Vous êtes sur la page 1sur 21

251

Solutions to Chapter 15 Assignment Problems

CHAPTER 15

Corporate Distributions, Windings-Up, and Sales


Solution 1 (Basic)
Effect on Income
Investments: ACL 1/2 ($22,000 ($60,000 + $500))........................................................................
Land: TCG 1/2 ($200,000 ($40,000 + $10,000))............................................................................
Building: TCG 1/2 ($125,000 ($70,000 + $6,000))........................................................................
Building: recapture ($45,000 $70,000)............................................................................................
Equipment: recapture (($8,000 $400) nil).....................................................................................
Eligible capital property: goodwill and customer lists:
Proceeds (3/4 (60K + 35K))............................................................................... $ 71,250
Less: CEC balance...............................................................................................
16,000
$ 55,250
14,000
Previous CECA claims ((3/4 $40,000) $16,000).............................................
$

$ (19,250)
75,000
24,500
25,000
7,600

41,250

27,500
Income (2/3 $41,250).........................................................................................
Income (recapture of CECA)...............................................................................
14,000
Income effect......................................................................................................................................
Capital Dividend Account
Balance: January 1, 2011....................................................................................................................
Investments: 1/2 ($22,000 ($60,000 + $500)).................................................................................
Land: 1/2 ($200,000 ($40,000 + $10,000)......................................................................................
Building: 1/2 ($125,000 ($70,000 + $6,000)).................................................................................
Eligible capital property: goodwill and customer lists:
2
/3 $41,250
Balance: December 31, 2011..............................................................................................................

41,500
154,350

Nil
$ (19,250)
75,000
24,500
27,500
$

107,750

The above can be summarized in tabular form as follows:

AII
$ (19,250)
75,000
24,500

Untaxed
fraction of
net cap.
gains
$ (19,250)
75,000
24,500

Income effect
Asset
Investments.....
Land................
Building...........
Equipment.......
ECP.................

ABI
$ 25,000
7,600
41,500
$ 74,100

Capital
dividend
received

Capital dividend account


Untaxed
fraction of
Untaxed
net gain
life ins.
on ECP
proceeds

Capital
dividend
paid

$ 27,500
80,250

80,250

Nil

$ 27,500

Balance
$ (19,250)
75,000
24,500
27,500

Nil

Nil

$ 107,750

252

Introduction to Federal Income Taxation in Canada

Solution 2 (Advanced)

1988
1990
1992
1994
2002
2004
2006
2009
2011

Disposal of bonds: $10,000 capital gain 1/2....................................................................


Received capital dividend.................................................................................................
Disposal of shares: $4,000 capital loss 1/4......................................................................
Disposal of equipment: $6,000 capital gain 1/4...............................................................
Sale of shares: $20,000 capital gain 1/2...........................................................................
Life insurance: $100,000 $20,000..................................................................................
Capital dividends paid......................................................................................................
Sale of customer list: ($100,000 $40,000)* 1/2............................................................
Sale of shares: $37,500 capital gain 1/2...........................................................................
Account balance........................................................................................................
* CEC balance
Proceeds 3/4

Capital
dividend
account
$
5,000
5,000
(1,000)
1,500
10,000
80,000
(50,000)
30,000
18,750
$

99,250

25,000
75,000
(50,000)
5,000

Previous CECA claims ((3/4 $40,000) $25,000)


$
$

CDA (2/3 $45,000)

45,000
30,000

The above can be summarized in tabular form as follows:

Year
1988
1990
1992
1994
1998
2002
2004
2006
2009
2011

Asset
bonds.................

Untaxed
fraction of
net cap.
gains
$ 5,000

Capital
dividend
received

Capital
dividend
paid

5,000

(1,000)
1,500
Nil
10,000
$ 80,000
$ (50,000)
18,750
$ 34,250

Balance
5,000
5,000
(1,000)
1,500
Nil
10,000
80,000
(50,000)
30,000
18,750
$ 99,250
$

$
shares................
equip.................
land...................
shares................
life ins...............
dividend paid.....
cust. list.............
shares................

Capital dividend account


Untaxed
fraction of
Untaxed
net gain
life ins.
on ECP
proceeds

5,000

30,000

30,000

$ 80,000

$ (50,000)

The following amounts are not included in the capital dividend account:
(1) Recapture is not included in the capital dividend account.
(2) Since the 1998 gain on the vacant land was reassessed as income, it is not included in the capital
dividend account.

Solutions to Chapter 15 Assignment Problems

253

Solution 3 (Advanced)
(a) The transaction results in an immediate deemed dividend of $1,000 due to the fact that the PUC of the
preferred shares increased by $14,850 (135 shares $110), but the increase in the FMV of the assets was only
$13,850 (cash $11,050 and assets $2,800) [ssec. 84(1)]. Also, the ACB increases by $1,000 to $14,850.
(b) (i) The payment of $3,750 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 return
of the original capital injected by the shareholders. This payment will, however, reduce the
adjusted cost base to $12,250 ($16,000 $3,750) [spar. 53(2)(a)(ii)]. This reduction would result
in a higher capital gain upon ultimate disposition of the shares because $3,750 of the cost in the
shares has been recovered tax-free by this payment.
(ii) The payment of $8,750 will result in an immediate deemed dividend of $3,250 because the
payment of $8,750 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 ($8,750 $3,250).
(c) 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) (i) The contribution of the assets will not result in a deemed dividend as the increase in the PUC of
the preferred 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 not receive a deemed dividend, since there is no
difference between redemption value and 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)).

254

Introduction to Federal Income Taxation in Canada

Solution 4 (Basic)
Redemption Versus Sale of Chiu Ltd. Class B Shares
(a) Redemption
Redemption proceeds (100 shares $100)................................................
Less: PUC (100 shares $5).....................................................................

$ 10,000
500

Deemed dividend [ssec. 84(3)]..................................................................


Redemption proceeds................................................................................
Deemed Dividend [ssec. 84(3)].................................................................
Proceeds of disposition [sec. 54]...............................................................
Less adjusted cost base (100 shares $5)..................................................

$ 9,500
$ 10,000
9,500
500
500

Capital gain (loss).....................................................................................

Nil

Proceeds of disposition (100 shares $100).............................................


Less adjusted cost base (100 shares $5)..................................................

$ 10,000
500

Capital gain (loss).....................................................................................

$
$

(b) Sale

Taxable capital gain (1/2 $9,500).............................................................

9,500
4,750

Note the in both cases, the economic gain is $9,500. In the case of the redemption, it is taxed as a dividend,
and in the case of the sale, it is taxed as a capital gain.
Open Market Purchase of Bellco Ltd. Shares
Subsection 84(3), which is applicable on a redemption, acquisition or cancellation of shares by a corporation, does not apply if the shares were acquired by the corporation in the open market in the manner in which
shares would normally be purchased by any member of the public [par. 84(6)(b)]. Therefore, the following tax
consequences would result:
Proceeds if disposition (100 shares $4.10).........................................................
Less adjusted cost base (100 shares $1.25)........................................................

$ 410
125

Capital gain (loss).................................................................................................

$ 285

255

Solutions to Chapter 15 Assignment Problems

Solution 5 (Basic)
(A)
Actual or
deemed
proceeds
Opening balance.................................
Cash....................................................
Accounts receivable(1).........................
Inventory(2)..........................................
Land(3).................................................
Building(4)...........................................
Equipment(5)........................................
Marketable securities(6)........................
Goodwill(7)..........................................
Liabilities............................................
Income taxes(8)....................................
RDTOH(9)............................................

2,500
7,500
15,500
45,000
95,000
10,000
32,000
47,500
(54,000)
(32,325)
14,900
$ 183,575

Income generated
ABI
AII
Nil
Nil
Nil
Nil
$ (1,250)
Nil
(6,750)
Nil
Nil
$ 17,000
27,500
30,000
(12,000)
Nil
Nil
8,875
23,750
Nil
$

31,250

Capital
dividend
account
$
4,000

RDTOH
Nil

17,000
30,000
8,875
23,750

55,875

$
$
$

14,900
14,900

83,625

(B) Funds available for distribution..........................................................................................................


Less: Paid-up capital...........................................................................................................................
Deemed dividend [ssec. 84(2)]...........................................................................................................
Less: Capital dividend [ssec. 83(2)]....................................................................................................
Deemed taxable dividend....................................................................................................................

$ 183,575
(10,000)
$ 173,575
(83,625)
$ 89,950

(C) Proceeds..............................................................................................................................................
Less: Deemed dividend [sec. 54: def. of proceeds of disposition].......................................................
Adjusted proceeds of disposition........................................................................................................
Less: Adjusted cost base.....................................................................................................................
Capital gain (loss)...............................................................................................................................

$ 183,575
(173,575)
$ 10,000
(10,000)
$
Nil

(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 had 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.
The vendor, regardless of whether section 22 is used, must add to income the reserve for doubtful accounts.
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 $1,500 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 $2,750 would be a business loss
such that the net effect on income would be a $1,250 business loss.

256

Introduction to Federal Income Taxation in Canada

(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)...................................................................................................
Cost of inventory.....................................................................................................................

15,500
22,250
$ (6,750)

257

Solutions to Chapter 15 Assignment Problems

(3) Land
Taxable capital gain:
Proceeds..........................................................................................................................
Adjusted cost base...........................................................................................................
Gain................................................................................................................................
Taxable capital gain (1/2 of gain)......................................................................................
Capital dividend account (1/2 of gain)......................................................................................

$
$
$
$

45,000
11,000
34,000
17,000 (A)
17,000 (B)

(4) Building
Taxable capital gain:
Proceeds..........................................................................................................................
Capital cost (adjusted cost base)......................................................................................
Gain................................................................................................................................
Taxable capital gain (1/2 of gain)......................................................................................
Capital dividend account (1/2 of gain)......................................................................................
Active business income
Cost.................................................................................................................................
UCC................................................................................................................................
Recapture........................................................................................................................
Increase in value
P of D..............................................................................................................................
UCC................................................................................................................................
(A) + (B) + (C)........................................................................................................................

$
$
$
$
$
$
$
$

95,000
35,000
60,000
30,000 (A)
30,000 (B)
35,000
7,500
27,500 (C)
95,000
7,500
87,500

(5) Equipment
Proceeds..................................................................................................................................
UCC........................................................................................................................................
Terminal loss...........................................................................................................................

$
$

10,000
22,000
12,000

(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)......................................................................................

$
$
$
$

32,000
14,250
17,750
8,875
8,875

(b) Business income 2/3 3/4 of $47,500................................................................................

$
$

47,500
23,750

(c) Capital dividend account (2/3 3/4) $47,500..................................................................

23,750

26,075

(7)
(a) Unrecorded goodwill (given)..........................................................................................

(8) Income taxes


Investment income:
462/3% $55,875.............................................................................................................
Business income:
20% $31,250................................................................................................................
Tax payable.............................................................................................................................

6,250
$

32,325

14,900

(9) RDTOH
262/3% $55,875.....................................................................................................................

258

Introduction to Federal Income Taxation in Canada

Solution 6 (Advanced)
(A)
Actual or
deemed
proceeds
Opening balance.......................................
Cash..........................................................
Accounts receivable(1)...............................
Land(2).......................................................
Building(3).................................................
Equipment(4)..............................................
Shares(5).....................................................
Goodwill(6)................................................
Liabilities..................................................
Income taxes(7)..........................................
RDTOH(8)..................................................

10,000
18,000
150,000
320,000
3,000
26,000
120,000
(35,000)
(82,033)
37,533
$ 567,500

Income generated
ABI
AII
Nil
Nil
Nil
Nil
$
5,000 $ (6,000)
Nil
47,500
75,000
75,000
(9,000)
Nil
Nil
5,500
54,500
Nil
$ 125,500

Capital
dividend
account
$
8,000

RDTOH
5,000

(6,000)
47,500
75,000
5,500
35,000

$ 122,000

32,533
$ 37,533
$ 165,000

(B) Funds available for distribution to shareholders..................................................................................


Less: paid-up capital...........................................................................................................................
Deemed dividend on winding up [ssec. 84(2)]....................................................................................
Less: capital dividend elected [ssec. 83(2)].........................................................................................
Deemed taxable dividend (sufficient to clear RDTOH)......................................................................

$ 567,500
(20,000)
$ 547,500
(165,000)
$ 382,500

Taxable capital gain to shareholder:


Proceeds on winding-up..............................................................................................................
Less: deemed dividend................................................................................................................
Proceeds of disposition...............................................................................................................
Cost.............................................................................................................................................
Capital gain.................................................................................................................................

$ 567,500
(547,500)
$ 20,000
(20,000)
Nil(9)

(C) If the winding-up is not implemented immediately, the shareholder can defer the tax on the deemed taxable
dividend and the taxable capital gain that arise on the winding-up. The corporation could declare a dividend
and elect that it be paid from the capital dividend account of $165,000. This dividend would be tax-free to
the recipient shareholder. The corporation could also pay a taxable dividend sufficient to clear its RDTOH,
but that dividend would attract tax in the hands of the shareholders. It would also be possible for the
corporation to reduce and distribute its PUC to be received tax-free by the shareholders. None of these
transactions require a winding-up distribution.
The corporation would have income from a specified investment business. As such its total tax rate
would be about 20% after the dividend refund. If the shareholder had no other source of income, it would be
possible to distribute substantial amounts of dividends without attracting further tax in the hands of the
shareholder. (See Chapter 13.) However, the corporation would no longer be a small business corporation
and the availability of the QSBC capital gains deduction would be lost.
(D) The sale of assets of Chow Enterprises Ltd. would be subject to the general HST rules. An election may be
available [ETA: ssec. 167(1)]. Subsection 167(1) deals with the situation where a registrant sells or transfers
all or substantially all of the assets used in a commercial activity. If Chow Enterprises Ltd. engages in a
commercial activity, it would appear an election under subsection 167(1) can be made when the assets are
sold.
Subsection 167(1) also applies when a corporation is wound up and the rules of subsection 88(2) of the
Income Tax Act apply.

259

Solutions to Chapter 15 Assignment Problems

NOTES TO SOLUTION
(1) Inclusion of last years reserve (active business income)

5,000

Allowable capital loss ( $12,000) (investment income offset).......................

(6,000)

Income effect (assuming taxable capital gain to offset allowable capital loss).....

$
$

(1,000)
(6,000)

Proceeds of disposition........................................................................................
Cost.....................................................................................................................
Capital loss..........................................................................................................

18,000
(30,000)
$ (12,000)*

Capital dividend account ( $12,000)..............................................................

* The disposition does not qualify for 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.

(2) Taxable capital gain ( ($150K $55K)) (investment income)...............................................

47,500
47,500

Capital dividend account ( ($150K $55K)).........................................................................

(3) Proceeds on sale of building.......................................................................................................

UCC............................................................................................................................................
Gain: Sum of (A), (B), and (C) calculated below........................................................................
Recapture ($95K $170K) (active business income)..........................................
(A)
Capital gain:
Proceeds of disposition................................................................................ $ 320,000
Cost.............................................................................................................
(170,000)
Capital gain................................................................................................. $ 150,000
(B)
Taxable capital gain ( $150,000) (investment income)...................................

75,000

(C)

75,000

(4) Proceeds on sale of equipment....................................................................................................

Taxable capital gain ( ($26K $15K)) (investment income).................................................

$
$

3,000
(12,000)
(9,000)
26,000
(15,000)
11,000
5,500

Capital dividend account ( ($26K $15K))..........................................................................

5,500

$
$

54,500
35,000*

(7) Tax @ 20% on active business income (20% of $125,500).........................................................

Tax @ 46% on investment income (46% of $122,000).........................................................


Total tax......................................................................................................................................
RDTOH (26% of $122,000).....................................................................................................

$
$

25,100
56,933
82,033
32,533

Capital dividend account ( $150,000)............................................................

UCC............................................................................................................................................
Terminal loss (active business income offset).............................................................................

(5) Proceeds on sale of shares...........................................................................................................


Adjusted cost base......................................................................................................................
Full increase in value..................................................................................................................

(6) CEC balance


Proceeds .......................................................................................................

18,000
(90,000)

Previous CECA ( $50,000 $18,000)...........................................................

(72,000)
19,500

Balance................................................................................................................
Income: $52,500.........................................................................................
Recapture (above)................................................................................

$
$

52,500
35,000
19,500

CDA: $52,500..............................................................................................

320,000
(95,000)
$ 225,000
$
75,000

$
$

* Check: ($120,000 $50,000) = $35,000

(8) Assumes a minimum $112,599 (i.e., 3 $37,533) is to be distributed as a taxable dividend to produce a
refund to clear the RDTOH.

260

Introduction to Federal Income Taxation in Canada

(9) The capital gains deduction on qualified small business corporation shares would not apply, because the
shares would not meet the small business corporation test after the assets have been sold for cash.

261

Solutions to Chapter 15 Assignment Problems

Solution 7 (Advanced)
(A)
Proceeds
Opening balance...................................
Cash......................................................
$ 15,000
Accounts receivable(1)........................... 52,000
Inventory(2)............................................127,000
Land(3)...................................................150,000
Building(4)............................................. 97,000
Equipment(5).......................................... 6,000
Marketable securities(6).......................... 26,000
Eligible capital property(7).....................130,000
Liabilities..............................................(45,000)
Income taxes(8)......................................(43,736)
RDTOH................................................ 17,733
$ 531,997

ABI
$

AII
Nil

Nil

5,000
17,000
Nil
43,000
(4,000)
Nil
55,013

(4,000)
Nil
32,500
15,500

$ 116,013

Capital
dividend acct.
$ 12,000
(4,000)
32,500
15,500

Nil
Nil
$

RDTOH
6,000

43,773
11,733(9)
$ 17,733

44,000
$

99,773

(B) Funds available for distribution to shareholder................................................................................... $ 531,997


Less: paid-up capital...........................................................................................................................
(18,000)
Deemed dividend on winding up [ssec. 84(2)].................................................................................... $ 513,997
Less: capital dividend elected [ssec. 83(2)].........................................................................................
(99,773)
Deemed taxable dividend (sufficient to clear RDTOH)...................................................................... $ 414,224

(C) Taxable capital gain to shareholder:


Proceeds on winding-up...................................................................................................................... $ 531,997
Less: Deemed dividend....................................................................................................................... (513,997)
Proceeds of disposition....................................................................................................................... $ 18,000
Cost....................................................................................................................................................
(18,000)
Capital gain.........................................................................................................................................
Nil
Taxable capital gain............................................................................................................................
Nil

NOTES TO SOLUTION
(1) Accounts receivable:
Inclusion of last years reserve (active business income)....................................................................
Proceeds of disposition*.....................................................................................................................
Cost....................................................................................................................................................
Capital loss.........................................................................................................................................
Allowable capital loss (1/2 $8,000)...................................................................................................
Capital dividend account (1/2 $8,000)...............................................................................................

5,000
52,000
(60,000)
(8,000)
(4,000)
$ (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.

(2) Inventory:
Proceeds..............................................................................................................................................
Cost....................................................................................................................................................

$ 127,000
(110,000)
$ 17,000

(3) Land:
Proceeds of disposition.......................................................................................................................
Cost....................................................................................................................................................
Capital gain.........................................................................................................................................
Taxable capital gain............................................................................................................................
Capital dividend account (1/2 $65,000).............................................................................................

$ 150,000
(85,000)
$ 65,000
$ 32,500
$ 32,500

(4) Building:
Proceeds on sale of building...............................................................................................................
UCC....................................................................................................................................................
Gain....................................................................................................................................................

97,000
(23,000)
$ 74,000

262

Introduction to Federal Income Taxation in Canada

Recapture ($23,000 $66,000)...........................................................................................................


Proceeds of disposition...............................................................................................................
Less: capital cost.........................................................................................................................
Capital gain.................................................................................................................................
Taxable capital gain (1/2 $31,000)....................................................................................................
Capital dividend account (1/2 $31,000).............................................................................................
(5) Equipment:
UCC....................................................................................................................................................
Less: lower of cost or proceeds...........................................................................................................
Terminal loss.......................................................................................................................................
(6) Marketable securities:
Proceeds..............................................................................................................................................
Adjusted cost base..............................................................................................................................
Increase in value.................................................................................................................................
Taxable capital gain............................................................................................................................
Capital dividend account.....................................................................................................................
(7) CEC balance ............................................................................................................... $ 20,600
(97,500)
Proceeds 3/4...............................................................................................................
(76,900)
11,240
Previous CECA ((3/4 $42,453) $20,600) ...............................................................
Balance ....................................................................................................................... $ 65,660
Income: 2/3 $65,660 ............................................................................................... $ 43,773
Recapture (above) .......................................................................................
11,240
CDA: 2/3 $65,660......................................................................................................

$
$

43,000
97,000
(66,000)
$ 31,000
$ 15,500
$ 15,500
$

10,000
6,000
$ (4,000)
$

26,000
(26,000)
Nil
Nil
Nil

$ 55,013
$ 43,773*

* Check: 1/2 ($130,000 $42,453) = $43,773

(8) Tax @ 20% on active business income (20% of $116,013).........................................................


Tax @ 462/3% on investment income (462/3% of $44,000)...........................................................
Total tax.......................................................................................................................................
(9) RDTOH (262/3% of $44,000).......................................................................................................

$ 23,203
20,533
$ 43,736
$ 11,733

263

Solutions to Chapter 15 Assignment Problems

Solution 8 (Advanced)
(A) Corporations position
Proceeds for land and building ($700,000 $170,000) .............................................. $ 530,000
Cost ............................................................................................................................
(400,000)
Capital gain ................................................................................................................ $ 130,000
Taxable capital gain (1/2 $130,000)...........................................................................
Proceeds for goodwill 3/4 ($170,000 3/4) ............................................................... $ 127,500
(75,000)
Cumulative eligible capital balance ($100,000 3/4) ..................................................
Balance ....................................................................................................................... $
52,500
Income 2/3 $52,500...........................................................................................................................
Division B income and taxable income...............................................................................................
Tax (20% $35,000) + (462/3% $65,000)........................................................................................
Refundable portion of Part I tax on TCG............................................................................................
(262/3% of $65,000)
Capital dividend account:
Untaxed one-half of capital gain.................................................................................................
Untaxed CEC (1/2 ($170,000 $100,000))...............................................................................
Balance.......................................................................................................................................
Funds available for distribution:
Proceeds of sale of business........................................................................................................
Tax..............................................................................................................................................
Dividend refund (requires taxable dividend of $51,999).............................................................
Funds available...........................................................................................................................
Distribution by corporation:
Repay loan (no tax consequences)..............................................................................................
Redeem share (tax-free)..............................................................................................................
Elect capital dividend (tax-free) [ssec. 83(2)].............................................................................
Taxable dividend (sufficient for dividend refund).......................................................................
Total distribution.........................................................................................................................
(B) Shareholders position
Taxable dividend.................................................................................................................................
Gross-up (1/4 $80,000)......................................................................................................................
Increase in taxable income..................................................................................................................
Tax on taxable income increase:.........................................................................................................
Combined federal and provincial tax @ 46%..............................................................................
Less: combined dividend tax credit (2/3 $20,000 + 1/3 $20,000).............................................
Net tax on distribution from corporation
(C) Summary
Proceeds to corporation......................................................................................................................
Net tax paid by corporation ($37,333 $17,333) ....................................................... $
20,000
Net tax paid by shareholder ........................................................................................
26,000
Net retained by shareholder................................................................................................................

65,000

35,000
$ 100,000
$ 37,333
$

17,333

65,000
35,000
$ 100,000
$ 700,000
(37,333)
17,333
$ 680,000
$ 499,999
1
100,000
80,000
$ 680,000
$

80,000
20,000
$ 100,000
$

46,000
(20,000)
$ 26,000
$ 700,000
46,000
$ 654,000

264

Introduction to Federal Income Taxation in Canada

Solution 9 (Advanced)
(A)
Actual or
deemed
proceeds
Income during year/opening balances.............
Cash................................................................
Marketable securities(1)...................................
Inventory........................................................
Land(2).............................................................
Building(3).......................................................
Goodwill(4)......................................................
Bonus(5)...........................................................
Liabilities........................................................
Income taxes(6)................................................
RDTOH(7).......................................................

Income generated
ABI
AII
$ 50,000
Nil
Nil $ (2,000)
9,000
Nil
28,000
215,000
15,000
42,500
(16,500)

Capital
dividend
account
$ 48,000

23,000
54,000
(2,000)
50,000
210,000
28,000
440,000
15,000
85,000
42,500
(16,500)
(43,000)
(79,133) $ 300,000 $ 41,000
10,933
$ 734,300
$ 131,500
(B) Calculation of deemed taxable dividend on the winding-up:
Funds available for distribution........................................................................................................
Less: Paid-up capital...............................................................................................................
Deemed dividend [ssec. 84(2)].........................................................................................................
Less: Capital dividend elected [ssec. 83(2)]............................................................................
Deemed taxable dividend
(C) Calculation of taxable capital gain on winding-up:
Actual proceeds................................................................................................................................
Less: Deemed dividend [sec. 54 def. of proceeds of disposition]...........................................
Deemed proceeds of disposition.......................................................................................................
ACB..................................................................................................................................................
Capital gain.......................................................................................................................................
Taxable capital gain..........................................................................................................................
Net cash retained after sale of assets and winding-up:
Funds distributed..............................................................................................................................
Bonus................................................................................................................................................
Tax on incremental income:
Deemed taxable dividend.................................................................................. $ 482,800
Gross-up............................................................................................................
120,700
$ 603,500
Bonus................................................................................................................
16,500
Taxable capital gain...........................................................................................
Nil
$ 620,000
Combined taxes @ 46%.................................................................................... $ 285,200
120,700
Less: Combined dividend tax credit (13% + 6% $603,500)...................
Net cash retained...............................................................................................................................

RDTOH

$ 10,933
$ 10,933

734,300
(120,000)
$ 614,300
(131,500)
$ 482,800
$

734,300
(614,300)
$ 120,000
(120,000)
$
Nil
$
Nil
$

734,300
16,500

(164,500)
586,300

(D) Minimum share price acceptable:


The calculation of net retention can be represented algebraically as:
P .46 [ (P $120,000)], where P = proceeds of disposition
To equate the above expression with the net cash retained of $586,300 derived in Part (C), above, from the
sale of assets and the wind-up of the corporation, the following equation in one unknown results:
P .46 [ (P $120,000)] = $586,300
Solving for P, P = $725,584
Therefore, Ms. Debbie should require an offer of $725,584 for the shares, given the indicated fair market
value of the net assets.
Note that 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 .46 [ (P $120,000)] = $586,300

Solutions to Chapter 15 Assignment Problems

265

Solving for P,
P = $663,247
(E) Maximum share price acceptable to Lets-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 vendors 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 $1,800 (i.e., $9,000 .20) 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 $1,800
from the purchasers 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.
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 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.
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-NRB in this case is given by:

c d t 1 r / 2
d r 1 r
=

$440,000 .06 .20 1 .10 / 2


1 .10
.06 .10

= $31,500
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:

cdt
dr
=

$195,000 .04 .20


.04 .10

= $11,143
The incremental tax saved from CCA on the purchase of assets in present value terms is $20,357 (i.e.,
$31,500 $11,143).
On the purchase of goodwill at a fair market value of $85,000, the purchaser can add $63,750 (i.e., 3/4
$85,000) to its cumulative eligible capital account and it can amortize that amount at 7% on a declining balance
basis. The present value of the write-off is given by:

cdt
dr
$63,750 .07 .20
=
.07 .10
= $5,250

266

Introduction to Federal Income Taxation in Canada

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/CECA:
Building..................................................................................................... $
31,500
Goodwill....................................................................................................
5,250
After-tax cost of assets.....................................................................................................................

862,000

(36,750)
825,250

* 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.

Next, we need to determine what the purchaser would pay for the shares to have an after-tax cost of
$825,250. This calculation would be as follows:
Price of shares...........................................................................................................
Liabilities assumed...................................................................................................
Tax on income of $50,000
Tax savings:
PV of future CCA:
Building.....................................................................................................
Tax costs:
PV of tax on accrued gains:
Inventory...................................................................................................
After-tax cost of shares.............................................................................................

x=
43,000
10,000

(11,143)

1,800
825,250

781,593
43,000
10,000
(11,143)

1,800
825,250

This net cost of $781,593 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:
Purchasers after-tax cost:
Asset purchase............................................
Share purchase............................................
Vendors after-tax proceeds:
Asset sale....................................................
Share sale....................................................

Pre-tax
$ 862,000
$ 781,593

After-tax
$ 825,250
$ 825,250

Pre-tax
$ 862,000
$ 725,584

After-tax
$ 586,300
$ 586,300

This table can be further summarized as follows:


The maximum the purchaser will pay...............................................................
The minimum the vendor will accept................................................................

Assets
862,000
862,000

Shares
781,593
725,584

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 $725,584. To be better off on the purchase of the shares, the purchaser must pay
less than $781,593. In this case, therefore, there is a negotiation range for a transaction in shares between
$725,584 and $781,593.
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 $663,247 for the shares, to be indifferent between a sale of shares and a sale of
assets. In this case, the range for negotiation of a share price changes from a low of $663,247 to a high of
$733,593 (i.e., $781,593 $48,000, since the value of the shares and the net assets will decrease by the $48,000
distributed as a capital dividend).
However, it should be noted that there may be a bigger benefit to the vendor in selling the assets and holding
the net proceeds in the corporation to defer the tax on the distribution dividend. That tax amounts to about
$156,910 (i.e., $164,500 .46 $16,500).
NOTES TO SOLUTION
(1) Proceeds of disposition.............................................................................................................
ACB..........................................................................................................................................
Capital loss...............................................................................................................................
Allowable capital loss...............................................................................................................
Capital dividend account...........................................................................................................
(2) Proceeds of disposition.............................................................................................................

$
$
$
$
$

54,000
(58,000)
(4,000)
(2,000)
(2,000)
210,000

267

Solutions to Chapter 15 Assignment Problems

ACB..........................................................................................................................................
Capital gain...............................................................................................................................
Taxable capital gain ( $56,000)...........................................................................................
Capital dividend account...........................................................................................................
(3) Proceeds of disposition.............................................................................................................
Capital cost...............................................................................................................................
Capital gain...............................................................................................................................
Taxable capital gain..................................................................................................................
Capital dividend account...........................................................................................................
Recapture ($195,000 $410,000).............................................................................................

$
$
$
$
$
$
$
$

(154,000)
56,000
28,000
28,000
440,000
(410,000)
30,000
15,000
15,000
215,000

268

Introduction to Federal Income Taxation in Canada

(4)

/4 of proceeds = 3/4 $85,000...................................................................................................


Capital dividend account (2/3 $63,750)...................................................................................
Income (2/3 $63,750)..............................................................................................................
3

(5) The $500,000 business limit for the small business deduction ($300,000 of which was
allocated to Shining Limited) 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]. In this case, $16,500 of business income would be
taxed at the corporate rate given as 31% for this problem. Therefore, it is probably advisable
to declare and pay a bonus equal to $16,500 to avoid the double taxation that occurs when
integration is not perfect, particularly, if the winding-up will take place fairly soon, such that
there is little deferral advantage. Imperfect integration will continue if the corporate rate of
tax on high-rate business income exceeds 31%. The bonus will be taxable, directly, in the
hands of Ms. Debbie.
Note that as part of the payment of liabilities, the bonus will be paid to Ms. Debbie who will
pay personal tax on that bonus.
(6) Tax @ 20% of $300,000...........................................................................................................
Tax @ 462/3% (i.e., 40% + 62/3%) of $41,000............................................................................
Total Part I tax...........................................................................................................................
(7) Refundable portion of Part I tax for RDTOH (262/3% of $41,000)............................................

$
$
$

63,750
42,500
42,500

60,000
19,133
79,133
10,933

$
$

Solutions to Chapter 15 Assignment Problems

269

Advisory Case
Case 1: Palace Catering Ltd.
ADVISORY CASE DISCUSSION NOTES

Main issues:
Should Glenda

purchase the
shares
or
assets of the
corporation?
If she were to

purchase the
assets, should
she
incorporate a
new company
(presently or
in the future)?

Factors to be considered:

(1) If Glenda purchases the shares of the corporation, the non-capital loss carryforwards will continue to be
available to the corporation (against future profits) as the loss business is continuing to operate. However, as
she is forecasting continuing losses, there is a low risk that the carryforward losses could expire before they
are used.
(2) If Glenda acquires assets and operates the company as a proprietorship, the accumulated non-capital loss
carryover is lost. 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, the continuing operating losses (as projected) would be deductible from her other
sources of income. This way, there would at least be some tax recovery from the losses, whereas inside the
corporation, there is no income to deduct them from. Should the business prove to be profitable in the
future, she can always incorporate at that time.
(4) 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. In an asset purchase scenario, the same would be true, only it would be
terminal losses on equipment and on eligible capital property (goodwill), if any.
(5) Although a corporation provides limited liability in the event of a business failure, banks advancing loans
often require that shareholders sign personal guarantees. Considering Glendas lack of business experience,
she will most likely have to sign such a guarantee in order to obtain her 8% small business loan. The
corporate form of organization does not provide Glenda with limited liability in regard to the bank loan.
(6) 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.
(7) If the shares are acquired, what protection does she have from undisclosed liabilities or potential future tax
reassessments for potential wrongful past tax filings?
The more conservative approach would be to acquire assets and, then, if the business ultimately proves
profitable, incorporate.

270

Introduction to Federal Income Taxation in Canada

Case 2: Ottawa Associates Inc.


ADVISORY CASE DISCUSSION NOTES
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 46% tax, leaving $27,000 after tax.
Alternatively, the corporation could retain the income and pay tax at 29.5% (16.5% federal and
13% provincial) leaving about 70.5%, or $35,250, after tax.
The tax deferral is (46% 29.5%) $50,000 = $8,250.
If the funds are kept in the corporation, then the $35,250 could be paid out later as a dividend from
GRIP with personal tax of approximately 24% (after the 41% gross-up and tax credit) on this
dividend, leaving about $26,790 after tax.
If a bonus is not paid, then:
o corporate tax instalment options will be based on this higher tax liability;
o 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;
o some tax is deferred with a little double tax on payment of the dividend.
If a bonus is declared, then:
o Was there a valid liability at December 31?
o Is it reasonable?
o Will it be paid before 180 days after the year end?
o 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.
(c) Salaries to children
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.
He might consider purifying the company by paying out the 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 ACB, but since his ACB is $40,000
before the reduction this will only reduce his ACB to $20,000.

Solutions to Chapter 15 Assignment Problems

271

(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 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.
(c) Company Loan for the Cottage [IT-119R3]
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 investment.
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.
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).
Betty could be included in the ownership, but corporate attribution [ssec. 74.4(2)] needs to be
considered.
He can receive cash on the transfer equal to the ACB without triggering a deemed dividend under
section 84.1.