tax assign 2.docx
Cases, Byrd & Chen’s Canadian Tax Principles 2024/25 Edition CASE 2 – Chapter 5 & 6 (Business Income) You have just started to work as an income tax auditor for the CRA. You have been assigned a file with a 2024 statement of business income of a Canadian Controlled Private Corporation (CCPC) that was recently assessed for its first taxation year beginning January 1, 2024 and ending December 31, 2024. Your job is to review and audit the statement of business income and, for each item identified as having an income tax potential, identify what reportesd amounts are correct and which are incorrect. Where an amount is incorrect determine the correct amount adding explanations (including ITA references) and supporting calculations where necessary. Finally determine the revised 2024 business income based on your conclusions. Taxpayer Submitted – Business Income Statement Business Income Gross Sales Revenue$4,580,000[endnoteRef:1] Less: Cost of goods sold 1,651,200[endnoteRef:2] Gross Profit – Sales Revenue$2,928,800 Gross Service-based Revenue 3,716,200 Less: Cost of goods sold 943,200[endnoteRef:3] Gross Profit – Sales Revenue$2,773,000 Total Business Revenues $5,701,800 [1: Sales are broken down by cash sales of $2,315,000, credit sales of $2,265,000. On December 31, 2024 the accounts receivables balance of the combined business is $604,000. ] [2: Cost of goods sold with respect to sales revenue are determined as opening inventory of nil plus purchases of $3,220,000 less ending inventory of $1,568,800 determined using the LIFO valuation method. The company has experienced rising costs in 2024 and has used LIFO to reflect the current financial reality claiming that this creates a more accurate picture of income. Had the company used the FIFO method the ending inventory would have been valued at $1,353,000. If the company had used average cost the ending inventory would have been $1,411,400. The inventory is such that specific identification is not feasible. ] [3: Cost of goods sold with respect to the service-based revenue and related sales are determined as opening inventory of nil plus purchases of $1,775,300 less ending inventory of $832,100 determined using specific identification. ] Business Expenses General and Administrative $1,148,550 Amortization 649,165 Salaries and Wages 1,420,975 Other[endnoteRef:4] 1,017,885 4,236,575 [4: This expense category does not include any current or future federal or provincial income taxes.] 2024 Business Income$1,465,225 You have interviewed the taxpayer representatives, reviewed the business income statement, and determined that the only potential items that require further audit review are identified in the following notes you have made: The Interview: You had the opportunity to interview representatives of the CCPC, ask numerous questions and reviewed and copied supporting documents provided. You learned the following from the interview: 1. The Business: The current incorporated business which is carried on solely in Ontario provides both the sale of hardware store goods and some industrial equipment plus offers service contracts largely for local manufacturers who utilize the industrial equipment sold. You learned that the current business represents the merger of two completely separate businesses both operated as sole proprietorships – the hardware store and the industrial equipment sales and services business – into one integrated business operated in the same building premises. At the end of 2023 the previous business owners who were arm’s length with each other agreed to combine their businesses in a new corporation beginning January 1, 2024. The voting shares of the new corporation (CCPC) are owned 50% by each of the previous business owners. 2. Employees[endnoteRef:5]: The company employs 22 full-time individuals, excluding the two shareholders who are senior executives and the only two members of the corporate Board of Directors, and 5 part-time staff. Salary expense includes gross salaries and wages, the corporate employer’s EI and CPP required payments as well as other employment related amounts such as commissions, workman’s compensation premiums and private health services plan (PHSP) premiums. PHSP premiums totalled $76,750 with $40,000 of that amount paid for a premium medical plan for the two shareholders and their spouses. The premium plan is not available to any non-shareholder employees. [5: The company has six full-time employees who regularly travel to customers to fulfill service contracts. Three of the employees have chosen to use one of the four corporate delivery vehicles while the remaining three use their own vehicles for which the company pays them $0.80 a kilometer which is considered reasonable based on the conditions of the roads in the areas frequented by the service technicians. In 2024 the company paid $41,700 in kilometer based allowances plus $2,900 in parking fines. Assume that each employee drives the same number of kilometers in 2024. The company decided that it is less expensive to pay parking fines than make valuable clients wait while parking is found in areas with limited restricted parking. As a result the company has agreed to reimburse all parking fines for the six service technicians.] 3. Conventions[endnoteRef:6] ($71,400 included in Other Expenses): During the year company employees attended three provincial conventions to market their goods and services. The conventions were held in Ottawa, Kitchener and Toronto at a cost of $18,000 for Ottawa, $19,500 for Kitchener and $33,900 for Toronto. Four employees attended each conference, which lasted two days. The employees were entitled to meals and drinks at each conference although the amount charged was not specified in any contract or invoice with the convention organizers. Note: the conventions are all held in Ontario which is within the territorial scope of the corporation. [6: During the year company employees attended three provincial conventions to market their goods and services. Three employees attended each conference which lasted two days. The employees were entitled to meals and drinks for each conference although the amount charged was not specified. ] 4. Charitable Donations ($21,000 General & Administrative Expenses): At a recent conference the company learned that it was expected that all incorporated businesses in the area contribute to certain local charities such as the food bank. Failure to do so could affect revenues. As a result the company agreed to donate to these and other charities every year. 5. Life Insurance ($45,700 General & Administrative Expenses): Life insurance premiums of $34,700 are paid by the company for 2024 on the lives of the two shareholder owners. The corporation is the beneficiary of the two life insurance policies. The life insurance does not relate to any financial requirements imposed by a lending institution. In addition the company pays $500 in life insurance premiums for each of the 22 full-time non-shareholder employees under a group term life insurance policy, a total of $11,000. The policyholders and beneficiaries are the spouses, common-law partners or any other individuals identified by the full-time employees. 6. Select Depreciable Property: The company acquired the following properties during its 2024 taxation year: 3 Diesel-powered Delivery Vehicles: The company paid $60,000 for each vehicle which were acquired from the previous industrial sales and services equipment business on a rollover basis. The three vehicles are all Class 10. As a result of the rollover the deemed capital cost of each vehicle is $91,000 and deemed CCA $31,000 resulting in a $60,000 addition to the UCC for each of the three vehicles. You have traced these amounts to the former business and determined that they were all correctly determined. These amounts ($180,000) were expensed in the year under the immediate expensing rules. 1 Electric Delivery Vehicle: The company purchased a new delivery vehicle for $93,000 on March 1, 2024 from an arm’s length seller. Note: All delivery vehicles have a limited seating capacity (two seats only) and are used more than half the time to transport goods and equipment in the course of carrying on a business. Office Equipment: The company acquired all of its office equipment for $212,000 from the previous businesses on a rollover basis. The deemed capital cost of all office equipment is $345,000 with deemed CCA of $133,000 resulting in an increase in the UCC of Class 8 of $212,000. 7. Client list & Goodwill: The company paid $75,000 for the client list of the industrial equipment sales and services business. The company also paid $110,000 for the goodwill of the former hardware stores business and $140,000 for the goodwill of the former industrial equipment sales and services business. 8. Business Premises (Rent expense $210,000, Improvements $182,400 + $17,900 + Landscaping $28,000): The hardware store business had been operated out of a building owned by the sole proprietor of that business. The sole proprietor did not wish to give up ownership of the building but agreed to lease the building to the company for $15,000 a month (plus two months or $30,000 of a security deposit) on the condition that landscaping was improved around the building and that an addition would be made to allow space for the industrial equipment sales and services business. The company incurred $28,000 in landscaping costs with $19,000 of that amount paid in 2024 and the remaining $9,000 paid in 2025. In addition the company contracted a construction company to add an addition to the leased premises that cost $182,400. An additional amount of $17,900 was paid in 2024 to add ramps and other mobility related equipment to allow disabled individuals to access the business premises. Rent and landscaping costs were all expensed in 2024. The improvements were treated as Class 13 depreciable property and claimed in part as CCA. The original term of the lease is eight years with one renewal option to add two years. 9. Bonuses: Based on a percentage of certain sales, bonuses were declared in December of 2024 for each of the two shareholders in the amount of $100,000 each and $90,000 for each of the two most senior non-shareholder managers in each of the hardware store and industrial equipment sales and services businesses. The bonuses to the two shareholders were paid in March of 2025 whereas the other bonuses were only paid in September of 2025. 10. Company-provided Automobile: The two shareholders were each provided with an all electric 2024 Cadillac LYRIQ on May 1, 2024 which at the time had 125 kilometres each on the odometer. The automobiles cost the employer $92,125 before HST of 13%. The two shareholders only used the automobiles to drive between their homes and the business. The odometer reading on December 31, 2024 was 17,400 and 22,100 for each of the two vehicles. Logbooks were maintained but only indicated the travel from home and the business premises. No non-shareholder employees are provided with similar automobiles. 11. Company-provided Automobile Expenses: The company paid the following operating expenses for the use of the two electric vehicles used by the shareholders: Maintenance and Repairs $ 2,225 Insurance 2,800 License and Registration 200 Electricity to Charge the automobile 100 Total $ 5,325 12. Stock Option Plan: In July 2024 the company obtained amended articles of incorporation which cost $7,200 in legal expenses. The amended articles added a class of non-voting shares to be used to grant stock options to employees with a minimum of two years experience. The stock option price would be equal to the FMV of those shares at the time of granting as determined by an independent valuator. In 2024 twelve employees took advantage of the stock option plan which the company estimated cost the company $2,000 per employee or $24,000 in total. The company expensed the $24,000 under “general administrative expenses” plus the legal expenses of $7,200. 13. Tax Planning Expenditures: In August 2024 $31,200 was spent to consult with a local law firm that specialized in family income tax planning. The result was a further amendment to the articles of the corporation which added four specialty non-voting preferred share classes for the family members of each shareholder. This amount was expensed in full in 2024 under general and administrative expenses. 14. Travel by the Shareholders and their Spouses: in February 2024 the two shareholders and their spouses went on an island-hopping first class luxury cruise through the Caribbean. The trip cost $26,500 and was expensed as promotion expenses. The shareholders explained that the reason for the trip was to explore the potential to establish a new travel related business by making contacts on certain Caribbean islands. The shareholders were unable to provide you the name of any contacts made. 15. Costs of Borrowing: The company paid $2,400 in finders fees to obtain a preferential rate of a line of credit offered by a wealthy local businessperson. Interest expense incurred for 2024 was $17,280. Of that amount $15,000 was simple interest and $2,280 was compound interest. On December 31, 2024 it was determined that of the unpaid interest $1,000 was compound interest which was only paid in January of 2025. All of the line of credit amounts drawn were used in the business. The company deducted $19,680 ($2,400 + $17,280) under general and administrative expenses. 16. Residential Property: In May of 2024 the company had a large cash surplus and no amount owing on its line of credit. It was decided to purchase two nearby residential properties to take advantage of the rapidly increasing real estate prices in that area. The two residential properties were sold in December 2024 for a profit of $38,000 on one property and a loss of $11,000 on the second