PROBLEM ONE
Carl owns 100% of the common shares of Extra Ltd., a Canadian-controlled private corporation operating a wholesale business in eastern Canada. Extra’s fiscal year end is May 31, 20X8. It is now April 15, 20X8, and Carl has just signed a letter of intent to sell the wholesale business to Q Ltd.
The initial discussions involved the sale of specific assets of Extra, but a sale of the shares of the company may also be considered. Carl has requested your assistance in estimating the tax liability to Extra if the business assets are sold. Information relating to the sale and to the current year’s operating income is provided below.
1.
The balance sheet of Extra at May 31, 20X8, is estimated as follows:
Accounts receivable Inventory, at cost
Land, at cost
Building, at book value Equipment, at book value Licence, at book value
Liabilities
Share capital Retained earnings
$
$ 500,000 1,000 539,000 $1,040,000
120,000 400,000 30,000 280,000 170,000 40,000 $1,040,000
2.
Net income before income tax and net gains from the sale of assets for the year ended May 31, 20X8, is estimated as follows:
Income from wholesale operations Dividend income
Net income before tax
The following additional information relates to the net income:
$490,000 1,000 $491,000
3.
The 20X7 income tax return indicates the following tax account balances:
RDTOH NIL Capital dividend account NIL
• •
The dividend income is eligible dividends received from a Canadian public corporation, the shares of which were sold during the year for proceeds equal to their original cost.
Expenses deducted from revenues included the following items:
Legal fees for collection of bad debts
Donations to registered charities
Meals and beverages to entertain customers Non-eligible dividend paid to Carl on March 31, 20X8 Replacing a broken window in the building
$ 2,000 3,000 4,000 20,000 2,400
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GRIP
Undepreciated capital cost
Class 1 Class 8 Class 14 Class 14.1
NIL
$290,000 140,000 42,000 0
4. The letter of intent regarding the sale of the business indicates that the closing date will be May 31, 20X8.The letter included the following list of assets to be sold, together with each asset’s estimated market value. For information, the original cost of each asset is provided in the chart below.
Market value
$
5. You have suggested to Carl that he consider selling the common shares of Extra, rather than the specific assets. You have estimated the market value of the shares to be $900,000.The shares were acquired in 20X1 for a cost of $100,000. In previous years, Carl had used the capital gains deduction to exempt $120,000 of gains from tax. His cumulative net investment loss (CNIL) at the end of 20X8 is estimated to be $40,000.
Required:
Under Part I of the Income Tax Act, determine the minimum income for tax purposes and the minimum taxable income for Extra for the 20X8 taxation year, assuming that all assets are sold.
Based on your answer to Requirement 1, calculate the minimum Part I and Part IV federal income tax for the 20X8 taxation year. Your answer should include a calculation of the RDTOH and dividend refund, if any. Assume the 20X8 taxation year began after 2018.
If an agreement is made to sell the assets of Extra, would you recommend the planned closing date of May 31, 20X8, or a delay of one day to June 1, 20X8? Explain.
Briefly outline what the purchaser should consider when choosing between the purchase of assets and the purchase of shares.
If Carl decides to sell the shares of Extra, what amount will be added to his net income for tax purposes in his 20X8 taxation year?
Cost
$ 120,000 400,000 30,000 320,000 200,000 50,000 0 $1,120,000 Payment for the above assets would consist of cash plus the assumption of Extra’s liabilities.
Accounts receivable Inventory
Land
Building
120,000 510,000 40,000 600,000 105,000 45,000 100,000 $1,520,000
Equipment Licence Goodwill
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Problem 2
Daniel and David Liu are the two sons of Matthew Liu, who is a Chartered Public Accountants (CPA) and an accounting professor. Both Daniel and David are also CPAs, but Daniel has significantly more experience in tax work than David does. Until 2018, the two brothers have worked separately. However, they have decided to work together, and they believe that this collaboration would produce synergies that would increase their aggregate income. Given this, as of January 1, 2018, they initiate the Liu and Liu Partnership.
The amount of entitled annual salaries are $60,000 and $40,000 for Daniel and David respectively. David will receive interest at 6 percent on his average capital balance for the year. All of these amounts were withdrawn from the partnership prior to December 31, 2018. Neither brother has Taxable Income that will be taxed federally at 33 percent in 2018.
The components of their partnership agreement dealing with income allocation are as follows:
Business Income
Capital Gains Dividends
After the allocation of priority amounts for salaries and interest on capital contributions, any remaining business income will be allocated 60 percent to Daniel and 40 percent to David.
As David has contributed the majority of capital to the partnership, he will be entitled to all capital gains that are recognized by the partnership.
Any dividends received by the partnership will be split equally between the two brothers.
For the year ending December 31, 2018, their GAAP based financial statements indicate that they had net business income of $630, 000. Other information related to this result is as follows:
Salaries to Daniel and David of $100,000 ($60,000 + $40,000) were deducted.
Interest on David's capital contribution of $4,000 was deducted.
Business meals of $18,000 were deducted.
Amortization expense of $31,500 was deducted.
Charitable contributions of $4,500 were deducted. Other Information:
For tax purposes, the brothers intend to deduct maximum CCA for 2018. This amount has been calculated to be $40,000.
The partnership has 2018 gains on the sale of shares held as temporary investments in the amount of $15,000.
The partnership receives $10,000 in eligible dividends during 2018.
The charitable contributions will be allocated equally between the two brothers.
Required:
Calculate the amounts of income from the partnership that would be included in the Net Income for Tax Purposes of each of the two brothers.
Indicate the amount of any federal tax credits that each of the two brothers would be entitled to as a result of allocations made by the partnership at December 31, 2018.
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