repaid $10,000 of this loan.

Comprehensive Section/Study Guide — Comprehensive Case Problems 5. 6.

8. 9.

10.

12.

Marilyn is a director for Taxed-to-the-Hilt Public Company, and this company paid her $500 in director’s fees for 2023. In February of 2023, Marilyn gave Jorge 200 shares of Looney Canadian Public Co., which she had bought three years ago for a total of $1,000. In May 2023, the shares paid dividends for the first time of $6 per share. Jorge sold all 200 shares in November 2023 for net proceeds of $10,000. Marilyn’s father runs a retail business. Marilyn owns the real estate out of which the business operates. In February 2023, she sold the land and building. There was no gain on the land. The selling price allocated to the land was equal to the original cost. The details on the building are as follows: Sale price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $250,000 Legal fees including HST . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000 Cost of building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160,000 Net rental income to Marilyn prior to the sale . . . . . . . . . . . . . . . . . . . . . . . . 1,400 Cash received . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,000 Mortgage receivable from the purchaser . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150,000 At the time of the sale, Marilyn did not have a mortgage payable on the property. Capital cost allowance of $2,300 had been claimed on the building since she had purchased it. Marilyn received interest of $3,000 on the mortgage during 2023. The balance of the mortgage outstanding at the end of 2023 was $145,000. In January 2023, Marilyn contributed $7,000 to her RRSP and $2,000 to a spousal RRSP for Jorge. She did not report or deduct these contributions on her 2022 income tax return. Marilyn showed you the carryforward information from her 2022 tax return. (a) Her earned income for 2022 was $80,000. (b) She had unused RRSP deduction room of $100 at the end of 2022. (c) Marilyn’s cumulative net investment income balance was $2,000 at the end of 2023. (d) She has a net capital loss carry forward from 2001 of $1,500. (e) She received Notices of Assessment for both 2021 and 2022 tax returns during 2023. She paid $450 for interest and penalties for her 2021 return in 2023. Also, in 2023, she received $200 refund interest on her 2022 refund. The two children received interest income in 2023: — $200 TOTAL generated by deposits of previously received child tax benefits cheques; and — $400 TOTAL from corporate bonds purchased by Marilyn during 2022. In January of 2024, Marilyn’s employer stopped the RRSP matching plan, so Marilyn stopped having RRSP contributions deducted from her pay. From October to December of 2023, Marilyn was off work and receiving disability insurance. She received $4,000 per month and did not have to pay any premiums during this time. Marilyn has paid a total of $413 of group disability insurance premiums, up to and including September 2023, since she started working for the company.

— REQUIRED Determine Marilyn’s taxable income for 2023. Show all your calculations. Briefly explain why you omitted any of the above information from your calculations. Calculate the effect of the disability insurance receipts on Marilyn’s 2023 tax situation.

Problem 9 On September 1, 2023, Stan moved 530 km from Ottawa, Ontario to Toronto, Ontario, to start a new job with Bullet Investors Group as a commissioned salesman. From January 1, 2023 to August 31, 2023, he was unemployed. Before he moved, he sold an antique table and painting for $800 and $1,500, respectively. They were purchased in 2011 for $1,100 and $700, respectively. Stan paid for the following moving expenses, which were then reimbursed by Bullet Investors Group: ?> Packing and moving furniture and other personal items .......................................................... $2,000 Three days receipted meals and accommodation in Toronto, waiting for the painting of the Toronto home to be finished (meals $200, accommodation $300) . . . . . . . . . 500 Cancellation of lease on the apartment he lived in until he moved on September 1 .............. 400 $2,900

Comprehensive Section

11.

593

594

Introduction to Federal Income Taxation in Canada

Stan received total remuneration of $34,000, inclusive of commission income of $10,000 from Bullet Investors Group in 2023. His payroll deductions consisted of the following: Canada Pension Plan (CPP) contributions* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Employment Insurance (EI) contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Union dues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Registered Pension Plan (RPP) contribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$1,815 554 210 1,300 5,700

His T4 slip indicated that his pension adjustment was $3,000 for 2023. Other amounts received by Stan during 2023: Interest on savings account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividends from taxable Canadian public corporations (cash amount) . . . . . . . . . . . . . . Dividends from a U.S. corporation, net of $300 foreign withholding tax ($Cdn) . . . . . . HST Rebate with respect to 2022 employment expenses, excluding CCA . . . . . . . . . . . Lottery winnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Employment insurance benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retiring allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 925 8,000 1,700 250 300 9,000 35,000

* The CPP premiums paid include enhanced CPP payments of $305.

The retiring allowance was received from Simple Ltd., his previous employer. He had worked for Simple Ltd. from February 1, 1988 to December 31, 2022, during which time he was always a member of the pension plan and all contributions to that RPP vested immediately. On March 20, 2023, Stan sold shares of Simple Ltd. for $70,000. These shares represented a minority arm’s length interest in his former employer, a Canadian-controlled private corporation. He paid $10,000 for the shares, which were purchased pursuant to the company’s stock option plan. The values of the shares were: at the time the option was granted in 2010, $15,000, and at the time he exercised the option in 2012, $25,000. His stock market transactions for 2023 were as follows: February 2 ............. purchased 500 shares of X Ltd. for $2 each February 28 ........... purchased 1,000 shares of X Ltd. for $10 each March 15 ................ sold 500 shares of X Ltd. for $5 each Stan had the following selected disbursements during 2023: Tax Free Savings Account (TFSA) administration fee paid outside the TFSA . . . . . . . Interest expense for the purchase of the marketable securities . . . . . . . . . . . . . . . . . Legal fees to contest income tax assessment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Donations to registered charities (consistent with prior years) . . . . . . . . . . . . . . . . . Registered Retirement Savings Plan (RRSP) contributions: January–February 2023 (all of which were deducted on his 2022 tax return) . . . March–December 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . January–February 2024 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 100 500 600 700 2,500 8,000 5,000 $19,400

The pension adjustment reported on Stan’s 2022 T4 slip was $1,400. His earned income for RRSP purposes for 2022 was $70,000. His unused RRSP deduction room at the end of 2022 was $800. Stan has net capital losses of $4,000 and listed personal property losses of $200, both incurred in 2016. He has used his entire capital gains deduction entitlement as of the end of 2022. Stan has to repay $2,700 of employment insurance benefits received during 2023 due to his high income level for 2023. — REQUIRED Determine Stan’s taxable income for 2023. Show all your calculations. Briefly explain why you omitted any of the above information from your calculations. Reconcile Stan’s taxable income to ‘‘adjusted taxable income’’ for minimum tax purposes.

Problem 10 You have been asked to reconcile net income for accounting purposes to taxable income for your client, Leonard Hockey Stick Manufacturing Corporation, a Canadian-controlled private corporation. The income statement for the year ended December 31, 2023 is shown below:

Comprehensive Section/Study Guide — Comprehensive Case Problems

595

Leonard Hockey Stick Manufacturing Corporation Statement of Income For the Year Ended December 31, 2023 Sales ...........................................................................................................$2,300,000 Cost of Goods Sold....................................................................................... 1,180,000 Gross Profit ..................................................................................................... $1,120,000 Operating EXpenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 470,000 Administrative EXpenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 450,000 Income from Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other Income and EXpenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 200,000 10,000

Income Before Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income Taxes — Current . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — Future . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 210,000 45,700 3,500

Net Income for the Year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 160,800

During your review of the working paper file and last year’s tax return, you made the following notes to yourself because you think that there might be tax implications associated with these items. 1. Leonard Hockey Stick Manufacturing Corporation is a Canadian corporation owned 50% by Chrisa and 50% by her husband, Neil. Chrisa and Neil are both residents of Canada for income tax purposes. The company manufactures hockey sticks in Mississauga, Ontario. 2. The opening allowance for doubtful accounts at January 1, 2023 was $12,000. The closing allowance for doubtful accounts was $18,000. The net increase has been reflected as bad debt expense for accounting purpose. The allowance is determined by identifying specific accounts where collection is unlikely. 3. The Other Income includes the following items: $12,000 7,000 500 200 1,520

(6,000) 1,500 1,000

4. During the year, the company’s purchases and dispositions of fiXed assets were as follows: July 31, 2023

August 1, 2023

September 15, 2023

Purchased a new gas automobile for company use — cost (including HST @ 13%) . . . . . . . . . . . . . . . . . . . . (The appropriate HST was recovered as an input tax credit) Sold the expensive car driven by Chrisa and Neil that the company had purchased in 2016 — proceeds (less HST) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (Purchase price of the car in 2016 was $36,000 before HST) Purchased specialized computer software for the company’s accounting department . . . . . . . . . . . . . . .

$45,200

27,000

6,000

Comprehensive Section

Capital dividend received from 80% owned small business corporation, David Hockey Pucks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividend received from 100% owned subsidiary company, Peter Wood Products Limited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividend received from 1% owned Lori Ice Machine Canadian Public Corp. Dividend from 1% foreign investment in Miriam Duffle Bags Inc. (in Canadian dollars) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Increase in cash surrender value of life insurance . . . . . . . . . . . . . . . . . . . A loss from investment in shares of Mark Goal Nets Inc. which was a small business corporation owned 99% by a neighbour of Chrisa and 1% by Leonard Hockey Stick Manufacturing Corporation. Unfortunately, the manufacturing company went bankrupt in November 2023 and Leonard Hockey Stick Manufacturing Corporation lost its original investment of $6,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign exchange gain on converting a long-term investment in the shares of Miriam Duffle Bags Inc., from US to Canadian dollars from 2022 to 2023 Gain on disposition of the expensive car driven by Chrisa and Neil for business purposes (difference between net book value and proceeds received) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Introduction to Federal Income Taxation in Canada

596

5. The closing Undepreciated Capital Cost (UCC) balances at December 31, 2022 were as follows: Class 1 . . . . . . . . . .

$102,000

Class 8 . . . . . . . . . .

50,000

Class 10 . . . . . . . . .

30,000 (delivery van)

Class 10.1 . . . . . . . .

10,000

Class 53 . . . . . . . . .

80,000

6. The schedule for interest expense showed the following items: (a)

Interest on long-term debt used to purchase building and manufacturing equipment ........................................................................................................... $31,000

(b)

Interest on loan used to purchase the new automobile this year . . . . . . . . .

$ 4,200

(c)

Financing fee charged by bank to purchase new automobile . . . . . . . . . . . .

300

(d)

Interest on late corporate income tax instalments . . . . . . . . . . . . . . . . . . . .

300

(e)

Interest on loan obtained in October 2023 used to purchase vacant land on which the company plans to build a driving range in the future . . . . . . .

$ 6,000

7. Operating and Administrative EXpenses include the following amounts: Landscaping expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 15,000

Amortization expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

48,000

Donations to registered charities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5,000

Premiums on life insurance policies on Chrisa and Neil — these policies are not required by the bank for any outstanding loans . . . . . . . . . . . . . . . . . . . .

2,000

Meals and entertainment expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3,440

Curling club memberships for Chrisa and Neil and Janna, the vice-president of marketing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6,000

Reserve for future warranty expense for hockey sticks (actual expenses paid in the year to honour warranties were $1,200) . . . . . . . . . . . . . . . . . . . . . . .

1,500

Management bonuses accrued — all paid by June 28, 2024............................................ 370,000

— REQUIRED Reconcile net income for financial statement purposes to taxable income for Part I federal tax purposes.

Problem 11 The following reconciliation between net income per the income statement and taxable income, for the year ending December 31, 2023, was prepared by the bookkeeper of your client, Bupkeh Manufacturing Ltd., a Canadian-controlled private corporation (CCPC). The engagement partner has asked you to identify those items which were handled incorrectly.

Comprehensive Section/Study Guide — Comprehensive Case Problems

597

Net income per the financial statements — (Note 1) . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 560,000

Add: Current year provision for warranties — (Note 2) . . . . . . . . . . . . . .

$ 85,000

EXcess registered pension plan contributions — (Note 3) . . . . . . . . . 35,000 Unpaid bonuses — (Note 4) .......................................................................... 140,000 Charitable donations — (Note 5) . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000 Taxable capital gains — (Note 6) Land ................................................................................................... 330,000 Building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

55,000

Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

40,000

745,000 $1,305,000

Deduct: Book profit — land — (Note 6) ....................................................................$440,000 — building — (Note 6)............................................................... 230,000 Inventory reserve — (Note 7) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

8,500

(678,500)

Income for tax purposes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 626,500

Charitable donations — (Note 5) . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 60,000

Non-capital losses — (Note 8) ...................................................................... 160,000 Net capital losses — (Note 8) ....................................................................... 280,000 Dividends from taxable Canadian corporations — (Note 9) . . . . . . . .

11,500

(511,500)

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 115,000

Note 1

Note 2 The reserve for warranties was computed as follows: Warranty reserve — January 1, 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 55,000

Current year provision for future warranties . . . . . . . . . . . . . . . . . . . . . . . . . . .

85,000 $140,000

Actual expenditures to honor warranties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

50,000

Warranty reserve — December 31, 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 90,000

Note 3 The company and its employees EACH contribute 6% of gross salary (12% total) to a registered pension fund which is a defined contribution (money purchase) plan. The $35,000 represents the company contributions in respect of 2023 made on January 31, 2024. Note 4 Because of cash-flow restrictions, payment of bonuses to certain key employees has been deferred although there is a bona fide obligation to pay them by May 2024. Dec. 31, 2023 Unpaid bonuses ................. $140,000 (accrued in 2023) Dec. 31, 2022 Unpaid bonuses ................. $115,000 (accrued in 2022)

Comprehensive Section

The net income per the financial statements includes a deduction for income taxes payable for the year of $71,000 and deferred income taxes of $14,000. This amount also reflects certain extraordinary items as reflected in subsequent notes.

Introduction to Federal Income Taxation in Canada

598 Note 5 Charitable donations for 2023 included the following amounts:

University scholarships paid directly to children of employees . . . . . . . . . . . . . . Assistance to the spouse of employee who recently died . . . . . . . . . . . . . . . . . . Donation to registered Canadian charities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Donation to Building Fund of several universities . . . . . . . . . . . . . . . . . . . . . . .

$ 20,000 6,000 25,000 9,000 $ 60,000

Note 6 On July 1, 2023, the corporation sold a warehouse and the related land. The company does not intend to replace the building and has entered into a long-term lease arrangement for similar space. Sale of land and building Land — cost . . . . . . . . . . . . . . . . . . . . . $125,000 — selling price . . . . . . . . . . . . . . . 565,000 Building — cost . . . . . . . . . . . . . . . . . . . . . 180,000 — book value . . . . . . . . . . . . . . . . 110,000 — UCC* Class 3 . . . . . . . . . . . . . . 140,000 — selling price . . . . . . . . . . . . . . . 340,000 Other: (1) The company paid a real estate commission of 10% and an appraisal fee of $2,500 in respect of this sale. These amounts were expensed. (2) The company took back, as part of the sale proceeds/consideration, a 10-year 11% annual percentage rate mortgage for $675,000 with interest and principal payment due on the anniversary date each year. Interest is included in income when received. * undepreciated capital cost

Long-term lease The company entered into a 10-year lease with two successive renewal options of five years each, on July 1, 2023. The annual rent is $30,000. In order to secure the lease, the company had to pay the owner the first and the last year’s rent in advance plus $35,000 for leasehold improvements. The last year’s rent and leasehold improvements were not expensed but are in a balance sheet account labelled ‘‘prepaid costs’’. Note 7 A reserve of $8,500 for an estimated decline in values was applied to the closing inventory. Note 8 The non-capital losses represent the balance remaining from a 2020 non-capital loss of $25,000 and the full amount of the 2021 non-capital loss of $135,000. The net capital loss originated in 2006. Note 9 These dividends were received from a wholly-owned subsidiary on June 15, 2023, and a grossed-up amount of 1.15 × the dividends received was included in income. Of the actual amount received, the subsidiary had elected that $2,000 be paid from its capital dividend account. — REQUIRED Prepare a draft memorandum for the client explaining the incorrect treatment of the items in the reconciliation (or omitted items) so that the bookkeeper can prepare the reconciliation correctly in the future.

Problem 12 Snowblowers Plus, Inc. is a Canadian-controlled private corporation (CCPC) owned 100% by Mr. Griffen Rock. The company’s year end is December 31. You are the audit senior and must prepare the tax return for the company. The income statement and additional information obtained from the audit are summarized below.

Comprehensive Section/Study Guide — Comprehensive Case Problems

599

Snowblowers Plus, Inc. Income Statement For the year ended December 31, 2023 Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$5,500,000

Cost of goods sold: Opening inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 300,000

Amortization on equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . .

20,000

Labour . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2,700,000

Materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

900,000

Ending inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(400,000)

Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(3,520,000) $1,980,000

Administrative expenses: Amortization of capital assets . . . . . . . . . . . . . . . . . . . . . . . . . .

15,000

Employee benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

28,000

Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

15,000

Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

20,000

Management salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

380,000

Office salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

90,000

Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

35,000

(583,000)

Sales expenses: Advertising and marketing . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 100,000 14,000 374,000

Travel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

45,000

Operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(533,000) $ 864,000

Other: Gain on sale of land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 130,000

Dividend income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

11,000

Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

10,000

Net income before taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

151,000 $1,015,000

Income taxes: Current . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 426,600

Deferred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

20,000

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(446,600) $ 568,400

Additional information that was noted for the purposes of preparing the client’s tax returns. 1. Opening Undepreciated Capital Cost (UCC) balances as at January 1, 2023: Class 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$83,000

Class 8 . . . . . . . . . . . . . . . . . . . . . . . . . . . .

60,000

Class 10 . . . . . . . . . . . . . . . . . . . . . . . . . . .

40,000

Comprehensive Section

Promotion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sales commissions and salaries . . . . . . . . . . . . . . . . . . . . . . . . .

Introduction to Federal Income Taxation in Canada

600

During the year, the company undertook the following transactions with respect to fi Xed assets. All costs are exclusive of HST @ 13% where applicable. The company is not associated with any other corporations. (a)

The existing administrative building was demolished. A new administrative building was constructed on the same land at a cost of $200,000. The original building was purchased in 2007 at a cost of $45,000. There is still a manufacturing plant and warehouse included in Class 1.

(b)

Two new gas vehicles were purchased to be used by the president and the vice-president for business purposes. The cars each cost $37,000.

(c)

The company sold three of its old computers to employees at a fair market value of $200 each. The computers had originally cost the company $1,000 each and are included in Class 10.

(d)

New manufacturing equipment was purchased during 2022 costing $90,000. Machinery which had originally cost $10,000 and had been set up in Class 43 several years ago, was scrapped during the year.

(e)

New office furniture was purchased during the year at a cost of $20,000.

(f)

The company sold a piece of land that it was holding, for the expansion of its business operations, for $150,000. The land had been purchased in 2015 for $20,000. On the sale of the property, a mortgage of $50,000 was taken back. The purchasers had repaid $27,500 by Snowblowers Plus, Inc.’s year end. The balance of the mortgage is due during the 2024 taxation year.

2. Ten thousand marketing brochures were purchased during 2023 costing $5,000. Only 1,000 brochures were used at December 31, 2023. The company did not set up a prepaid expense as the amount was immaterial for accounting purposes. 3. Promotion expense contains the following items: Meals for salespersons who travel outside the city . . . . . . . . . . . . . . . . . . .

$3,000

Meals for entertaining business clients or potential clients . . . . . . . . . . . . .

4,300

Season tickets to Ottawa Senators hockey games . . . . . . . . . . . . . . . . . . .

800

Staff Christmas party . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

900

Golf club membership for the president and vice-president . . . . . . . . . . . .

5,000 $14,000

4. Management salaries include a bonus to the president/shareholder of $90,000. This amount was paid on August 31, 2024 and all source deductions (income tax, Canada Pension Plan) were remitted by the company on September 15, 2024. 5. Dividend income consists of the following amounts: Deemed dividend on redemption of 250 preferred shares of ABC Canadian Ltd. (before the redemption, the company owned 9% of the shares; now it owns 7% of the shares) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$2,500

Taxable dividend from XYZ Inc., a CCPC in which the company owns 50 of 200 issued common shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3,000

Taxable dividend from a US corporation, EX-why-zee Corp., net of 15% foreign non-resident withholding tax. The company owns less than 1% of EX-why-zee’s shares. The dividends are stated in Canadian dollars . . . . . . .

1,700

Capital dividend from Y Not Ltd., a Canadian corporation in which the company has a 50% interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3,800 $11,000

6. During 2023, the sole shareholder transferred, to the company, a warehouse that he had purchased in 2005. The transfer was done by way of a tax-free rollover under section 85 of the Income Tax Act. The details on the transferred property at the date of the transfer are as follows:

Comprehensive Section/Study Guide — Comprehensive Case Problems Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . UCC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$100,000 95,000

Fair market value . . . . . . . . . . . . . . . . . . . . Elected transfer price . . . . . . . . . . . . . . . . .

200,000 190,000

Consideration Note to shareholder . . . . . . . . . . . . . . . 10,000 preferred shares . . . . . . . . . . . .

190,000 10,000

601

The shareholder reported the disposition on his 2023 personal tax return. He reported $5,000 recapture and $90,000 capital gain. The shareholder utilized his capital losses carried forward to eliminate the gain elected. 7. In 2001, the company sustained a net capital loss of $12,000. To date, this loss has not been used. 8. In order to finance the new administrative building (Note 1), the company had to obtain new financing. The company incurred $600 in obtaining this financing. The amount was claimed as an expense on the financial statements. 9. The company is registered for HST. — REQUIRED Determine the taxable income for the December 31, 2023 tax return of Snowblowers Plus, Inc. Show all your calculations.

Problem 13 The CA in your office who has completed the file for your client, Make-it and Save-it Inc., has left for a well-deserved two-week vacation. Before leaving, she asked you to prepare Schedule 1 of the T2 Corporate Tax Return and calculate federal Part I and Part IV tax for the year ended December 31, 2023. The CA has provided you with financial statements, which have been prepared for tax purposes, and notes on selected items in the financial statements (AppendiX I). — REQUIRED

APPENDIX I Make-it and Save-it Inc. Balance Sheet December 31, 2023 Assets Current: Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 410,000 935,000 35,000 1,025,000

Capital assets, net of amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$2,405,000 1,322,000 790,000 $4,517,000

Liabilities Current: Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income taxes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 360,000 280,000

Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Due to shareholder . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 640,000 1,000,000 1,353,000 $2,993,000

Comprehensive Section

Calculate net income, taxable income, and federal Part I and Part IV tax for Make-it and Save-it Inc. for the year ended December 31, 2023.

Introduction to Federal Income Taxation in Canada

602 Shareholder’s Equity

Share capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 150,000

Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,374,000 $1,524,000 $4,517,000

Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$6,865,000

Cost of goods sold, Schedule A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5,878,000

Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 987,000

EXpenses: Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 152,000

Amortization of capital assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

12,000

Automotive expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

58,000

Bad debts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

138,000

Charitable donations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2,000

Interest on long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

80,000

Management salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

200,000

Moving expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

25,000

Office expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

118,000

Professional fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

36,000

Promotion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

63,000

Salaries and benefits: Administrative staff . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

205,000

Sales staff . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

410,000 $1,499,000

Loss from manufacturing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ (512,000)

Other income (deductions): Dividend income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

55,000

Gain on sale of Plant #1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,300,000

Loss on sale of equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(9,000)

Income from Make-it and Save-it (Alberta) Inc. . . . . . . . . . . . . . . . . . . . . . . .

100,000

Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

7,500

Rental, Schedule B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

30,400

Restructuring cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(50,000)

Write-down of investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(25,000) $1,408,900

Income before income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

896,900

Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

200,000

Net income for the year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 696,900

Retained earnings, beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

977,100

Non-eligible dividends (paid October 15, 2023) . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ (300,000)

Retained earnings, end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$1,374,000

Comprehensive Section/Study Guide — Comprehensive Case Problems

603

APPENDIX I (continued) Schedule A Make-it and Save-it Inc. Cost of Goods Sold For the Year Ended December 31, 2023 Opening inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$1,675,000

Material cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Direct labour . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4,020,000 720,000

Amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Overhead . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

128,000 360,000

Less: Closing inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$6,903,000 1,025,000

Cost of Goods Sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$5,878,000

Schedule B Make-it and Save-it Inc. Statement of Rental Income and EXpenses For the Year Ended December 31, 2023 Rent

40,000 3,000

Property taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Repairs and maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4,000 1,800 800

Net Rental Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

9,600

30,400

Make-it and Save-it Inc. Additional Notes 1.

Make-it and Save-it Inc. (MSI) is a Canadian-controlled private corporation (CCPC). The company is a manufacturer of office furniture. It also has marketable securities, some interest-bearing investments and a rental property. MSI has a wholly-owned subsidiary, Make-it-Rich Investments Ltd. and owns 37.5% of Make-it and Save-it (Alberta) Inc. All capital asset additions are considered to be capital property and are available for use. The total capital asset additions that are considered to be eligible property did not exceed $1.5 million in total for the associated group for the taxation year.

The inventory is valued at cost which is determined on a standard cost basis. The cost of the inventory exceeds fair market value by $10,000. The write-down was not recorded for financial statement purposes since it was not considered material.

Capital assets, net of amortization

Comprehensive Section

Rental EXpenses: Amortization of capital assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Introduction to Federal Income Taxation in Canada

604 December 31, 2022 Cost Land

— Plant #1 . . . . . . . . . .

$ 187,500

December 31, 2023

Accumulated Amortization $

—

Cost $

—

Accumulated Amortization $

—

— Plant #2 . . . . . . . . . .

—

300,000

—

— Warehouse . . . . . . . .

50,000

—

50,000

—

— Rental property . . . . .

80,000

—

80,000

—

Building — Plant #1 . . . . . . . . . .

280,000

180,000

—

— Plant #2 . . . . . . . . . .

—

— Warehouse . . . . . . . .

100,000

—

500,000

20,000

40,000

100,000

43,000

— Rental property . . . . .

120,000

60,000

120,000

63,000

Manufacturing equipment . . . . . . .

655,000

370,000

725,000

455,000

Office equipment . . . . . . . . . . . . . Computer equipment . . . . . . . . . .

50,000 30,000

30,000 10,000

50,000 30,000

36,000 16,000

$1,552,500

$ 690,000

$1,955,000

$ 633,000

Cost, net of accumulated amortization . . . . . . . . . . . . . . .

$ 862,500

$1,322,000

Due to significant advancements in just-in-time inventory control, the company was able to significantly reduce its space requirements for its manufacturing plant. As a consequence, the company sold its Plant #1 for $1,850,000 ($918,750 for the land and $931,250 for the building) and purchased Plant #2 during the year. The company purchased two new pieces of manufacturing equipment in 2023: one machine was traded-in for a new machine for a net price of $37,000 in July 2023 and the second one (without a trade-in) for a price of $62,000 in November 2023. The new machine purchased in July 2023 had a list price of $43,000. The machine traded in had an original cost of $35,000 and a net book value of $15,000. There were no other additions or disposition of capital assets during the year. The closing Undepreciated Capital Cost (UCC) balances at December 31, 2022 were: Class 1 — rental property . . . . . . . . . . . . . Class 1 — plant and warehouse . . . . . . . . . Class 8 . . . . . . . . . . . . . . . . . . . . . . . . . . . Class 10 . . . . . . . . . . . . . . . . . . . . . . . . . . Class 53 . . . . . . . . . . . . . . . . . . . . . . . . . . 4.

$ 60,000 160,000 20,000 20,000 200,000

The investment in Make-it-Rich Investments Ltd. is accounted for using the cost method and the investment in Make-it and Save-it (Alberta) Inc. is accounted for using the equity method.

Make-it and Save-it (Alberta) Inc. Opening . . . . . . . . . . . . . . . . . . . . . . . . . . Share of income . . . . . . . . . . . . . . . . . . . . Dividend . . . . . . . . . . . . . . . . . . . . . . . . . . Closing . . . . . . . . . . . . . . . . . . . . . . . . . . . Make-it-Rich Investments Ltd. . . . . . . . . . . . . . Term deposits . . . . . . . . . . . . . . . . . . . . . . . . . Marketable securities Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Write-down to market value . . . . . . . . . . .

2022

2023

$280,000 60,000 (40,000)

$300,000 100,000 (60,000)

$300,000 200,000 100,000

$340,000 200,000 150,000

125,000 —

125,000 (25,000)

$725,000

$790,000

Comprehensive Section/Study Guide — Comprehensive Case Problems

605

The dividend paid by Make-it and Save-it (Alberta) Inc. on January 31, 2023 resulted in a dividend refund of $23,000 out of its non-eligible refundable dividend tax on hand. 5.

Accounts payable at December 31, 2023 includes bonuses payable to employees of $40,000 and bonuses payable to the owner/manager of $110,000. The bonuses are considered reasonable and are expected to be paid in September 2024.

The promotion account has been analyzed and includes the following items: Concert tickets given to customers . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 1,000

Meals and entertainment incurred by salespeople . . . . . . . . . . . . . . .

22,000

Meals and entertainment incurred by management . . . . . . . . . . . . . .

8,000

Staff Christmas party . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

32,000 $63,000

In the latter part of the year, management completed an operational review of the company and determined that there were excess staff members. Management determined that $50,000 in severance payments will be owing to staff to be laid off. This was accrued in 2023. The staff were terminated during January 2024.

Dividend income: Marketable securities — received evenly throughout the year . . . . . . $ 5,000 Make-it-Rich Investments Ltd. — received August 1, 2023 ............................ 50,000 $55,000 The dividend paid by Make-it-Rich Investments Ltd. resulted in a dividend refund of $19,167.

Problem 14

Value at Dec. 31, 2023

Type of Income in 2024

Income Anticipated

ABC Company Bonds . . . . . .

$100,000

Interest

$ 11,000

XYZ Canada Co. shares . . . .

400,000

Dividends

20,000

Ace Technology shares . . . . .

50,000

Capital gains

15,000

Safe Bank of Canada shares

50,000

Dividends

4,000

Capital gains

3,000

$600,000

$ 53,000

In addition to the above investment income, Ryan expects to earn appro Ximately $80,000 of employment income. The total adjusted cost base for the above investments is $450,000. The abovenamed companies are all public companies. — REQUIRED Ryan asks you whether it is financially more attractive for him to own his investments through a corporation or to own them directly, as he currently does. Assume that he and his investments will generate the anticipated amounts mentioned above. In addition to his $80,000 employment income, he requires $14,000 more disposable cash. Assume federal personal tax credits of $3,074 and provincial personal tax credits of $2,049. Use hypothetical provincial personal tax rates as set out in chapter 10 of the text.

Comprehensive Section

Ryan Taylor lives in a province with a combined federal and provincial corporate tax rate of 40% on Canadian-Controlled Private Corporation (CCPC) investment income, before applying any refundable tax on CCPCs investment income. He owns the following investments and anticipates the following Canadian-source income for future years.

Introduction to Federal Income Taxation in Canada

606

Problem 15 Your client, Maven Public Co. Ltd., which is listed on the Toronto Stock EXchange, has asked you to give some tax advice to their new vice-president, Morris Minor, age 50, who will be responsible for the marketing of the company’s products starting next January. This position will require extensive travel across Canada. In particular, Morris will have direct responsibility in renewing the contracts for several chain-store private brand products. In your first interview with Morris, the following facts and background information were brought to your attention. Morris is presently employed by Action Properties Ltd., a family-owned company (a CCPC) operating out of Moose Jaw, Saskatchewan. Morris is not related to the controlling group of shareholders. The company had no pension plan but did have a generous stock option plan in which Morris actively participated. Morris has acquired shares at an option price of $15 on January 1, of the following years: 2020 — 200 shares 2021 — 100 shares

2022 — 300 shares 2023 — 400 shares

Morris can acquire an additional 1,000 shares at an option price of $15 before he ceases employment with Action Properties Ltd. However, upon ceasing employment, he must sell all of the shares obtained under the stock option plan to the controlling family at the fair market value based on an independent valuation (approXimately $100 each). This value has remained the same throughout the period over which shares were purchased. Since Morris does not have any spare cash, he plans to borrow the required funds from the bank in order to purchase the additional 1,000 shares. Your client, Maven Public Co. Ltd., has made the following offer to Morris. The employment benefits are part of a standard package available for all the senior executives. — Salary of $150,000. — A moving allowance of $15,000. — A reimbursement of any actual loss on the disposition of his Saskatchewan family home up to a maximum of $50,000. — A monthly travel allowance of $1,500. — Membership in two clubs of his choice. — Premiums for the following medical plans: — Liberty Mutual Insurance — EXtended Health Care: $250 — Sun Life Insurance — Drug Plan: $200 — Sun Life Insurance — Sickness/Accident/Disability coverage: $800 — Participation in a contributory defined benefit pension plan of 2% of his gross salary which would result in a pension income of $1,715 for each year of service plus a retiring allowance of one year’s salary. — An annual security option, granted on January 1 each year, to purchase 5,000 shares of the company. The first option will be granted January 1, 2024. Options can be exercised after a one-year period has expired from the date of grant. The first option will be exercisable at 80% of the market value at the time of grant (January 1, 2024 — estimated market value $10 per share). — Group term life insurance coverage of $400,000, paid by the company at a cost of $2 per $1,000 of coverage. — 2% loans available January 1, 2024: — to acquire a home up to a maximum of $250,000, evidenced by a 25-year mortgage. — to acquire an automobile up to a maximum of $15,000 with no definite repayment period. (Assume that the prescribed rate for 2024 will be 5% for all quarters) — REQUIRED Assuming Mr. Minor ceases employment with Action on December 31, 2023, prepare a draft memorandum to Mr. Minor explaining the tax implications of the events arising from the proposed departure from Action Properties and the proposed compensation package offered by Maven Public Co. Ltd.

Comprehensive Section/Study Guide — Comprehensive Case Problems

607

Problem 16 Mr. Grocer has been a friend of your family for years. It is early January 2024 and Mr. Grocer knows that you are studying personal income tax. He has asked you to look at his 2023 tax situation for him. He provides you with the following information: 1. Mr. Grocer is 40 years old. His wife is 38 years old. They have two children: Bran, who is eight, and Muffin, who is five. After a five-year absence, Mrs. Grocer decided to re-enter the work force to continue her career as an electrical engineer. She started work in September of 2023. 2. Mr. Grocer has never been part of a company pension plan. In June 2023, he contributed $8,000 to his own Registered Retirement Savings Plan (RRSP) and $6,000 to Mrs. Grocer’s RRSP. His employment income for tax purposes for 2022 was $65,000. Based on his 2022 Notice of Assessment, Mr. Grocer had no unused RRSP contribution room. 3. He earns a gross salary of $70,000 (deductions for income tax, Canada Pension Plan (CPP) premiums and Employment Insurance (EI) premiums of $20,000, $3,754 and $1,002, respectively). The CPP premiums paid include enhanced CPP payments of $631. He has the following employment-related benefits. – For all of 2023, he had the use of a car purchased by his employer for $26,000 exclusive of $2,080 HST. During 2023, he drove the car 30,000 kilometres of which 19,500 kilometres were for employment purposes. – The supermarket paid for all of the operating expenses of the car.

Net Gas . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 3,097

Oil changes . . . . . . . . . . . . . . . . . . . .

HST $

Total $ 3,500

266

300

Repairs . . . . . . . . . . . . . . . . . . . . . . .

531

600

Insurance . . . . . . . . . . . . . . . . . . . . .

1,200

–

1,200

– He received a $60,000 loan from the supermarket on December 1, 2022 in order to purchase a house in Dundas. The loan is interest-free and the principal is repayable in five equal, annual instalments on the anniversary date of the loan. 4. He paid $8,000 of eligible moving expenses in December 2022, to move from Saskatoon to Dundas. He was able to deduct $5,400 of this in 2022, the balance he carried over to 2023 and is hoping to use this year. 5. In January of 2023, he sold 5,000 shares in Outasite Corp. which are qualified small business corporation shares. He felt that he had done well selling them for $26,000 as he had purchased them in 2020 for only $5,000. The shares of Outasite Corp. had provided him with cash, noneligible dividends of $300 in 2020, $300 in 2021, and $200 in 2022. These dividends were his only investment income and he thought that the gain and the $800 dividends over the past four years were a pretty good deal. Mr. Grocer has not used any of his capital gain exemption in prior years. 6. Mr. Grocer owns a rental property in Saskatoon which he purchased in 2022. In 2022, there was a rental loss of $3,000. However, in 2023 the property generated a loss of only $1,000. These losses do not include Capital Cost Allowance. 7. Bran and Muffin have no income other than $200 EACH of interest from bonds purchased in their names by Mr. Grocer on December 30, 2022. 8. Mrs. Grocer’s only sources of income for 2023 are employment income of $23,000 for September to December employment and RRSP income of $2,000, which she withdrew from her spousal RRSP in August 2023.

Comprehensive Section

403

Introduction to Federal Income Taxation in Canada

608

Note: Assume that the applicable prescribed rates are as follows: 4th quarter 2022 . . . . . . . . . . . . . . . . . . . . . . . . . .

1st quarter 2023 . . . . . . . . . . . . . . . . . . . . . . . . . .

2nd quarter 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . 3rd quarter 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . 4th quarter 2023 . . . . . . . . . . . . . . . . . . . . . . . . . .

4% 4% 4%

— REQUIRED Compute Mr. Grocer’s federal income tax payable for 2023 showing all necessary calculations.

Problem 17 Scrum Limited is a Canadian-controlled private corporation (CCPC) started by Lach Forward with an investment in common shares equal to their paid-up capital of $150,000. Lach is the only shareholder of the company and would like to retire from the business. He is considering several alternatives for the disposition of the business. The corporation is taxable at a total corporate rate of 20% on its active business income eligible for the small business deduction and 502/3% initially on its investment income (including the 10 2/3% refundable tax on CCPC’s investment income). Lach has never had any capital gains or losses personally. The following is a projected balance sheet with estimated fair market values at the expected date of disposition. Scrum Limited Balance Sheet as at December 31, 2023 Assets Current assets Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

47,000

Marketable securities at cost (FMV: $35,000) . . . . . . .

65,000

RDTOH . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Inventory at cost (FMV: $82,000) . . . . . . . . . . . . . . . .

10,000 114,000 $ 236,000

FiXed assets Land at cost (FMV: $460,000) . . . . . . . . . . . . . . . . . . . Building at UCC (FMV: $1,600,000; Cost: $1,300,000)

220,000 1,120,000 $ 1,576,000

Liabilities and Shareholder’s Equity Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Shareholder’s equity

$ 134,000

Paid-up capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital dividend account . . . . . . . . . . . . . . . . . . . . . . Other surplus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

150,000 85,000 1,207,000 $ 1,576,000

FMV = fair market value UCC = undepreciated capital cost RDTOH = refundable dividend tax on hand

Comprehensive Section/Study Guide — Comprehensive Case Problems

609

— REQUIRED (A) If Lach sells the assets on the open market and winds up the corporation immediately thereafter, what would be the net amount available for distribution to him after paying all liabilities? Assume 2023 corporate and personal tax rates for all calculations. Also assume that the company is not associated with any other corporations and that all of the corporation’s income has been taxed at the low corporate rates over the years. Show all computations. (B) If these funds are distributed to Lach, determine the nature of the distribution to him for tax purposes and its components. (C) Determine the amount that Lach would retain from this distribution after tax. Assume that Lach’s marginal tax rate on income from this transaction is 44% (including Provincial Tax). (D) How would this retention after taxes compare with the retention from a sale of the shares of the company for $2,000,000?

Problem 18 Fine Foods Inc. is a Canadian company owned 60% by Dom Delicious and 40% by his friends and relatives. All shareholders are Canadian residents. The company is a retailer of specialty foods. You are the auditor for Fine Foods Inc. and have been given the following income statement which has been prepared for financial accounting purposes for the fiscal year ended December 31, 2023. Fine Foods Inc. Income Statement for the Year Ended December 31, 2023 $ 2,850,000 1,200,000

Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 1,650,000 780,000

Operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

870,000 210,648

Net income before taxes . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 1,080,648

Additional Information: 1. Administrative expenses include the following items: (a) amortization $26,050; (b) landscaping of grounds, $8,000; (c) payments of $9,500 made to the company’s lawyer and bank in the course of obtaining a threeyear second mortgage on the company’s head office building. The company used the funds for its business operations; and (d) racquet club memberships totaling $9,500 for both Dom and the Vice-President, Marketing 2. Other income includes the following items: (a) taxable dividends of $60,000 from sundry portfolio investments in Canadian public companies; (b) a capital dividend of $5,000 from Good Grub Corp., a Canadian company of which Fine Foods Inc. owns 1%; (c) gain on sale of land, building and equipment of $96,000; (d) interest income of $12,000 received from an associated corporation, Fine Wine Corp., which deducts the interest payments in computing its income from an active business carried on by it in Canada; (e) interest of $5,000 on a two-year guaranteed investment certificate; and

Comprehensive Section

Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cost of sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Introduction to Federal Income Taxation in Canada

610

(f) net rental income of $22,000 earned from renting out 10% of the company’s warehouse for the annual three-month slow period. 3. The non-eligible refundable dividend tax on hand account balance at December 31, 2022 was $25,000. The non-eligible dividend refund for 2022 was $5,000. The capital dividend account balance as at December 31, 2022 was $4,000. The eligible refundable dividend tax on hand balance at December 31, 2022 was $0. 4. Undepreciated Capital Cost (UCC) of depreciable assets at December 31, 2022 Class 1 . . . . . . . . . . . . . . . . . .

$ 99,000

Class 3 . . . . . . . . . . . . . . . . . . Class 8 . . . . . . . . . . . . . . . . . .

210,000 2,000

5. The proceeds from the sales of the land, building, and equipment were $50,000, $80,000, and $2,500, respectively. These were the only assets disposed of during the year. The land, building, and equipment cost $20,000, $50,000, and $3,000, respectively. The land and building are an old property that was acquired in 1987 and as a result the building is included in Class 3 for Capital Cost Allowance (CCA) purposes. The Class 3 building was not the last asset in the class. 6. On December 15, 2023, Fine Foods Inc. purchased a new $40,000 automobile. The automobile is to be used by Dom who negotiates contracts for the company. This was the only asset acquired by the company during the year. 7. The company paid its shareholders non-eligible taxable dividends of $30,000 on January 31, 2023. 8. The business limit, for small business deduction purposes, allocated to Fine Foods Inc. is $150,000. 9. Fine Foods Inc. took immediate write-off of $1,200,000 of eligible depreciable property purchased in the year. — REQUIRED (A) Compute the federal Part I tax payable by the company for the 2023 taxation year. (B) Compute the refundable dividend tax on hand balance at the end of the year and the dividend refund for the taxation year. (C) Compute the maximum capital dividend that can be paid to the shareholders.

Problem 19 Ottawa Associates Inc. is a business that was set up 25 years ago by Grant Carter to provide consulting services to the federal government. When the economy was good, the company was able to generate substantial profits. Currently, the profits are appro Ximately $550,000 before tax. Grant feels that the company is worth $1,200,000 based on the income it is generating. Grant is 50 years old this year. When he started the business, another shareholder, John Price, owned the other 50% of the shares. Each shareholder invested $10,000 of cash into the corporation as share capital. Initially, their working relationship had been excellent, but John had wanted to branch out into other areas of consulting, while Grant wanted to concentrate on government consulting. Fifteen years ago, they had agreed to go their separate ways and Grant had bought John’s shares from him for $30,000. Grant’s wife, Betty, does not work in the business directly. However, she does receive a salary for her work as secretary-treasurer of the corporation and for the time she spends on charitable activities, which is sometimes of benefit to Grant in his business. Grant would like to involve Betty in the ownership of the business, unless there are any problems with this. Grant and Betty’s two children, Scott and Kelly, are 21 and 16 years old, respectively. Scott is in university at Queen’s and Kelly is in high school in Ottawa. At this point, it is not certain whether Scott and Kelly will join Grant in the business, but both are open to the possibility. Both work in the business during the summer holidays and are paid enough to cover their schooling costs. Grant and Betty are now planning to build the cottage they have always wanted. They feel they need a place to unwind on the weekends and, also, they want a place for the children to come back to once they have left home. They see the cottage as a family gathering place. The land and construction costs are going to be approXimately $200,000. Although they have that much extra cash in the

Comprehensive Section/Study Guide — Comprehensive Case Problems

611

corporation, they do not want to pay tax on the dividends to get the cash out. As a result, they plan to take out a mortgage to finance the cottage and pay it off over 10 years from Grant’s bonus cheques. Please provide your recommendations. Assume a total corporate tax rate on income not eligible for the small business deduction of 27% (i.e., 15% federal and 12% provincial). Assume that Grant is in the 50% marginal tax bracket.

Problem 20 Mr. Soul Proprietor has come to you asking your advice on incorporating his second-hand book business, which he began in 2009. Soul has three bookstores under the name Slightly-Dirty Books and is considering further expansion in the future. Soul provides you with the following financial statements. SLIGHTLY-DIRTY BOOKS BALANCE SHEET as at December 31, 2023 Assets Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accounts receivable (net of $100 reserve) . . . . . . . . . . . . . . . Inventory — at cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Land — at cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Buildings (Note (1)) .................................................. $360,000 Less: accumulated depreciation ................................191,000

$ 2,000 500 40,000 80,000 169,000

Office equipment (Note (1)) . . . . . . . . . . . . . . . . $ 20,000 Less: accumulated depreciation ................................12,000

8,000

Goodwill (Note (2)) . . . . . . . . . . . . . . . . . . . . . .

7,500 $307,000

$ 7,500 5,000 1,200 8,000

$ 21,700

Long-term Mortgages on building at 101/2% . . . . . . . . $150,000 Less: current portion . . . . . . . . . . . . . . 8,000

142,000 $163,700 143,300

Capital — S. Proprietor . . . . . . . . . . . . . . . . . .

$307,000 INCOME STATEMENT for the year ended December 31, 2023 Sales: — used books ........................................................ $230,000 — magazines . . . . . . . . . . . . . . . . . . . . . . . . . 40,000 — tobacco and sundries . . . . . . . . . . . . . . . . . 80,000

$350,000

Cost of sales: — opening inventory . . . . . . . . . . . . . . . . . . . . $ 23,000 — purchases — net .................................................. 260,000 — closing inventory . . . . . . . . . . . . . . . . . . . .

$283,000 40,000

243,000 $107,000

Comprehensive Section

Liabilities and Capital Liabilities: Current Accounts payable . . . . . . . . . . . . . . . . . . . Bank loan . . . . . . . . . . . . . . . . . . . . . . . . Accrued liabilities . . . . . . . . . . . . . . . . . . Current portion of long-term debt . . . . . .

Introduction to Federal Income Taxation in Canada

612 Selling costs: — Wages (Note (3)) . . . . . . . . . . . . . . . . . . . .

$ 35,000

— Property taxes . . . . . . . . . . . . . . . . . . . . . .

5,000

— Utilities and heat . . . . . . . . . . . . . . . . . . . .

3,000

— Insurance . . . . . . . . . . . . . . . . . . . . . . . . . .

1,000

— Others . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3,000

47,000

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 60,000

Notes to Financial Statements: (1) The buildings and equipment were in classes 1 and 8, respectively. The book value is equal to undepreciated capital cost (UCC) and depreciation expense for accounting purposes has been equal to capital cost allowance (CCA) in each year. (2) The goodwill was purchased when Soul bought out another bookstore this year. The balance sheet amount reflects the UCC. (3) The wages expense includes $10,000 paid to Mrs. Proprietor and $5,000 (total) paid to his two children, ages 19 and 16, who work on a part-time basis at the store. Additional Information: (1) Soul has withdrawn approXimately $35,000 each year from the business. (2) Soul has contributed the maximum amount to a spousal Registered Retirement Savings Plan (RRSP) annually. Assume that Soul’s earned income for RRSP purposes for 2022 was $35,000. (3) Soul has a net capital loss of $25,000 that arose in December 2022. (4) Soul is considering further expansion of his business and expects additional net income of $12,000 for each store that he adds. (5) The fair market values of the assets shown on the balance sheet are as follows: Accounts receivable . . . . . . . . . . . . . . . . . .

500

Inventory . . . . . . . . . . . . . . . . . . . . . . . . . .

40,000

Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

140,000

Buildings . . . . . . . . . . . . . . . . . . . . . . . . . .

360,000

Equipment . . . . . . . . . . . . . . . . . . . . . . . . .

3,000

Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . .

20,000

— REQUIRED Prepare a memo outlining the tax implications of the impending incorporation in a province with a 4% corporate tax rate in income eligible for the small business deduction, including: — taxation of income in a proprietorship vs. a corporation; — transfer of business assets and liabilities to a corporation; — other considerations. Ignore Canada Pension Plan (CPP) and the application of personal tax credits (except for the dividend tax credit) in your computations. Assume the personal tax rates are as set out in Chapter 10 of the textbook.

Comprehensive Section/Study Guide — Comprehensive Case Problems

613

Problem 21 Ever EZ Ltd. is a Canadian-controlled private corporation (CCPC) that carries on business in Canada. All of the issued shares are owned by Mr. EZ. The income statement for the year ended December 31, 2023 is as follows: Ever EZ Ltd. Income Statement For the Year Ended December 31, 2023 Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$3,000,000

Cost of sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

800,000

Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$2,200,000

Selling and administrative expenses . . . . . . . . . . . . . . .

1,200,000

Operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$1,000,000

Other income and expenses . . . . . . . . . . . . . . . . . . . . .

56,000

Income before income taxes . . . . . . . . . . . . . . . . . . . . .

$ 944,000

During the audit of Ever EZ Ltd., which takes place in April 2024, the following information is obtained: 1. Selling and administrative expenses include the following: Salesperson bonuses based on 2023 sales, not paid as at the time of the audit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 200,000

Management bonuses, not paid as at the time of the audit: Mr. EZ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 300,000

Mr. Jack, the controller, not related to Mr. EZ . . . . . . . . . .

100,000

400,000

Golf club annual dues for Mr. EZ . . . . . . . . . . . . . . . . . . . .

2,000

Golf club annual dues for the sales manager . . . . . . . . . . .

1,500

Community service club membership for the sales manager

200

Fitness club membership for the controller . . . . . . . . . . . .

800

4,500

Travel expenses for which the salespersons were reimbursed: Meals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

8,000

Accommodation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6,000

Air fare . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

13,000

27,000

Entertainment expenses for which the salespersons were reimbursed: Cocktails . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2,000

Lunches and dinners . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

800

Tickets to baseball games . . . . . . . . . . . . . . . . . . . . . . . . .

2,400

Automobile allowances for the salespersons . . . . . . . . . . . . . . .

5,200 15,960

Advertising: Advertising space in the June 2023 issue of a foreign magazine aimed at the Canadian market . . . . . . . . . . . . . . Advertising space in the November 2023 and February 2024 issues of a Canadian magazine . . . . . . . . . . . . . . . . .

8,000 13,000

21,000

Donations to registered charities . . . . . . . . . . . . . . . . . . . . . . .

66,000

Amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

180,000

Comprehensive Section

Club membership fees and dues:

614

Introduction to Federal Income Taxation in Canada Accounting fees: For the audit of the financial statements . . . . . . . . . . . . . . For a five-year projection required by the bank to approve long-term financing for the new warehouse . . . . . . . . . . . .

$ 12,000 4,000

Premium on term insurance on the life of Mr. EZ with the company as the beneficiary. The life insurance policy was required as collateral for the mortgage on the warehouse Interest expense: January 1 to April 30 on loans to cover materials and labour for the new warehouse during the period of construction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . May 1 to December 31, mortgage interest on the new warehouse . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

16,000

2,600

$ 28,000

July 1 to December 31 for the purchase of a new automobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

42,000 2,000

$ 72,000

2. EZ Ltd. employs four salesmen. Each salesman drove 7,000 kilometres for employment purposes in 2023. As the automobile allowances are based on a per km rate of $0.62, which is considered reasonable, these are not reported as a taxable benefit to any of the salespersons involved. 3. EZ Ltd. always claims the maximum capital cost allowance (CCA) possible under the Income Tax Act. The controller calculated the CCA for 2023 to be $200,000. In calculating the $200,000, the controller forgot to calculate CCA on the following items: (a) Ever EZ Ltd. spent $30,000 in 2023 on improvements to the office building, which it leases. The lease is a three-year lease that commenced March 1, 2023 with two threeyear renewal options. (b) Ever EZ Ltd. purchased land for $80,000 and built a new warehouse costing $700,000 on it in 2023. It was completed April 30, 2023. The land and building have been included on the balance sheet at cost. The cost of the building was calculated as follows: Materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$316,000

Labour . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

320,000

Utilities service connection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Landscaping . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

14,000 50,000 $700,000

4. Included in the caption ‘‘other income and expenses’’was a gain of $100,000 on the sale of shares of a long-term investment. Ever EZ Ltd. had paid $20,000 for the shares when purchased in 2012. It sold them for $120,000 in 2023. Ever EZ Ltd. received a down payment of $30,000 on the sale. The remainder of the proceeds are due in $18,000 instalments on January 31, each year, commencing January 31, 2024. 5. Also included in the caption ‘‘other income and expenses’’ were the following dividends: Eligible dividends received from taxable Canadian corporations (less than 5% of the issued shares owned by Ever EZ Ltd.) . . . . . . . . . Eligible dividends received from taxable Canadian corporations

$ 12,000

(25% of issued shares owned by Ever EZ Ltd.) . . . . . . . . . . . . . . . . . . . Dividends received from foreign corporations (less than 5% of the issued shares owned by Ever EZ Ltd.) . . . . . . . . .

43,000 5,000 $ 60,000

Comprehensive Section/Study Guide — Comprehensive Case Problems

615

6. Ever EZ Ltd. wound-up its wholly-owned subsidiary, ‘‘Sub Ltd.’’ on March 31, 2022. At that time, Sub Ltd. had the following unused losses:

Fiscal year ended December 31, 2020 . . . . . . . . . . Fiscal year ended December 31, 2010 . . . . . . . . . .

Non-capital

Net Capital

$200,000

— $ 27,500

7. In 2022, Ever EZ Ltd. incurred Scientific Research and E Xperimental Development (SR&ED) expenditures of a current nature of $500,000. Only $200,000 of this expenditure was deducted for tax purposes in 2022. Investment tax credits of $175,000 related to the $500,000 expenditures were claimed on the 2022 tax return. No further SR&ED expenditures were made in 2023. — REQUIRED (A) Reconcile the income, as stated in the income statement, to net income for income tax purposes on the assumption the corporation wishes to minimize both net income and taxable income. Show all your calculations. (B) Reconcile net income, as calculated in Part A, to taxable income.

Problem 22 Fred Famished has just telephoned you to ask you about an opportunity he has to acquire another business. Fred is the president of Tasty Foods Inc. (Tasty), an extremely successful company which owns a chain of fast food restaurants across Canada. Fred has been concerned with the rising cost of food supplies for his restaurants. In your conversation, he told you that he was considering purchasing all of the shares of Yummy Supplies Ltd. (Yummy), a restaurant supply business, which supplies many of Tasty’s restaurants. Yummy has recently incurred losses from its operations. Fred feels that this was due to poor management of the business; with the right people in charge of the company, Fred feels that it could be restored to profitability.

Taxation Year Ended

Net Capital Losses

Non-Capital Losses (from business)

December 31, 2022 December 31, 2021

$20,000 $55,000

$250,000 $450,000

Fred proposes that Tasty buy the shares of Yummy on July 16, 2023. It is estimated that Yummy has incurred additional business losses of $120,000 in the period January 1, 2023 to July 15, 2023. The following information about Yummy’s fi Xed assets as at July 15, 2023 was also included in the e-mail: Assets

Cost

UCC

FMV

Land . . . . . . . . . . . . . . . . . . . . . . . . . Class 1 . . . . . . . . . . . . . . . . . . . . . . .

$200,000 400,000

N/A $350,000

$500,000 450,000

Class 8 . . . . . . . . . . . . . . . . . . . . . . . Class 10 . . . . . . . . . . . . . . . . . . . . . .

80,000 90,000

50,000 80,000

60,000 20,000

Inventory . . . . . . . . . . . . . . . . . . . . . Marketable Securities . . . . . . . . . . . .

200,000 12,000

N/A N/A

100,000 8,000

UCC = undepreciated capital cost FMV = fair market value Fred is very excited about the acquisition of Yummy. In particular, he feels the losses of the company will be helpful in the future to save income taxes.

Comprehensive Section

Fred has just sent you the following information about Yummy:

616

Introduction to Federal Income Taxation in Canada

— REQUIRED (A) Fred has asked you about the income tax implications to Yummy with respect to Tasty’s acquisition of the shares of Yummy. Discuss these implications, supporting your answer with calculations where necessary. (B) Fred is interested in using the losses of Yummy to reduce taxes on the profits of Tasty. Advise him if this is possible and, if so, how he could use these losses.

Problem 23 Belleville Furniture Inc. (‘‘Belleville’’) is a manufacturer of high-quality dining room furniture. This is the second generation of the Parker family that has owned the company, and the founder’s son, Dave Parker, is having some problems since foreign imports are being brought into Ontario and sold at a price lower than Belleville’s cost. Dave is certainly concerned about the short term, but feels that within the next eight to twelve months Belleville can adjust its sourcing of raw materials and the manufacturing process in order to reduce its costs to the point where it can be competitive, not only in the local market, but also in the Northeastern United States. Dave’s immediate problem is that when he asked the bank to increase Belleville’s operating line of credit enough to cover Belleville’s operational problems for the next eight to twelve months, the bank became concerned since its sole security for the operating loan is the inventory and the under 90-day accounts receivables. To maintain the existing line of credit, and to even consider the increase, the bank wants personal guarantees from both of Dave and his wife, Nancy, as well as a collateral mortgage on the company’s building. As a result, Dave has you working on cash flow projections to support the loan, his lawyer is preparing the collateral mortgage, and an appraiser is preparing a valuation of the property. Dave feels that his chances of being approved are good. Dave has agreed that he will sell the 20% interest that he personally owns in a company that operates a lumber mill that supplies Belleville. Dave bought the shares from the company on incorporation five years ago for $50,000 to help the arm’s length supplier start the lumber mill. The other 80% of the company is owned by the supplier who has agreed to have his holding company buy the shares from Dave for $40,000 in cash. Dave had borrowed all the money for this investment through an interest-only demand loan with the bank. The bank has agreed to leave the full amount of the loan outstanding as long as Dave contributes the full $40,000 of proceeds into Belleville. To prepare for its entry into the U.S. market, Belleville will set up a U.S. dollar bank account at its local bank for deposits from U.S. customers. Dave would like your advice on the tax implications of his situation.

Comprehensive Section/Study Guide — Solutions to Comprehensive Case Problems

617

SOLUTIONS TO COMPREHENSIVE CASE PROBLEMS [NOTE: Solutions ignore effect of leap year where applicable]

Problem 1 Net income per income statement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

8,688,286

Add: Provision for income tax — current — current ................................................................................... $ 2,352,000 — deferred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

540,000

Amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

230,000

Loss on sale of portfolio investments . . . . . . . . . . . . . . . . . . .

52,400

Reserve — decline in market price on inventory . . . . . . . . . . .

57,000

Cost associated with valuation of land sold . . . . . . . . . . . . . . .

2,800

Donations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

64,000

Advertising in a foreign magazine . . . . . . . . . . . . . . . . . . . . .

13,375

Membership in private clubs . . . . . . . . . . . . . . . . . . . . . . . . .

3,200

Cost of reorganization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

16,000

Non-deductible portion of meals and entertainment ($12,000 × 50%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest on deficient tax instalments . . . . . . . . . . . . . . . . . . . Taxable capital gain on land ($202,800 -- 65,000 -- 2,800) × 1/2

6,000 1,200 67,500

Amortization of bond premium . . . . . . . . . . . . . . . . . . . . . . . .

375

Taxable capital gain on building ($60,000 -- 50,000) × 1/2 . . . .

5,000

3,410,850

Deduct: Profit on sale of fiXed assets . . . . . . . . . . . . . . . . . . . . . . . . . $ 100,000 Equity income from an associated company . . . . . . . . . . . . . .

92,096

Gain on sale of land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

189,800

Capital cost allowance (Note 1) ....................................................... 2,404,150 Allowable capital loss — portfolio investments [($7,600 -- $60,000) × 1/2] . . . . . . . . . . . . . . . . . . . . . . . . . . 26,200 Division B Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(2,812,246) $

9,286,890

Items not included: (i) Connection of gas line — deductible under par. 20(1)(ee). (ii) Premium for life term insurance policy on president — deductible because it is used as collateral for the loan. (iii) Employee training seminar expenses — deductible as a cost of doing business. (iv) Cost of Christmas party to which all employees were invited — deductible as a cost of doing business and not limited under sec. 67.1. (v) Bond interest paid/accrued for 2023 is deductible per par. 20(1)(c). Interest on municipal property taxes — deductible if used as alternative financing. (vi) Dividends are included in Division B income and therefore no adjustment is required. (vii) The capital losses on the disposition of the truck and equipment are denied.

Comprehensive Section

$ 12,099,136

Introduction to Federal Income Taxation in Canada

618 Notes: 1. CCA schedule. Cl. 1: 4%

Cl. 8: 20%

Cl. 10: 30%

UCC, start of year . . . . Add: purchases . . . . . . . Add: accelerated investment incentive . . . . . . . Deduct: disposal of equipment (LOCP) . . . . Deduct: disposal of truck (LOCP) . . . . . . . . Deduct: disposal of equipment (LOCP) . . . . Deduct: disposal of building (LOCP) . . . . . .

$225,000

$ 55,000 550,000

UCC before CCA . . . . . . CCA — regular . . . . . . . CCA — AII full expensing . . . . . . . . . . . . . . . CCA — immediate expensing . . . . . . . . . . Deduct: accelerated investment incentive

$175,000 $530,000 (7,000)

UCC, end of year . . . . .

$166,250

Cl. 14.1: 5%

Cl. 53: 50%

Total

$ 354,000 $ 0 $190,000 1,000,000 16,000 700,000 8,000 (7,500) (25,000)

(75,000) (50,000) $1,329,000 $ 24,000 $882,500 (108,450) (1,200) (95,000) ($ 211,650) (692,500) (530,000)

(692,500)

(970,000)

(1,500,000) (8,000)

$ 250,500

$ 14,800

$ 95,000

$(2,404,150)

Notes to CCA: 1. The ‘‘accelerated investment incentive’’ amends certain CCA rules effective for eligible property acquired after November 20, 2018. These rules remain in effect through 2028, subject to phase-out rules for 2024 through 2027. ●

There is a 50% adjustment to additions made.

●

There is no half-year rule applied.

●

The end result is to allow for 3 X the CCA otherwise calculated under the old rules that applied the half-year rule. As part of this regime, certain classes, including class 53 became eligible for ‘‘full expensing’’ of additions within the same period. Therefore, the addition to class 53 is fully expensed in the year, net of the disposal. The opening balance is subject to the regular 50% declining balance calculation.

2. The April 19, 2021 Federal Budget introduced an ‘‘immediate expensing regime’’ for certain eligible property purchased by CCPCs on or after the budget date, provided that it is available for use before January 1, 2024. Eligible property includes capital property that is subject to the CCA rules, with the exception of property in classes 1 through 6, 14.1, 47, 49 and 51. The maximum annual write-off available is $1,500,000, to be shared amongst members of an associated group of CCPCs. In this problem, the class 8 and class 10 purchases are eligible. The class 10 immediate expensing is limited to $970,000 because of the $1.5 million overall limit for the year.

Problem 2 Employment income Salary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Toronto social club membership (assumed for benefit of company) Imputed interest ($500,000 × 5% × 61/365)(1) . . . . . . . . . . . . . . . . . Standby charge 2/3 × ($15,000 -- $1,000) . . . . . . . . . . . . . . . . . . . . . . Operating costs ($0.33 × 80% of 20,000 km)(2) . . . . . . . . . . . . . . . . . Registered pension plan and medical plans (not taxable) . . . . . . . . . .

$350,000 0 4,178 9,333 5,280 0 $368,791

Comprehensive Section/Study Guide — Solutions to Comprehensive Case Problems Property income Rental — property 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — property 2 (loss prior to claiming CCA $16,000 -- $8,000)

$ 3,000 (8,000)

Recapture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

10,000

CCA limited to rental income (max: $8,000 (given) on property 2) . . .

$ 5,000 (5,000) $

Dividends from taxable public Canadian corporations ($8,000 × 1.38) Dividends — U.S. corporations (gross) ($3,400/(1-15%)) . . . . . . . . . .

619

0 11,040 4,000 2,650

Stock dividend — X Ltd. Shares ($1,920** × 1.38) . . . . . . . . . . . . . . Attributed interest — wife . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 16-year-old son(3) . . . . . . . . . . . . . . . . . . . . . . Attributed dividend — wife ($1,500 × 1.38) (public company shares sold for less than FMV) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

20,000 3,000 2,070 $ 42,760

Net taxable capital gains: Rental property (($200,000 -- $70,000) -- $10,000)) × 1/2 . . . . . . . . . .

$ 60,000

Shares — X Ltd. ($10,000 -- ((100 × $21.55)** -- $300)) × 1/2 . . . . . . Shares — Y Ltd. — wife (500 × ($5 -- $5))*** . . . . . . . . . . . . . . . . . . — son (500 × ($15 -- $5))**** × 1/2 . . . . . . . . . . . . .

3,773 0 2,500 0 0

Antique table — ($1,000 -- $1,200) personal use property loss = NIL Antique clock — ($1,000 -- $1,000) . . . . . . . . . . . . . . . . . . . . . . . . . . Jewellery — ($1,600 -- $1,000) × 1/2 . . . . . . . . . . . . . . . . . . . . . . . . . . Sailboat — $2,625* × 1/2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Shares — Y Ltd. — wife ($5 -- $5)*** . . . . . . . . . . . . . . . . . . . . . . . . . — son ($15 -- $5)**** × 1/2 . . . . . . . . . . . . . . . . . . . .

300 1,313

Net taxable capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 67,886

Comprehensive Section

0 2,500

* Sailboat Proceeds of Disposition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Adjusted cost base . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

32,000 (25,000)

Capital Gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

7,000

Reserve — lesser of (1) 4/5 × $7,000 = $5,600 (2) $20,000/$32,000 × $7,000 = $4,375 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital Gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(4,375) $

** Adjusted Cost Base of X Ltd. Shares 2015: 200 shares (purchase) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2,625

Dollars

8,000

200

2016: 20 shares (10% stock dividend)(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

200

2018: 500 shares (purchase) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

11,400

500

2020: 1200 shares (purchase) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2023: 192 shares (10% stock dividend) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

24,000 1,920

1,200 192

45,520

2,112

21.55

Weighted average cost per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . *** Mr. Rich did not elect out of the rollover in ssec. 73(1).

**** Section 69 applies to deem proceeds to be equal to the fair market value of the property.

Introduction to Federal Income Taxation in Canada

620 — NOTES TO SOLUTION

(1) No interest paid in 2023, therefore no reduction in the imputed interest benefit. (2) As business use of the vehicle is less than 50%, Mr. Rich may not elect to include 50% of the standby charge (assuming it were more beneficial to do so) in lieu of the operating cost benefit determined by the $0.33 per km alternative. (3) Note that if Mr. Rich had loaned the funds to his adult children (instead of giving them the funds) and it can reasonably be considered that one of the main reasons for making the loan was to reduce or avoid tax, interest income would be attributed to Mr. Rich under ssec. 56(4.1). (4) A stock dividend received has an ACB equal to the increase in paid-up capital on the issue.

Problem 3 Net income after taxes, per income statement ...............................................................$238,000 Add: Par. 18(1)(a)

Provision for income taxes . . . . . . . . . . . . .

$91,000

Sec. 10

EXcess of FIFO over LIFO (Dec. 31, 2023)

63,000

Par. 18(1)(e)

Reserve — decline in market prices on inventory . . . . . . . . . . . . . . . . . . . . . . . .

35,000

Ssec. 147.2(1)

Disallowed RPP deduction (Schedule 1) . . .

1,800

Par. 20(1)(e)

80% of equipment financing issue costs of $4,900 . . . . . . . . . . . . . . . . . . . . . . . . . .

3,920

Par. 18(1)(b)

Amortization of bond discount . . . . . . . . . .

700

Par. 18(1)(l )

Membership in social clubs . . . . . . . . . . . . .

2,800

Ssec. 18(9)

Prepaid advertising . . . . . . . . . . . . . . . . . .

17,500

Par. 18(1)(a)

Charitable donations . . . . . . . . . . . . . . . . .

11,200

Sec. 3

Book loss — securities ($10,500 - $7,000)

3,500

Sec. 3

— equip. ($15,000 - $11,200) . . . .

3,800

Sec. 3

— trucks ($4,200 - $1,300) . . . . .

2,900

Sec. 38

Taxable capital gain — patent [1/2 × ($70,000 -- $45,000)] . . . . . . . . . . .

12,500

Sec. 38

Taxable capital gain — Government license [($35,000 -- 8,000) X 50%] . . . . . . . . . . . .

13,500

Ssec. 13(1)

Recapture — patent (Schedule 2) . . . . . . . .

9,100

Ssec. 9(3)

Writedown of wholly owned subsidiary . . . .

52,500

Par. 18(1)(b)

Cost of reorganization (added to Class 14.1) . . . . . . . . . . . . . . . . . . . . . . .

12,600

Par. 18(1)(b)

Depreciation . . . . . . . . . . . . . . . . . . . . . . . .

55,000

392,320 $630,320

Deduct: Sec. 10

EXcess of FIFO over LIFO (Dec. 31, 2022)

Sec. 38

ACL — securities ($7,000 -- $10,500) × 1/2

(45,500) (1,750)

Sec. 3

Book gain — patent ($70,000 -- $3,500) . . .

(66,500)

— licence ($35,000 -- $700) . . . .

(34,300)

Par. 20(1)(a)

CCA (Schedule 2) . . . . . . . . . . . . . . . . . . .

(125,093)

Ssec. 20(16)

Terminal loss — trucks (Schedule 2) . . . .

(200) (240,093)

Division B income ..............................................................................................................$390,227

Comprehensive Section/Study Guide — Solutions to Comprehensive Case Problems

621

Schedule 1: RPP deductible contribution is the least of:

(1) Total of employer and employee contributions (2) 18% of employment compensation . . . . . . . . . (3) Dollar limit . . . . . . . . . . . . . . . . . . . . . . . . . .

$16,700 23,400 31,560

$12,800 12,600 31,560

$10,600 9,000 31,560

Least is . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$16,700

$12,600

$ 9,000

Total employer and employee contributions

$16,700

$12,800

$10,600

$ 1,600

$ 1,800

Non-deductible employer contributions . . . . . . . . .

200

Schedule 2: Cl. 1: 4%

Cl. 8: 20%

Cl. 10: 30%

Cl. 12: 100%

UCC, start of year . . . . . . . . . . . . . . . . . . . . . Add: Purchases . . . . . . . . . . . . . . . . . . . . . . . Add: Accelerated investment incentive . . . . . Deduct: Disposals . . . . . . . . . . . . . . . . . . . . .

$ 49,000 315,000 157,500

$ 8,400

$ 1,500

UCC before CCA . . . . . . . . . . . . . . . . . . . . . . Deduct: CCA for 2023 . . . . . . . . . . . . . . . . . Terminal loss . . . . . . . . . . . . . . . . . . . . . . . . Deduct: Accelerated investment incentive

$521,500 $ 8,400 $ (20,860) (1,680)

UCC, end of year . . . . . . . . . . . . . . . . . . . . .

$343,140

$ 6,720

Cl. 13: S.L.

Cl. 14: S.L.

Cl. 14.1: 5%

$ 35,900

(1,300) 200

$ 16,000 (16,000)

(200) (157,500)

0 7,000 3,500

Cl. 53: 50%

$ 29,650 $ 15,750 12,600 $ 87,000 2,300 (45,000) (8,000) (11,200)

UCC before CCA .................................................... $ 10,500 $ (9,100) Deduct: CCA for 2023 . . . . . . . . . . . . . . . . . (1,050) Recapture . . . . . . . . . . . . . . . . . . . . . . . . . . 9,100 Deduct: Accelerated investment incentive . . . (3,500)

$ 36,550 $ 91,550 (1,828) (83,675)

UCC, end of year . . . . . . . . . . . . . . . . . . . . .

$ 32,422

$ 5,950

(2,300) $ 7,875

Total CCA for 2023 = $130,693 Terminal loss = $200 Recapture = $9,100 Notes: 1. The ‘‘accelerated investment incentive’’ amends certain CCA rules effective for eligible property acquired after November 20, 2018. These rules remain in effect through 2028, subject to phase-out rules for 2024 through 2027. 2. Class 1 – The new accelerated investment incentive permits an additional allowance of 50% × $315,000 (the 2023 addition) to be added to the class for CCA purposes. 3. Class 1 – The building must not have been previously in use on March 19, 2007 to receive either the 10% CCA rate for manufacturing buildings or 6% CCA rate for non-residential buildings. The building purchased in 2023 was constructed in 2001 and would not qualify for the enhanced deduction.

Comprehensive Section

UCC, start of year . . . . . . . . . . . . . . . . . . . . Add: Purchases . . . . . . . . . . . . . . . . . . . . . . Add: Accelerated investment incentive . . . . . Deduct: Disposals . . . . . . . . . . . . . . . . . . . . .

0 16,000

Introduction to Federal Income Taxation in Canada

622

4. Class 12 – Since the CCA rate is already 100% with no half-year rule for this addition, the new accelerated investment incentive is not applicable. 5. Class 13 – the new accelerated investment incentive permits an addition of $7,000 + 1/2 × $7,000 = $10,500 for purposes of calculating CCA, with no half-year rule. Therefore, the CCA for 2023 is $10,500/(5 years remaining + 5 years in first renewal period) = $1,050. 6. Class 14.1 – The government licence was sold in the current year for $35,000. The original cost was $8,000; therefore, we would remove the cost (lower of cost and proceeds) from the pool. The sale of government licence would also create a capital gain of $13,500 [50% × ($35,000 -- $8,000)]. 7. Class 14.1 – The new accelerated investment incentive applies to add an additional 50% equal to the 2023 addition of $12,600 less the 2023 disposal of $8,000 = 50% × ($12,600--8,000) = $2,300 for purposes of calculating CCA. The half-year rule does not apply on the current year net addition. 8. Class 53 – for the 2023 addition, the amount qualifies under the accelerated investment incentive for full expensing, net of the disposals. The opening balance in Class 53 is subject to the regular 50% rate for Class 53. Other Items (i) damages paid as part of a normal risk of doing business [par. 18(1)(a)] (ii) only 20% of costs of obtaining financing for machinery and equipment is deductible [par. 20(1)(e)]; remainder is deductible over next four years (iii) bond interest paid is deductible [par. 20(1)(c)] (iv) accrued bond interest is deductible, provided it is in respect of the year, which it is in this case [par. 20(1)(c)] (v) ads in South American magazine not prohibited because the magazine is not directed to a Canadian market [ssec. 19(1)] (vi) cash dividend included in Division B income [par. 12(1)(j )] (vii) charitable donations deductible under Division C, not Division B.

Problem 4 Part A

Par. 3(a)

Par. 3(b)

Income — employment . . . . . . . . . . . . . .

$100,000

— business . . . . . . . . . . . . . . . . .

8,900

— property (Note 2) . . . . . . . . . .

3,423

— other ($8,251 + $1,490) . . . . . .

9,741

Y Ltd . . . . . . . . . . . . . . . . . . . . . . . . . . . LPP ($3,000 × 2 for full capital gain) . . .

500

$ 6,000

Less: carry forward (full capital loss) . . .

(2,000)

Net LPP gain . . . . . . . . . . . . . . . . . . . . .

$ 4,000

Taxable LPP gain ($4,000 × 50%) . . . . . .

2,000

PUP . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,000 $ 3,500

Less: X Ltd allowable capital loss . . . . . . .

(6,000)

0 $122,064

Par. 3(c)

Capital portion of annuity . . . . . . . . . . . .

(200)

CPP enhancement . . . . . . . . . . . . . . . . . .

(631)

Old Age Security benefits subject to clawback (Note 3) . . . . . . . . . . . . . . . .

(3,048)

(3,879) $118,185

Comprehensive Section/Study Guide — Solutions to Comprehensive Case Problems Par. 3(d )

ABIL — ABC Ltd. (no disallowed portion of BIL) . . . . . . . . . . . . . . . . . . . . . Rental loss . . . . . . . . . . . . . . . . . . . . . . .

(3,000) (11,000)

Income under Division B . . . . . . . . . . . . .

623

(14,000) $104,185

Division C deductions: Par. 111(1)(b) Net capital loss of $6,000 (limited to par. 3(b) net TCG)

Taxable income . . . . . . . . . . . . . . . . . . . .

$104,185

— NOTES TO SOLUTION 1. Subsection 82(3) is not considered because Mr. Debit gets a higher overall credit by using the equivalent-to-spouse credit. 2. Income from property: Canadian interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable dividends from Canadian public corporations ($560 × 1.38) Taxable dividends from U.S corporations (before foreign non-resident withholding tax) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 1,350 773 1,500 $ 3,623 (200) $ 3,423

3. OAS Clawback Lesser of:

EXcess . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . EXcess @ 15% . . . . . . . . . . . . . . . . . . . . . . . .

8,251

$ 107,233 (86,912) $

20,321 3,048

Part B

Federal tax on first . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . on next . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 53,359 50,826

$ 8,004 10,419

$ 104,185

$ 18,423

Less: Federal tax credits Basic personal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Spousal credit — Ms. Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(2,250) (1,280)

Caregiver amount — Ms. Credit’s mother . . . . . . . . . . . . . . . . . . . . .

(1,200)

Dependants — David (infirm but not over 18) . . . . . . . . . . . . . . . . . . Age . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(375) 0

Canada employment credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Employment Insurance premiums (15% of $1,002) . . . . . . . . . . . . . .

(205) (150)

CPP contributions (15% of ($3,754 -- $631) . . . . . . . . . . . . . . . . . . . (469) Pension [15% of $1,490; maximum $300] . . . . . . . . . . . . . . . . . . . . . . (224) Disability transfer — David [$1,414 basic + $825 supplement for <18 yrs old]................. (2,239) — Ms. Credit’s mother [Folio S1-F2-C2, par. 2.30] ............................... (1,414)

Comprehensive Section

(a) Old Age Security received . . . . . . . . . . . . . (b) Income under Division B (before 60(w) deduction for OAS clawback) . . . . . . . . . . . . . Less: threshold for the current year clawback

Introduction to Federal Income Taxation in Canada

624

Transfer of tuition fees — Donald . . . . . . . . . . . . . . . . . . . . . . . . . . . Transfer from spouse — pension credit not required to reduce taxes to NIL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Medical expenses — Mr. Debit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Medical expenses — Donald . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Charitable gifts (15% × first $200 + 29% of balance) . . . . . . . . . . . . Dividend tax credit (6/11ths of ‘‘gross-up’’ on eligible dividend) . . . . Basic federal tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: federal foreign tax credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . federal political contribution tax credit ($300 + 50% ($500 -- 400)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net federal tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Repayment of Old Age Security . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(450) (300) 0 (196) (262) (116) $ 7,293 (116) (350) $ 7,293 3,048

Total federal tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 9,885

— NOTES TO SOLUTION 1. Spousal Credit — Ms. Credit Mr. Debit can claim the spousal credit since Ms. Credit’s net income for tax purposes is below the base for the basic personal amount. Spousal Credit: Basic amount of spousal credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Spouse’s Division B net income . . . . . . . . . . . . . . . . . . . . . . . . Net amount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 15,000 (6,464) $ 8,536

2. Caregiver and Dependant Credits David qualifies for the Canada Caregiver credit for infirm children under age 18. Mrs. Debit’s mother qualifies for the Canada Caregiver credit for an infirm adult relative. 3. Tuition Transfer — from Donald Lesser of: (a) maximum transferrable tuition - $5,000 @ 15% . . . . . . . . . . . . . . . . . . $ 750 (b) student tuition paid -$3,000 @ 15%............................................................. 450 Lesser is . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 450

Since Donald’s net income for tax purposes is clearly below the base for the basic personal credit ($15,000). Donald requires none of his tuition credit to reduce his taxable income to 0. Therefore, Donald’s tuition credit can be transferred to Mr. Debit. 4. Pension Credit Transfer — from Mrs. Credit Since Mrs. Credit’s net income for tax purposes is clearly below the base for the basic personal credit ($15,000), Mrs. Credit requires none of her pension credit to reduce her taxable income to 0. Therefore, the maximum is transferable. BACKUP CALCULATIONS Age Credit base . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: base reduction of the lesser of: (a) age credit base . . . . . . . . . . . . . . . . . . . . . . . . . . . . (b) Division B income . . . . . . . . . . . . . . . . . . . . . . . . . . Less: current year threshold for age credit . . . . . . .

$8,396 $104,185 (42,335)

EXcess, at 15% . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 61,850

$ 8,396

9,277

Net age credit base . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Medical expense credit — Mr. Debit Eligible expenses: Premiums — private plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less the lessor of: (a) annual limit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (b) 3% × net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net eligible for tax credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(8,396) $

$ 380 $ 2,635 3,126

(2,635) 0

Comprehensive Section/Study Guide — Solutions to Comprehensive Case Problems Medical expense credit — Donald Eligible expenses:

625

$ 1,500

Less the lessor of: (a) annual limit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (b) 3% × net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 2,635 197

(197)

Net eligible for tax credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 1,304

Credit @ 15% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 196

Political Donation Tax Credit $300 + 50% of ($500 -- $400) Federal foreign Tax Credit Lesser of: (a) foreign non-business tax paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (b) $1,500/$104,185 × ($7,293 -- $116) . . . . . . . . . . . . . . . . . . . . . . . . .

$ 225 116

Lesser . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 116

The unused foreign taxes paid of $225 -- $116 = $109 can be claimed on a provincial tax return subject to a similar formula to the federal formula above and any balance still not claimed can potentially be claimed under ss. 20(11) as a deduction in computing income.

Problem 5 Part A

Salary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 100,000

Sec. 6(1)(k) Sec. 6(1)(e)

Operating benefit — car (election) . . . . . . . Standby charge . . . . . . . . . . . . . . . . . . . . . . .

962 1,925

Note (1) Note (2)

Sec. 6(1)(b)(v) Sec. 6(1)(b)

Travel allowance . . . . . . . . . . . . . . . . . . . . . . Moving allowance . . . . . . . . . . . . . . . . . . . . .

5,400 17,000

Note (3)

Sec. 6(9) Sec. 7(1)

Interest on debt . . . . . . . . . . . . . . . . . . . . . . Stock option exercised . . . . . . . . . . . . . . . . .

1,765 21,600

Note (4) Note (5)

Sec. 8(1)(h)

Less: Travel expenses . . . . . . . . . . . . . . . . . . . . . .

7,750

Note (3)

Employment income — Subdivision a . . . . .

$ 140,902

Note (6)

$ 148,652

Calculations and other explanations: (1) The operating costs using the elective method under subsection par. 6(1)(k) would result in a lower income inclusion. ($2,475 ($0.33 × 7,500 km) vs. $963 (50% × $1,925)). (2) The standby charge will be computed as: 7,500 km

× (2/3 × $7,700) = $1,925 20,004 km Ms. Janrayad is entitled to the standby charge reduction, since she uses the car for business greater than 50% of the total kilometres. (3) Allowances are dealt with in par. 6(1)(b), which includes all allowances in income with specified exceptions. Subparagraph 6(1)(b)(v) applies to persons who negotiate contracts such as Ms. Janrayad. The allowance must be reasonable in order for it not to be taxable.

Comprehensive Section

Sec. 5(1)

Introduction to Federal Income Taxation in Canada

626

Ms. Janrayad received the following allowances for travel expenses during 2023: Automobile allowance -- 70% × 25,000 kms × 62¢ = ....................................................$ Accommodation and meals allowance -- $450 × 12 = . . . . . . . . . . . . . . . . . . . . .

10,850 5,400

The 62¢ per kilometre is based solely on kilometres driven (spar. 6(1)(b)(X)) and it is reasonable (spar. 6(1)(b)(v)) given CRA’s guidance for the year. Therefore this allowance is not taxable. Her other actual travel expenses were $9,500 (i.e., $3,500 for meals, $6,000 for accommodation). Since her other actual travel expenses, which were reasonable, exceeded her $450 monthly allowance, this monthly allowance was not a reasonable amount. Therefore, the monthly allowance is included in income and she can claim her actual accommodation and meal expenses under 8(1)(h). However, the maximum amount deductible in respect of meals is the 50% fractional amount. Therefore, she can deduct the following: Meals (50% × $3,500) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $

1,750

Accommodation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6,000 $

7,750

No amount is deductible under paragraph 8(1)(h.1) in respect of motor vehicle expenses (i.e., insurance and gas and oil), because she was in receipt of an excluded allowance of 62¢ per kilometre. (4) The subsection 6(9) benefit as calculated under section 80.4 would be the sum of: A.

share loan — prescribed rate 4th quarter 5% × $35,000 × 92/365 = . . . . . . . . . . . . . . . . . . . . .

home relocation loan Lesser of the prescribed rate at the time of the loan (i.e., 4%) and the prescribed quarterly rate while the loan is outstanding in the year compared on a quarter-by-quarter basis

441

The resulting calculation is: 4% × $150,000 × 365/365 = . . . . . . . . . . . . . . . . . . . . . . . . .

6,000 $ 6,441

Less amounts paid: (a) 2% × $35,000 × 92/365 . . . . . . . . . . . . . . . . . . . . . . . . . (b) 3% × $150,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

176 4,500

4,676 $ 1,765

(5) There is no tax effect when Ms. Janrayad is granted the right to purchase shares through the stock option plan. When Ms. Janrayad exercises the stock option in respect of 3,600 shares in 2023, she is in receipt of employment income equal to the difference between the fair market value and the option price of the shares at the time of exercise. 3,600 shares × ($17 — $11) = $21,600 (6) An HST rebate would be available based on 2023 deductible expenses, calculated as: 13/113ths of $7,750 (meals and accommodation) .......................................................... $892 Paragraph 6(8)(a) would require the inclusion of the $892 rebate in 2024 employment income. Part B — Items excluded from computation of employment income in Part A: (i) Income tax is not deductible. The income tax deducted is the amount paid in the year towards her total tax payable.

Comprehensive Section/Study Guide — Solutions to Comprehensive Case Problems

627

(ii) CPP contributions and EI premiums are not deductible in computing income from employment, but are eligible for non-refundable tax credits in the calculation of federal taxes payable. In 2020, the federal government introduced an increased CPP contribution premium. The CPP enhancement portion of the CPP premiums paid is deductible in the calculation in computing income for tax purposes. The amount deducted reduces the amount that is eligible as a tax credit. (iii) Massive Ltd.’s contribution to the dental plan is not a taxable benefit under par. 6(1)(a). (iv) Registered pension plan contributions by the employer are exempted under par. 6(1)(a). (v) Membership fees paid by the employer for social clubs will not be included in the income of the employee if the advantage is primarily the employer’s not the employee’s (Income Tax Folio S2-F3-C2: Employees Fringe Benefits). (vi) Moving expenses are not deductible in computing employment income, but are deductible against all sources of income under subdivision e. Part C — Other tax consequences: (1) Allowable moving expense deduction Par. 62(3)(a) Travelling cost — air fare . . . . . . . . . . . . . . . . . . . . . . . . . $

1,750

Par. 62(3)(b) Household effects — transporting . . . . . . . . . . . . . . . . . . .

1,400

Par. 62(3)(c) Meals and lodging near the new residence — meals (100% deductible per s. 67.1(1))* . . . . . . . . . . . . . . . . . . .

— lodging . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

175

Par. 62(3)(e) Selling costs of Halifax residence — legal fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

800 15,500

Par. 62(3)(f ) Allowable purchase cost of London residence — legal fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,100

— land transfer tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

450 $

21,255

Prepaid realty taxes not deductible under ssec. 62(3). * If no receipts are provided, the CRA permits a simplified method deduction of $23 per meal to a maximum of $69 per person per day for 2022. The 2023 rates will be available on the CRA website in 2024.

(2) There will be a deduction under paragraph 110(1)(d ) in 2023, since: ● ●

●

the option price ($11) is equal to the fair market value at the date the option was granted, on the assumption that Ms. Janrayad will be dealing with the corporation at arm’s length after the transaction, and the options granted do not exceed the $200,000 annual vesting limit (assuming the company has annual gross revenues in excess of $500 million).

The par. 110(1)(d ) deduction is equal to 1/2 of the ssec. 7(1) inclusion or $10,800. (3) Ms. Janrayad can deduct imputed interest of $265 (i.e., $441 – 176) as an expense by virtue of sec. 80.5 and par. 20(1)(c), plus the $176 interest paid on her loan to buy shares by virtue of par. 20(1)(c).

Comprehensive Section

— real estate commission

Introduction to Federal Income Taxation in Canada

628

Problem 6 Part A

Income — Division B Par. 3(a) Employment Income Gross salary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . RPP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 70,000 (800) $ 69,200

Property Income: Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 9,000 6,000

15,000

Pension income . . . . . . . . . . . . . . . . . . . . . . . . . . .

90,200

Less: disallowed ABIL on X Ltd. shares (2 × $11,250) × 1/2 . . . . . . . . . . . . . . . . . . . . . . .

(11,250) $

LPP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: LPP carryover . . . . . . . . . . . . . . . . . . . . . . . .

$ 6,000 (6,000)

Par. 3(b) Capital Gains Y Ltd. ($11,250 × 1/2 . . . . . . . . . . . . . . . . . . . . . . . PUP ($4,500 × 1/2) . . . . . . . . . . . . . . . . . . . . . . . . .

6,000 $ 5,625 2,250

$ 7,875

$ Par. 3(c) Subdivision e deductions: CPP enhancement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Legal fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . RRSP — lower of: 1) RRSP Deduction Limit Unused RRSP Deduction Limit at End of 2022 = $0 Plus: Lesser of: (i) 18% of $45,000 (prior year earned income*) = $8,100 (ii) $30,870 (2023 RRSP limit) Less: Pension Adjustment (1,400) RRSP Deduction Limit for 2023 = $6,700 2) RRSP contribution made for current year = $8,500 RRSP Deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

90,200

(631) (1,000)

(6,700)

(8,331) $

81,869

Par. 3(d ) Rental property loss . . . . . . . . . . . . . . . . . . . $(10,000) BIL on X Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Business Investment loss ............................................. $ 28,000 Less: disallowed portion ($11,250 × 2) ........................ (22,500) $ 5,500 Allowable BIL (1/2 × BIL) . . . . . . . . . . . . . . . . . . . .

(2,750)

(12,750)

Division B income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Division C deductions . . . . . . . . . . . . . . . . . . . . . . . . . . Par. 111(1)(b) Net capital losses (limited to par. 3(b) net TCG) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Taxable Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

69,119 0 0 69,119

* Earned income for 2022: Par. 146(1)(c) Employment income before RPP deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 55,000 Rental loss ...............................................................................................................................................(10,000) $ 45,000

Comprehensive Section/Study Guide — Solutions to Comprehensive Case Problems

629

Part B

(i)

Income taxes are not deductible in arriving at income or taxable income.

(ii)

Brokerage fees are added to adjusted cost base of the acquired share.

(iii)

The excess RRSP contribution of $1,800 in 2023 will not be subject to a penalty of 1% per month for each month it remains in the plan, since the amount contributed in excess of the amount deductible is not greater than $2,000. The excess RRSP contribution should be deductible in 2024 given Mr. White has earned income for 2023 which will create an additional RRSP deduction limit in 2024.

(iv)

Federal political donations are not deductible under Division B or C but a tax credit would be calculated of $75 to reduce federal taxes payable, under Division E.

(v)

LPP loss can be carried forward for a maximum of seven years.

(vi)

Net capital losses can be carried forward indefinitely.

(vii)

The disallowed portion of BIL under par. 39(9)(b) is twice the cumulative capital gains deduction. i.e., 2 × $11,250 for a capital gains deduction claimed prior to 1988.

(viii)

The net capital loss balance at December 31, 2022 is: 2001 — $12,000 2023 — $3,375 The 2023 net capital loss is the portion of disallowed ABIL not utilized against taxable capital gains in 2022 [$11,250 -- $7,875].

(ix)

CPP and EI premiums and charitable donations provide tax credits to reduce federal taxes payable, under Division E. A portion of the CPP premiums paid ($631) is an enhanced contribution and is deductible in computing income under subdivision e as shown above. This portion is not eligible to be claimed as a tax credit.

Part A

3(a) Employment Income Gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Less: RPP (pars. 8(1)(m) and 147.2(4)(a)) . . . . . . . . .

90,000 (3,600) $

Pension Income

86,400 18,000

Property Income: Attributed from — wife . . . . . . . . . . . . . . . . . . . . . . . — Charles . . . . . . . . . . . . . . . . . . . . .

600 300

900 $ 105,300

3(b) Net taxable Capital Gains ($18,000 + $600 -- $1,000) . . . . . . . . . . . . . . . . . . . . . . . . .

17,600

3(c) Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 122,900

Less: CPP enhancement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(631)

Split pension income with his wife . . . . . . . . . . . . . . . . . .

(9,000)

Division B Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 113,269

Comprehensive Section

Problem 7

Introduction to Federal Income Taxation in Canada

630

Division C Deductions Net capital loss carryover limited to par. 3(b) Net TCG . . . . . . .

(17,600)

Taxable Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

95,669

Taxable income of $95,669 will result in $42,310 of income taxed at the 20.5% rate. Split Pension Income Decision The maximum split pension is $18,000 × 1/2 = $9,000. Tax savings to Buck Shot ($9,000 × 20.5%) . . . . . . . . . . . . . . . Loss of married credit: Before split 15% × [$15,000 -- (600 × 1.38 + 300 + 250 + 3,600)] . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . After split 15% × [$15,000 -- (9,000 + 600 × 1.38 + 300 + 250 + 3,600)] . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax payable by Mrs. Shot on split pension (see below) . . . . . . . .

Net savings from splitting pension income . . . . . . . . . . . . . . . . .

495

13,978

Tax paid by Mrs. Shot: Division B Income ($600 × 1.38 + 300 + 250 + 3,600 + 9,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Federal tax @ 15% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: basic amount . . . . . . . . . . . . . . . . . Less: pension amount . . . . . . . . . . . . . . . Net tax payable . . . . . . . . . . . . . . . . . . . .

1,845

(1,503) 153 0

2,097 (2,250) (300)

Due to the decision to split pension, it doesn’t make sense to include Mrs. Shot’s dividends in Mr. Buck Shot’s income, because he won’t gain any additional married credit but will pay tax at a rate of approXimately 20% on the dividend. Part B

Federal tax on first . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . on next . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Less: Federal tax credits Basic personal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Spousal — see above . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Canada caregiver — Charles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Canada employment credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Employment Insurance premiums (15% of $953) . . . . . . . . . . . . . . . CPP contributions (15% of ($3,500 - $461 enhancement)) . . . . . . . . Pension credit [15% of $2,000] . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Transfer of impairment credit — Charles [$1,414 basic + $825 supplement for <18 yrs old] . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Transfer of tuition fees and education credits . . . . . . . . . . . . . . . . . . Transfer from spouse — pension income amount . . . . . . . . . . . . . . . . Medical expenses tax credit [15% × ($4,000 + 320) - lesser of (i) $2,479 and (ii) 3% × $96,259 = $2,888] . . . . . . . . . . . . . . . . . . . . Charitable gifts (15% × first $200 + 29% of balance) . . . . . . . . . . . . Basic federal tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 53,359 42,310

$ 8,004 8,674

$ 95,669

$ 16,678 $ (2,250) (153) (375) (205) (150) (469) (300) (2,239) (750) (300) (254) (161) $ 9,072

Comprehensive Section/Study Guide — Solutions to Comprehensive Case Problems

631

— NOTES TO SOLUTION Income taxes withheld from employment income are not deductible. (i) The portion of CPP premiums that is the CPP enhancement is a deduction in computing income and is not eligible for a tax credit. (ii) The $300 of interest income from the GIC given to Robert is taxable to Robert because he is 18 or older in 2023. (iii) Provincial political party donations are not deductible against federal taxes (par. 18(1)(n)). A provincial tax credit may be available in computing provincial taxes payable, not taxable income.

Problem 8 Taxable Income Calculation Inclusions: Salary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

70,000

Performance bonus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

15,000

Commissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5,000

RRSP contributions made by employer, par. 6(1)(a) . . . . . . . . . . . .

3,000

Automobile standby charge (Note 1) . . . . . . . . . . . . . . . . . . . . . . . .

5,424

Automobile operating benefit (0.33 × 60% × 30,000 km) . . . . . . . . Payment by employer for tax return preparation, par. 6(1)(b) . . . . .

5,940

Trip to St. Lucia, received by virtue of employment, par. 6(1)(a) . . .

900

400

Director’s fees, par. 6(1)(c) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

500

Disability income (Note 4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

11,587

Taxable dividends attributed to Marilyn ($6 × 200 shares × 1.38) . . Interest income on mortgage receivable . . . . . . . . . . . . . . . . . . . . . .

1,656

Net rental income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,400

Recapture on rental building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2,300

Income tax refund interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

200

Taxable capital gains (Note 2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest income attributed from children . . . . . . . . . . . . . . . . . . . . .

23,190 400

3,000

Deductions: CPP enhancement RRSP deduction (Note 3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Repayment of shareholder loan, par. 20(1)(j ) . . . . . . . . . . . . . . . . .

(631) (14,000) (10,000)

(24,631)

Net income for tax purpose Net capital loss utilized in the year . . . . . . . . . . . . . . . . . . . . . . . . .

$ 125,266 (1,500)

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 123,766

Items not included in the above calculation: (i) Income taxes withheld are not deductible in computing income for tax purposes. (ii) CPP and EI premiums paid by an employee are not deductible in computing income for tax purposes, but are eligible for non-refundable tax credits. The portion of CPP premiums that is the CPP enhancement is deducted in computing income and is not eligible for non-refundable tax credit. (iii) There is no taxable benefit for group disability insurance premiums paid by the employer [par. 6(1)(a)]. There is no deduction for group disability premiums paid by an employee. (iv) Donations to United Way are not deductible in computing income for tax purposes, but are eligible for non-refundable tax credits.

Comprehensive Section

$ 149,897

Introduction to Federal Income Taxation in Canada

632

(v) Membership in the golf club appears to be primarily to the employers advantage and is, therefore, not a taxable benefit. (vi) There is no capital gain/loss to Marilyn on the transfer of the shares of Looney to Jorge because the transfer is deemed to occur at the ACB of the shares [ss. 73(1)]. Jorges ACB for the shares will be $1,000 (equal to Marilyn’s ACB at the time of the transfer) [ss. 73(1)]. (vii) Payments of interest and penalties for income taxes are not deductible for tax purposes. (viii) Interest income on child tax benefits invested for children is not attributable to Marilyn. Note 1: Automobile Standby Charge Benefit Automobile Standby Charge Benefit, par. 6(1)(e) and ssec. 6(2) ($20,000 + $2,600 HST) × 2% per month × 12 months = $5,424 There is no reduction available in computing the standby charge because the automobile was driven less than 50% for employment purposes in 2023. Note 2: Calculation of Taxable Capital Gains 1. The transfer of the shares of Looney Canadian Public Co (Looney) from Marilyn to Jorge is done at proceeds of disposition = adjusted cost base = no capital gain. 2. Sale by Jorge of the Looney shares attributed to Marilyn Proceeds of disposition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 10,000 Adjusted cost base (equal to Marilyn’s adjusted cost base at transfer) .................(1,000) Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $

9,000

Taxable capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $

4,500

Sale of building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds of disposition ........................................................................................ $250,000 Adjusted cost base ................................................................................................ (160,000) $ 90,000 Less: Cost of sales — legal fees ......................................................................... (1,000) Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 89,000 2023 reserve per spar. 40(1)(a)(iii) Lesser of: (i) $145,000/$250,000 × $89,000 = $ 51,620 (ii) 4/5 × $89,000 = $71,200 Lesser is ............................................................................................................... $(51,620) Capital gain on shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 37,380 Taxable capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 18,690 Note 3: RRSP Deduction Calculation Contributions deducted from pay (12 × $250) . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,000 Contributions made by employer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000 Contribution in January 2023 to own plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,000 Contribution in January 2023 to spousal plan . . . . . . . . . . . . . . . . . . . . . . . . . . 2,000 Less: amounts used on 2022 return ($6,000/12 months × 2 months) . . . . . . . . . (1,000) Total contributions available for 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,000 Least of: 2022 earned income ................................................................................. $80,000 X 18% $14,400

Comprehensive Section/Study Guide — Solutions to Comprehensive Case Problems

633

2023 RRSP limit .............................................................................................$30,780 Least is ....................................................................................................... 14,400 Plus: unused RRSP deduction room from 2022 .................................... 100 $14,500 RRSP deduction for 2023 is lesser of $14,000 and $14,500 ..................................... $14,000

Note 4: 2023 Disability Benefits Marilyn must include the disability benefits in income per par. 6(1)(f ) 3 months of disability benefit received...................................................................... $12,000 Less: Disability insurance premiums paid January 1, 2021 thru September 30, 2023 ($25/month × 1/2 × 331 months) ...................................................................... 413 Amounts to be included on 2023 return ................................................................ $11,587

Marilyn did not pay premiums for October to December 2023 when she was off work.

Problem 9

$34,000

S. 6(8) HST Rebate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . S. 7(1.1) Stock option benefit $25,000 -- $10,000 = $15,000

250 15,000

S. 8(1)(i ) Union dues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . S. 8(1)(m) RPP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(210) (1,300) $47,740

Property income: S. 12(1)(c) Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

S. 12(1)(j ) Dividends from taxable Canadian corporations [$8,000 × 1.38] S. 12(1)(k) Dividends from a U.S. corporation [no gross up — include gross amount $1,700 + $300 in tax withheld] . . . . . . . . . . . . . . . . . . S. 20(1)(c) Interest expense re marketable securities . . . . . S. 38 Taxable capital gain: Simple Ltd. shares $70,000 - $25,000 = . . . . . . . . . . . . . . . . Table: $1,000 -- $1,100 = (100) [PUP loss denied] . . . . . . . . Painting: [$1,500 -- $1,000] . . . . . . . . . . . . . . . . . . . . . . . . .

925

11,040 2,000 (500)

13,465

$45,000 0 $

500

Less: 2016 LPP loss (200) . . . . . . . . . . . . . . . . . . . . . . . . . .

(200)

X Ltd. Proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 2,500

300

ACB ............................................................................................... (3,665) Superficial loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Retiring allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Employment insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ (1,165) 1,165

0 $45,300 × 1/2

22,650

$35,000 9,000

44,000

Comprehensive Section

Employment income: S. 5 Salary and commission . . . . . . . . . . . . . . . . . . . . . . . . .

Introduction to Federal Income Taxation in Canada

634 Other deductions: CPP enhancement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(305)

RRSP least of (a) undeducted premiums paid on or before 60 days after 2023 $8,000 + $5,000 . . . . . . . . . . . . . . . . . . . . . . . . . (b) lesser of (1) $30,780 (2) 18% of 2022 earned income (18% × $70,000) . . . . . . . . . . . . . . minus 2022 PA . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 13,000

$ 12,600

$11,200 800

plus unused deduction room . . . . . . . . . . . . . . . . . . . S. 60(j.1) least of (i) retiring allowance received . . . . . . . . . . . . . . . . . (ii) contributions ($30,000 -- $12,000) . . . . . . . . . . . (iii) $2,000 × 8 years (pre-1996) . . . . . . . . . . . . . . S. 60(o) Legal Fees to Contest tax assessment . . . . . . . . . .

$12,600 (1,400) (12,000)

35,000 18,000 16,000

(16,000) (600)

S. 60(v.1) Employment Insurance repaid . . . . . . . . . . . . . . .

$98,950 (2,700)

Net income under Division B . . . . . . . . . . . . . . . . . . . . . . . .

$96,250

S. 110(1)(d ) Stock option deduction /2 × $15,000 = . . . . . . S. 111 Net capital loss carry over . . . . . . . . . . . . . . . . . . . .

(7,500) (4,000)

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$84,750

Adjusted taxable income for minimum tax purposes: Taxable income .............................................................................................................. $ Add: 30% (i.e., 80% - 50%) of capital gain 0.3 × $45,300 . . . . . . . . . . . . . . . . . .

82,826 13,590

Stock option deduction ...........................................................................................

7,500

Less: Dividend gross-up . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30% of capital loss applied (0.3 × $4,000 × 2) ...............................................

$ 103,916 3,040 (2,400)

Adjusted taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 104,556 Information omitted from calculations: (i) Stan is not entitled to a deduction for moving expenses as he was reimbursed by his employer for all moving expenses incurred. (ii) CPP, EI, and income tax withheld are not deductible for tax purposes ssec. 8(2), except for the portion of CPP premiums that is the CPP enhancement. (iii) Lottery winnings are not taxable. (iv) Donations are not deductible in computing income for tax purposes, but will be eligible for a non-refundable tax credit. (v) Foreign tax paid on dividend is not deductible since it is better to claim an FTC. (vi) TFSA administrative fee is not deductible.

Comprehensive Section/Study Guide — Solutions to Comprehensive Case Problems

635

Problem 10 Net income per financial statements . . . . . . . . . . . . . . . . . . . . . Add: Current income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Book loss on investment in Mark Goal Nets Inc. (MGNI) . . . . . . Non-deductible interest on car loan [$4,200 -- (365 × $300/30)] Cost of financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-deductible interest on income taxes . . . . . . . . . . . . . . . . . . Non-deductible interest on vacant land (Note 1) . . . . . . . . . . . . Amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Donations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Life insurance premiums on Chrisa and Neil . . . . . . . . . . . . . . . Non-deductible cost of meals and entertainment (50% of $3,440) . . . Curling club memberships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Reserve for future warranty costs . . . . . . . . . . . . . . . . . . . . . . .

$ 160,800 $

45,700 3,500 6,000 550 300 300 6,000 48,000 5,000 2,000 1,720 6,000 1,500

126,570 $ 287,370

Deduct: Capital dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Increase in cash surrender value of life insurance . . . . . . . . . . . Allowable business investment loss in MGNI (6,000 × 1/2) . . . . . . Unrealized gain on foreign exchange . . . . . . . . . . . . . . . . . . . . . Book gain on disposition of car . . . . . . . . . . . . . . . . . . . . . . . . . CCA (Note 1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20(1)(e) [1/5 × 300 cost of financing × 365/365] . . . . . . . . . . . . Actual warranty expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

12,000 1,520 3,000 1,500 1,000 106,580 60 1,200

(126,860) $ 160,510

5,000 7,000 500

Taxable income for Part I tax . . . . . . . . . . . . . . . . . . . . . . . . . .

(12,500) $ 148,010

Note 1 — Calculation of CCA

Class 1 . . . . . . . . . . . . . . Class 8 . . . . . . . . . . . . . . Class 10 . . . . . . . . . . . . . Class 10.1 . . . . . . . . . . . . Class 10.1 . . . . . . . . . . . . Class 12 . . . . . . . . . . . . . Class 53 . . . . . . . . . . . . .

Opening UCC $ 102,000 50,000 30,000 10,000 0 0 80,000

Additions $ 0 0 0 0 36,000 6,000 0

Lesser of Cost and Proceeds $

0 0 0 0 0 0 0

CCA Rate 4% 20% 30% 30% 30% 100% 50%

CCA for the Year $ 4,080 10,000 9,000 1,500 36,000 6,000 40,000 $106,580

CCA Notes (i) Interest on vacant land added to cost of property — can only claim CCA once available for use / substantially complete. (ii) Class 10.1 (New) - Maximum addition is limited to $36,000 in 2023. This is eligible property for purposes of the immediate expensing rules introduced in the April 19, 2021 Federal Budget

Comprehensive Section

Deduct: Donations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividend from Peter Wood Products . . . . . . . . . . . . . . . . . . . . . Dividend from Lori Ice Machine Canadian Public Corp . . . . . . . .

636

Introduction to Federal Income Taxation in Canada

for Canadian-controlled private corporations and does not exceed the $1.5 million immediate expensing limit. (iii) Class 10.1 (sold) - 1/2 year of CCA is allowed on opening balance in year of disposition no recapture. UCC at the end of the year would be 0. (iv) Per the accelerated investment incentive, applicable to purchases after November 20, 2018, there is no half-year rule for CCA calculations.

Problem 11 Reconciliation Errors 1. Income taxes payable of $71,000 and deferred taxes of $14,000 must be added to income for financial statement purposes, since they are not incurred to earn income. 2. A reserve for future warranties is not an allowable deduction unless the special conditions of par. 20(1)(m.1) are met, so the $85,000 addback in the reconciliation is correct. However, the actual expenditure of $50,000 should be deducted. 3. The $35,000 of RPP contributions may be deductible in 2023 or 2024 as long as they were made in accordance with the plan as registered (par. 147.2(1)(a)). The overall limit of employer and employee contributions is $31,560 for 2023. There will also be limitations based on the employment income of each individual employee. Contributions to a registered pension plan can be made up to 120 days after the end of the year to which the contributions apply and still be deductible. [sec.147.2(1)] 4. The 2023 bonus is deductible in 2023, if it is paid on or before June 29, 2024. The 2022 bonus should have been added back to 2022 income when the corporation income tax return was filed. If it was not, then an amended return for 2022 should be filed as soon as possible to reduce interest charges. The 2022 bonus will be deductible when it is paid in 2024. 5. (a) The scholarships would be a deductible expense of the corporation, as part of employee remuneration under par. 18(1)(a). (b) The assistance to the spouse of an employee would be deductible from the income (Division B) of the corporation as an expense of doing business, in the form of a death benefit as defined in sec. 248. 6. (a) The real estate commission and the appraisal fee are expenses of disposition which would be deducted with adjusted cost base from proceeds of disposition in the calculation of a taxable capital gain. Therefore, these amounts must be added back in the reconciliation and the taxable capital gains figures must be adjusted. Both expenditures should be pro-rated to the land and the building. (b) The capital gain inclusion rate is 1/2. (c) Recapture on the building must be added in the reconciliation. (d) A capital gains reserve in respect of the land and building is deductible. It would be calculated as the lesser of: (i) $675,000 / ($565,000 + 340,000) × capital gain on the land and building (as corrected) (ii) 4/5 × capital gain on the land and building (as corrected) A reserve deducted in 2023 must be brought into income as a capital gain in 2024 and a new reserve can be deducted in 2024 and the following four years. (e) Interest for siX months at 11% of $675,000 would have to be accrued and added to the reconciliation (ssec.12(3)). (f) Since the lease began July 1, 2023 and a payment of the first year’s rent was made, si X month’s rent or $15,000 is a prepaid expense at December 31, 2023 and should not be deducted, i.e., it should be added back in the reconciliation. Leasehold improvements are class 13 depreciable property eligible for capital cost allowance on a straight-line basis. Since the corporation is a CCPC and the property was acquired after April 19, 2021, the leasehold improvements should qualify for immediate expensing. The CCA deduction for the leasehold improvements in 2023 should be $35,000 if the company did not acquire more than $1.5 million of eligible property in the taxation year. 7. The reserve for decline in value of inventory must be added back to closing inventory in the calculation of cost of goods sold resulting in an addition to income in 2023. 8. Capital cost allowance should be deducted in arriving at net income for the year. 9. The net capital loss deducted in 2023 cannot exceed the taxable capital gains for the year. 10. The capital dividends received are not taxable and should be deducted in arriving at income for tax purposes. Furthermore, no deduction under Division C may be taken for these dividends. 11. The actual dividend of $8,000 (i.e., ($11,500/1.15) -- 2,000)) should be all that is included in the calculation of income under Division B and deducted in Division C in the calculation of taxable income.

Comprehensive Section/Study Guide — Solutions to Comprehensive Case Problems

637

Problem 12 Net income per financial statements . . . . . . . . . . . . . . . . . . . . . . .

$ 568,400

Add: Income tax provision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 446,600

Amortization [$20,000 + 15,000] . . . . . . . . . . . . . . . . . . . . . . . . . .

35,000

Taxable capital gain on sale of land (Note 2) . . . . . . . . . . . . . . . . Prepaid expenses expensed for accounting [9,000/10,000 × $5,000] . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

55,250

Meals and entertainment (Note 3) . . . . . . . . . . . . . . . . . . . . . . . .

4,050

Club dues, par. 18(1)(l ) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5,000

Management bonus not paid within 179 days after the year end [ssec. 78(4)] . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

90,000

4,500

Financing costs (par. 20(1)(e) -- /5 × $600) . . . . . . . . . . . . . . . . Foreign taxes withheld, netted from accounting income (Note 4)

480

300

641,180 $ 1,209,580

Less: CCA (Note 1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(232,940)

Gain on sale of land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(130,000)

Capital dividend not taxable . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(3,800)

Net income for federal tax purposes . . . . . . . . . . . . . . . . . . . . . . .

(366,740) $ 842,840

Less: Dividends from taxable Canadian corporations [S.112] Deemed dividend on preferred shares . . . . . . . . . . . . . . . . . . . . .

(2,500)

Dividend from XYZ Inc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(3,000)

(5,500) (12,000)

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 825,340

Note 1 — Capital Cost Allowance Class 1 4% UCC, Start of year . . . . . . .

$83,000

Add: purchases . . . . . . . . . .

145,000

Add: accelerated investment incentive . . . . . . . . . . . . .

Class 1b

Class 8

Class 10

Class 10.1

Class 53

20%

30%

100%

$0 $60,000 $40,000 200,000

20,000

36,000

90,000

100,000

Deduct: disposals . . . . . . . .

(600) $228,000 $300,000 $80,000 $39,400

CCA — regular . . . . . . . . . .

$0 36,000

$9,120

CCA — immediate expense . . .

$18,000 $12,000 $11,820 $20,000

Total CCA per class . . . . . .

$9,120

Total CCA . . . . . . . . . . . . .

$232,940

$36,000 $36,000 $90,000

$18,000 $32,000 $11,820

$90,000 $36,000 $36,000 $36,000 $36,000 $90,000

(i) The accelerated investment incentive applies to class 1 and allows for an additional 50% to be included in the CCA class for CCA calculation purposes and eliminates the half-year rule.

Comprehensive Section

Net capital losses of previous years . . . . . . . . . . . . . . . . . . . . . . .

638

Introduction to Federal Income Taxation in Canada

(ii) The Class 8 and 10.1 additions are eligible property for purposes of the immediate expensing rules since they are acquired by a CCPC after April 19, 2021 and the company did not exceed the maximum amount of additions of $1.5 million per taxation year. (iii) A separate class is required for each automobile costing greater than $36,000. The addition to the CCA class is limited to $36,000 since the company would have received an HST input tax credit on $34,000 for each car. (iv) The new administrative building is eligible for a 6% CCA rate, provided that it is put into a separate class 1b from the existing buildings. (v) The warehouse transferred from the sole shareholder using section 85, is added to Class1. Since the shareholder and the corporation are related, the capital cost is limited to the shareholder’s capital cost ($100,000) plus the taxed portion of the capital gain realized by the shareholder on the transfer (1/2 X $190,000 - $100,000 = $45,000). Therefore, the total addition to Class 1 is $145,000. The accelerated investment incentive does not apply for 2023 on the warehouse since the property was previously owned by a non-arm’s length person (Mr. Griffin Rock) and the property was transferred to the corporation on a tax-deferred basis. Note 2 — Gain on Disposition of Land Proceeds of disposition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 150,000

Less: adjusted cost base . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(20,000)

Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 130,000

Less: reserve [par.40(1)(a)(iii)] . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(19,500)

Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 110,500

Taxable capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 55,250

Reserve Calculation Lesser of: (i)4/5 × gain of $130,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 104,000

and (ii) ($50,000 -- 27,500)/$150,000 × $130,000 . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 19,500

Note 3 — Meals and Entertainment Meals for salespeople . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 3,000

Meals for entertaining clients . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4,300

Seasons tickets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

800 $ 8,100

Rate disallowed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

50%

Disallowed portion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 4,050

Note 4 — Foreign Dividends $1,700 is net of withholding tax of 15%. Therefore, withholding tax must be $1,700/(1--0.15) × 15% = $300.

Comprehensive Section/Study Guide — Solutions to Comprehensive Case Problems

639

Problem 13 Schedule 1 Net income for the year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Add:

Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amorization – cost of sales . . . . . . . . . . . . . . . . . . . . . . – rental . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 200,000 128,000 3,000

– other . . . . . . . . . . . . . . . . . . . . . . . . . . . Charitable donations . . . . . . . . . . . . . . . . . . . . . . . . . .

12,000 2,000

Meals and entertainment (Note 1) . . . . . . . . . . . . . . . .

15,500

Unpaid bonuses – employee . . . . . . . . . . . . . . . . . . . . . – shareholder . . . . . . . . . . . . . . . . . . . .

40,000 110,000

Restructuring cost (a reserve) . . . . . . . . . . . . . . . . . . . Write-down of investments . . . . . . . . . . . . . . . . . . . . . .

50,000 25,000

Loss of disposition of equipment . . . . . . . . . . . . . . . . . Dividend – Make-it and Save-it (Alberta) Inc. . . . . . . . .

9,000 60,000

Inventory write-down . . . . . . . . . . . . . . . . . . . . . . . . . .

$ (10,000)

Capital cost allowance (Note 2) . . . . . . . . . . . . . . . . . . – Class 1 (10%) . . . . . . . . . . . . . . . . . . . . . . . . . .

(24,000)

– Class 1 (Rental) . . . . . . . . . . . . . . . . . . . . . . . . .

(2,400)

– Class 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 696,900

654,500 $1,351,400

Deduct:

Income from Make-it and Save-it (Alberta) Inc. . . . . . .

(100,000) (1,648,400) $ (297,000)

Taxable capital gains (Note 3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

525,000

Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 228,000

Dividends (Note 4)....................................................................................................... (115,000) Donations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,000) Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 111,000

Income Analysis ABI Securities . . . . . . . . Make-It-Rich . . . . . . Make-It-And-Save-It Rental . . . . . . . . . . . TCG . . . . . . . . . . . . Interest . . . . . . . . . . ABI (balance) . . . . .

AII

Connected $

50,000 60,000

110,000

Portfolio Dividends $

5,000

$ 228,000

30,400 525,000 7,500

$ (449,900) $ (449,900) $ 562,900

Total 5,000 50,000 60,000 30,400 525,000 7,500 (449,900)

Comprehensive Section

– Class 8 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (4,000) – Class 10 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (6,000) – Class 53........................................................................ (202,000) Gain on disposition of Plant #1 ............................................. (1,300,000)

Introduction to Federal Income Taxation in Canada

640

Part I Tax Federal tax 38% @$111,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 42,180 Less: federal tax abatement [10% × 100% × $58,500] . . . . . . . . . . . . . . . . . . . (11,100) Small business deduction (Note 5) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 Tax reduction - 13% × [$111,000 - SBD income ($0) - AII ($562,900)] . . . . . . . 0 Additional refundable tax (Note 7) .......................................................................... 11,840 Part I tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 42,920 Less Dividend refund (Note 6) ...................................................................................... (63,749) Net Part I tax (refund) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ (20,829)

Part IV Tax Dividend income subject to Part IV tax Marketable securities — eligible/not connected ($5,000 × 38 1/3%) . . . . . . . . . . . $ 1,917 Makeit-and Save-it (Alberta) Inc. — non-eligible connected ($23,000 × 37.5%) 8,625 Make-it_Rich Investments Ltd. — non-eligible connected ($19,167 × 100%) .......................................19,167 Part IV tax ..........................................................................................................................$ 29,709 — NOTES TO SOLUTION 1. Meals and Entertainment Concert tickets given to customers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,000 Meals and entertainment incurred by salespeople............................................................. 22,000 Meals and entertainment incurred by management .........................................................8,000 $ 31,000 × 50% $ 15,500 2. Capital Cost Allowance Cl. 1 10%

Cl. 1 (Rental) 4%

Cl. 1 4%

UCC, start of year . . . . . . . . . . Add: Purchases . . . . . . . . . . . Add: accelerated investment incentive . . . . . . . . . . . . . . . Dispositions . . . . . . . . . . . . . .

80,000 (120,000)b

UCC before CCA . . . . . . . . . . . CCA . . . . . . . . . . . . . . . . . . . . Deduct: AII . . . . . . . . . . . . . . . UCC, end of year . . . . . . . . . .

$240,000 $ 60,000 $ (24,000) (2,400) (80,000) $136,000 $ 57,600 $

$280,000c

Cl. 8 Cl. 10 Cl. 53 20% 30% 50%

$ 60,000 $160,000 $20,000 $20,000 $200,000 105,000 (160,000)a

(6,000)

0 $20,000 $20,000 $299,000 0 (4,000) (6,000) (202,000) 0 $16,000 $14,000 $ 97,000

The Class 53 additions qualify for immediate expensing since they are eligible properties acquired after April 19, 2021 that are available for use and the associated group did not exceed the maximum amount of $1.5 million per taxation year. The remainder of the balance in the class is subject to the 50% CCA rate, net of dispositions. 3. Replacement Property — election on former business property a

S. 13(4)(c) reduction of UCC Lesser of: (i) proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . (ii) capital cost . . . . . . . . . . . . . . . . . . . . . . . . .

$ 931,250 280,000

$ 280,000

(A)

Comprehensive Section/Study Guide — Solutions to Comprehensive Case Problems

641

Less: Lesser of:

(i) EXcess of (A) over UCC . . . . . . . . . . . . . . . .

120,000

(ii) cost of replacement . . . . . . . . . . . . . . . . . . .

500,000

Deemed proceeds of disposal under 13(4)(d ) . . . . .

(120,000)

(B)

$ 160,000

(A) -- (B)

$ 120,000

Building - capital cost

Cost of replacement . . . . . . . . . . . . . . . . . . . . . . . . . Less: S.44(1)(f ) reduction for deferred gains (Note 3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 500,000 (220,000) $ 280,000

Replacement Property — Capital Gain Land — Lessor of (1) Proceeds of dispostion . . . . . . . . . . . . . . . . . . . . . .

less: ACB . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(187,500) $

(2) Proceeds of dispostion . . . . . . . . . . . . . . . . . . . . . .

918,750

less : Replacement cost . . . . . . . . . . . . . . . . . . . . .

731,250 918,750 (300,000) 618,750

931,250

618,750

Building — Lesser of (1) Proceeds of dispostion . . . . . . . . . . . . . . . . . . . . . . less: ACB

(2) Proceeds of dispostion . . . . . . . . . . . . . . . . . . . . . .

(280,000) $

651,250

931,250

Replacement cost . . . . . . . . . . . . . . . . . . . . . . . . . .

(500,000) $

431,250

Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . .

× 1/2

431,250 $

1,050,000

525,000

4. Dividends - section 112 deduction Marketable securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5,000

Make-it and Save-it (Alberta) Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

60,000

Make-it-Rick Investments Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

50,000 $ 115,000

Comprehensive Section

Introduction to Federal Income Taxation in Canada

642 5. Small business deduction - 19% × Lesser of: (a) Active business income less active business loss, if any

(b) Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

111,000

(c) Business limit for the year . . . . . . . . . . . . . . . . . . . . . . . Lesser is . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

500,000

SBD = 19% × $0 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

The business limit will not be reduced next year due to the adjusted aggregate investment income in the current year. Taxable capital gains from the disposal of active business assets are excluded from this balance as well as dividends from connected corporations. So the adjusted aggregate investment income for the current year is: Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 5,000

Rental income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

30,400 7,500 $42,900

Dividend Refund Total of: 1. Lesser of (i) 381/3% × eligible dividends paid ($0) . . . . . (ii) Eligible RDTOH (Note 9) . . . . . . . . . . . . .

0 1,917

63,749

11,840

2. Total of (A) Lesser of: (i) 381/3% × non-eligible dividends paid ($300,000) . . . . . . . . . . . . . . . . . . . . . . . . (ii) Non-eligible RDTOH (Note 9) . . . . . . .

$ 115,000 61,832

61,832

and (B) greater of: (I) Lesser of: (i) excess, if any, of A(i) over A(ii) above . . . . . . . . . . . . . . . . . . . . . . . .

53,168

(ii) Eligible RDTOH – (1) above . . . . .

1,917

(II) nil . . . . . . . . . . . . . . . . . . . . . . . . . . .

and 1,917

6. Additional Refundable Tax (ART) 102/3% × lesser of: 102/3% × lesser of: 1. AII . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 562,900

2. Taxable income - SBD amount . . . . . . . . . . . . . . . . . . . . .

111,000

ART = 10 /3% × $111,000 . . . . . . . . . . . . . . . . . . . . . . . 2

Aggregate Investment Income (AII) Net TCG for the year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

525,000

less: net capital losses claimed . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 525,000

Comprehensive Section/Study Guide — Solutions to Comprehensive Case Problems Property income (Cdn. and Foreign) . . . . . . . . . . . . . . . . . . . . . – Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 115,000 – Rental . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,400 – Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,500 less: dividends deducted under Division C .............................................. (115,000) less: losses from property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0

643

37,900 $ 562,900

7. Refundable Portion of Part I Tax Least of: 1. 302/3% × AII = 30 2/3% × $562,900 . . . . . . . . . . . . . . Less: NBFTC -- 8% × FII . . . . . . . . . . . . . . . . . . . . . . . 2. 302/3% × taxable income -- SBD amount -- 100/382/3 × NBFTC -- 4 × FBTC) . . . . . . . . . . . . . . . . . . . . . . . . . . 3. Part I tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Least is . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

172,623 0

172,623

34,042 34,040 17,940

8. RDTOH

Non-eligible

Opening balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Refundable Part I Tax (Note 8) . . . . . . . . . . . . . . . . . . . . . . Part IV tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . less: prior year dividend refund from non-eligible RDTOH

Eligible

0 34,040 27,792 0

61,832

0 1,917 0 1,917

Problem 14 Note: There are several alternative ways to approach this question. The following is an example of one approach.

In the Corporation Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital gains - taxable portion . . . . . . . . . . . . . . . .

11,000 24,000 9,000

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividends (sec. 112) . . . . . . . . . . . . . . . . . . . . . . . .

44,000 (24,000)

Taxable income subject to Part I tax . . . . . . . . . . . .

20,000

Dividend income subject to Part IV tax . . . . . . . . . .

24,000

Aggregate investment income Interest . . . . . . . . . . . . . . . . . Taxable capital gain . . . . . . .

11,000 9,000

20,000

10,133 9,200

19,333

Part I tax @ 50.67% of taxable income (40% + 10.67%) . . . . . . . . . . . . . . . . . . . . . . . . . Part IV tax @ 381/3% of dividends . . . . . . . . . . . . . . Net tax before dividend refund potentially available Dividend refund potentially available Non-eligible = 302/3% × Aggregate investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eligible = Part IV tax . . . . . . . . . . . . . . . . . . . .

$ 6,133 9,200 $ 15,333

Comprehensive Section

Investments Owned by a Corporation

$19,333

Introduction to Federal Income Taxation in Canada

644 Dividend refund if $40,000 dividend paid (@ 381/3%) [See Note below] . . . . . . . . . . . . . . . . . . . . . . . . . Dividend refund if $5,000 dividend paid (@ 381/3%) [See Note below] . . . . . . . . . . . . . . . . . . . . . . . . .

(15,333) (1,917)

Total corporate tax . . . . . . . . . . . . . . . . . . . . . . . . .

4,000

$17,416

Note: If a dividend refund of $15,333 were received, this would be a combination of the eligible RDTOH of $9,200 (equal to the Part IV tax paid on the eligible dividends received) and the non-eligible RDTOH of $6,133 based on the aggregate investment income for the year. The full balance of each RDTOH would be paid out. If a dividend refund of only $1,917 were received due to a lower taxable dividend paid out to Ryan, this would be paid out of the eligible RDTOH of $9,200, leaving eligible RDTOH of $9,200 -- 1,917 = $7,283 and non-eligible RDTOH of $6,133. Investments Owned by The Corporation Investments Owned by Ryan

$40,000 Dividend

$5,000 Dividend

Employment income . . . . . . . . . . . . . . . . . . . Interest income . . . . . . . . . . . . . . . . . . . . . .

$80,000 11,000

$ 80,000 0

Dividend (eligible) . . . . . . . . . . . . . . . . . . . . Dividend (non-eligible) . . . . . . . . . . . . . . . . .

24,000

24,000 16,000

5,000

Add dividend gross-up (eligible) . . . . . . . . . . Add dividend gross-up (non-eligible) . . . . . . Capital gains — taxable portion . . . . . . . . .

9,120

9,120 2,400

1,900

Taxable income . . . . . . . . . . . . . . . . . . . . . .

$133,120

Federal Tax on $53,359 @ 15% . . . . . . . . . . . on next $53,358/or balance @ 20.5% on balance @ 26% . . . . . . . . . . . . .

80,000 0

9,000 $ 131,520

86,900

$8,004 10,938 6,865

8,004 10,938 6,449

8,004 6,876

$25,807

$ 25,391

14,880

Personal tax credits . . . . . . . . . . . . . . . . . . . Dividend tax credit (eligible) . . . . . . . . . . . . Dividend tax credit (non-eligible) . . . . . . . . .

(3,074) (4,975)

(3,074) (4,975) (1,662)

Basic federal tax . . . . . . . . . . . . . . . . . . . . . Provincial tax* . . . . . . . . . . . . . . . . . . . . . . .

$17,758 15,699

$ 15,680 15,459

Provincial personal tax credits . . . . . . . . . . . Dividend tax credit (eligible)** . . . . . . . . . . . Dividend tax credit (non-eligible)** . . . . . . .

(2,049) (4,145)

(2,049) (4,145) (738)

Total personal tax . . . . . . . . . . . . . . . . . . . .

$27,263

$ 24,207

17,218

Total tax paid (corporate and personal) . . . .

$27,263

$ 28,207

34,634

(3,074) (1,036) $

10,770 9,361 (2,049) (864)

The provincial personal tax has been calculated using provincial rates as set out in chapter 10.

Provincial dividend tax credits on eligible dividends assumed to be 5/11 of the gross up $4,145 ($9,120 × dividends assumed to be 4/13 of the gross up $738 (2,400 × 4/13).

5/11); on non-eligible

There is a nominal tax cost related to the use of the corporation if the corporation pays out all of the corporation’s after-tax earnings to Ryan each year. However, if Ryan only pays $14,000 of dividends from the corporation, $9,000 of which the corporation can elect to pay to Ryan as a tax-free capital dividend, Ryan will incur a pre-payment of $6,427 of tax ($34,634 -- $28,207) if the investments are held through a corporation. This is because the effective corporate tax rate on the retained income exceeds Ryan’s personal marginal tax rate.

Comprehensive Section/Study Guide — Solutions to Comprehensive Case Problems

645

Therefore, there are no tax advantages to incorporating this investment income. Note: The gross-up for Ryan personally on $24,000 of public company dividends is 38%. The federal dividend tax credit is 6/11 of the gross-up and the provincial dividend tax credit is assumed to be 5/11 of the gross-up. If Ryan’s corporation receives $24,000 of dividends from public corporations, this amount can be added to the General Rate Income Pool (GRIP) of the corporation. Thus, when the entire aftertax earnings of the corporation of $40,000 [$44,000 income less $4,000 corporate tax] is paid to Ryan as a dividend, $24,000 can be elected to be paid out of GRIP and the remaining $16,000 is considered paid out of LRIP. Therefore, a dividend up to $24,000 is subject to the 38% gross-up and related dividend tax credit and a dividend in excess of this amount is subject to a 15% gross-up and related dividend tax credit. Other considerations: (i) The assets could be transferred to the corporation without incurring a tax liability on the accrued gains by making a proper election under section 85 of the Income Tax Act. (ii) The corporation would provide greater flexibility in the timing of the receipts of income subject to personal tax. (iii) The corporation provides a vehicle for estate planning. (iv) There would be additional administrative costs in maintaining the corporation (i.e., legal, accounting, capital tax, etc.) The potential for double taxation exists when the corporation is used. The accrual gain on the assets will be taxed in the corporation when the assets are sold. This same accrued gain would be reflected in the shares of the corporation and would be taxed on their disposal.

Problem 15 Old Employer’s Stock Option ●

●

Can acquire additional 1,000 shares and must dispose of all 2,000 shares upon ceasing his employment with Action Properties Ltd. on December 31, 2021.

2,000 shares × ($100 -- $15) = $170,000 ●

Since the value of the shares has remained consistent, the shares were in the money at grant date. Therefore, in order to qualify for the Division C deduction, he must have held the shares purchased through the stock option plan for at least 24 months. 300 of the shares, from 2018 and 2019, will qualify for the par. 110(1)(d.1) deduction, due to their holding period in excess of two years: 300 shares × ($100 -- $15) × 1/2 = $12,750

●

Interest on bank loan may not be deductible since the loan is for the purpose of acquiring shares for a quick resale and the only income that could result is a capital gain, since there will be too little time in the holding period to receive dividends.

Public Co. Compensation Package ●

Salary of $150,000 is taxable under s. 5 as employment income.

●

Moving allowance is taxable under par. 6(1)(b) since it is not one of excepted allowances. ●

●

One-half of a reimbursement of an actual loss in excess of $15,000 on the disposition of the family home upon a change of employment location is a taxable benefit (ssec. 6(22)). ●

●

Only certain moving expenses are deductible under sec. 62 and, hence, there may be a net taxable amount, (i.e., house hunting expenses).

Capital loss on family home is $0 since it is personal-use property.

Monthly travel allowance is taxable unless it is reasonable in the circumstances (spar. 6(1)(b)(v) for taxpayers involved in negotiating contracts). ●

If his reasonable travel expenses exceed his allowance, he may deduct them under par. 8(1)(h) and (h.1), provided that he is required to pay them according to the terms of his

Comprehensive Section

There will be an employment income inclusion in the year he ceases employment and must dispose of his shares acquired through the stock option plan:

Introduction to Federal Income Taxation in Canada

646

contract; of course, in order to deduct travel expenses, the travel allowance must be included in his income on the basis that it is not reasonable. ●

●

A club membership paid by an employer will not be considered to be a taxable benefit under par. 6(1)(a) by administrative practice (IT-470R — ARCHIVED) as long as the membership is principally for the employer’s advantage. Premiums on medical-related plans: ●

●

● ●

●

Would have a deduction under paragraph par. 8(1)(m) of $3,000 (2% × $150,000) for his premiums paid into the plan. He would still have a potential Registered Retirement Savings Plan (RRSP) contribution to his or his spouse’s plan which will depend on the dollar limit for the year, his prior year’s earned income, and his pension adjustment for the prior year.

Stock option: ●

●

Sun Life income protection is not taxable as employment income per par. 6(1)(a), but any benefits received from said plan are taxable under par. 6(1)(f ), since the employer paid all or any part of the premium.

Pension plan: ●

●

Liberty Mutual EXtended Health Care and Sun Life-Drug plan are specifically exempted as a taxable benefit under par. 6(1)(a) as these are private health insurance premiums.

Employment inclusion will be difference between fair market value at time of exercise and $8 option price = # of shares exercised × (FMV -- $8). ACB of acquired shares will equal the FMV at time of acquisition. Assuming that Maven has annual gross revenues in excess of $500 million, the stock option deduction may still be available because the annual option grants do not exceed the $200,000 annual vesting limit (2024 estimated at $10 × 5,000 = $50,000). However, because the option price is set at 80% of the FMV at the grant date, no deduction is available in Division C [par. 110(1)(d )] since the option is granted in the money and the employer is a public company.

Group term life insurance premium is a taxable benefit. Hence, there is a taxable benefit of $800. Loans ● ●

Would not be a shareholder at the time of the loan, so ssec. 15(2) not relevant. Subsection 80.4(1) (by virtue of employment) would impute a benefit on the housing loan at the lesser of: ● ●

●

prescribed rate in force at the time the loan was made (5%) the changing prescribed rate in force during the calendar quarters the loan is outstanding (5%)

Subsection 80.4(1) would impute a benefit on the automobile loan at the changing prescribed rate in force during the calendar quarters the loan is outstanding ●

Interest paid + imputed interest on the loan would be eligible for potential deduction as an expense under para 8(1)(j ), subject to a maximum of $300 per 30-day period and subject to employment use of the car.

Problem 16 Employment income Salary . . . . . . . . . . . . . . . . . . . . . . . . . . .

$70,000

Car — Standby charge (Note 1) . . . . . . . .

3,537

Car — Operating benefit (Note 2) . . . . . .

1,769

Housing loan benefit (Note 3) . . . . . . . . .

2,508

Total employment income . . . . . . . . . . . . . . .

$77,814

Comprehensive Section/Study Guide — Solutions to Comprehensive Case Problems RRSP income attributed from spousal plan . . . Interest income attributed from children ($200 × 2) . . . . . . . . . . . . . . . . . . . . . . . . . . . Rental loss . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable capital gain (Note 5) . . . . . . . . . . . . .

647

$2,000 400 (1,000) 10,500 $89,714

Less: CPP enhancement . . . . . . . . . . . . . . . . . . . . Moving expense remaining from prior year ($8,000 -- 5,400) . . . . . . . . . . . . . . . . . . . . . RRSP contribution deductible (Note 4) . . . . . . . . . . . . . . . . . .

$(631) (2,600) (11,160)

(14,221)

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Capital gains deduction (Note 7) . . . . . . . . .

$75,323

Taxable income . . . . . . . . . . . . . . . . . . . . . . .

$67,500

(7,823)

Federal Tax Payable: Tax on $53,359 @ 15% . . . . . . . . . . . . . . . . . . Tax on $14,141 @ 20.5% . . . . . . . . . . . . . . . .

$8,004 2,899

Non-refundable tax credits: Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Employment . . . . . . . . . . . . . . . . . . . . . . . . . . CPP ($3,754 -- 631 enhancement) . . . . . . . . . . EI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$15,000 1,368 3,123 1,002

Federal tax payable . . . . . . . . . . . . . . . . . . . .

(3,074) $7,829

— NOTES TO SOLUTION 1. 6(1)(e) Standby Charge Benefit Mr. Grocer is allowed the standby charge reduction since the car is used greater than 50% for business. 10,500/20,004 × 2% × 12 months × ($26,000 + 2,080) = $3,537 2. 6(1)(k) Benefit on Operating Costs Calculation Lesser of: (i) Total kilometres . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: business use kilometres . . . . . . . . . . . . . . . . . . . . . . . .

30,000 19,500

Personal use kilometres ...................................................................10,500 × $0.33 = $3,465 (ii) /2 × $3,537 = $1,769 1

Lesser is $1,769. Mr. Grocer qualifies for the alternative method of determining a benefit derived from employer paid automobile operating costs under par. 6(1)(k), since he drove the automobile greater than 50% for employment purposes in the year and assuming that he notified his employer before December 31, 2023. The operating benefit under the alternative method results in a decreased income inclusion. 3. Imputed interest benefit calculation The loan qualifies as a home purchase loan and home relocation loan.

Comprehensive Section

$20,493 × 15%

$10,903

Introduction to Federal Income Taxation in Canada

648 Details: $60,000 principal received December 1, 2022 $12,000 principal repaid December 1, 2023 $48,000 outstanding as of December 1, 2023 Imputed interest rate for each quarter is the lesser of:

(a) prescribed rate in effect at the date the loan was received (6%) (b) prescribed rate in effect for each quarter in the year Calculation 1st quarter -- $60,000 × 5% × 90/365 days . . . . . . . . . . . . . . . . . .

$ 740

2nd quarter -- $60,000 × 4% × 91/365 days . . . . . . . . . . . . . . . . .

598

3rd quarter -- $60,000 × 4% × 92/365 . . . . . . . . . . . . . . . . . . . . .

605

4th quarter -- $60,000 × 4% × 62/365 + $48,000 × 4% × 30/365

565 $2,508

4. Deductible RRSP Contribution Least of: (a) 2022 earned income × 18% Employment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$65,000

Rental loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(3,000)

Earned income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$62,000 × 18% $11,160

(b) Amounts contributed Self . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$8,000

Spousal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6,000

$14,000 $30,780

Least is . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$11,160

5. Taxable Capital Gain on Outasite Corp. Shares Proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$26,000

Less: adjusted cost base . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(5,000)

Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$21,000

Taxable capital gain (1/2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$10,500

6. Cumulative Net Investment Loss Calculation 2020 Income — dividends ($300 × 1.16) . . . . . . . . . . . . . . . . .

348

2021 Income — dividends ($300 × 1.15) . . . . . . . . . . . . . . . . . 2022 Income — dividends ($200 × 1.15) . . . . . . . . . . . . . . . . .

345

2022 EXpenses — rental loss . . . . . . . . . . . . . . . . . . . . . . . . . .

(3,000)

2023 Income — interest from children . . . . . . . . . . . . . . . . . . .

400

2023 EXpenses — rental loss . . . . . . . . . . . . . . . . . . . . . . . . . .

(1,000)

CNIL account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

($2,677)

230

Comprehensive Section/Study Guide — Solutions to Comprehensive Case Problems

649

7. Capital Gains Deduction Taxable capital gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$10,500

Less: CNIL (Note 6) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(2,677)

Capital gain deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$7,823

Problem 17 (A) Opening balance Cash . . . . . . . . . . . . . Marketable securities (Note 1) . . . . . . . . . Inventory . . . . . . . . . . Land (Note 2) . . . . . . Building (Note 3) . . . Liabilities . . . . . . . . . . Income tax (Note 4) RDTOH (Note 5) . . . .

Proceeds $

Business Income

Investment Income

Capital Dividend

RDTOH

85,000

10,000

47,000

35,000 82,000 ($ 32,000) 460,000 1,600,000 180,000 (134,000)

( $15,000)

(15,000)

120,000 150,000

(158,800) $ 148,000

$255,000

78,200

88,200 $2,019,400

88,200

$ 340,000

(B) Funds available for distribution ............................................................. $2,019,400 Less: paid-up capital ......................................................................................................... (150,000) Deemed dividend on winding-up (s. 84(2)) .............................................................. $1,869,400 Less: capital dividend elected under s. 83(2) (s. 88(2)(b)(i))..................................... (340,000)

(C) Calculation of taxable capital gain on the disposition of shares on the winding-up: Actual proceeds from distribution ................................................................................. $2,019,400 Less: deemed dividend ................................................................................................... (1,869,400) Proceeds on disposition (s. 54) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 150,000 Cost .............................................................................................................................. (150,000) Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Taxable capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Net cash retained after sale of assets and subsequent winding-up: Funds distributed on wind-up ....................................................................................... $2,019,400 Tax on incremental income from distribution: Deemed taxable dividend ........................................................................ $1,529,400 Gross-up (15%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 229,410 Grossed-up dividend ................................................................................ $1,758,810 Taxable capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 Capital gains exemption (Note 6) . . . . . . . . . . . . . . . . . . . . . . . . 0 Incremental taxable income .................................................................... $1,758,810 Combined tax rate of 44% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: approXimate combined dividend tax credit = gross-up . . . . . Net cash retained . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

773,876 (229,410)

(544,466) $1,474,934

Comprehensive Section

Deemed taxable dividend (sufficient to clear RDTOH) ............................................... $1,529,400

Introduction to Federal Income Taxation in Canada

650

(D) Sale of shares for $2,000,000 Proceeds of disposition Proceeds of disposition $2,000,000 Adjusted cost base ................................................................................. (150,000) Capital gain.............................................................................................. $1,850,000 Taxable capital gain (1/2 × $1,850,000) . . . . . . . . . . . . . . . . . . . . $ 925,000 Capital gains exemption assuming Scrum Limited is a qualifying small business corporation (1/2 × $892,218) ......................................... (446,109) Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 478,891

Tax thereon at 44% ............................................................................... (210,712) Net proceeds ($2,000,000 -- $212,656) ................................................... $1,789,288 Conclusion: Wind-up and distribution will provide Lach with $314,354 less than a straight sale of shares ($1,474,934 vs $1,789,288). However, if on the sale of assets, the cash is retained in the corporation and the windup does not occur, personal tax of $544,466 is deferred indefinitely. The corporation will have cash of $2,019,400 -- RDTOH $88,200 = $1,931,200 to invest. — NOTES TO SOLUTION 1.

Marketable Securities Proceeds of disposition . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Capital loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

($ 30,000)

Allowable capital loss ( /2 × $30,000) . . . . . . . . . . . . . . . . .

($ 15,000)

Capital dividend account ( /2 × $30,000) . . . . . . . . . . . . . . .

($ 15,000)

Land Proceeds of disposition . . . . . . . . . . . . . . . . . . . . . . . . . . . . ACB . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 460,000 (220,000)

Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 240,000

Taxable capital gain (1/2 × $240,000) . . . . . . . . . . . . . . . . .

$ 120,000

Capital dividend account (1/2 × $240,000) . . . . . . . . . . . . . .

$ 120,000

Building Proceeds of disposition . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$1,600,000 (1,300,000) $ 300,000

Taxable capital gain (1/2 × $300,000) . . . . . . . . . . . . . . . . .

$ 150,000

Capital dividend account ( /2 × $300,000) . . . . . . . . . . . . . .

$ 150,000

UCC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lesser of cost and proceeds . . . . . . . . . . . . . . . . . . . . . . . .

$1,120,000 (1,300,000)

Recapture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

($ 180,000)

Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Active business income: Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Building recapture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

($ 32,000) 180,000

35,000 (65,000)

$ 148,000

Comprehensive Section/Study Guide — Solutions to Comprehensive Case Problems Tax @ 20% on active business income . . . . . . . . . . . . . . . .

651

29,600

Investment income: Marketable securities, allowable capital loss . . . . . . . . . . . .

($ 15,000)

Land, taxable capital gain . . . . . . . . . . . . . . . . . . . . . . . . . Building, taxable capital gain . . . . . . . . . . . . . . . . . . . . . . .

120,000 150,000 $ 255,000

Tax @ 502/3% of investment income . . . . . . . . . . . . . . . . . .

129,200

Part I Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 158,800

The adjusted aggregate investment income for purposes of determining next year’s business limit for small business deduction purposes is 0 because the gains and losses on the sale of active business assets is not included. There will be no impact on next year’s business limit. 5.

RDTOH - Non-eligible Opening balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Add: 302/3% × Aggregate inv. Income . . . . . . . . . . . . . . . . .

10,000 78,200

88,200

A distribution of $230,087 (i.e., $88,200 / 381/3%) in non-eligible taxable dividends will be required to receive a dividend refund of $88,200, which clears the RDTOH account. 6.

CGE At the time the company is wound up and the disposition of shares takes place, the only asset in the company is cash, which is not used in an active business. Therefore, immediately before the determination time the company is not an SBC and therefore cannot be a QSBC.

Problem 18 Net income before taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 1,080,648

Add: Amortization per financial statements . . . . . . . . . . . . . . . . . . . .

26,050

Financing expenses (Note 2) . . . . . . . . . . . . . . . . . . . . . . . . . . .

7,600

Racquet club memberships (par. 18(1)(l )) . . . . . . . . . . . . . . . .

9,500

Recapture (Note 3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable capital gains (Note 4) . . . . . . . . . . . . . . . . . . . . . . . . . .

500 30,000

73,650 $ 1,154,298

Deduct: Book gain on sale of fiXed assets . . . . . . . . . . . . . . . . . . . . . . . .

(96,000)

Capital dividend received (par. 83(2)(b)) . . . . . . . . . . . . . . . . . CCA (Note 3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(5,000) (47,960)

(148,960)

Net income for federal tax purposes . . . . . . . . . . . . . . . . . . . . . Less: taxable dividends received (sec. 112) . . . . . . . . . . . . . . . .

$ 1,005,338 60,000

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 945,338

Part I Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax at 38% of taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . Federal tax abatement ($945,338 × 10%) . . . . . . . . . . . . . . . . .

$ 359,228 (94,534) $ 264,694

Comprehensive Section

A. Computation of Part I tax payable.

Introduction to Federal Income Taxation in Canada

652

Additional refundable tax (Note 8) . . . . . . . . . . . . . . . . . . . . . .

3,733

Less: Small business deduction (Note 6) . . . . . . . . . . . . . . . . . .

(28,500)

General rate reduction (Note 7) . . . . . . . . . . . . . . . . . . . . . . . .

(98,844)

Part I Tax Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 141,083

— NOTES TO SOLUTION 1. The amount paid for landscaping of grounds is specifically allowed as a deduction (par. 20(1)(aa)). 2. Fine Foods Inc. can deduct only 20% of the financing costs incurred during the year (par. 20(1)(e)) (20% × $9,500). Therefore, $7,600 (being $9,500 — $1,900) must be added back to income for tax purposes. 3. Capital Cost Allowance

UCC, start of year . . . . . . . . . . . . . . . . . .

Cl. 1

Cl. 3

Cl. 8

Cl. 10.1

20%

100%

99,000

$ 210,000

2,000

Add: Purchases . . . . . . . . . . . . . . . . . . .

0 36,000*

Add: Accelerated investment incentive Deduct: Disposals . . . . . . . . . . . . . . . . . UCC before CCA . . . . . . . . . . . . . . . . . . .

(50,000) $

CCA . . . . . . . . . . . . . . . . . . . . . . . . . . . .

99,000

$ 160,000

(3,960)

(8,000)

Recapture . . . . . . . . . . . . . . . . . . . . . . . . Total CCA . . . . . . . . . . . . . . . . . . . . . . . .

(2,500) $

(500) $

(36,000) $

36,000

500

47,960

* $36,000 is the maximum capital cost that can be added to Class 10.1, assuming that the corporation is HST

registered. This is an eligible property purchase for purposes of the immediate expensing rules introduced in the April 19, 2021 Federal Budget.

4. Sale of Assets Land — Proceeds of disposition . . . . . . . . . . . . . . . . . . . . . . . . .

ACB . . . . . . . . . . . . . . . . . . . . . . . . . . . .

50,000 (20,000)

Capital gain . . . . . . . . . . . . . . . . . . . . . . .

30,000

Capital gain . . . . . . . . . . . . . . . . . . . . . . .

30,000

Capital gains Taxable portion . . . . . . . . . . . . . . . . . . . . . . . . . .

60,000

Building — Proceeds of disposition . . . . . . . . . . . . . . . . . . . . . . ACB . . . . . . . . . . . . . . . . . . . . . . . . . . . .

80,000 (50,000)

× 1/2 Taxable capital gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

30,000

Comprehensive Section/Study Guide — Solutions to Comprehensive Case Problems 5. Income Analysis

Dividends ABI

AII

Connected

Dividend income . . . . .

Portfolio $

Interest income - from GIC . . . . . . .

Total

60,000

$ 5,000

Rental income - ancillary . . . . . . . .

$ 22,000

Interest income - deemed active . . .

12,000

5,000

12,000 30,000

30,000

876,338 $ 910,338

60,000

22,000

Taxable capital gains Active business income (balance) . . . . . . . . .

653

876,338 $ 35,000

60,000

$ 1,005,338

6. Small business deduction 19% of the least of: (a) active business income (Note 5) . . . . . . . . . . . . . . . . . . . . .

$ 910,338

(b) taxable income (no foreign tax credits) . . . . . . . . . . . . . . . .

945,338

150,000

Least is . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

150,000

SBD @ 19% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

28,500

945,338

7. General rate reduction - 13% of Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $

Less: 100/19 × small business deduction . . . . . . . . . . . . . . . . . .

150,000

Less: Aggregate investment income . . . . . . . . . . . . . . . . . . . . . .

35,000

General rate reduction @ 13% . . . . . . . . . . . . . . . . . . . . . . . . . .

($ 185,000) $

760,338

98,844

8. Additional refundable tax 102/3% × the lesser of: (i) Aggregate investment income . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 35,000

(ii) Taxable income less SBD income ......................................................... 795,338 Lesser is . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 35,000

ART @ 102/3% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 3,733

Comprehensive Section

Less: 100/13 × M&P profit deduction . . . . . . . . . . . . . . . . . . . .

Introduction to Federal Income Taxation in Canada

654

B. Computation of the refundable dividend tax on had balance at the end of the year and the dividend refund for the taxation year. Noneligible RDTOH

Eligible RDTOH

RDTOH Opening balance as of January 1, 2023 . . . . . . . . . . . . . . . . . . .

Less: prior year dividend refund . . . . . . . . . . . . . . . . . . . . . . . .

25,000 (5,000)

Refundable Part I tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

10,733

Part IV tax on connected dividends . . . . . . . . . . . . . . . . . . . . . .

Part IV tax on portfolio dividends - 381/3% . . . . . . . . . . . . . . . . .

23,000

Balance as of December 31, 2023 . . . . . . . . . . . . . . . . . . . . . . .

23,000

0 23,000

30,733

Dividend Refund Total of: 1. Lesser of: (i) 381/3% × eligible dividends paid . . . . . . . . . . . . (ii) Eligible RDTOH . . . . . . . . . . . . . . . . . . . . . . .

2. Total of: (A) Lesser of: (i) 381/3% × non-eligible dividends paid . . . . . . . . . (ii) Non-eligible RDTOH . . . . . . . . . . . . . . . . . . . .

11,500 30,733

11,500

and (B) greater of: (I) Lesser of: (i) excess, if any, of A(i) over A(ii) above . . . . . . .

(ii) Eligible RDTOH minus 1 above . . . . . . . . . . . .

0 0

and (II) nil . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Refundable Portion of Part I Tax Least of: 1. 302/3% × AII = 302/3% × $35,000 . . . . . . . . . . . . . . . . . . . . . . Less: NBFTC — 8% × FII . . . . . . . . . . . . . . . . . . . . . . . . .

$ 10,733 0

$ 10,733 243,904

2. 302/3% × TI -- SBD amount -- 100/382/3× NBFTC -- 4 × FBTC 3. Part I tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

141,083

Least is . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 10,733

C. Computation of the maximum capital dividend that can be paid to the shareholders (par. 89(1)(b)). Capital dividend account balance, beginning of year . . . . . . . . . . . . . . . . .

4,000

Add: Capital dividends received from Good Grub Corp. . . . . . . . . . . . . . . .

5,000

Non-taxable portion of capital gains ($60,000 -- 30,000) . . . . . . . . . . . . . .

30,000

Capital dividend account balance, end of year . . . . . . . . . . . . . . . . . . . . .

39,000

Comprehensive Section/Study Guide — Solutions to Comprehensive Case Problems

655

Problem 19 The main issues in this case relate to: ●

compensation, and

●

how to get cash out of a corporation.

1. Compensation (a) Bonus ●

●

● ●

●

The pre-tax profit in the corporation is $550,000, so he could pay himself a bonus of $50,000 on which he would pay about 50% tax, leaving $25,000 after tax. Alternatively, the corporation could retain the income and pay tax at 27% (15% federal and 12% provincial) leaving about 73%, or $36,500, after tax. The tax deferral is (50% – 27%) × $50,000 = $11,500. If the funds are kept in the corporation, then the $36,500 could be paid out later as a dividend from the General Rate Income Pool (GRIP) with personal tax of appro Ximately 31% (after the 38% gross-up and tax credit) on this dividend, leaving about $25,185 after tax. If a bonus is not paid, then: — corporate tax instalment options will be based on this higher tax liability; — the final tax instalment will be due at the end of the second month instead of at the end of the third month following year end; — some tax is deferred with a little double tax on payment of the dividend.

●

If a bonus is declared, then: — Was there a valid liability at December 31?

— Will it be paid before 180 days after the year end? — Some double tax will be avoided; in fact, a slight tax savings will be realized. (b) Salary to Betty ●

Is the salary reasonable in relation to the work performed?

●

Especially important since she is not dealing at arm’s length.

●

What is reasonable to pay a secretary-treasurer for the activities she performs?

●

Was this expense incurred to earn income, since her activity was to be involved with local charities? If disallowed, then double tax; no deduction in the company but income to the recipient.

What is a reasonable amount to pay Scott and Kelly?

●

Was this expense incurred to earn income?

●

If disallowed, then double tax; no deduction in the company but income to the recipient.

(d) Reorganization to involve Betty in share ownership and provide her with dividend income ●

●

Given the excess cash it is holding, the corporation may not be a small business corporation (SBC) (may not meet the 90% test). Grant cannot crystallize to use up his capital gain exemption if the company does not qualify as an SBC.

Comprehensive Section

— Is it reasonable?

Introduction to Federal Income Taxation in Canada

656

●

He might consider purifying the company by paying out the paid-up capital (PUC), paying off liabilities, or paying a dividend, etc. The corporate attribution rules in subsection 74.4(2) may apply to deem an interest benefit on the full value of the shares received as consideration less any interest received and 5/4 times any dividend received.

2. Methods of Receiving Cash from the Company (a) Paid-up capital reduction ● ●

●

The paid-up capital of the corporation appears to be $20,000. Now that Grant owns all the shares, he can reduce the paid-up capital of the company by $20,000 and there will be no deemed dividend under subsection 84(4). A PUC reduction will cause a corresponding reduction in his adjusted cost base (ACB), but since his ACB is $40,000 before the reduction this will only reduce his ACB to $20,000.

(b) Arm’s length ACB ●

●

Grant can transfer his shares to a holding company under subsection 85(1), elect at whatever value he chooses between his ACB and fair market value (FMV), and take back cash equal to his arm’s length ACB without triggering a subsection 84.1 deemed dividend. This is one way of getting some extra cash out of the corporation tax free, i.e., the $20,000 by which his ACB exceeds the PUC.

● ●

Interest paid on a mortgage taken out to buy a cottage personally will not be deductible. They can borrow from the company but need to assess subsections 15(2), 80.4(1), and 80.4(2). Who should borrow the money, Grant or Betty? This withdrawal of cash will probably not cause the corporation to become a SBC, since the cash has been replaced with an asset (i.e., due from Shareholder).

(d) Intergenerational Transfer under Bill C-208 ●

●

If Grant is ready to transfer his ownership of the business to the next generation, he could receive cash proceeds on the sale to a holding company that is controlled by Scott, Grant’s child who is over 18 years old. If Scott controls the holding company, the holding company does not dispose of the shares for a minimum of 60 months, the shares sold by Grant are Qualified Small Business Corporation shares, and the shares are sold to the holding company at fair market value, then Grant could receive cash proceeds or a promissory note from the holding company without triggering a deemed dividend under section 84.1, based on the amendments that were made under Bill C-208. Grant will be subject to tax on the capital gain, for the amount of the gain that exceeds Scott’s lifetime capital gains exemption, on the sale of the shares to a holding company owned and controlled by Scott. If the transaction occurs on or after January 1, 2024, Budget 2023 introduces additional conditions that must be met to ensure that a deemed dividend pursuant to section 84.1 isn’t triggered. This includes meeting the conditions under one of two transfer options: an immediate intergenerational business transfer or a gradual intergenerational business transfer based on traditional estate freeze characteristics.

3. Other Issues (a) Valuation ●

Is the company really worth $1,200,000, or is most of that value personal goodwill of Grant?

(b) Holding company ●

Consider setting up a holding company to separate the excess cash from the business liabilities.

Comprehensive Section/Study Guide — Solutions to Comprehensive Case Problems

● ●

●

657

After the holding company has been established, pay a dividend. On the transfer to the holding company, the capital gain exemption can be crystallized by electing under subsection 85(1). Grant can receive cash on the transfer equal to the ACB without triggering a deemed dividend under section 84.1. Betty could be included in the ownership, but corporate attribution [c. 74.4(2)] needs to be considered.

Problem 20 (A) Comparison of taxes of proprietorship vs. corporation Proprietorship Net income per income statement . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 60,000

Less: RRSP contribution (18% of $35,000) . . . . . . . . . . . . . . . . . . . .

(6,300)

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 53,700

Tax on first $53,359 @ 25% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 13,340

Tax on next $341 @ 32.5% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

111

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 13,451

Net tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 13,451

Corporation $ 60,000

Less: salary to Soul . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(35,000)

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 25,000

Tax @ 13% (38% - 10% - 19% + 4%) . . . . . . . . . . . . . . . . . . . . . . . .

(3,250)

Retained in the corporation available for distribution . . . . . . . . . . . .

$ 21,750

Comprehensive Section

Income for tax purposes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Shareholder Employment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 35,000

Dividend income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

21,750

Gross-up @ 15%

3,263

Less: RRSP (18% of $35,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(6,300)

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 53,713

Tax on first $53,359 @ 25% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

13,340

Tax on next $354 @ 32.5% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

115

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 13,455

Dividend tax credit (assumed equal to gross-up on dividend above)

(3,263)

Net tax

$ 10,192

Comparison of taxes Taxes on proprietorship income . . . . . . . . . . . . . . . . . . . . . . . . .

$ 13,451

Taxes through corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Corporate tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 3,250

Personal tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

10,192

Tax savings (cost) of using corporate1 . . . . . . . . . . . . . . . . . . . . . . .

13,442 $

Introduction to Federal Income Taxation in Canada

658 Potential advantages of using a corporation

(a) the possibility of deferring tax, if funds are retained in the corporation (b) potential limited liability (c) family income splitting using a ‘‘small business corporation’’ engaged in active business in Canada (i) the children could own shares (minor child’s shares should be held in trust) to allow for the payment of dividends from profits of future expansion at a low or no tax cost. However, the rules related to tax on split income and the related requirements for involvement in the business of children at various ages would need to be taken into consideration before incurring any costs to set up a structure that allows for this (ii) similarly, wife could own shares for the same purpose, but again, the rules related to tax on split income would need to be reviewed in light of the spouse’s involvement in the business (d) potential estate freeze of the business assets (e) separation of business and personal activities (f) availability of RPP to the owner-manager and family members as well as other fringe benefits that can be provided to such employees at a low or no after-tax cost (e.g., loans, car, insurance, and private medical coverage) (g) stabilization of income to individual and timing flexibility (h) availability of $913,630 capital gains exemption to each individual shareholder, if shares are of a small business corporation and meet certain other conditions (i) continuity of separate legal entity Potential Disadvantages of using a corporation (a) cost of incorporation (b) cost of compliance with laws (c) loss of availability of business and capital losses to offset personal income (d) capital gains deduction not available to a corporation (B) Tax implications of transferring assets to a corporation Items not transferred under ssec. 85(1) (transfer at FMV for debt consideration) Tax value

FMV

Transfer

Debt

Income

Cash . . . . . . . . . . . . .

$ 2,000

2,000

$ 2,000

Equipment2 . . . . . . .

8,000

3,000

A/R (sec. 22)3 . . . . . .

500

Inventory4 . . . . . . . .

40,000

$ 50,500

$45,500

45,500

$45,500

Comprehensive Section/Study Guide — Solutions to Comprehensive Case Problems

659

Items transferred under ssec. 85(1) Consideration Tax value

FMV

Elected Amount

Debt

Pref Shares5

Income

Land* . . . . . . .

$ 80,000

$140,000

$130,000

$10,000

$25,000

Building . . . . .

169,000

360,000

169,000

191,000

Goodwill . . . . .

7,500

20,000

7,500

12,500

$256,500

$520,000

$306,500

$213,500

$25,000

Liabilities assumed

$163,700

New debt issued

142,800 $306,500

* Taxable capital gain to offset net capital losses of $25,000. Add the full capital gain ($25,000 × 1/2 = $50,000) to the ACB of the land.

Cost of consideration received Elected amount . . . . . . . . . . . . . . . . . . . . . . . . . .

$306,500

Allocated to debt consideration: Liabilities assumed . . . . . . . . . . . . . . . . . . . . .

$ 163,700

New debt issued . . . . . . . . . . . . . . . . . . . . . .

142,800

Cost of preferred shares . . . . . . . . . . . . . . . . . . . .

306,500 $

PUC of preferred shares Legal stated capital (LSC) of preferred shares . . . . . . .

$ 213,500 $213,500

(i) Increase in LSC of shares issued . . . . . . . . . . . (ii) Corporation’s cost of property [85(1)] . . . . . . .

$ 306,500

less: FMV of non-share consideration . . . . . . .

(306,500)

EXcess, if any . . . . . . . . . . . . . . . . . . . . . . . .

PUC reduction . . . . . . . . . . . . . . PUC for tax purposes . . . . . . . . . . . . . . . . . . . . . . . . .

213,500 $

— NOTES TO SOLUTION 1. Due to imperfections in tax rates preventing perfect integration. 2. The terminal loss is denied. The capital cost addition to UCC to the corporation will be $3,000. Soul will hold a notional asset in Class 8 with a value of $5,000 in the class. Note that the Accelerated Investment Incentive will not apply as the property was acquired through a rollover. 3. Add back the $100 reserve and deduct a $100 business loss, due to the election under section 22. The result is net income of nil. 4. It is not necessary to transfer the inventory, in this case, by electing under subsection 85(1), because there is no income to defer. 5. Shares should be taken such that fair market value of total consideration from the corporation equals the fair market value of assets transferred. This will avoid any problem with the benefit rule which would arise if the wife and/or children own shares in the corporation.

Comprehensive Section

Less: ssec. 85(2.1) reduction in PUC

Introduction to Federal Income Taxation in Canada

660

Problem 21 Part A

Income per the financial statements . . . . . . . . . . . . . . . . . . . . . . . .

$ 944,000

Add: Bonuses unpaid 180 days after the end of the tax year ($200,000 + $400,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

600,000

Non-deductible club dues ($4,500 – $200) . . . . . . . . . . . . . . . .

4,300

Non-deductible meals and entertainment ($13,200 × 50%)

6,600

Non-deductible automobile allowances Allowance paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 17,360

Deductible portion ($0.68 × 5,000 + $0.62 × 2,000) × 4

(18,560)

Foreign magazine aimed at Canadian market . . . . . . . . . . . . . .

8,000

Prepaid advertising ($13,000 × 1/2) . . . . . . . . . . . . . . . . . . . . .

6,500

Donations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

66,000

Amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

180,000

Accounting fee for arranging financing ($4,000 × 80%) . . . . .

3,200

Ssec 18(3.1) construction period interest . . . . . . . . . . . . . . . .

28,000

Taxable capital gain on the sale of shares Proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$120,000

less: adjusted cost base . . . . . . . . . . . . . . . . . . . . . . . . . .

(20,000)

Capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$100,000

Less: capital gains reserve, lesser of: (1) $100,000 × 4/5 = $80,000 (2) $100,000 × $90,000/$120,000 = $75,000

(75,000)

Capital gain × 1/2 = taxable capital gain . . . . . . . . . . . . . .

$ 25,000

12,500 $1,859,100

Deduct: Gain on the sale of the shares . . . . . . . . . . . . . . . . . . . . . . . . .

(100,000)

SR&ED expenditures $500,000 – $200,000 . . . . . . . . . . . . . . . .

$300,000

ITC claimed prior year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(175,000)

(125,000)

Landscaping . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(50,000)

CCA — Class 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(61,020)

CCA — Class 13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(30,000)

CCA — Other (given) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(200,000)

Net income for tax purposes

$1,315,580

CCA Class 13 - Leasehold4 Lessor of: (a) 1/5 × ($30,000 + $15,000) . . . . . . . . . . . . . . . . . . . . . . . . (b) ($30,000+15,000)/(3 + 3) . . . . . . . . . . . . . . . . . . . . . . . . Lesser is

9,000 7,500 $

7,500

Comprehensive Section/Study Guide — Solutions to Comprehensive Case Problems

661

A Class 13 leasehold improvement is an ‘‘eligible property’’ that was acquired by a CCPC after April 19, 2021 and available for use in the year. This addition qualifies for immediate expensing, on the assumption that the company has not exceeded the $1.5 million per taxation year limit for immediate expensing. CCA Class 1 - Warehouse1 Material . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 316,000

Labour . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

320,000

Interest during construction . . . . . . . . . . . . . . . . . . . . . . . . .

28,000

Utilities service connection2

14,000

.........................

$ 678,000 Add: 50% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

339,000

Addition for CCA purposes . . . . . . . . . . . . . . . . . . . . . . . . . .

$1,017,000

CCA @ 6% (no half-year rule) . . . . . . . . . . . . . . . . . . . . . . .

61,020

Notes to CCA Calculation: 1. Accelerated investment incentive allows for an additional 50% to be added to additions, for CCA purposes, AND eliminates the half-year rule. 2. This solution assumes the utilities service connection cost was incurred during the construction period and thus the cost has been added to the cost of the building [ssec. 18(3.1)]. If the utilities service connection was done outside the construction period, it is fully deductible. Part B

Division C deductions Net income for tax purposes (Part A) ...................................................................... $1,315,780 75% = . . . . (66,000)

Dividends from taxable Canadian corporations ($12,000 + $43,000) . . . . . .

(55,000)

Net capital losses (limited to taxable capital gains)* . . . . . . . . . . . . . . . . . (12,500) Noncapital losses** ........................................................................................................... (200,000) Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . *

$ 982,280

Available $27,500

These non-capital losses (as well as the net capital losses) became losses of Ever EZ when Sub Ltd was wound up in 2021. The losses are available to use starting the year after the winding-up, which is the 2022 taxation year.

Problem 22 Part A

Tax Implications of Acquisition 1. Deemed Taxation Year-End On July 16, 2023, Tasty will acquire control of Yummy, and Yummy is subject to a loss restriction event. The rules in the Income Tax Act (ssec. 249(4)) deem Yummy to have a taxation year end immediately prior to the loss restriction event. Therefore, Yummy will have a taxation year ending July 15, 2023, which will cover the period January 1, 2023 to July 15, 2023. Consequences of a taxation year end include: (i) Corporate tax returns must be filed for Yummy within siX months of this deemed year end (by January 15, 2024). (ii) Any CCA claimed in this deemed year end must be prorated for a short taxation year (196/365).

Comprehensive Section

Donations to registered charities, not to exceed $1,315,780 ×

Introduction to Federal Income Taxation in Canada

662 2. Accrued Losses at July 15, 2023

The Income Tax Act requires certain unrealized losses to be realized for tax purposes when there has been a loss restriction event. Therefore, the non-capital loss for the taxation period ended July 15, 2023 should be calculated. Adjustments to the loss include: (i) Ssec. 111(5.1) requires inherent terminal losses on each CCA class to be realized for tax purposes on a class-by-class basis. For Yummy, the losses that are realized by virtue of ssec. 111(5.1) are as follows: Class 10 $60,000 (FMV of $20,000 – UCC of $80,000) (ii) Ssec. 10(1) requires that inventory be valued at the lower of cost and FMV. Therefore, the inherent loss in Yummy’s inventory of $100,000 must also be realized on the acquisition of control. Therefore, the non-capital loss of Yummy for the taxation period ending July 15, 2023 should be recalculated to be: Operating loss to date of purchase (given) . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 120,000

Loss per S.111(5.1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

60,000

Loss per S.10(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

100,000 $ 280,000

3. Elective Options – Recapture Yummy can choose to recognize accrued recapture by making a designation under par. 111(4)(e). This designation sets a ‘‘deemed proceeds of disposition’’, that results in capital gain and/or recapture, depending on the circumstances. The effect of this designation on classes with accrued recapture would be to reduce the non-capital loss of Yummy for the period ending July 15, 2023. Elections to recognize recapture can be done on the following assets: Recapture would be the lesser of (i) cost and (ii) FMV MINUS UCC Class 1 . . . . . . . . . . . . . . . . . . . .

Class 8 . . . . . . . . . . . . . . . . . . . . $

50,000

(Cost of $400,000 - UCC of $350,000)

10,000

(FMV of $60,000 - UCC of $50,000)

60,000

There are set limits on the amount that can be designated. It cannot be below the lesser of: (i) the cost of the asset and (ii) the FMV of the asset. It cannot be greater than the FMV of the asset. The minimum designations are therefore $400,000 for Class 1 and $60,000 for Class 8, respectively, and the maximum designation for each class is the FMV. If the designation is made under par. 111(4)(e) for both classes, the non-capital loss for the taxation period ending July 15, 2023 is decreased as follows: Revised Non-capital Loss Non-capital loss per mandatory rules in (2) above ..................................................... $

280,000

Less: recapture resulting from elected proceeds . . . . . . . . . . . . . . . . . . . . . . .

(60,000) $

220,000

While the designation under par. 111(4)(e) is available, it may not be best to do it as the objective may be to maximize non-capital losses carried forward as it is expected that Yummy will be profitable very soon.

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4. Net Capital Losses At the time of the loss restriction event Yummy’s net capital losses carried forward of $75,000 expire by virtue of par. 111(4)(a). They will not be available after the deemed taxation year end ending July 15, 2023. The unrealized capital loss in the marketable securities of $4,000 is triggered at the time of the loss restriction event (par. 111(4)(d )). This creates an additional net capital loss of $2,000 [$4,000 × 1/2] in the taxation year ending July 15, 2023, which will also expire at the time of the loss restriction event. The ACB of the marketable securities is reduced to $8,000, being the FMV of the asset (par. 111(4)(c)). 5. Elective Options – Capital Gains An election can be made (par. 111(4)(e)) to set deemed proceeds of disposition on certain capital assets to recognize accrued capital gains immediately before the loss restriction event to use up any net capital losses that exist prior to that time as well as current year allowable capital loss triggered by the deemed disposition of capital property in (4) above. The deemed proceeds can be any amount between the ACB and the FMV of the elected asset. The net capital losses that exist at July 15, 2023 are $77,000 ($75,000 + $2,000). This reflects gross capital losses (pre-inclusion rate) of $154,000. Both the land (gain of $300,000) and the building ($50,000) have accrued capital gains as at July 15, 2023, which total $350,000. If the land is elected, a capital gain of $154,000 can be generated which will offset the capital losses that would otherwise be lost. The new ACB of the land after the election would be $354,000 (current ACB $200,000 + elected proceeds $154,000). Alternatively, Yummy could elect to recognize a $50,000 capital gain on the building and elect on the land to realize a capital gain of $104,000. The full capital gain of $350,000 could be triggered, resulting in a taxable capital gain of $175,000. Of this gain, $77,000 would be offset by net capital losses with the remaining taxable capital gain of $98,000 reducing the non-capital loss for the taxation period ending July 15, 2023). However, as discussed in (3) above, triggering the entire gain may not be wise as Fred expects to turn Yummy around and make it profitable in the near future. He would likely want to have non-capital losses carried forward maximized in order to reduce taxable income in the future.

Sec. 3(a) Business and property income . . . . . . . . . . . . . . . . . . Sec. 3(b) Taxable capital gain . . . . . . . . . . . . . . . . . . . . . . . . . .

$ $

Allowable capital loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sec. 3(c)

77,000 (2,000)

75,000 $

75,000

Sec. 3(d ) Business loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(280,000)

Division B income (technically cannot be negative) . . . . . . . . . .

$ (205,000)

Division C deductions: Net capital losses applied . . . . . . . . . . . . .

(75,000)

Non-capital losses applied . . . . . . . . . . . .

Non-capital loss for the deemed year ended July 15, 2023 . . . . .

$ (280,000)

Non-capital loss balance December 31, 2022 . . . . . . . . . . . . . . .

(700,000)

Non-capital loss balance at July 16, 2023 . . . . . . . . . . . . . . . . . .

$ (980,000)

Part B

Availability of Non-Capital Losses After the Loss Restriction Event Ssec. 111(5) states that non-capital losses will be available for deduction after a loss restriction event only if the business of Yummy (restaurant supply business) is carried on for profit, or with a reasonable expectation of profit throughout the year the losses are to be used (spar. 111(5)(a)(i)).

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Assuming that just enough taxable capital gain is realized through the elective option, to offset the expiring net capital losses, the loss non-capital loss remaining at July 15, 2023 will be as follows:

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If the above condition is met, the losses can only be deducted to the extent of income from the restaurant supply business or from a business selling similar products or providing similar services (spar. 111(5)(a)(ii)). Methods For Tasty To Utilize Losses of Yummy After the shares of Yummy have been acquired, Tasty could get access to these losses by using the following techniques: 1. Amalgamate Tasty and Yummy — By virtue of section 87 of the Income Tax Act, an amalgamation could take place on a tax-deferred basis. The losses of Yummy would be available to the amalgamated company by virtue of s. 87(2.1). Note that both Tasty and Yummy would have deemed year ends immediately before the amalgamation. 2. Wind-up Yummy into Tasty — By virtue of section 88 of the Income Tax Act, a wind-up of a parent and its wholly-owned subsidiary could take place on a tax-deferred basis. The losses of Yummy would be available to Tasty by virtue of ssec. 88(1.1). Note that the losses would be available for use in the first taxation year of Tasty that commences after the wind-up and in subsequent years. 3. Transfer profitable assets from Tasty to Yummy under a tax-deferring basis using s. 85 — These assets would generate profits in Yummy — the losses of Yummy could then be applied against these profits. 4. Run the business profitably — Change financing structure. 5. Increase prices to Tasty, if possible — For the losses to be available against the taxable income of Tasty, however, the business of Tasty must be a restaurant supply business or a business providing similar services or similar products. It will have to be determined as to whether the fast food restaurant business is providing similar products or similar services as the restaurant supply business. If it is not, the non-capital losses of Yummy will only be available to be used against income generated from the restaurant supply business.

Problem 23 The main tax issues in this case relate to: 1. inventory valuation, 2. liability for U.S. tax, 3. the refinancing of the business, and 4. foreign exchange.

1. Inventory valuation a. Lower of cost or market or all at market are acceptable methods of valuing inventory for tax purposes (ssec. 10(1); Reg. 1800). b. Reserves for decline in the value of inventory are not allowed as a deduction for tax purposes (par. 18(1)(e)). c. A deduction is allowed if the decline is real and measurable as at year end.

2. Liability for U.S. Tax a. It needs to be determined whether the company has a permanent establishment in the U.S. ●

If they do, then this will result in it having to file a U.S. tax return and pay tax in the U.S. on the profits allocated to that permanent establishment.

b. A business foreign tax credit would be available for any tax paid in the U.S. (ssec. 126(2)). c. The 10% federal abatement is not available, in computing Canadian federal corporate income tax, for profits earned by a Canadian company carrying on business in the U.S.

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3. Refinancing Issues a. Personal guarantees ●

●

Tax treatment of losses resulting from contributions made to the company as a result of a personal guarantee being called (IT-239R2). These losses may be business investment losses (BILs) if the company is a small business corporation (SBC) and if the money was loaned to earn income from business or property (par. 39(1)(c)). Interest expense deductible if borrowing to meet obligation under personal guarantee (IT-445). Guarantee fees could be charged to show that the guarantees were made to earn income.

b. Professional fees for the financing ●

Legal fees for collateral mortgage, accounting fees for cash flows and the appraiser’s fees for the real estate appraisal can be deducted straight-line over five years (par. 20(1)(e)).

c. Sale of shares ●

Since the supplier’s company is probably a SBC and Dave deals at arm’s length with the supplier, the loss should qualify as an allowable business investment loss (ABIL) (sec. 251, par. 39(1)(c); IT-219).

d. Interest expense ●

●

After the sale of the shares, interest on the full $50,000 loan will be deductible (ssec. 20.1(1)). He should secure the loan that he makes to the company.

4. Foreign exchange issues on US dollar bank account Foreign exchange gains and losses on the money in this account would probably be income in nature, given that the bank account is for the collection of accounts receivable (IT-95R).

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